Thanks to favorable global market conditions, Russian shipping companies have replaced their aging fleets and become leaders in transporting oil from the Persian Gulf to the US. Yet to weather the approaching storm, they will have to turn back to the Russian market.

Alexei Khazbiev

Full steam ahead

The marine shipping industry is experiencing an unexpected upswing. Over the last fifteen years the amount of freight shipped by sea has grown one and a half times to 5.7 billion tons. In monetary terms, world sea trade exceeds $4.5 trillion. Few observers doubt that in another 5-6 years, the market will break five trillion. The war in Iraq and China’s rapid growth and increasing demand for raw inputs has tripled freight rates in the shipping industry. The margins of major shipping companies soared to an astounding 200% last autumn. The likes of this increase have not been seen since the Suez Canal Crisis of 1956 and the Six-Day War of 1967. Yet shipments have been unaffected. Even with the jump in prices, it is still very profitable to ship freight by sea. For this reason, it is not surprising that more than 80% of the world’s cargo is shipped by sea. In Russia, this figure is slightly lower. Only two thirds of Russian trade is based on sea shipments. Yet while the lion’s share of export and import shipments are controlled by local shipping companies in the West, this business in Russia is practically under foreign control.

On the open sea

Last year, Russian ports dealt with more than 270 million tons of freight. This year, this figure has already risen to 350 million, or around $6.5 billion in monetary terms. However, almost all of this money goes into the pockets of Western shipping companies. Presently, foreign shipping companies conduct more than 70% of Russia’s export sea trade. Only fifteen years ago, the situation was just the opposite. Russian ships carried 80% of export shipments, and the industry earned $2-2.5 billion a year.

After the collapse of the Soviet Union, the situation changed completely. According to Vyacheslav Rukshi, Director of the Federal Agency for Sea and River Transport, “in the early 1990s, cargo shipping related to imports and exports collapsed.” As a result, industry was thrown off balance. “At first there was a lot of cargo and a lot of ships, but then the cargo disappeared and the ships remained,” Ruksha explains. These conditions forced Russian shipping companies to look abroad. Thus, Sovkomflot, which owns 44 ships with a total deadweight of 3.2 million tons, focused on transporting oil from the Persian Gulf to the US. Sovkomflot’s main competitor, Novorossiisk Sea Shipping or Novoship, is taking the same approach. Novoship has a fleet of 59 ships with a total deadweight of 3.4 million tons and has leased almost most all of its tankers to Shell and BP-Amoco. The owner of the third largest tanker fleet in Russia, Primorsky Sea Shipping, prefers to work with ChevronTexaco. Primorksy not only leases its ships out to the Americans, but also operates on Asian and African markets.

An inconvenient flag

Russia’s terrible tax policies have forced almost all shipping companies to fly other flags and move their fleets into offshores. Now, all of Sovkomflot’s fleet, 39 Novoship tankers, and the better part of Primorsky’s ships fly the flags of Cyprus, Malta, Liberia, or Panama. The only Russian company still flying the Russian flag is Far Eastern Shipping. Far Eastern pays a high price for its patriotism. Chairman of the Board at the Industrial Investors Group Sergei Generalov stated that it means $20 million fewer earnings a year for his companies.

According to the Director of Brunswick UBS Dmitri Vinogradov, shipping companies operating under the Russian flag are obligated by law to pay 24% in profit tax when their competitors registered in offshores pay no profit tax at all. Instead, they pay a minimal registration duty. In addition, all cargo shipments under the Russian flag, including exports, are subject to VAT. Taxes require companies to have double the cash on hand compared to offshore businesses. But that’s not all. Shipping companies flying the Russian flag have practically zero chance of expanding their fleet inexpensively, as any newly purchased ship is also subject to VAT.

The mass exodus of Russian shipping companies into offshores has cut the total deadweight registered in Russia in half in just twelve years, from ten to five million tons. Meanwhile, the offshore fleet registered to Russian shipping companies has grown dramatically. At present, more than 200 Russian ships are flying more “convenient” flags, to use the words of Mikhail Romanovsky, with a total deadweight of almost eight million tons.

Tax breaks and high prices have worked their magic. In the last five years, Russian shipping companies have not only secured a place for themselves among the world’s leading companies, they have outperformed market leaders in a number of areas. For example, Sovkomflot and Novoship, both among the top twenty tanker companies in the world, have some of the newest fleets in the industry. The average age of Sovkomflot’s ships is less than eight years, while Novoship’s average is less than eleven. The industry average, Intertanco reports, runs 13-14 years. Russian shipping companies are some of the most productive in the world and their programs to replace old vessels can be actively implemented. According to Tagir Izmailov, President of Novoship, in the next three years, shipyards in South Korea and Croatia will build sixteen tankers for the company. Yet a serious crisis looms ahead for the shipping industry. Are Russian companies ready?

To their native shores

A crisis is expected because by 2007 there will be 25% more tankers than market demand. According to Mikhail Ganelin, an expert at TsentrInvest Group, almost a thousand ships are currently under construction with a total deadweight of 90 million tons. They will bring about a rapid decline in prices for cargo shipments. Naturally, prices have already started to fall. While they fluctuated late last year around 340 points on the World Scale Index, by the middle of 2004 they had fallen to 240-250. Ganelin believes that by 2006 the World Scale Index will fall to 130, and it could go even lower after 2007. Russian companies will be able to maintain profits only by turning back to the Russian market.

Russian authorities have little faith in their ability to do so. For this reason, someone got the brilliant idea of merging Sovkomflot and Novoship. As Sergei Frank told Expert in an interview, the companies have already developed a merger plan. Of course, they can only merge after getting shareholder (read state) approval. Frank believes that uniting the companies will offer clients better terms, as the companies’ routes will be combined.

Frank further noted that a Sovkomflot-Novoship merger with yet a third shipping company would not make economic sense at the moment. Nonetheless, Far Eastern could join the new company in an alliance, as Far Eastern has a leading position on the container shipment market. In any case, Russian shipping companies will have to focus on Russian cargo. Many of them already understand this perfectly well. Frank explained that this would be a key point in Sovkomflot’s strategy in the coming years.

Last week, Sovkomflot signed a tripartite 20-year contract with Japanese company Nippon Yusen Kabashiki Kaisha (NYK) and the Sakhalin Energy Consortium to transport compressed natural gas from Sakhalin to North America’s West Coast. In addition, Sovkomflot is working with Gazprom to consider options for building a factory to produce compressed natural gas and a transfer terminal in Leningrad Province to supply Russian gas to the British market.

The owners of Far Eastern, whose business is based on Russian cargo and transfer shipments, plan to start expanding into the container market. According to Generalov, Far Eastern plans to set up a venture with Russian Railways (RZD) called Russkaya Troika, and a company called Neokont with Severstal Transportation. Starting in 2005, these companies will be able to provide “door-to-door” cargo shipping. Russia’s transportation system, in the opinion of container shipping companies, is still in its nascent state but the market for container shipments is growing by 25% each year. Thus, Far Eastern has every chance at success.

According to Brunswick UBS forecasts, Russian imports and exports will increase by at least 80% over the next seven years and most of this trade will be serviced by Russian shipping companies. Vinograd believes that Russian shipping companies will gain significant competitive advantages over foreigners by working on the Russian market. Long-term contracts for oil shipments are being signed left and right, and prices are determined based on the market prices for the previous year. Thus, if Russian shippers get moving, they should make excellent profits for the next several years and should be able to survive the coming crisis.

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