In the midst of March’s fierce winds in Tokyo, a Japanese shipping operator discussed the volatile state of the dry bulk shipping industry. With a backdrop of economic uncertainty and the lingering effects of the 2008 financial crisis, the focus was on the challenges and potential shifts in fleet management strategies among Japanese shipping companies.
（Text by Hirofumi Yamamoto, Image picture is created by Hirofumi Yamamoto)
The Shadow of Long-term Charter Risks
Since the Lehman Brothers’ collapse in late August 2008, the shipping market experienced a significant downturn. Japanese operators, who had locked in high-rate time charter contracts, found themselves struggling with charter hire debts for almost a decade. A shipping executive shared, “In reality, high-rate capesize time charter contracts that were entered into before the crisis only concluded in 2024. The dry market, which plummeted during the Lehman shock, saw a temporary rise between 2011 and 2012. It was during this period that Japanese shipowners and capesizes, under a 10-year charter agreement, finally reached the end of their contract term in 2024.”
During this time, some Japanese operators continued to pay shipowners charter rates significantly higher than the actual market rates for capesizes, around “$10,000 per day,” according to the aforementioned executive. Ideally, with the expiration of the 10-year contracts, operators could renegotiate charter agreements at lower rates, thus operating ships more cost-effectively.
However, there have been few instances where Japanese operators have chosen this route. One major reason is the prevalence of purchase options (POs) in capesize charter contracts between Japanese operators and shipowners, a relatively rare arrangement in these partnerships.
This insight reflects a critical juncture for Japanese shipping operators, as they navigate the delicate balance between managing long-term charter risks and adapting to a dynamic global shipping market. With the red flags raised over asset-light strategies, the industry is prompted to reconsider its approach to chartering practices and fleet composition, potentially marking a new chapter in Japanese maritime operations.
Industry insiders often discuss the nuanced world of shipping contracts, highlighting a particular aspect known as Purchase Options (POs) and how they influence the delicate balance of power between ship operators and owners. According to a trading company source, “Generally, POs are seen as more advantageous to operators and less so to shipowners. In the case of international operators, Japanese shipowners engaging in Bareboat Charter (BBC) agreements or Sale and Leaseback (S&LB) arrangements often find POs attached to these contracts. This essentially gives operators the option, but not the obligation, to purchase the vessel at the end of the contract if the dry bulk market—or the secondhand ship market—has appreciated. Conversely, if the market has softened, they can simply return the ship to the owner. The critical element here is that the operator holds the decision-making power through the PO,” explains a member from the shipping department.
The inclusion of POs in charter contracts between Japanese operators and shipowners around 2011-2012 raises questions. Even back then, there was an awareness that POs tended to tilt the scales in favor of operators.
A shipping broker offers further insights, “Perhaps neither party placed significant emphasis on the inclusion of POs. Unlike the current situation where the dry bulk market is on an uptrend, and with the yen trading at around 150 to the dollar, such a scenario was beyond anyone’s expectations at the time. For operators, it represented a once-in-a-lifetime opportunity.”
These reflections shed light on the strategic considerations behind POs in shipping contracts, illustrating how market conditions and currency exchange rates can dramatically alter the attractiveness of these options for both operators and shipowners.
In the shifting sands of the shipping industry, Japanese operators are reevaluating their strategies, particularly regarding the duration of charter contracts for their dry bulk ventures. An official responsible for tramp shipping notes a pervasive skepticism towards long-term charters, deemed by some as inherently risky. This caution stems from a desire to align cargo contracts with charter periods precisely, theoretically mitigating financial losses. However, this strategy, dubbed “asset-light,” often leads to reverse margin risks—where the costs of operation exceed the revenue from cargo contracts, particularly when shipping contracts precede cargo agreements.
One illustrative scenario involves the transport of general coal for power companies under a Contract of Affreightment (COA), where the agreement spans one or several years. Ideally, if a shipping company possesses enough vessels to meet the cargo volume required by the COA, there should be no issue. Yet, due to economic efficiency concerns, maintaining a fleet solely for COA purposes is not always feasible. Japanese operators, therefore, customarily source coal ships from the market to fulfill parts of their COA obligations, exposing them to potential operational deficits if market conditions turn unfavorable.
This dynamic underscores the delicate balance Japanese shipping operators must navigate between contractual commitments and the operational realities of the volatile shipping market.
Forward Freight Agreements Leading the Way Amidst Shipping Contract Debates
With the cycle of long-term charter debt obligations having come full circle, Japanese ship operators are now contemplating the optimal charter durations to expand their dry bulk operations in the future.
A specialist in tramp shipping reiterates a cautionary stance, stating, “A deep-seated belief among some Japanese operators equates long-term charters with negativity. In theory, aligning the cargo contract period with the charter duration should preclude any losses. However, adopting an asset-light strategy without owning vessels introduces the risk of incurring losses (negative spread) when cargo contracts precede charter agreements.”
What does this mean in practice?
One scenario prone to negative spreads involves transporting coal for power generation under a Contract of Affreightment (COA), where a utility company and a shipping firm agree on transporting a certain quantity of coal over one or multiple years. Ideally, if a shipping company owns enough vessels to cover the contracted cargo volumes, there wouldn’t be an issue.
However, from an economic efficiency standpoint, having a fleet of coal carriers ready exclusively for COA purposes has its downsides. It’s customary for Japanese operators to source coal carriers from the market to fulfill parts of their COA obligations.
A representative for general tramp shipping shared insights on the challenges faced, “Cases of negative spreads, where vessels sourced from the market at rates higher than the contract freight rate, have occurred with Ultramax and other medium-sized bulk carriers, similar to previous situations with coal transport. Lacking medium to long-term charters, operators are forced to rely on short-term or spot charters.”
“These charter rates are influenced by the Freight Forward Agreements (FFA) indices. This year, factors like the Red Sea detour and the Panama Canal drought have prevented a drop in the dry market conditions from January to March. Consequently, operators lacking sufficient controlled vessels must procure spot charters at higher rates than their contract freight rates.”
Indeed, this issue affects not only Japanese operators but also asset-light players internationally, facing financial deficits.
For operators managing fleets of over 100 dry bulk vessels, maintaining a balanced fleet composition remains a constant challenge. “To avoid negative spreads, a mix of about 50% medium to long-term and 50% spot or short-term charters is necessary,” explains the tramp shipping specialist.
However, it remains to be seen whether this suggestion will be acceptable to the leadership of Japanese ship operators, many of whom are still wary of the risks associated with long-term charter commitments.