POLICY PERSPECTIVES

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Letter.
Transformations in gas shipping: Market

structure and efficiency
S t e v e E n g e l e n a, * a n d Wo u t D u l l a e r t b, c
a
Joachim Grieg & Co, Karenslyst Allé 2, Oslo N-0213, Norway.
E-mail: steve.engelen@gmail.com
b
Institute of Transport and Maritime Management (ITMMA) – University of
Antwerp, Keizerstraat 64, Antwerp BE-2000, Belgium.
c
Antwerp Maritime Academy, Noordkasteel Oost 6, 2030 Antwerp, Belgium.
*Corresponding author.
A b s t r a c t This article aims to improve understanding of the gas shipping markets

which, contrary to the main merchant markets – namely the dry, the tanker and the
container markets – have not been subject to the same scrutiny. We examine the funda-
mentals and segment these versatile markets in which expanding gas production and the
drive towards liberalization are affecting market conditions. The analysis shows that the
industrial LNG, LPG, ammonia and petrochemical markets are slowly transforming to a
competitive setting with an increasing number of private buyers and sellers rendering the
market more efficient. The gas asset markets are still too small in size and illiquid so that
entry and exit through the second-hand market remains difficult.
Maritime Economics & Logistics (2010) 12, 295–325. doi:10.1057/mel.2010.10
Keywords: market efficiency; gas markets; LNG; LPG; ammonia; petrochemical
r 2010 Macmillan Publishers Ltd. 1479-2931 Maritime Economics & Logistics Vol. 12, 3, 295–325
www.palgrave-journals.com/mel/
Engelen and Dullaert
Introduction
Unlike the main merchant shipping markets, gas markets have not been
thoroughly investigated in the academic literature. Different reasons can be
pinpointed. Firstly, the market is much smaller in size which might explain
the lower level of interest. In 2008, the Liquefied Natural Gas (LNG) seaborne
trade was around 180 million tons, while the LPG, ammonia (NH3) and
petrochemical markets constituted respectively 57, 15 and 13 million tons. In
contrast, seaborne trade in both tanker (crude and product) and dry bulk
products is estimated at around 3 billion tons. Secondly, the gas shipping
market is often referred to as an industrial market with a lack of public coverage
which has undeniably fuelled belief that the market might not comply with
competitive norms. Thirdly, a lack of knowledge about the gas products
themselves could prove a reason for the lack of analysis. The most notable
reason however is probably the lack of data and journal articles published on
gas shipping. The above elements hence do little to encourage researchers and
analysts not effectively active in this industry to examine this market.
Using insights from practice, this article starts by offering a general over-
view of the gas markets. It will thus become clear that segmenting this market
is not straightforward. There are different types of gases that, in turn, can be
transported by different types of ships. Technical aspects play an important role
in chartering ships which as a result interfere with efficient market functioning
across the different gas markets. Hence, substitutability between the different
ship sub-segments is not as strong as in the main merchant markets.
In general, gas shipping consists of the LNG market on the one hand and
the LPG, NH3 and petrochemical markets on the other hand. Both markets are
clearly differentiated in terms of ships and product as well as in the prevailing
industry structure and market clearing mechanisms. For each separate market,
we set out on the demand and the supply side of the market and conclude with
efficiency implications.
The LNG Market
LNG can be defined as a natural gas that has been chilled to liquid form,
reducing it to one-six-hundredth of its original volume at minus 164 degrees
Celsius, for transportation by ship to destinations that are often not connected
by pipeline. It mostly contains methane (CH4) which has a melting and boiling
point of around 184 and 161 degrees, thus demanding that LNG carriers are
sophisticated vessels with double-hull special design and insulated storage
tanks. The definition reveals the close link with the energy markets. In 2009,
296 r 2010 Macmillan Publishers Ltd. 1479-2931 Maritime Economics & Logistics Vol. 12, 3, 295–325
Transformations in gas shipping
natural gas accounted for almost a quarter of the world marketed energy use
(EIA, 2010a). Natural gas is primarily used to produce electricity (30 per cent of
global use in 2009) and as an industrial feedstock for a wide range of plastics
and fertilizers (27 per cent). It is also used as heat in commercial (14 per cent)
and residential (21 per cent) settings. The use of natural gas as a fuel is still in its
infancy (o5 per cent) but this is expected to change thanks to increased global
attention for green energy sources (EIA, 2010b).
As LNG comes as a distilled and fragmentation product from gas wells, its
product characteristics are not homogeneous. The product is often fabricated in
a particular manner which is prescribed by the buyers (Bramoulé et al, 2004).
This heterogeneity in product supply is a first indication of differentiation
with respect to the distribution and the efficient allocation of the product. In
Europe, for instance, most end-use facilities are designed for ‘leaner’ pipeline
gas quality which currently dominates the overall EU gas mix. LNG has a higher
purity, higher methane and overall energy content. As a result, receiving
and processing LNG at the terminal is more difficult (Kavalov et al, 2009). The
product characteristics of LNG can basically differ per project, per country or
per seller.
Figure 1 demonstrates that the LNG market has evolved from a complete
state-controlled business to a heterogeneous supply chain in which shipping
Figure 1: Evolving LNG market dynamics.

Source: Own representation based on Shively and Ferrare (2005).
r 2010 Macmillan Publishers Ltd. 1479-2931 Maritime Economics & Logistics Vol. 12, 3, 295–325 297
has obtained independent status. As part of the global trend of privatization

in the energy markets, the transformations taking place in the LNG market are
in keeping with the deregulation and liberalization tendencies in both the
upstream and downstream gas markets. The best example is Europe’s quest to
achieve energy security and reduced independence vis-à-vis Russian piped gas.
The ongoing changes have recently resulted in a greater number of cooperation
agreements and the establishment of creative consortia between market players.
Different evolutions are developing at the same time: on the one hand, more
independent shipowners are cooperating with upstream gas sellers by investing
in liquefaction projects (for example, the strong cooperation between Golar
LNG and the BG group since 2004). On the other hand, more shipping
companies are taking over the role of refrigeration terminals by converting ships
to floating gas production or regasification units (for example, the core business
of Flex LNG). The trend has even emerged where investments with downstream
buyers are made in the import terminals (for example, CNOOC investing in
the new Chinese LNG import terminals), although the public sector is still
predominant in this area. The dominance of a few large buyers or state
monopolies is decreasing although the key gas-rich countries in the Middle East
still hold a national LNG fleet and control most of the upstream and down-
stream business. Qatar is a good case in point, shipping all the national gas
output from Qatargas by way of their public shipping company, Nakilat, or
Qatar Gas Transport.
Besides liberalization trends, an important factor to changing markets is
the increase in global LNG supply from 140 to 180 million tons in the period
2005–2008. Figure 2 demonstrates that this evolution has just begun, as a
massive expansion of new LNG capacity is currently being built and planned
250
200
150
100
50
0
Atlantic Basin Middle East Far East
Operational Under construction Planning Uncertain
Figure 2: Regional LNG capacity expansion by phase – March 2009 (Million ton).
Source: LNG database Lorentzen & Stemoco.
worldwide: 85 million tons capacity is under construction and 185 million tons
is in the planning phase. The focal point is Qatar with ca. 35 million tons of
capacity under construction in the period 2009–2014.
As a result of expanding markets, many more buyers and sellers have
emerged in the LNG market. On the exporting side, new players such as Norway
(Snohvit), Equatorial Guinea (Bioko Island), Yemen (Balhof) and other Latin-
American countries (Peru, Brazil) have recently become net sellers of LNG. In
China, new LNG import terminals are being built at a rapid pace. Since China’s
first LNG terminal in 2006, five new terminals have already been built while
another three are under construction and six additional terminals are under
development (TGE, 2010). These developments are in turn leading to a more
dispersed and more public marketplace on the shipping side with the fleet
expanding drastically. Since 2003 the LNG fleet has literally doubled from 150 to
over 300 ships.
In the last 15 years, the significantly decreasing cost structure in the
entire LNG value chain has enabled LNG to compete with piped gas. Maxwell
and Zhu (2010) estimate that the logistics costs of liquefaction activities
have three-halved during the period 1980–2005, mostly thanks to reduction in
capital costs to set up the plant. LNG liquefaction capacity and regasification
terminals have increased in scale as has accordingly the size of LNG ships.
Not only scale effects but also technical progress has brought down costs in the
LNG value chain. Along with more competition from shipyards, the cost of
building a 145 k Cbm LNG carrier has fallen from US$280 to 155 million during
the last 30 years. It is estimated by Maxwell and Zhu (2010) that in 2006
the average logistics costs in the LNG value chain were between and 2 and
3.7 $/MMbtu:
K Exploration and production (0.5–1 $/MMbtu)

