Winston Churchill is credited with saying, “Those who fail to learn from history are doomed to repeat it.” The curious thing about shipping is that history’s lessons are learned and understood, but rarely followed.

IHS Fairplay is conducting a series of interviews with industry veterans to examine the lessons of the latest shipping cycle. Over the past few months, we’ve sat down with shipping registry partner Clay Maitland, executive Robert Bugbee, consultant Paul Slater, and restructuring specialist Randee Day – with many more interviews to come in 2017.

Regarding shipping’s inability to follow this famous dictum, Bugbee explained, “The lessons are always shown. They’re always the same lessons. It’s always the same syllabus. And yet the participants and capital providers just won’t learn.” Likewise, Maitland is convinced that “the same thing will happen all over again” in the cycle to come.

What does the past teach us? The central theme that emerged in conversations with industry veterans is: Beware investing when you see undisciplined behaviour by equity, debt, and management, which is almost always, and increase your exposure when you see discipline across all three categories, which is almost never.

For Slater, the bellwether of undisciplined shipping behaviour is the ordering and financing of newbuilds with no long-term charters attached, driven by faith that such vessels will earn high returns from spot trading and/or asset value appreciation.

“If I was to ask you to invest USD75 million in anything and the only income stream that was for sure lasted for three months, you’d think I was crazy,” said Slater. Nevertheless, this is exactly what shipping has done, repeatedly and on a large scale, most recently when private equity-backed entities piled up bulker and product tanker orders in 2010–13.

For Day, undisciplined management behaviour can be seen in the booking of ships on long-term contracts at rates that are clearly unsustainable, a practice laid bare by Hanjin charter defaults. “If owners had looked at any sort of historical standards, they would have seen that the rates were too high, they couldn’t be supported, and they were not sustainable – and these owners would never have ordered those ships in the first place if they had not been backed up upon delivery by these charters,” she asserted.

Day also pointed to undisciplined management behaviour at public companies that pay out all free cash flow via dividends. “If all your cash is going out every year [via dividends] and the market is lousy and you have a giant bullet payment due on your loan, you’re going to fall off a cliff,” she warned.

Maitland highlighted the lack of discipline at shipping banks, which “have a tendency to feed the beast, because they make money by lending money and the more money they lend, the more ships get built”, with individual bankers “feathering their own nests by lending to any cockamamie outfit you could imagine”.

On the equity side, Maitland cited the recurring appearance and ultimately destructive role of speculators, whom he described as “the cowboys, the riverboat gamblers, the guys from Las Vegas, the ones who believe ‘the streets will be paved with gold and we’re going to get rich’”.

Bugbee also emphasised undisciplined behaviour on the part of equity investors, citing the case of “shareholders with big positions in Scorpio Tankers who were funding start-ups ordering the very same ships they were investing in with Scorpio Tankers, for their own reasons”.

In each of these examples, the reason for the lack of discipline is that the allegedly undisciplined decision is actually believed by the individual decision-maker to be in his or her best financial interest, at least in the short term. In reality, it’s not a lack of discipline, it’s a conflict of interest. And that individual decision, in combination with all the other individual decisions that surround it, add up to a net result that is ultimately a negative for the broader market.
In other words, this is a textbook case of the famous economic theory called ‘the tragedy of the commons’, which refers to the failure of a shared-resource system due to individual participants acting in their own self-interest as opposed to the common good, depleting shared resources through collective decisions.

This also explains why ‘learn from history’ wisdom carries little weight in shipping. The reason is that lessons learned apply at the industry level, not necessarily at the individual decision-maker level.
This doesn’t mean that the lessons of shipping history are valueless. Far from it. The value in knowing these lessons is obtained from gauging the extent to which individual stakeholders ignore them, which provides an important indicator of where shipping is in the cycle, which in turn provides you with valuable information on how you should make your own business decisions.

Is shipping doomed to repeat its historical pattern ad infinitum? Not necessarily, but the cards remain stacked against change.

The tragedy of the commons theory is used to refer to situations in which government is better suited than the private sector to perform a certain task (examples include environmental regulation, public safety, and national defence). Because shipping is international in nature, individual governments have limited ability to counter shipping’s tragedy of the commons problem. But they are not entirely powerless. Recently instituted European Union banking restrictions have had a major impact on shipping by enforcing discipline among European banks, decreasing their ability to repeat past mistakes.

Beyond that, it comes down to a question of how commoditised shipping will remain. In a commoditised business, players compete on price, not uniqueness or brand. To the extent shipping remains commoditised, the only way to instil discipline on stakeholders is consolidation, a shift on the perfect-competition-to-monopoly spectrum towards monopoly. Bulk shipping has been largely resistant to consolidation, but Bugbee believes a combination of capital-access scale economies and advancing technology could finally make it happen.

Another way to enforce more discipline on shipping equity, debt, and management is for the industry to evolve away from commoditisation towards a non-commoditised model based on brand value and uniqueness. It is easy to replicate the business model of a commoditised business if you have enough money and if that industry is not too consolidated – which is exactly why shipping continually goes from boom to bust. In contrast, it is very difficult to replicate a successful business in a non-commoditised arena, regardless of your bankroll.

The only realistic path for bulk shipowners to become less commoditised is based upon much stronger, more integrated ties with cargo interests, a direction advocated by Slater. I believe the only way this will happen is if technology advances to the extent that a more integrated relationship makes sense for cargo interests, a change that seems likely to be years away.

Which leads to the next lesson: Monitor future trends towards consolidation and away from commoditisation. If both fail to materialise, expect no change in shipping’s historical pattern, and plan your business accordingly, by pulling back when market discipline vanishes and jumping back in if and when it reappears.