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Fuel Efficiency & Ship Finance

Sokje Lee82 2 3774 1781sokje@miraeasset.com

June 2011

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Ship investment yields are determined by fuel efficiency

How to hedge the downside risks?

Fuel efficiency will wage a bigger power going forward

Positive long-term outlook

Key points

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Fuel efficiency became everything

Bunker price trends (Singapore 380CST bulker, USD/ton) vs. average ship earnings (USD/day)

Source: Clarksons

• 1990-2000 avg. bunker price at USD90/ton vs. current price at US$650/ton• Growing focus on fuel efficiency, as fuel costs amounted to 17-19% of revenue in 2010• In 2011E, the fuel cost is expected to reach 25% of revenue

0

100

200

300

400

500

600

700

800

Jan-

90Au

g-90

Mar-9

1Se

p-91

Apr-9

2No

v-92

Jun-

93Ja

n-94

Aug-

94Ma

r-95

Oct-9

5Ma

y-96

Nov-9

6Ju

n-97

Jan-

98Au

g-98

Mar-9

9Oc

t-99

May-0

0De

c-00

Jul-0

1Fe

b-02

Aug-

02Ma

r-03

Oct-0

3Ma

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06Se

p-06

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7No

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8De

c-08

Jul-0

9Fe

b-10

Sep-

10

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10,000

20,000

30,000

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50,000

60,000

Bunker price (USD/ton) Ship earnings per day (USD/day, RHS)

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Discounted Cash Flow Analysis of Ship Investment• Main purpose: peer comparison rather than assessment of each ship investments• Base case: expected IRR of 8.08 (3.075% 10 year treasury rate + 5.0% equity

premium)• Initial investment of US$100mn, 80tons/day fuel consumption

AssumptionsVessel price (US$m) 100 * Freight earnings are fixed throughout life time at USD36.8mn a yearBunker price (US$/ ton) 700 * Owner with lower efficiency should assume bigger bunker costs and less profitAvg. daily consumption of bunker (ton/ day) 80 * Bunker consumption of 80tons/ day (laden: 90tons/ day, ballast: 70tons/ day) Annual increase of bunker consumption 0.5% * Risk free rates = 3.075% (based on 10 year US treasury bond) plus equity risk premium: 5.0%Years of depreciation 20 * Depreciation period: 20 yearsInflation rates 3.0% * Yearly Annual increase of revenue 0.0%

ScrapYear to Dec. (US$m) Year 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 valueFreight earnings 36.8 36.8 36.8 36.8 36.8 36.8 36.8 36.8 36.8 36.8 36.8 36.8 36.8 36.8 36.8 36.8 36.8 36.8 36.8 36.8 36.8 36.8 36.8 36.8 36.8

- Bunker costs 14.0 14.1 14.1 14.2 14.3 14.4 14.4 14.5 14.6 14.6 14.7 14.8 14.9 14.9 15.0 15.1 15.2 15.2 15.3 15.4 15.5 15.5 15.6 15.7 15.8 daily consumption of bunker (tons) 80.0 80.4 80.8 81.2 81.6 82.0 82.4 82.8 83.3 83.7 84.1 84.5 84.9 85.4 85.8 86.2 86.6 87.1 87.5 88.0 88.4 88.8 89.3 89.7 90.2 - Diesel costs 2.3 2.3 2.4 2.4 2.4 2.4 2.4 2.4 2.4 2.4 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.6 2.6 2.6 2.6 2.6 2.6 2.6 - Other costs (ports and others) 5.0 5.2 5.3 5.5 5.6 5.8 6.0 6.1 6.3 6.5 6.7 6.9 7.1 7.3 7.6 7.8 8.0 8.3 8.5 8.8 9.0 9.3 9.6 9.9 10.2 - Depreciation 5.0 5.0 5.0 5.0 5.0 5.0 5.0 5.0 5.0 5.0 5.0 5.0 5.0 5.0 5.0 5.0 5.0 5.0 5.0 5.0 - Operating costs 3.5 3.6 3.7 3.8 3.9 4.1 4.2 4.3 4.4 4.6 4.7 4.8 5.0 5.1 5.3 5.5 5.6 5.8 6.0 6.1 6.3 6.5 6.7 6.9 7.1Operating income (EBIT) 9.3 9.0 8.7 8.3 8.0 7.6 7.3 6.9 6.5 6.1 5.7 5.3 4.9 4.4 4.0 3.5 3.0 2.5 2.0 1.5 6.0 5.5 4.9 4.4 3.8Depreciation 5.0 5.0 5.0 5.0 5.0 5.0 5.0 5.0 5.0 5.0 5.0 5.0 5.0 5.0 5.0 5.0 5.0 5.0 5.0 5.0Gross cashflow 14.3 14.0 13.7 13.3 13.0 12.6 12.3 11.9 11.5 11.1 10.7 10.3 9.9 9.4 9.0 8.5 8.0 7.5 7.0 6.5 6.0 5.5 4.9 4.4 3.8