K Liquefaction (0.8–1.2 $/MMbtu)
K Shipping (0.4–1 $/MMbtu)
K Regasification and storage (0.3–0.5 $/MMbtu)
At these levels, LNG is more competitive than the recently discovered shale gas
that can viably be produced in the United States at about 4 $/MMbtu (TGE,
2010). A direct comparison with piped gas prices is difficult given the many
tailor-made supply contracts in place and the various price structures used
globally. Also, the distance travelled by the gas has a large impact on the use of
piped gas or LNG. Brito and Hartley (2007) estimate that pipeline gas becomes
uneconomical beyond ca. 3000 km. The IEA (2007) and Ndao (2004) point out
that apart from geographical constraints or political factors, LNG can increas-
ingly compete at lower distances thanks to lowering logistics costs.
Table 1: Carbon emissions by fuel – Mass of carbon dioxide emitted per quantity of energy
Fuel name Gram CO2/106Joule Mgram SO2/106Joulea

Natural gas 50.3 0.1
LPG 59.76 —
Diesel oil 63.34 15
Gasoline 65.78–67.07 —
Fuel oil 69.22 250
Coal 88.13–97.59 —
Source: Voluntary Reporting of Greenhouse Gases Program 2009, EIA (www.eia.doe.gov); TGE (2010).
a
Sulphur emissions by shipping transport fuel.
The green debate has sparked mounting interest from gas-rich and gas-poor
countries to venture into the LNG market. It is well-known that natural
gas contains less carbon content than, for example, oil or coal as Table 1
summarizes (for a detailed comparison of LNG with natural gas in terms of
emissions and efficiency, we refer to Kavalov et al, 2009, where a technical
discussion is contained). Among other things, the purity of the product, the
gas mix as well as the manner in which the product is processed, are all
important factors to consider. The relevance of greenhouse emission programs
relates especially to LNG substituting oil and coal in the power generation
sector in Japan and Korea, the two largest importers of LNG that together
account for over 50 per cent of global imports. In Japan, power plants account
for 60 per cent of total LNG consumption affirming their dominant market
power (Argus Global LNG, 2009).
Another reason for expanding gas markets and more versatile LNG use is
inspired by emission and fuel-substitution standards. In 2008, the IMO adopted
stringent new standards to control harmful exhaust emissions from the engines
that power ships. The standards can be found in Annex VI to the 73/78
MARPOL convention and aim in particular at reducing sulphur emissions which
vary widely by fuel type as Table 1 indicates. Figure 3 plots the sulphur content
limits allowed in shipping fuel henceforth. These emissions apply globally or
in specially designated (Sulphur) Emission Control Areas or (S)ECAs. These
(S)ECA zones are predominantly coastal areas such as the Baltic or the North
Sea ((S)ECA zones since 2007), but in 2009 it was proposed that larger areas
should be subject to stricter sulphur standards (the Mediterranean and
US-coasts). Given the low sulphur exhaust of natural gas, it is ascertained
that the share of LNG use as a fuel will quickly increase as more (S)ECA zones
are adopted.
The above evolutions are slowly but surely impacting on the dynamics in
the LNG shipping market by modifying its industry structure and related
shipping contracts.
0
2008 2012 2016 2020 2024
Global limit ECA limit
Figure 3: Marpol Annex VI Sulphur Limits (per cent sulphur content in fuel).
Source: TGE (2010).
LNG demand
The LNG market does not function in the same way as the other merchant
shipping markets because of the fact that it is supply driven and governed
mainly by long-term contracts. Demand increases by a supply push of lique-
faction projects rather than by an expanding LNG demand per se (Holmes,
2009). The proliferation of long-term contracts provides the market with a
typical industrial profile. The need for 20–25-year contracts is rooted in the high
capital costs involved and the mutual need to plan investments. The sellers of
LNG need buyers to start up projects (regasification terminals), while buyers
need to secure their demand in time and have shipping capacity available. The
fact that regasification terminals are easier to build than liquefaction plants
explains that market power is centred at the seller’s end. The project-based
approach is also inspired by the fact that there has traditionally been no trading
or marketing of LNG with third parties. Contracts are negotiated directly
between sellers and buyers expounding the lack of a common market (Holmes,
2007).
The industry typically uses supply agreements on a ‘Take-or-Pay’ principle.
The seller of the LNG has a price risk as quite often the price is related to the
actual natural gas market price. Prices are mostly determined ex-ship, where
contract prices reflect downstream prices (for example, the Henry Hub natural
gas price in the United States) less gasification and other terminal and shipping
costs. The remainder or netback for the producer must be sufficient to cover all
upstream related costs such as feedstock, liquefaction and export terminal
costs. The buyer of the LNG has a supply risk as he has to receive the volumes
stipulated in the agreement in the long run (Jensen, 2003). Gkonis and Psaraftis
(2009) therefore consider these supply agreements as an example of Cournot

or Stackelberg quantity competition. The subsequent need for shipping in the
long run explains that tonnage is chartered in for the duration of the supply
contract. An example of a long-term contract is the deal signed in 2008 by
CNOOC with Qatargas III to buy 2.7 billion cubic feet per year for a period of
25 years (IEA, 2009). The first cargo was delivered by Nakilat at the end of 2009.
Thus far it has been very profitable for shipping companies to lock in their fleet
for long-term margin contracts. Speculative ordering under the traditional
system has been very rare and was only undertaken by Golar LNG in 2002.
In this respect, it is clear that the market consists predominantly of term
contracts. In 2002, 95 per cent of the trade concerned dedicated trade. Today, in
light of the above market developments, trade patterns are changing and more
flexible freight contracts are being used. Figure 4 shows that about 75 per cent
of the trade is still administered by long-term contracts. Japan and Korea for
instance secure most LNG deliveries by long-term contracts with Indonesia
(22 per cent of 2008 imports), Malaysia (19 per cent), Australia (20 per cent)
and the Middle East (40 per cent) (Argus Global LNG, 2009).
The setback with the traditional ‘Take-or-Pay’ principle is the inherent des-
tination clause forbidding the buyer to resell the gas. Selling excess gas to other
buyers has hence not been possible and caused many companies to suffer heavily
if, for example, domestic demand fell after the contract was in operation. Also, a
delay in LNG output meant that it was compulsory for a dedicated ship that was
16
Dedicated Flexible Spot
14
12
Exports Imports
10
0
Total Atlantic Asia/Pacific Middle East Europe Asia/Pacific North/South
America
Figure 4: Monthly LNG breakdown by supply type 2008 (million tons).
Source: Argus Global LNG, Purvin & Gertz.
chartered in for a specific project to remain idle. A welcome development came in

