Category Archives: Transport

Baltic Dry Index – the forgotten indicator

A lot of attention has been paid to the drop in oil prices to $28 per barrel as of today which is indicative of the increase in supply from US shale producers and the fall in global demand especially from China. However there is another indicator that shows the global economy is in pause mode and that is the Baltic Dry Index which measures the cost of shipping raw materials – iron ore, coal, metal etc.

In mid January this year the index fell below 400 (see graph) for the first time since records began in1985. In June 2015 the index was comfortably above the 1000 mark and in 2010 approximately 4000, therefore transport costs are at a very low level.

Why are shipping costs at such low levels?

It comes down to simple supply and demand. On the supply side shipping companies have increased their dry bulk capacity as the cost of borrowing money is at very low levels. On the demand side it was assumed that global trade would keep expanding but according to a World Bank report global trade has slowed down sharply in recent years to around 3% and it predicted to slow further.

Cost for ship owners

Owners of the largest container ships (known as capsize vessels) reckon it costs $8,000 per day for running costs. However in today’s market, users of these ships only pay around $5,000 in fees which makes it uneconomical for ship owners to offer their service. With this is mind shipping bankruptcies are bound to feature this year and unless China produces a new growth spurt the Baltic Dry Index will keep heading south.

Baltic Dry Index – Jan 2009- Jan 2016

Baltic Dry Index

Elasticity of Demand for Air Travel

At the most basic level, demand for air travel is stimulated by economic activity and economic and social linkages between countries and cities. Travel is also stimulated by economic linkages (i.e. international trade) and social linkages (i.e. international migration). In general, there will be greater demand for travel between countries that have larger economies and populations. In addition, destination attractiveness is a key driver of demand for leisure travel.
There are many other factors that affect demand for air travel. When the economy grows, greater economic activity stimulates business travel and leisure travel increases as people’s income increases.

  • Demand is stimulated by lower prices, both airfares and the price of tourism expenditure (e.g. accommodation and food) ‘on the ground’ at a destination.
  • Demand for travel to any particular destination also depends on the price of travel to alternative destinations. Other factors that affect demand include distance, safety, and other one-off events such as health and terrorism scares.

The concept of elasticity is very useful for understanding demand drivers. Elasticity measures the responsiveness of demand for air travel to changes in some other variable such as prices or income. A price elasticity of -0.5, for example, means that a 10% increase in price leads to a 5% reduction in the level of demand for travel. Or an income elasticity of 1.2, for example, means that a 10% increase in income leads to a 12% increase in the level of demand for travel.

Many studies have attempted to estimate various demand elasticities for air travel. In terms of price and income elasticities, a meta-study by Gillen et al (2008) summarised 254 different estimates from 21 published studies and found an overall median price elasticity of -1.1, indicating that demand for air travel is relatively sensitive to price changes.

As would be expected, the results also indicate that travel for business purposes is less price sensitive than travel for leisure purposes with business short/medium hail elasticities between -0.8 and -0.6 and long haul elasticities between -0.5 and -0.2, compared to -1.5 to -0.9 for short/medium haul and -1.7 to -0.5 for long haul leisure travel. Gillen et al also report a median income elasticity of 1.4, suggesting that demand for air travel is relatively sensitive to changes in income. The table below represents the median for each market segment – Source: Air Travel Demand Elasticities: Concepts, Issues and Measurement.

PED Air TravelGiven that someone has decided to travel, their choice of airline and airport, when such a choice exists, depends on a number of micro-level factors including purpose of travel, ease of access to the airport, flight frequency, expected delays, and departure/arrival times (Ishii et al, 2009). Thus the demand faced by a particular airline depends on macroeconomic factors as well as other factors more directly under its control.

Source: The New Zealand Aviation Operational Environment: A Guide for the Tourism Sector 2010

Quirky Economic Indicator – length of a ladder

Listening to “From Our Own Correspondent” on the BBC World Service I came across an interesting piece by Kate Adie on Global Trade. With the downturn in global trade the international transport industry has been very much affected. Those that have been associated with the distribution of goods get an early indication of the slowdown in global growth. The obvious indicators are: idle cranes, queues of merchant ships dwindle etc. But what about the speed of cargo ships and the length of ladders to climb aboard?

When the world economy was “steaming” ahead the captain of a merchant ship said that they cruised at 20 knots but when the economic crisis of 2008 arrived we slowed to 16 knots. A harbour pilot summed up the state of world trade by the length of the ladders that he climbs on the sides of ships.

