Many theories we rely on in shipping carry contradictions, as Pierre Aury explains.
What do ordering an ice class vessel or a VLCC, using the Black Scholes model or deploying intermittent renewable energies have in common? This is, hopefully, what we will find out in this column.
Before ordering a vessel a lot of potential buyers are going to great lengths to try to assess as accurately as possible the demand for that vessel over her life or at least over the duration of the repayment of the loan. This implies making calls on the overall economic situation, patterns of trades while at the same time trying to gauge the likely evolution of the fleet among other things. Strange though that, if that vessel happens to be an ice class one, the fact that there will be ice or not in 10 years from now is implicitly accepted with no question asked. No owner is commissioning a study on that rather important subject. Granted weather forecasters can’t get the weather right for the next day so how could they get it right predicting if there will be ice or not in the Baltic in 10 years from now. Mind you a saying goes that economists exist to make the weathermen look good”which doesn’t prevent would be owners from listening and trusting economists when they issue their forecasts. The ordering of a VLCC is based as well on an implicit assumption which is that there will be a seaborne crude oil trade in the future. Some have made an explicit call about it like John Fredriksen who said mid-2022: “I know we are facing a transition to more sustainable growth, but this will take time.”
So his bet is to stay in tankers having made a call that oil will be carried on ships for many years to come. And he is probably right as the more intermittent renewable power we put on the grid with no commensurate long duration energy storage (LDES see below) facilities the more oil and gas we will need to operate small power plants to supply the grid when the sun and/or the wind are not available. The history of new technologies would suggest as well that he will be right. For instance, while the first large seagoing diesel-powered vessel was built in 1911, the last commercial sailing boat stopped trading in the mid-1950s.
Moving now from the physical world to the derivatives world a few words on the Black Scholes model that is used by more or less everybody in finance/trading including in shipping to value options. Most people using this model on a daily basis however are not aware of the implicit assumptions underpinning the model, otherwise they would not be using it. One of the assumptions is that the market in which the model is used is perfectly liquid i.e. that one can transact at any given time which of course is not the case in the shipping market which is not a continuous market but a discrete one. Another assumption is that the underlaying market is ‘efficient’, efficient meaning that the market prices at any given moment reflect all the available information which of course is not the case for many markets especially for the shipping markets. In fact one feature of shipping markets is the huge asymmetry of information with a few big market participants having access to a wealth of information while the others have information crumbs to feed on. The model requires as well that interest rates are constant until the option’s maturity, which of course is not true. True though some assumptions are actually met, at least in shipping as the model is designed to value European style options only, which is the case for options traded in the FFA market. Clearly most of the assumptions made while building the model are not met in real life. This is the same for most of the economic theories which assume implicitly that all market participants are, among other things, all equally clever and all making rational decisions having all relevant information at their disposal. The guys who came up with these assumptions to underpin their theories have obviously never set a foot on a trading floor.
To end this column let us visit the ever present topic of decarbonisation and then within that context the topic of deploying intermittent renewable energies. The world has embarked on the long and tortuous journey to transition away from a carbon-based economy. The implicit assumption there is that it is not too late to do so. And it is rather important to be right on that implicit assumption because if we are not we might be spending money, and a lot of it, to avoid a disaster when we should be spending that money to cope with the consequences of the disaster. At a more granular level and if we assume that indeed it is useful to decarbonise our economy the call has been made that solar panels and wind turbines are the best way forward. Accordingly the installed capacity keeps on increasing all over the world with predictions in countries like the US that intermittent renewable energies will cover up to 80% of the demand by 2030. The implied assumption there is a that a massive LDES network will be developed at the same time across the world to cope with periods with no sun light (night and cloudy weather) and/or no or too much wind. Today still in the US the LDES capacity is less than 1% of the overall demand. Failing to have enough LDES capacity while still ramping up the installation of solar panels and wind turbines will only result in the increase of the number of small diesel and/or gas fired power plants which are the only type of power plants that can replace near instantly the production losses in case the wind dies or clouds are hiding the sun. Good news for tanker owners but bad news for the environment.
Beware of implicit assumptions!
