When Economies of Scale fail

Oversized shipping in the 21st Century:

So as a relative neophyte in the world of Maritime studies I thought I might share some of my recently imparted observations and knowledge to those with even less experience and in particular what I want to share is what “Too big to fail” means in the shipping world.

You see, when we say “Too big to fail” in the context of banks, what we really mean is “The cost of them collapsing is more expensive than the cost of us rescuing them”. In shipping “Too big to fail” really means “If this happens we are so f***ed”.

Two particular cases in point for this are as follows: The Costa Concordia and the Emma Maersk:

The Costa Concordia:

The Titanic may have had the great romance and mythical status that no other Cruise ship has had, but the honour for the most expensive mistake (financially just to clarify) is without question the Costa Concordia. Firstly the vessel itself is a right off or in Insurance terms “A Total Loss”. Secondly you have compensation claims to the families of the 30 individuals who tragically died and lastly you have the cost of cleaning the whole thing up.

Currently it is estimated that if the latest salvage attempt works and then compensation is paid out in the manner that is currently anticipated, then the total direct cost to the Protection and Indemnity clubs (Shipowners mutual Insurance Companies), will be just shy of $2 billion. If…….

The salvage of the Costa Concordia is the most ambitious Salvage attempt ever made of a vessel that size. To understand the scale of this project look no further than the description from the salvors of what they plan to do:

  • The vessel will have an entire underwater support structure built onto the seabed with cables attached from the Costa all along the support structure underwater.
  • The vessel will then be pulled upright onto this structure with float supports on either side to prevent the vessel from tilting.
  • Once on the platform the vessel will then have all the damage to its hull re-welded by teams of underwater divers and when that is finished, they water will be pumped from the vessel.

If all those stages go to plan, the vessel will then be floated into port on the Italian mainland and broken up. Oh and this will take two years. Cost $400 million. And they have one attempt. One. If it doesn’t work, they start again…..

Then there is the implications for Insurance as a whole. The world’s largest Insurance programme for the Non-Energy, Marine sector had its toughest renegotiation and renewal in memory for many brokers and the insurance companies have increased their fee’s for this year between 5-15%. This not only hits the bottom line of cruise companies and their affordability but it also has ramifications for the design and training of all new cruise vessels potentially costing millions more.

The Emma Maersk:

For some photos of the vessel check out this site (having technical issues with putting them in this post) http://www.emma-maersk.com/photo/gallery/

The Emma Maersk is the latest addition to the Danish giant’s arsenal and can carry an estimated 13,000 Teu (twenty foot unit equivalent containers). It is currently the largest container vessel in existence but will be surpassed in the next 3-4 years by the Maersk C-Class vessels which are planned to be capable of carrying 18,000 Teu.

So what’s the problem with this? Where do we even start!

Lets start with the vessel herself. In less than 1 full year of service the vessel has had numerous engineering faults and structural failures, most spectacular of which (and chronically under-reported!), was the fact that the Emma Maersk was towed into port in Panama (not the canal) with 9 metres of sea water in her engine room. Yes that’s righ, 9 METRES!.

Now in this case the vessel is safely in port and undergoing repairs but lets imagine for a moment that either of those two alternative (and highly plausible scenarios) had occurred:

  1. The sea water had caused the vessel to list (Marine term for tilt), to either side.
  2. The vessel had lost power while taking on water in the middle of a major waterway: i.e. the Malacca straits, the straights of Gibraltar or the English channel.

In scenario 1 we have a serious problem. The modern design of containerships is that their structure allows cranes in a port terminal to easily access and remove the containers, which are neatly stacked, at a highly efficient level. For this to work effectively however the vessel has to be balanced for the cranes to work. Now when the vessel is tilted the containers have to be removed manually, a process that can be as slow as 6 per hour. On a vessel with 13,000 containers that is a problem. Not only may any perishable goods be long gone before they are emptied, but the cost in man hours to extract all those containers would also be staggering.

Next let’s look at scenario 2. Under old international laws a vessel did not have to be recovered provided that it did not sink in an international waterway and therefore provide a danger to other vessels on that route. That law has now (or imminently will have) changed and exempting a vessel sinking in the middle of the Atlantic or Pacific it will have to be recovered from the sea (or the company will have to prove it is technically impossible to do so).

The problem of course in this is scale. We mentioned the cost and technical difficulties of removing the Costa Concordia in relatively shallow water, where at least 40% of the vessel was out of the water and there were no container units. Conceptually even trying to guage the cost in environmental damage, loss of goods, increased Insurance premiums, delays in trade, etc, etc of a “Emma Maersk”-esque vessel sinking in a key strategic waterway is an example of how these vessels have become “Too big to fail”.

The most ridiculous thing however in my personal perception is that vessels of the scale we are seeing under construction, The Emma Maersk to name just one, are actually the final nail in the coffin of many players in the shipping industry. The shipping industry is currently experiencing one of its toughest periods in memory, with former ship-finance banking giants like Commerzbank leaving the industry entirely (though still with huge loans on its books). The key problem of course being an oversupply of vessels and insufficient demand, which as every Business Studies and Economics student can tell you: When supply outstrips demand, prices will fall and fall they have.

Whether its OSX (World’s 6th largest fleet), filing for chapter 6 in the USA or the comments by Maersk’s CEO that they will scale back their shipping services due to poor returns, the industry is in the doldrums over this supply side problem. And its about to get worse. Even if older, smaller vessels are scaled out (which is already happening) you then have accessibility problems. Few ports can handle these vessels currently and to do so requires significant (if not cost-inefficient) investment.

Concluding Comments:

The old cliché that size matters still holds significant weight in the Maritime world, as long as the cost-per-unit declines or cost per passenger declines, then the “Economies of Scale” will seem irresistible. The concerns of course are also enormous but the problem is people are only beginning to realise this now.

Gordon Geco is often cited for his phrase “Greed is Good”, but perhaps on this particular scenario businesses in the maritime sector should consider more the implications of an RDS (Realistic Disaster Scenario) actually occurring, rather than focusing on the “Cost per unit” side.


One thought on “When Economies of Scale fail

  1. Robert Jarman

    Dear Christopher,

    Thanks for this, and I hope to see you again soon; meanwhile please wish your Father a very Happy Birthday from Chrissy and me; I remember his 30th, 40th, and 50th birthdays with great fondness, and hope to celebrate with him again someday soon



    Robert Jarman

    The VintageMagazineCompany

    Click on the link below to subscibe to The Vintage Magazine

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