A long climb up the ladder signifies that the ship is high in the water and exports are correspondingly low.

A short climb up the ladder signifies that the ship is low in the water and exports are correspondingly high.

The seafarers say that they take air to China before they load up with goods for the US.

Petrol Tax in New Zealand

The New Zealand Parliamentary Library “Monthly Economic Review” published a feature on taxes and levies on petrol.

Taxes and levies on a litre of petrol in New Zealand account for approximately 43 percent of the overall price.

July 2014 – Retail price = 223.9 cents per litre

A forecast $1,702 million is expected to be raised through the excise duty on petroleum in the year ended June 2015. This includes:

– $936 million in petroleum excise duty on domestic production
– $766 million on petroleum imports.

The following diagram shows the taxes and levies on a litre of petrol (including GST).

Petrol Tax NZ

Holiday reading – “Deep Sea and Foreign Going”

Deep Sea bookDeep Sea and Foreign Going is an account of a 5 week trip from Felixstowe in the UK to Singpaore. Rose George explains how on a train journey that most items of clothing, electronics, food etc are brought to the UK by ship. The reason being that shipping has become so cheap that it makes sense to import items. She uses the example of cod – it is less costly for Scottish cod to be sent to China to be filleted and then exported back to UK restaurants than it is to pay the (small) salaries of Scottish filleters. Some interesting facts from the review of the book in the Guardian Weekly:

* Containers are the largest man-made moving objects on the planet;
* Triple-E class boats are around 400 metres in length and can carry 18,000 boxes;
* In 2011, 360 commercial ports in America took in international goods worth $1.73tn – 80 times the total value of all US trade in 1960;
* Even in the UK, whose sense of itself as a seafaring nation has long waned, the shipping industry employs nearly 635,000 people;
* Port authorities inspect less than 10% of boxes, making them of great interest to counterfeiters and drug barons.

How big can container ships get?

BBC business correspondent Alastair Fee boards a Chinese container ship off the coast of England and reports on the enormous size of it – holds 13,500 containers. And they are getter bigger. More than 40% of the UK’s sea trade comes into the Southampton Dock and to meet increasing demand from container ships a new 500 metre birth is being dredged. However trade goes the other way as in 2012 the demand for cars from the growing Chinese middle class saw over 20,000 BMW Minis make their way to Chinese ports.

US infrastructure could create those jobs

US InfrastructureSome alarming figures have been banded about with regard to America’s infrastructure. It is estimated that over 700,000 bridges are rated as structurally deficient. In 2009 Americans lost approximately $78 billion to traffic delays – inefficient use of time and petrol costs. Also crashes which to a large extent have been caused by road conditions, cost a further $230 billion.

According to the American Society of Civil Engineers the US needs to spend $2.2 trillion bring their infrastructure up to standard. The Congressional Budget Office estimated in 2011 that for every dollar the federal government spent on infrastructure the multiplier effect was up to 2.5. Other indicators state that every $1 billion spent on infrastructure creates 18,000 jobs, almost 30% more than if the same amount were used to cut personal income taxes. – The Economist

Positive Externalities from infrastructure.

Investment in infrastructure has a lot of positive externalities – faster traveling time for consumers and companies, spending less time on maintenance. Research has shown that the completion of a road led to an increase in economic activity between 3 and 8 times bigger than it initial outlay with eight years after its completion. But what must be considered is that now is the best time to invest in infrastructure as it is very cheap – much cheaper than it will be when the economy is going through a boom period.

AS – Supply and Demand – Oil refineries stumble on hard times

Although oil producing nations might not like the recent troughs in oil prices, refineries in Europe are experiencing good times even with petrol and diesel prices being relatively high.

According to The Economist refining hasn’t been the most profitable business as overcapacity has dogged the industry. Oil companies had assumed that the world demand for petrol would continue to expand rapidly and built refineries to cope with the this added pressure. However with oil demand peaking this led to an over-supply in the market. Furthermore in the developing world new and more efficient refineries have added to the problem and this had led to some changes in the market players this year.

* Petroplus (Swiss refinery) went out of business
* Shell bought a former Petroplus plant in London and downgraded it to a storage facility.
* Sunoco biggest refinery in north-eastern US is in trouble financially
* Refineries in Pennsylvania and the Virgin Islands have ceased production

Demand for petrol is falling in both the US and Europe as:

* People are driving less
* People are switching to more fuel-efficient cars – especially diesel. This has caused some concerns as Europe’s refineries cannot easily switch to producing more diesel.