2005 when the European Commission abolished the rigid destination clauses
from all supply contracts in the European Union, as this was deemed a main
barrier to constituting a single free market (Smith, 2005). The resulting increase
in uncommitted gas will therefore facilitate more flexible contracts.
Employment contracts increasingly contain a destination flexibility clause
in off take agreements, permitting the opportunity to seek the market of highest
return. The share of flexible trades, estimated around 20 per cent of total trade
in 2008, has been increasing rapidly in recent years and is set for further growth
with the changing industry structure. The increase in flexible LNG trade
requirements in the United States provides a good example as, with the US
natural gas oversupply persisting since the financial crisis in 2008, the United
States is more willing to export than to find itself being forced to import
(contracted) LNG (EIA, 2010a). At the same time, more arbitrage opportunities
are surfacing as more exporters/importers are established. The United States,
for example, has only being importing LNG from sources other than Algeria and
Australia since 2005 with Trinidad & Tobago, Qatar and Nigeria as new sources.
The arbitrage is best illustrated in the Atlantic basin where price differences
between the Henry hub price and North West European prices are increasing
the number of diverted and rerouted cargoes. This evolution is facilitated by the
increased use of FOB contract pricing, replacing traditional ex-ship pricing.
With FOB pricing the buyer benefits from reducing shipping costs as the
seaborne transport is his responsibility, whereas on ex-ship basis it is the pro-
ducer that cashes in possible netbacks. Due to their position in the LNG value
chain, the buyers of LNG are better placed under the FOB system to exploit
profit opportunities through arbitrage and seek the market of highest return
(Maxwell and Zhu, 2010). Having control of shipping costs is crucial as freight
rates – although relatively stable (see Figure 6) compared to other merchant
shipping markets – are the most volatile cost component in the LNG value
chain.
In line with expanding gas trades, seasonal swings are increasing and
sizing up the spot market which is still far from developed and accounts for
only 5 per cent of total trade (Brito and Hartley, 2007). The spot market cur-
rently exists mainly to cover imbalances as a result of, for instance, delays in
terminal expansion or maintenance, and is not established as such nor operated
through brokers. The existence of a spot market is important as a means of
checking for efficient markets in the short run, given that it adds to the allo-
cative efficiency of the market. There are additional reasons that support
enlarging spot markets. Aune et al (2009) emphasize that ever more long-term
supply agreements are not covering the entire liquefaction capacity anymore.
The LNG output of the Qatargas IV plant, for example (operational in 2009) is
only partly sold to ConocoPhilips, a co-investor that will market and sell the gas
exclusively in the United States. Moreover, thanks to technical efficiencies,
more and more spare capacity is generated at the liquefaction trains, so that the
excess supply is growing and will be sold on the free market. Given the large
expansion programmes underway (Figure 2), it is expected that correspond-
ingly more project delays will impel an increasing number of spot vessels
available to the market.
LNG supply
The supply side has largely adapted to the transformations and changes
permeating the LNG market. Ownership patterns in this respect are rapidly
changing. Coming from traditional state control, ownership patterns are in-
creasingly spread over more and different private companies. The wave of new
entrants since the expansion in the LNG market last decade has reduced its
oligopolistic structure. Currently it is the buyers and no longer the LNG con-
sortia or sellers that are the source of new orders for LNG ships. Back in 2004,
independent shipowners and oil/gas companies owned only 3 and 9 per cent
respectively of the operating fleet (Ndao, 2004). By the end of 2008, major oil/
gas companies and independent owners together vouched for 68 per cent of the
fleet and 88 per cent of the orderbook. The increasing number of exporters
coincides with the doubling of LNG importers since 2000. In view of the
expanding market and greater trading opportunities, it is possible that in a next
phase integrated oil companies will no longer require their own LNG fleet. This
recalls the embryonic phase of the tanker market when the oil majors also
deployed their own tanker fleet.
Inspired by the increased use of flexible contracts, some owners such as, for
example, Golar LNG in 2002 were even tempted to contract tonnage on a
speculative basis. The timing, however, was not beneficial since finding ship
employment proved difficult. Some ships have consequently been converted to
floating (production) storage systems or used as regasification vessels with
the aim to overtake the import terminal’s role. The solutions offered are good
illustrations of the flexibility and creative drive present in the market (Jensen,
2004).
As markets are becoming more liquid and competitive, the transport in-
dustry is benefitting from decreasing transport costs. As indicated earlier and
confirmed by IELE (2003), the transport cost of LNG is sizable, sharing 15–25
per cent of the total product cost with an obvious bearing on the LNG market’s
capacity to compete with pipeline gas. The industry has performed well to
reduce costs by, among others, upscaling ship size as demonstrated in Table 2.
Table 2: LNG fleet statistics – March 2009
Vessel type Size Cbm Propulsion system Fleet Mio Orderbook

Cbm Mio Cbm
Qmax 255–265 k SSD/reliquefaction 1.8 1.8
Qflex 200–230 k SSD/DFDE 4.5 2.1
Standard LNG 120–180 k DFDE/ST 34.5 9.6
Small-Medium 1–90 k DFDE/ST 1.7 0.06
All vessels are pressurized at 0.25 bar.

SSD: Slow speed diesel; DFDE: Dual-fuel diesel electric; ST: Steam turbine.
Source: Lorentzen & Stemoco.
The fact that the supply side of the market is still maturing is evidenced by
the orderbook, reflecting the expansion and upscaling of the fleet underway.
This coincides with the upsizing of LNG trains from around 1 to recently
8 million tons liquefaction capacity for the Qatargas and Rasgas trains in the
period 1960s to date. A typical standard LNG ship is around 145 k Cbm and
considered the workhorse in the Cross-Atlantic trades. The small- to medium-
sized ships were the first ships contracted 30–40 years ago when the sector was
created and are gradually being outphased. The cross-Mediterranean and
Middle East-Japan trades are the most important in the 70–90 k segment. The
smallest units are mostly engaged in coastal and small distribution trades
(Holmes, 2009). The relatively new Qflex and Qmax fleet owned by Nakilat
constitutes a separate segment with most tonnage being committed to Middle
East contract trading on fixed trading schedules. The market is thus clearly
segmented with the reference standard LNG ships considered the most flexible.
Apart from the quest for scale effects, technical improvements have also
brought down the cost of newbuildings. In particular, technological develop-
ments in the containment systems, such as better cryogenic insulation and
a more efficient propulsion system have lowered building costs. The Moss
Rosenberg systems have a better track record than the Membrane system (for
example, the leakage problem of membrane tanks because of bad weather),
explaining shipowners’ preference for the former. Charterers however reveal no
specific preference so that the transport capacity seems homogeneous (Tusiani
and Shearer, 2007).
Determining how shipping strategies will evolve is difficult to predict but
the LNG market shows a considerable number of resemblances to the evolution
in the other shipping markets. A good example is the container market in
which transport is also a part of the logistics chain. It is common practice that
shipping lines and terminal operators cooperate closely to secure volumes and
terminal capacity (Vernimmen et al, 2007). The same evolution could develop
in the LNG segment where independent shipowners will be eager to leverage
uncommitted shipping capacity into upstream projects to lock-in high margin

contracts. This practice will to a large extent depend on how markets will clear
going forward.
Efficiency and market clearing
It is not straightforward to evaluate the efficient market hypothesis as the LNG

