A premium of 25% on new-building prices is commercially viable for ECO ships

Overview

We have been heard a lot of debate and speculation regarding the commercial viability and attractiveness of ECO ships and fears of a two tier market reflecting ship energy efficiency. As a natural consequence of the obvious uncertainties and in an effort to address these, BIMCO has undertaken a review, the result of which is outlined below.
We have heard a lot of debate and speculation regarding the commercial viability and attractiveness of ECO ships and fears of a two tier market reflecting ship energy efficiency. As a natural consequence of the obvious uncertainties and in an effort to address these, BIMCO has undertaken a review, the result of which is outlined below.

Chief Shipping Analyst at BIMCO, Peter Sand, says: “Our calculations show that, should you choose to invest in an ECO MR2-tanker, you could pay up to 25% more for your vessel before settling for a non-ECO MR2-tanker”.

BIMCO has been looking at the basic economics of this development and can conclude that a fairly large premium can be paid on newbuildings to operate ECO ships instead of traditional ships.


The effect of fuel savings 
The calculations that are based on our assumptions (see below), disclose that a 15% saving on fuel potentially enables the owner of the ECO ship to charge extra up to the amount that is saved in fuel – which is USD 2,197 more per day than what a regular vessel can obtain. The extra income means that a ship owner can pay up to USD 8.31 million more for an ECO ship for the investment to be equally good or better off as compared to a standard tanker. That is a premium of 25%, when the standard vessel is priced at USD 33 million.
 
In the same way and based on the same fuel consumption and fuel prices assumptions, a ship owner can pay up to USD 5.5 million more for an ECO ship for every 10% of fuel savings – or 17% more when a standard vessel is priced at USD 33 million.

An obtainable premium to the market-given time charter rate (USD per day), where the charterer pays the fuel, is implied to be equal to an obtainable cost deduction on a market-given voyage charter rate (USD per tons) where the owner pays for the fuel.

The effect of fuel prices 
If bunker prices go up, the fuel-saving premium increases, making investments in ECO ships more viable. For each increase of USD 100 per tons in bunker prices the premium goes up by USD 338 per day, improving the net present value (NVP) of the investment by USD 1.3 million.

A change to the fuel price tends to affect time charter rates directly, but we fix the rate at USD 12,750 per day in the following calculation, which is the latest 1-year time charter rate for a 47-48k products tanker according to CRSL. If the bunker price stays at the current level of USD 651 per ton, the fuel saving premium will not be high enough to make investment in an ECO ship profitable for a ship owner; even the psychological barrier of USD 1,000 per ton will not make the investment sustainable with a negative net present value of USD 0.7 million. The bunker price has to exceed USD 1,060 per tons to make a new ECO ship an investment with a positive NPV, if the ECO ship is priced at USD 33 million. In other words, bunker prices would have to increase by two thirds, all things being equal, to make the investment viable under the circumstance of a fixed time charter rate and OPEX level going forward.

The general case
At the current 1 year time-charter rate of 12,750 USD/day, a standard vessel does not meet its cash break even rate, making the investment unprofitable with an NPV loss of USD 13.5 million – more than the initial equity outlay. Even if we were able to secure the ECO ship at a cost of USD 33 million, the investment will still be unprofitable, despite being able to charge a fuel saving premium of 2,197 USD on top of the time charter rate, making an NPV loss of USD 5.2 million.

The cash break even cost for a vessel priced at USD 33 million is USD 13,928 a day, covering the daily operating and financial expenses, but not a return to equity, which explains why the time charter rate plus the fuel saving premium is not enough to make the investment in an ECO ship profitable in the current environment. 

The effect of newbuilding prices
As stated above, the current time charter rates at a fixed level for the next 20 years are not high enough to sustain investments in new vessels at present newbuilding prices. Returning to the benchmark case of 15% fuel saving and time charter rates of 12,750 USD/day for a standard vessel, an ECO ship must not cost more than USD 27.8 million to be a profitable investment for a ship owner. Comparably, a standard vessel must cost as little as USD 19.5 million to be profitable in today’s market.
 
“The current newbuilding prices reflect some optimism in the shipping industry. Higher freight rates are expected to be part of the not too distant future. From our calculations, two results are striking; Firstly, newbuilding prices are not as closely related to the present market condition as they normally are, and secondly, ECO ships seem to be the best profitable choice for the future fleet” adds Peter Sand.

The effect of time charter rates
Instead of changing the newbuilding prices, we will now examine how high the time charter rates must go before the purchase becomes profitable. For a standard vessel priced at USD 33 million, time charter rates must be as high as USD 16,328 per day for the purchase to be sustainable – but rates have not been this high since mid-2009. If the ECO ship costs USD 33 million, the ship also needs to make USD 16,328 per day before the purchase is profitable; but a portion of the rate reflects the fuel-saving premium. By deducting the premium of USD 2,197 per day, we can compare the rate to the historical values observed by a standard vessel. This means that the base rate needs to be USD 16,328-2,197=14,131 per day before an ECO ship becomes a profitable investment. By looking at historical freight rates, this is achievable. The 10-year average for 2003-2012 is USD 19,214 per day for a 1-year TC for a 47,000-48,000 DWT products tanker. It should be noted that we have assumed that the whole advantage of the investment would go to the ship owner. 

The fundamental assumptions in the calculations
We are looking at the prospect of purchasing a standard MR2 product tanker from a shipyard at a price of USD 33 million. We also have the option of purchasing an ECO MR2 product tanker for an undisclosed higher price, which uses 15% less fuel, potentially allowing the owner to charge charterers with a fuel saving premium. As the charterer focuses on the total sum of charter costs and bunker costs, industry sources confirms that a premium to a standard vessel with a higher fuel consumption can be obtained.

Either purchase is financed by a 15-year annuity loan with an interest rate of 7%. The loan amounts to 60% of the purchase price, while the remaining 40% is financed by equity. The return on equity is set to 7%.
 
The fuel price is set to USD 651 per tons – the average of current bunker prices in Singapore and Rotterdam, the daily fuel consumption to 30 tons, and the annual transit rate is set to 75%. The transit rate indicates the share of days that the vessel is using fuel, which is a crucial factor to determine the economic viability of an ECO ship. 

The operating expenses are fixed at USD 7,600 per day. OPEX is set to be flat for the lifetime of the vessel, to make the conclusions more straightforward to comprehend. By assuming constant time charter rates, we keep both key revenue and key expenditure numbers fixed in all calculations. You can modify the fundamentals yourself by using the dynamic members only spread sheet, which is available by request. The number of operating days is assumed to be 353 (1 day off-hire every month).
 
The vessel is assumed to be sold for scrapping after 20 years for a price of USD 3.8 million, regardless of the type.
 
For further simplicity we have not taken into account the effect of trading in ECAs. But intuitively, if low sulphur fuel is used in ECAs, the fuel costs will rise, resulting in the same conclusions as if fuel prices go up.

Final remarks
In the near future, BIMCO will publish an article covering the implications of the use of ECO ships based on the development regarding future fuel regulation, with the coming stricter sulphur limits coming into force in 2015.

The spread sheet, including all the calculations and assumptions, is available for members who would like to do their own calculation on what to do in the future. Please contact ps@bimco.org for more information. 

in Copenhagen, DK
 

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