Oil Prices 2012

The chart below from the Sustainability Blog shows the oil production has reached an effective cap at around 75 million barrels of regular crude per day.  Production over the past six years has increased little despite continued upward oil prices. This they argue has occurred as the oil industry passed a transition point and moved from an elastic supply curve to an inelastic supply curve.

While global oil demand remains relatively weak today, with the International Energy Agency predicting global oil demand growth in 2012 of around 1.1 million barrels per day, that inelastic supply curve could yet push oil prices back up to record levels which in turn will increase costs for the refining industry.

Airbus + China + ETS = Prisoner’s Dilemma

Last week saw Chinese officials indicating that Chinese airlines will not buy European airplanes as long as the EU insists on including foreign airlines in its emission trading system. Orders of 35 Airbus A330 planes have been cancelled and another 10 A380’s were in danger of being cancelled because of the ETS. The Chinese argument is that it is not reasonable to charge Chinese airlines taxes at the same time that the plane is made in Europe. China currently buys more than 1 in 5 Airbus planes being produced and the total of Chinese orders amounts to US$9bn. Therefore one could say that the future of Airbus hinges on the ETS. This raises the question of climate change and what are the options that countries face.

Climate Change as Prisoner’s Dilemma
The initial impression from the discussions over climate change is that of a typical Prisoner’s Dilemma and some of the data provided in the Stern Review (2006) can be used to populate the payoff table.

–The cost of tackling climate change is approximately 1% of annual per capita GDP. However, if nothing is done about the issue the cost is estimated to be between 5% to 20% of GDP. So that defines what happens at the extreme of cooperative or non-cooperative behaviour. From the table above, a country that refuses to act, whilst the other cooperates, will experience a free-rider benefit – enjoying the advantage of limited climate change without the cost. On the flip side, any country that imposes limits, when its competitors do not, incurs not just the cost of limiting its own emissions, but also a further cost in terms of reduced competitiveness – estimated here at an additional 3.0%. From the table it seems predictable that countries should prefer to be self-interested: the best national policy, if others reduce emissions, is to defect; likewise, if other countries are not taking action, then it is pointless to be the only sucker to take action, and one should again defect.

Repeated Prisoner’s Dilemma and Cooperation
The dynamics of the prisoner’s dilemma do change if participants know that they will be playing the game more than once. In 1984 an American political scientist at the University of Michigan, Robert Axelrod, argued that if you play the game repeatedly you are likely to see emerging is cooperative rather than defective actions. He identified four elements to a successful strategy which is this case can be applied to climate negotiations:

1. Be Nice – sign up to unilateral cuts in emissions, as deep as your economy and financing capacity allows.

2. Be Retaliatory – single out countries that have not commenced action and, in collaboration, find ways of pressurising them until they do so.

3. Be Forgiving– when non-compliant countries come onboard give them generous applause; signal that good behaviour will be rewarded with even deeper cuts in your own emissions.

4. Be Clear
– let everyone know in advance exactly how you are going to behave – that you will work with them if they take action on emissions, and that you will retaliate if they do not.

It is the belief of Michael Liebreich that this research by Axelrod should be put into practice by the world’s climate negotiators. As treaties on climate change are on-going and therefore become part of the game.

Economies of Scale – Sending a T Shirt from China to Europe for 2.5 cents.

The Economist had interesting piece on the economics of very big ships. If you wanted a good example of economies of scale look no further than sending a T shirt from China to Europe – 2.5cents is the cost. What allows it to be so cheap is the enormous scale of the new container ships that are now being produced – mainly in South Korea.

Maersk container ships transport a considerable percent of the world’s ocean freight and they have a fleet of over 500 container ships that sail every major trade lane. The big ships are 400m long and the ship can carry 7,500 40ft containers each of which can hold 70,000 T shirts – that makes a total of 525,000,000 T Shirts per container ship. Furthermore it only takes 3 weeks for the T shirts to arrive in Europe and the combination of the largest combustion engine ever built and a minimum crew of 13 personel to run the ship leads to signifiacnt economies of scale (see graph below – Point A being the lowest point on the long-run average cost curve LAC).

Given the rising price of fuel many companies feel they need bigger ships to improve efficiency and ultimately improve their margins. Maersk are looking to increase the size of container ship so that it can hold 18,000 x 20ft units. Freight rates have dropped significantly over the last year with the downturn in global demand and the oversupply of container ships in the market – the main players are:

Maersk – Neptune – K Line – Orient Overseas

According to The Economist shippers will seek economies of scale not only from bigger ships but also from mergers.