product and freight markets are clearly interwoven. The market is changing
from an oligopolistic industry with few sellers and suppliers connected only
through long-term contracts to a more competitive setting with more sellers
and many more suppliers requiring more flexible contracts.
It is not easy to enter or exit the LNG (shipping) market, although raising
capital has historically not been the problem. Most entrants have had experi-
ence in the gas segment before, or try to cooperate with incumbents to be able
to enter the market. Branding and knowledge is still a key to entering the
segment. It is not easy to exit the market and sell, for example, old LNG ships.
The ships have a lifetime of 40 years and are too expensive to scrap prematurely
while owners are not keen to take over a competitor’s fleet. K-line, for instance,
has on several occasions tried to sell off its older LNG fleet in 2009 but without
success. Golar LNG underwent a similar experience, being unable to find
employment for its speculative units or find a buyer for its ships.
Access to the import terminals could be a problem, for example, for spot
ships on the market because of technical requirements. This has been an issue
at European and Chinese terminals in which LNG needs to meet specific
requirements. On the one hand, it is true that the product is not homogeneous:
LNG differs in heat content and product characteristics. On the other hand,
the refusal of cargoes is often inspired by reasons of energy security, state
intervention and protectionism. Moreover, an increasing number of import
terminals are able to regulate heat content (Tusiani and Shearer, 2007). If the
gas is too rich, inert gas can be injected, while too lean gas can be enriched
with propane. Many more cargoes could potentially be swapped, thus making
the market more productive and efficient.
In order to do so, markets should be more transparent and information
should be made publicly available. This might be the case for international
product prices but not for freight rates. There is no benchmark freight rate or
consensus on the average market level. Also, the free mobility of ships which
is an important efficiency condition in shipping markets (Zannetos, 1966) is
hampered by the fact that ships are locked in duration contracts. There is no
backhaul trade and ships are in ballast for around 50 per cent of their time
(Jensen, 2004).
Moreover, the existence of market power and the effect of a lack of industry
interest in optimization have propelled a number of inefficient procedures. For
example, as supply agreements focus on quantities, it is striking that the sector
has not used more Contracts of Affreightment as transport contracts. The
advantage for the shipowner is that he would be able to deploy his fleet
more efficiently, as he does not need to conform to the project owner’s
schedule. However, at this moment the regasification terminals determine the
schedule delivery of LNG shipments. The liquefaction facilities (and the ship-
owners) are still following their lead and require a ship ready at all times to
timely load at the liquefaction plant. The chartering side of the market, namely
the liquefaction plants, have in this respect been too passive by hooking up
capacity long term without having responsibly calculated the exact need for
ship capacity per project. The overcapacity in the LNG market in the period
2008–2009 was imminent and shipowners have been able to bridge these ailing
market conditions because of their long-term charter coverage. The charterers,
often state bodies sharing in LNG consortia, seemingly did not object to paying
for an idling fleet. In Qatar, for example, Nakilat fully owned 20 ships at the end
of 2009 consisting of QMax and Qflex vessels. By analysing the vessel tracking
system offered by Bloomberg and the Lloyd’s MIU movement database, it
appears that the employment figures of the fleet have been below 50 per cent for
most of the time. This is not only because of the ships delivering before the
start-up of the liquefaction plant but also because of the fact that too much
tonnage was assigned to one project. With increasing private involvement, it
seems that the industry, assisted by academic research, has started to initiate
fleet optimization procedures to make chartering operations more efficient (see,
for example, Christiansen et al, 2005). Gkonis and Psaraftis (2009) present
a simple game theoretic approach illustrating the benefits of cooperation
(instead of acting completely independently) with respect to supply or capacity
decisions. The question remains whether this will change the charterer’s easy
preference to hook up (over)capacity at all times.
The price-taking assumption is to a certain extent fulfilled. The contract
price is negotiated and often anchored to competitive oil and gas prices. In the
United States, the benchmark price is either a long-term determined price or
the Henry Hub price for short-term sales. In Europe, prices have for a long time
been related to fuel prices such as low-sulphur residual oil. LNG is recently
starting to be linked to natural gas spot and futures market prices. In Asia,
prices are linked to imported oil. The price formula typically includes a base
price indexed to crude oil prices which thus far can explain the higher
LNG prices in the Far East as Figure 5 affirms (EIA, 2010a). The distinguishing
characteristics of competitive markets are often reconciled with only the
price-taking assumption, owing to the fact that, in a competitive setting, prices
16
14
12
10
8
6
4
2
0
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009
EU Japan South Korea USA
Figure 5: LNG prices 2000–2009 ($/MMBTU).

Source: Bloomberg, Argus Global LNG.
equal marginal cost (Evans, 1994). It is difficult to evaluate LNG product prices
(FOB, CFR or ex-ship) in that respect, given the different price structures in
place. It is expected that because of rising opportunities to exploit regional
price differences by flexible trades, global LNG prices will increasingly move in
concert. In the Atlantic, arbitrage between the United States and Europe is
already established so that prices follow each other while there still remains a
premium for Eastbound cargoes.
As previously mentioned, the LNG shipping market is transforming and
the rigidly inefficient conditions (product homogeneity, immobility of ships,
oligopolistic market power) are slowly being shaped to a more liquid and
competitive setting on the back of more flexible contracts. This change is im-
portant in terms of how markets clear (Foss, 2005). It is logical that freight
markets governed by fixed supply contracts do not clear in the same way as the
other merchant shipping markets. The emergence of a market with flexible
trades is developing and partially improving the allocative efficiency of the
market. The spot market is still small and fragmented, but nevertheless already
important for market clearing in the very short run with respect to, for example,
price competition. A good example to illustrate the improved transparency
of the market is Platts, the world’s leading energy information provider,
which in June 2010 began publishing daily price assessments for LNG imported
in Southwest and Northwest Europe to monitor the increased level of spot
trading.
Figure 6 plots the different LNG freight rates used and newbuilding
prices. On the one hand, it is clear that spot rates can soar overnight in line with
market events. Plummeting gas prices, seasonal arbitrage, product imbalances
or a severe winter are just a few examples that can quickly ignite prices. On the
120 300
100 250
80 200
60 150
40 100
20 50
0 0
jan.05 jul.05 jan.06 jul.06 jan.07 jul.07 jan.08 jul.08 jan.09 jul.09
Long-term Spot 145k NB prices (right axis)
Figure 6: LNG freight rates (1000 $/month) and newbuilding prices (Mio $) 2005–2009.
Source: Lorentzen & Stemoco, Argus Global LNG.
other hand, it does show that the average spot rate is lower than contracted
rates. The fact that spot volumes are underpriced is inefficient in view of the
theory on the term structure of freight rates (Adland and Cullinane, 2005).
Long-term rates are quite stable and voyage calculations point to decent
returns to shipowners. However, if shipping is not a bottleneck in the LNG
supply chain and markets behave efficiently, period rates should have the
potential to decline. This depends on the chartering side of the market and their
willingness to invest in efficient solutions and fleet optimization procedures.
If less overcapacity were to be chartered on the back of LNG liquefaction supply,
there would undoubtedly be more pressure on freight rates. In 2008–2009, an
overhang of tonnage did not affect the period freight market. Rather than
scrapping old vessels, the industry sought creative solutions (for example, the
decision to convert the Golar Freeze to a floating unit). The conversion and
building of floating (production) units is a good example of how to stretch the
economic life of a vessel, which in addition matches the industry’s eagerness
for further cost reduction.
An increase in efficiency does not only benefit the chartering side of the
market. Possible improvements also help shipowners, for example, when one
ship is no longer linked to one project but more ships are pooled into a fleet and
assigned to different liquefaction projects. This strategy would certainly trigger
a reduction in global spare capacity, but could however shift the problem to the
peculiar competitive legislation on pools. This discussion will be continued in
the analysis of the other gas markets.
T h e L P G , N H 3 a n d Pe t r o c h e m i c a l M a r k e t s
The LPG, NH3 and petrochemical markets – henceforth called gas markets – are,
like the LNG market, also industrial markets given that ownership strategies are
mainly aimed at servicing clients with transportation and logistics needs
over the longer term. Many players have an operational focus and aim to
remain in the business for the longer run. Contrary to the LNG market, the
notable difference is that these gas markets tend to clear in a similar way to
the dry and tank tramp markets, because of the lesser need for lifetime
duration projects and long-term charter contracts. In the very large gas carrier
(VLGC) market for instance, all the conventional charter contracts are used:
in 2008, the in-house fixture book of Lorentzen & Stemoco showed that
ca. 900 voyages were carried out of which 15 per cent spot, 15 per cent COA
(spot related), 30 per cent time charter and 40 per cent period/own system
trading.
Another feature is that the commodities carried are not raw materials but
are derived from different upstream products or feedstock. This means that
often energy substitutes exist (for example, naphtha replacing butane as feed-
stock for petrochemical crackers) rendering shipping demand more elastic
which in turn reduces freight rate volatility. Understanding how the various gas
products are made is important to grasp their shipping dynamics. Nevertheless,
the same drivers are at work including the global economic outlook, shaping
crude and gas demand as well as the demand for consumption and industrial
products to a comparable extent.
LPG (mainly propane and butane) is normally produced at refineries from
crude oil or natural gas processing plants that fractionate natural gas liquids.
LPG is thus basically a by-product that can be used for a variety of purposes. In
the Far East, 59 per cent of the LPG consumption in 2008 was destined for
domestic heating and cooking purposes. In Europe and the United States,
35 and 61 per cent of the LPG was consumed as feedstock in refineries and the
petrochemical industry respectively. To a lesser extent, LPG is used as autogas
(8 per cent of global LPG consumption in 2008), for agricultural ends
(2 per cent) or to feed power plants (o1 per cent) (World LP Gas Association,
2009).
Ammonia (NH3) is usually gained from adding nitrogen to the steam
performing process, with natural gas as principal feedstock. It is mainly used as
a basic component in the production of mineral fertilizers such as urea, nitrates