Net CAPEX (maintenance, drydocking and others) 100.0 1.5 1.5 1.5 1.5 3.0 1.5 1.5 1.5 1.5 5.0 1.5 1.5 1.5 1.5 7.0 1.5 1.5 1.5 1.5 7.0 1.5 1.5 1.5 1.5 1.5

Free Cashflow (100.0) 12.8 12.5 12.2 11.8 10.0 11.1 10.8 10.4 10.0 6.1 9.2 8.8 8.4 7.9 2.0 7.0 6.5 6.0 5.5 (0.5) 4.5 4.0 3.4 2.9 2.3 20.0

No. of years remained 0.0 1.0 2.0 3.0 4.0 5.0 6.0 7.0 8.0 9.0 10.0 11.0 12.0 13.0 14.0 15.0 16.0 17.0 18.0 19.0 20.0 21.0 22.0 23.0 24.0 25.0 26.0WACC (%) 8.1% 8.1% 8.1% 8.1% 8.1% 8.1% 8.1% 8.1% 8.1% 8.1% 8.1% 8.1% 8.1% 8.1% 8.1% 8.1% 8.1% 8.1% 8.1% 8.1% 8.1% 8.1% 8.1% 8.1% 8.1% 8.1%Discounting Factor 1.1 1.2 1.3 1.4 1.5 1.6 1.7 1.9 2.0 2.2 2.3 2.5 2.7 3.0 3.2 3.5 3.7 4.0 4.4 4.7 5.1 5.5 6.0 6.4 7.0 7.5PV of FCFF (100.0) 11.9 10.7 9.6 8.7 6.8 7.0 6.2 5.6 5.0 2.8 3.9 3.5 3.0 2.7 0.6 2.0 1.7 1.5 1.3 (0.1) 0.9 0.7 0.6 0.4 0.3 2.7

Discounted NPV Value 0

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Fuel Efficiency Dictates Ship Yields• 10% less fuel efficiency implies 2.4%pt less IRR• 10% better fuel efficiency implies 2.1%pt extra IRR

Ship Investment IRR depending on fuel efficiency

Source: Mirae Asset Securities

2.92%

4.38%

5.70%

6.93%8.08%

9.16%10.20%

11.19%12.15%

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

12.0%

14.0%

20% 15% 10% 5% Base case -5% -10% -15% -20%Saving of fuel consumption byExtra fuel consumptions by

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To Compensate for IRR…• With 10% less efficiency from shipbuilder, ship owners can ask 15.5% discounted

price• Shipbuilders, with superior fuel efficiency to average, can ask premium over

market price, up to 15.5% (US$15.5m in our analysis)

Compensation/premium of ship prices according to fuel efficiency

Source: Mirae Asset Securities

Bunker price (US$/ ton)

500 550 600 650 700 750 800 850 900

68.0 -15% 60.8 51.4 42.0 32.6 23.2 13.8 4.4 (5.0) (14.4)

72.0 -10% 55.3 45.3 35.4 25.4 15.5 5.5 (4.4) (14.4) (24.3)

Daily consumption 76.0 -5% 49.7 39.2 28.7 18.2 7.7 (2.8) (13.3) (23.8) (34.3)

bunker 80.0 Base 44.2 33.2 22.1 11.1 0.0 (11.1) (22.1) (33.2) (44.2)

(ton/day, %) 84.0 5% 38.7 27.1 15.5 3.9 (7.7) (19.3) (31.0) (42.6) (54.2)

88.0 10% 33.2 21.0 8.8 (3.3) (15.5) (27.6) (39.8) (52.0) (64.1)

92.0 15% 27.6 14.9 2.2 (10.5) (23.2) (35.9) (48.6) (61.4) (74.1)