and NPK, accounting for 65 per cent of worldwide consumption in 2008. The
remaining 35 per cent of NH3 used in 2008 was for industrial application and
used to produce civil explosives or Caprolactan for industrial ends such as inner
lining and airbags in cars (Fertecon, 2010).
The petrochemical gases are produced at the end of the petrochemical flow
and derived from the steam cracking process of oil and gas feedstock. These
gases mainly consist of ethylene and propylene which are used to make all
kinds of polymers or plastics. VCM or vinyl chloride monomer is mainly
produced by the cracking of ethylene dichloride and almost entirely used in
the manufacturing of PVC. The mixed group of butadienes and Crude C4s are
predominantly used to make all kinds of rubber products.
Demand for LPG, NH3 and petrochemicals
The particular manner in which gas products are fabricated explains why
market functioning can be different. As LPG is extracted from crude oil and
natural gas, the market has traditionally been supply driven or referred to as a
seller’s market. This is intensified by the fact that LPG storage is lacking or
deemed too expensive. LPG exports are largely determined by the Middle East
crude/LPG production, especially Saudi LPG exports, sharing 23 per cent of
the market in 2008. This has given the latter significant pricing power – the
so-called Contract Price (CP) set ad hoc every month – which is intransparent
and follows crude values to only a certain extent (ca. 70 per cent correlation
between the CP and the Arabic Light oil prices in the period 1999–2009). The
market, however, is changing with ever more LPG volumes distilled from LNG
production. While in 2005 around 70/30 per cent of global LPG production was
derived from oil/gas production, Aspden (2009) expects that by 2012 the shares
will change to 60/40 per cent. Relatively new players such as Abu Dhabi and
Qatar could potentially surpass Saudi Arabia in terms of LPG exports. Qatar
exported 5 million tons LPG in 2008 but is set to increase exports to over 13
million tons when all LNG projects become operational. Saudi Arabia has
decreased LPG exports in recent years from 13 to 10 million tons in the period
2007–2009 because of reduced oil production and, in particular, expanding
domestic petrochemical consumption where LPG is used as a feedstock (Laven,
2009). Owing to the step up in overall LPG volumes, it is expected that world
LPG will become cheaper and that more countries will emerge as importers.
Ammonia has seen stable growth in recent years on the back of strong
underlying growth in global food production, with seaborne trades expanding
from 14.2 to 17.5 million tons in the period 2002–2008. The key exporters
are Russia (3.7 million tons exports in 2008), Ukraine (1.4 million tons) and
Table 3: Cash costs NH3 supply 2006–2009 ($/ton)
Pricing region 2006 2007 2008 2009

North Africa 73 74 75 80
Middle East 74 74 78 78
Trinidad – minimum cost 72 75 78 81
Russia via Yuzhny 122 148 169 167
Russia via Ventspils 137 162 176 180
West Europe (spot based) 285 246 298 205
Ukraine via Yuzhny 175 243 310 301
US Gulf ex-plant 271 284 350 174
West Europe (contract based) 288 330 485 316
Source: Fertecon (2009).
Trinidad (4.5 million tons), mainly serving the US Gulf and Europe. The
dynamics in the seaborne trade are largely determined by changes in natural
gas prices, as these shape production cost differences across regions. Table 3
summarizes the cash costs for the main regions supplying NH3 and explains
why exports out of Yuzhny collapsed in 2009. As a result of Russian gas becoming
too expensive, Black Sea exports were uncompetitive and 1 million tons less
was exported to the United States. In the United States, natural gas prices fell in
line with the financial crisis so that domestic production of NH3 became cheap
and was started up again.
The expansion in NH3 trade comes from a fundamental demand increase
and also from new product capacity in the Middle East and Africa. In the period
2009–2014, Qatar ( þ 1.5 million ton), Iran ( þ 680 k ton) and Saudi Arabia
( þ 1 million ton) will account for over 3 million tons of potential exports. Egypt
has already started up its EBIC plant (750 k tons export capacity) while new
capacity in Algeria will add around 2 million tons of potential exports. As new
plants are built in low-cost feedstock regions, trades will be affected and new
pricing structures will arise. In 2010 Yara, the largest fertilizer company in
the world, accounting for ca. 5 mio tons of total ammonia trades. Yara started to
link ammonia pricing to gas-hub pricing instead of an oil price formula or an
ammonia cost-based formula (Fertecon, 2010). It is expected that this will
further reduce the West European spot and contract prices.
The largest transformations or structural changes underway are emerging
in the small gas segment that saw seaborne trade in chemical gases expanding
by 46 per cent from 8.6 to 12.6 million tons during 2002–2008. The transportation
part of the market has traditionally been considered a by-product resulting from
plant imbalances and an overflow or shortage in local production output. In
2008, the share of seaborne petchem gases trade was estimated at 5 per cent
of total production, which is significantly lower than for LPG (24 per cent) and
NH3 (13 per cent). The market has been widely fragmented as a result of the
presence of many small trades and ports. This is rapidly changing with the
Middle East becoming the petrochemical centre of the world for ethylene
and propylene production in particular. As the Middle East lacks domestic
consumption or downstream plants to make plastics, petchem gases have to be
exported. Given their well-known advantage in feedstock costs, the Middle East
is in a position to outcompete any export region across the globe and undermine
the old cracker output in West-Europe, the United States or Japan. According to
the Eitzen Group (2009), Middle East ethylene exports increased from 500 k to
1.3 million tons in the period 2004–2008. On the import side, Chinese customs
trade data (available at www.chem.cn) show that China is ramping up imports
and increasing its share in total petrochemical imports from 13 to over 20 per
cent in the period 2004–2008.
Figure 7 provides an overview of the 2008 seaborne gas trade, split by
product and type of ship used. Apart from a few ships in clean petroleum
products, VLGCs are only transporting LPG, while NH3 is carried by smaller
vessels. The different petrochemicals are solely taken by semi-refrigerated and
pressurized gas ships, both of which are usually below 23 k Cbm. The biggest
problem encountered is the significant lack of data on petrochemical trades.
Many countries, especially those in the Middle East, do not collect sufficient
trade data or do not register them in orderly fashion. This makes it difficult to
follow the demand side of the market, let alone the requirement for shipping
services.
As in the LNG market, the freight element can represent a significant
share of the total product cost for LPG, NH3 or petchem transports, especially
when smaller ships are used and economies of scale disappear. Figure 8 relates
70
60
50
40
30
20
10
0
LPG NH3 Petchem products
VLGC LGC MGC Sub 23Cbm
Figure 7: Seaborne gas trade 2008 (Million tons).
30 %
25 %
20 %
15 %
10 %
5%
0%
jan.07 mai.07 sep.07 jan.08 mai.08 sep.08 jan.09 mai.09 sep.09 jan.10 mai.10
Baltic VLGC spot rate / FOB Middle East large propane
2k Pr spot rate East / FOB Middle East small propane
Figure 8: Proportion of spot rates to product prices 2007–2010 ($/ton).
Source: Bloomberg, Joachim Grieg & Co.
the spot rates of a small pressurized ship and a VLGC for a Middle East–Far East
voyage to their corresponding propane product prices. The cargo prices for
small and large tonnage are about equal, while freight rates decrease
considerably as a result of scale effects: VLGC spot rates averaged 33 $/ton
during 2007–2010 compared to 78 $/ton for the 2 k Pressurized ship. Evans and
Marlow (1990) indicate that the freight element is important with respect to
the difference between FOB and CFR pricing and possible profit opportunities.
The spot rates of VLGC gas carriers are more volatile (between 15 and 81$/ton
in the period 2007–2010) than spot rates in the smaller gas segment (between
60 and 100 $/ton for a 2 k pressurized ship) so that, besides larger volumes
involved, traders have more opportunities to exploit arbitrage by constantly
buying and selling LPG in the VLGC segment. Evans and Marlow (1990) also
point to the relevance of demand and supply elasticity with respect to product
prices. In the petrochemical market, LPG demand is price sensitive and com-
petes with naphtha so that minor price differences could swiftly trigger trading
opportunities.
In this respect, it is important to note that while freight rates are determined
on the free market, product prices often are not. In developing countries in
particular, LPG is often subsidized to render it affordable. India is a good
example showing that the more the government subsidizes LPG, the higher its
consumption rate (Argus LPG World, 2010). The successful ‘Kerosene to LPG
conversion program’ implemented by the government of Indonesia in

2007–2010 is another case that quickly led to increased LPG use (Kasih, 2010).
Hence, an analysis on production and consumption patterns does not always
suffice to determine whether the country will import or export. Energy policies
and changes in product prices are also factors that interfere with the competi-
tion of LPG vis-à-vis other energy substitutes. Demand for LPG and its
corresponding shipping requirements is less inelastic than in the dry cargo or
the LNG market.
Seaborne demand for NH3 is also to a certain degree inelastic. In the
aftermath of the financial crisis at the end of 2008 for instance, the industry was
struck by a sudden collapse in demand and global NH3 prices. US CFR Tampa
prices fell below 200 $/ton for several months which was below production
costs for many exporters across the world (see Table 3) putting a halt to US NH3
imports. The transport cost was proportionally too high so that NH3 was used
domestically for the downstream production of urea. If the same event were to
occur in the petrochemical segment, the product would analogously no longer
be shipped but be used in the local petrochemical plants as feedstock.
Supply of LPG, NH3 and petrochemicals
As Table 4 indicates, gas markets can be segmented in different ways, the most
common of which is to distinguish between the fully refrigerated and the small
petrochemical market. Fully refrigerated ships typically cool cargoes down to
around 48 degrees Celsius to transport, for example, propane in a liquefied
state. In the small segment, other techniques are used to liquefy cargo. Pres-
surized ships solely rely on high pressure whereas semi-refrigerated ships
employ a combination of refrigeration and pressurization techniques. Ethylene
ships are semi-refrigerated ships with the additional feature to transport ethylene/
ethane, requiring cooling temperatures to 104/82 degrees. The technical
Table 4: Fleet statistics gas markets – March 2009
Vessel type Size Cbm Type Pressure Fleet Mio Cbm Orderbook
Mio Cbm
VLGC 60–85 k Fully ref 0.5bar 11 1
LGC 50–60 k Fully ref 0.5bar 1.2 0.06
MGC 18–42 k Fully ref/Semi-ref 0.5/7.5 bar 1.2 0.7
Small 1–23 k Semi-ref 7.5 bar 2.2 0.4
Ethylene
Fully pressurized 18 bar
differences are the underlying basis for segmentation, for they are interwoven
with the loading or unloading capacity of the terminal. In recent times, how-
ever, the Handy segment (14–25 k Cbm) has sometimes been referred to as a
separate segment disregarding the technical vessel particulars. Given that this is
one of several factors which complicate the segmentation of the 0–14 k Cbm and
the MGC (Medium gas carrier) segment, we stick to the traditional segmenta-
tion approach.
Unlike the LNG segment, the supply side of the market has matured and
has thus not been upscaled. There have hardly been additional reductions in
building costs through innovation. The reasons as to why the different products
are carried by different ship sizes/types is because the demand side, or the
receiving end, is – apart from technical restrictions – unable or not willing to
accommodate bigger shipments. One recent evolution in this market is the
shrinking of the illiquid LGC (Large gas carrier) fleet to less than 25 ships. An
LGC newbuilding has historically been 10 million $ more expensive than an
MGC but has obtained the same freight levels (see Figures 9 and 10). Also, an
MGC trades globally and is more versatile in terms of employment opportu-
nities. In addition there is the increased Just-in-Time focus of the market re-
quiring smaller intakes. Another evolution permeating the sector is the increase
in the average size in the small petrochemical segment on the back of larger
cracker sizes and output in the Middle East. The Oil and Gas Journal con-
struction survey shows that most of the new steam crackers in Iran, Qatar
and Saudi Arabia have a nameplate capacity of above 1 million tons, while
1400
1200
1000
800
600
400
200
0
jan. 96 jan. 98 jan. 00 jan. 02 jan. 04 jan. 06 jan. 08 jan. 10
VLGC LGC MGC 35k 15k Sr 3.5k Pr
Figure 9: Twelve-month time charter rates 1996–2010 (1000 $/month).

Source: Lorentzen & Stemoco, Joachim Grieg & Co.
180
160
140
120
100
80
60
40
20
0
1980-01 1984-01 1988-01 1992-01 1996-01 2000-01 2004-01 2008-01
VLCC 320k Cape 180K Cont 6.5k TEU
VLGC LGC MGC
Figure 10: Newbuilding prices 1980–2010 (Million $).
Source: Joachim Grieg & Co, Clarkson (www.clarksons.net).
traditional cracker sizes vary between 0 and 800 k ton (Nakamura, 2009). This
scale increase adds to the further establishment of the Handy segment, with
freight rates of small MGCs and large semi-refrigerated carriers increasingly
concerting (see Figure 7).
Ownership patterns in the gas markets show similarities with the tanker
markets. State ownership has decreased over time and many players are
incumbents with an operational focus enabling them to remain in the business.
In 2009, 13 per cent or 18 out of the 140 VLGCs were publicly owned. LPG
traders and oil companies have an important stake in the LPG market, often
holding some capacity in house. In 2009 for example, the traders and oil
companies controlled 18 per cent of the total VLGC market via long-term
contracts. Unlike the tanker or dry bulk markets, however, typical asset players
do not exist in the gas markets mostly because of a lack of liquidity. There are
simply not enough transactions done to engage in asset play. In 2009, only
about 30 public Sale and Purchase transactions were done in the gas markets,
out of which four in the VLGC market.
The issue of ownership and market power is often scrutinized in combi-
nation with the typical traditional industry practice of pools. In all three
segments, the use of pools was a dominant strategy to increase market share or
to improve the efficiency of the combined fleet. In 2003 for instance, the LGC
pool consisting of Bergesen (previous name of BW Gas) and Solvang controlled
70 per cent of that segment. In the light of the formal adoption, on 1 July 2008,
of the ‘Guidelines on the application of Article 81 EC to maritime transport
services’, much more stringent procedures exist to establish pools or other
forms of cooperative agreements. The Commission inspects each pool on a
case-by-case basis and pools are forbidden should they restrict competition, or
to the extent that the efficiency gains of the pool, for the community, outweigh
its restrictive effects. In the latter case, it is the responsibility of the pool
members to motivate the efficiency defence and prove that it is in the interests
of society that the pool is formed. It is intuitively comprehensible that this
legislation rendered it more difficult for the larger pools to fulfil the conditions
for exemption from competition law. It is in that respect, for example, that the
longstanding and reputed pools in the VLGC, LGC and MGC segments
were abolished in 2008, and that a new wave of entrants emerged. For the first
time, Eletson Shipping and Prime Marine entered the gas segment with two
MGC newbuildings each delivered in 2009. Two additional MGCs will be
delivered in 2011 for Prime Marine, while one additional MGC is expected in
2012 for Eletson Shipping.
Efficiency and market clearing
A widely used segmentation in the industry is to distinguish between the VLGC,

the LGC/MGC and the small petrochemical segment. As the main driver for the
total gas market is basically world economic growth, and correspondingly crude
production (VLGC), fertilizer demand (LGC/MGC) and demand for consumer
goods (small gas), it is not surprising that freight rates are to a certain extent
correlated. Figure 9 conversely shows that rates across the respective segments
can for longer periods move differently, which is caused by a lack of spill-over
effects or interdependence between markets.
It is striking that VLGCs earned less than LGC/MGCs during the previous
recessions, which was entirely because of the NH3 market outperforming the
LPG market. It is not straightforward to engage VLGCs in buoyant NH3 trades
because of charterer preferences and parcel size demand which indicates that
these markets should not be examined in an integrated manner. Engelen et al
(2006; 2009) formally demonstrated that in dry bulk shipping, freight rates
across ship segments are highly correlated because of the intrinsic arbitrage
behaviour in the market. There is enough demand substitution present in the
market to enable a Panamax to transport cargoes from a Handy and vice versa.
Arbitrage opportunities arising between ship segments are also investigated in
Beenstock and Vergottis (1993), Strandenes (1999) and Alizadeh (2001).
The consequence of strictly differentiated segments is that markets become
rather small with the risk of becoming illiquid. In the VLGC market, a separate
spot market exists with the daily published benchmark rate Ras Tanura – Chiba
referred to as the Baltic Gas Index. There has been considerable criticism in
the industry on the daily stipulation of this rate, as this is the only rate used and
applied to compute rates on other routes. The geographic premium or discount
added is difficult to substantiate (Adland et al, 2008; Engelen et al, 2010).
Hence, it is effectively the number of ships open in Ras Tanura that determines
the Baltic rate (and the rates in the entire market) explaining why volatile spot
rates historically fluctuate between 15 and 83 $/ton.
Figure 9 demonstrates that the LGC and MGC segment have approximately
been earning the same money which justifies treating them together. Both ship
types tend to be equally employed in the NH3 and LPG trades. This segment has
for a long time been dominated by pools and a few big shipowners cooperating
with the oil companies or key fertilizer companies under period contracts. In
2009 for example, BW Gas and Yara shared common interests in 6 MGCs and
2 LGCs via ownership structures and long-term contracts. There has basically
not been a common public spot market. Twelve-month time charter rates are
the only rates published. Following regulatory developments regarding pools,
and new players emerging, the segment is expected to become more transparent
with possibly a spot market emerging that would in turn improve the allocative
efficiency of the market.
The petrochemical market is a difficult market to monitor, as significant
data are lacking on the demand side, which is an important requirement in the
examination of market efficiency (Evans, 1994). The small segment is also the
most bifurcated segment in terms of freight rates. Basically, a pallet of different
rates coexists, varying with size and type of ship. The lack of (public) fixtures or
contracts renders it difficult to assess market conditions. Admittedly, freight
rates are highly correlated and have proved relatively stable over time as the
3.5 k Pr time charter rate visualizes in Figure 9. Just as in the LGC/MGC
segment, there is no benchmark spot rate in the small segment, explaining the
use of 12-month time charter rates as a reference. The drawback is that time
charter contracts contain more information than current market fundamentals
and also embody expectations or tailor-made contract stipulations (for example,
redelivery clauses), and often vary in duration. Spot rates, by contrast, truly
encapsulate demand and supply dynamics and better conform to the law of one
competitive price.
Because of the above elements, opinion in the industry is divided on how
to segment the small gas market, be it based on size, type or even product
(for example, the so-called ethylene market only to be serviced by dedicated
ethylene carriers). Often, a different approach is inspired by the business
the company (for example, shipowner, broker, bank) is engaged in, which is
however irrelevant at market level. Both semi-refrigerated and pressurized
ships, for instance, transport LPG, corroborating that a separate approach

would be a misspecification. Per definition, a separate segmentation can only
be defended insofar as the segment is governed by distinct supply/demand
dynamics and a unique freight rate path. As this is difficult to discern in
practice, the presence of different beliefs on market segmentation is expounded.
As explained earlier, the proliferation of the Handy segment provides a good
example by grouping small MGCs and the larger small gas ships as one market.
In practice however, we still find that technical differences in ships are
significant, supporting our traditional segmentation between MGCs and the
other small gas types such as Semi-refs. MGCs are fully refrigerated ships that
often load, transport and unload cargo in the same cooled down temperature.
Semi-ref ships on the other hand have the flexibility of loading, transporting and
unloading cargo at different temperatures and at ports (often in Latin-America
and the Mediterranean) and terminals inaccessible to fully refs. The remaining
efficiency conditions will be analysed in combination with an examination of
the other ship markets.
The Newbuilding, Second-hand and Scrap Market
As mentioned earlier, the gas markets are much smaller than the tanker, the dry
or the container markets. Market size is important with respect to the formation
of prices, as the shipbuilding and demolition markets are considered integrated
markets. The construction of gas carriers represents only a small part (8.5 per
cent on average in the period 2000–2009 measured in compensated gross
tonnage, 7 per cent of which on account of LNG carriers) in the total
shipbuilding market (MSI, 2010). Although gas carriers are built by a few
specialized and reputed yards, notably in Korea and Japan, there are enough
substitution opportunities for these yards to build other types of ships. Given
the cyclical nature of shipping, yards have proved extremely flexible in building
ships the market desires. They are logically required to do so, as the market is
order driven (Dikos, 2004). Hence, the price of a gas carrier largely depends on
the contracting as well as on the prices of other types of ships as Figure 10
indicates. Even when gas contracting is non-existent, newbuilding prices of gas
ships can soar on the back of strong momentum in tanker and dry ordering.
This event was evidenced in the contracting boom for tanker and dry ships in
the period 2006–2008, rendering the market in a sense inefficient as the reverse
cannot happen because of the small size of the gas market.
Owners have often been in the position of contracting an LPG carrier
without being able to do so because freight earnings did not suffice to repay the
expensive newbuilding price. This has resulted in many shipping companies
cross-subsidizing the gas segment with cash earned in other freight markets (for
example, BW Gas was able to curb the negative results of their fully ref fleet in
2008–2009 thanks to the profitable long-term LNG contracts), in turn demon-
strating that the exit of companies was limited. As a consequence, utilization
levels in the gas freight markets are lower than in the more liquid and com-
petitive markets of tank and dry ships. By analysing the employment figures of
the Eitzen Group (2009), it seems that their small gas fleet has historically been
operating at around 70–90 per cent utilization which is far lower than their dry
cargo ships which perform mostly at above 85 per cent utilization. The intrinsic
oversupply in the gas market largely precludes the opportunity of going through
a peak freight period in the longer run. Period rates are therefore relatively
stable as Figure 9 confirms.
The same rationale holds for the integrated scrap market where gas
ships also account for a negligible share. The low share is also substantiated
by the fact that the small gas shipping industry is about 30 years old and
therefore has still to reach its first scrapping cycle in the period 2010–2015. In
2009, no LNG carriers were scrapped while 15 LPG carriers were scrapped
totalling 620 k dwt. The dry and the tanker segment in contrast saw demolition
increasing to each 10.5 million dwt. This means that even substantial scrapping
of gas ships will hardly influence global scrap prices. Conversely this fact is
not particularly relevant given that, just as in any other shipping market,
owners do not scrap ships as a source of income. Rather, the scrapping
decision is predominantly inspired by lack of employment opportunities or
age restrictions and not by the scrapping price as such. The collapse in the
NH3 markets, for instance, facilitated the decision to scrap 25 per cent of
the LGC fleet or six LGCs in 2009, most of them around 30 years old. The
differences in demolition income because of adverse prices are undoubtedly
negligible in relation to ship earnings on the freight and asset markets
(Strandenes, 2002).
The second-hand market is an auxiliary market that alters ownership pat-
terns and is a special case in the gas markets. In the maritime literature, there is
consensus on the fact that second-hand values for standard ships are largely
shaped by freight earnings (Alizadeh, 2001). Newbuilding and second-hand
prices are highly correlated because of substitution effects and evident market
forces at work. Higher earnings will propel higher second-hand prices at the
same time that increased contracting will boost newbuilding values. This logic
is more difficult to apply in the gas market.
As already mentioned, the gas market is too small to impact on new-
building prices, even with high contracting. Newbuilding prices are rather
determined on the global market as a result of yard utilization levels and overall
contracting levels. Freight earnings however are entirely determined in the gas
freight market itself. Applying asset pricing theory (Fama, 1970) would allow
for significant price differences between gas newbuilding and second-hand
prices, which is impossible for substitutes. Any price difference would create
arbitrage opportunities and owners would engage in the cheapest solution.
Arbitrage behaviour however does not occur frequently in the gas market as
there is no liquid second-hand market as such. It is then virtually impossible for
the market to balance the newbuilding market with the freight market through
the auxiliary second-hand market.
To overcome this issue, second-hand ships cannot simply be given a price
based on earnings but have to be valued differently. If the few sale transactions
are scrutinized, it appears that second-hand values are often roughly stipulated
as a depreciated fraction of newbuilding values. For instance the 2009 sale of
the Althea Gas (2003 built, 82 k Cbm) from I.S. Carriers to Stolt Gas for
$55 million reflected exactly her depreciated newbuilding value. This manner of
pricing ships adds to the illiquidity in the market apart from the previous
mentioned reasons of size and industry structure. Hence, the strong correlation
between earnings and second-hand values is not confirmed in the gas markets,
but only holds in the liquid and larger merchant markets (Adland and Koeke-
bakker, 2004).
It is obvious that the above industry practices strongly affect the free entry
and exit market conditions (Bain, 1956). Entering the market is difficult as there
is no established second-hand market. Access to the market is often done by
co-investing with an incumbent or by bareboat-agreements, in which the ship
is chartered long term. Exit is difficult as purchase candidates will often be
inclined to go for newbuildings if the second-hand price is not largely
discounted (for example, Prime Marine and Eletson Shipping entering the gas
segment by contracting newbuildings in 2009). This strategy follows from the
proportional pricing of second-hands vis-à-vis newbuildings.
Concluding Remarks
It is striking that in the academic literature, efficiency results on shipping

markets are often limited to analysing the freight market as such without
examining the product side of the market. Often, however, the freight rate is
integrated in the product price when certain Incoterms (for example, CFR) are
used. This practice applies especially to industrial markets such as the LNG
market in which long-term freight contracts are done on the back of typical
supply agreements and in which shipping companies constitute only a small
part in the logistics chain. In order to analyse the competitive nature of the (gas)
shipping markets, one needs to take an integrated approach and consider the
freight rate mechanism in a larger context.
The analysis shows that the LNG markets, as well as the LPG, ammonia and
petrochemical ones, are transforming and evolving to a more competitive
setting. In the LNG market, operational efficiency can be increased significantly
with sellers taking a more thorough stance towards contracting tonnage on the
back of product supply. More flexible contracts will be used in a market with
more dispersed sellers and buyers. The LPG, ammonia and petrochemical gas
markets are slowly becoming more competitive thanks to increased size and
the regulatory developments regarding pools. Better market information and the
establishment of a common spot market would improve the allocative efficiency
of the market.
The lack of liquidity in the gas markets is inherent in the industry structure:
the markets are small with still an insufficient number of market players,
combined with the absence of an auxiliary second-hand market that can quickly
redistribute ownership. In all markets discussed, the price-taking assumption
holds, which is often the most reconciled condition for efficient markets.
Acknowledgement
The authors are grateful to the LNG analyst Anders Wadahl (Lorentzen &
Stemoco) for his valued comments and suggestions that helped improve the
presentation of the article.
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POLICY PERSPECTIVES

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Policy Perspectives

Transformations in gas shipping: Market

A b s t r a c t This article aims to improve understanding of the gas shipping markets

Maritime Economics & Logistics (2010) 12, 295–325. doi:10.1057/mel.2010.10

Keywords: market efficiency; gas markets; LNG; LPG; ammonia; petrochemical

The LNG Market

Figure 1: Evolving LNG market dynamics.

has obtained independent status. As part of the global trend of privatization

K Exploration and production (0.5–1 $/MMbtu)

Fuel name Gram CO2/106Joule Mgram SO2/106Joulea

(2009) therefore consider these supply agreements as an example of Cournot

chartered in for a specific project to remain idle. A welcome development came in

Table 2: LNG fleet statistics – March 2009

Vessel type Size Cbm Propulsion system Fleet Mio Orderbook

All vessels are pressurized at 0.25 bar.

uncommitted shipping capacity into upstream projects to lock-in high margin

Efficiency and market clearing

It is not straightforward to evaluate the efficient market hypothesis as the LNG

Figure 5: LNG prices 2000–2009 ($/MMBTU).

a basic component in the production of mineral fertilizers such as urea, nitrates

Demand for LPG, NH3 and petrochemicals

Table 3: Cash costs NH3 supply 2006–2009 ($/ton)

Pricing region 2006 2007 2008 2009

Source: Fertecon (2009).

conversion program’ implemented by the government of Indonesia in

Supply of LPG, NH3 and petrochemicals

Table 4: Fleet statistics gas markets – March 2009

Source: Lorentzen & Stemoco.

Figure 9: Twelve-month time charter rates 1996–2010 (1000 $/month).

Efficiency and market clearing

A widely used segmentation in the industry is to distinguish between the VLGC,

ships, for instance, transport LPG, corroborating that a separate approach

The Newbuilding, Second-hand and Scrap Market

It is striking that in the academic literature, efficiency results on shipping

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