96.0 20% 22.1 8.8 (4.4) (17.7) (31.0) (44.2) (57.5) (70.8) (84.0)

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Bigger Gap is the Secondhand Market• 10% gap in fuel efficiency will result in 18.8% gap in secondhand vessel prices• For a 5 year old vessel, the contraction of ship value is estimated at 37% for 10%

less efficient vessel (23% for average)

The gap in 5-year secondhand vessel prices (base = USD77mn)

Source: Mirae Asset Securities

Bunker price (US$/ ton)

500 550 600 650 700 750 800 850 900

68.0 -15% 73.9% 62.5% 51.1% 39.7% 28.2% 16.8% 5.4% -6.0% -17.5%

72.0 -10% 67.2% 55.1% 43.0% 30.9% 18.8% 6.7% -5.4% -17.5% -29.6%

Daily consumption 76.0 -5% 60.5% 47.7% 35.0% 22.2% 9.4% -3.4% -16.1% -28.9% -41.7%

bunker 80.0 Base 53.8% 40.3% 26.9% 13.4% 0.0% -13.4% -26.9% -40.3% -53.8%

(ton/day, %) 84.0 5% 47.1% 32.9% 18.8% 4.7% -9.4% -23.5% -37.6% -51.8% -65.9%

88.0 10% 40.3% 25.5% 10.8% -4.0% -18.8% -33.6% -48.4% -63.2% -78.0%

92.0 15% 33.6% 18.1% 2.7% -12.8% -28.2% -43.7% -59.2% -74.6% -90.1%

96.0 20% 26.9% 10.8% -5.4% -21.5% -37.6% -53.8% -69.9% -86.0% -102.2%

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Projection of Secondhand Vessel Prices

Secondhand vessel price projection according to fuel efficiency (US$m, from US$100m new builds)

Source: Mirae Asset Securities

• Secondhand vessel prices of less fuel efficient vessel is expected to have sharper contraction of price

91.7

68.8

48.9

84.4

62.4

43.7

77.1

55.9

38.6

69.9

49.5

33.4

62.6

43.0

28.3

0102030405060708090

100

5 year 10 year 15 year

72 76 Base case (80 tons/day) 84 88

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To Hedge the Downside Risks… (for ship finance)• Energy Efficiency Design Index (EEDI) will be a key investment decision

tool• Proper spread should be levied on new ship finance

(eg. 350bp spread for 5 year loan)

To Hedge the Downside Risks… (for ship owners)• Energy Efficiency Design Index (EEDI) will be a key investment decision

tool• Ask for a price discount for less fuel efficient vessels• Secure new and fuel efficient vessels

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To be Considered… 1. Market Based Measure• Market Based Measures (MBM) by IMO probably from 2018 or 2019• SOx and NOx emission regulations• Potential further hikes of oil prices

GHG funds: Market-based measures

Source: IMO, MEPC 59/INF.10

All ship

s

Carbon tax per bunker GHG

fund

Incentives Efficient

ships

e.g. US$700/ton bunker price + US$100/ton carbon tax = US$800/ton

USD200/ton incentives to fuel efficient vessels

Realized bunker prices: US$600/ton vs. US$800/ton

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To be Considered… 2. EEDI

Development of required EEDI

Source: IMO, MEPC 59/INF.10

New shipbuilding process

Source: IMO, MEPC 59/INF.10

1.01.52.02.53.03.54.04.55.05.56.0

50,000 150,000 250,000 350,000DWT

gram per ton per nm

Orignal baselineEEDI

verificationDesign

Construction

Test

Delivery

EEDIverification

Contract

Classification society

• Starting from 2015, new building contracts are subject to required EEDI verified from 3rd party(10%, 20% and 35% reductions in 2015, 2020, and 2025)

• Two risks for ship owners: 1. timely delivery, and 2. competition against new & efficient vessels

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To be Considered… 3. Favorable Long-term Demand

• Slow steaming is the first step to reduce CO2

• 10% reduction of ship speed implies 9~10% contraction of ship supply

• New ship demand comes to transport same amount of cargo

• Vessels over 20 years old amount to 30% of global fleet (42~43% for over 15 years)

• Relatively big investment required to improve efficiency of old ships

• Best solution is scrap

Contraction of ship supply Scrap of old vessels

Big replacement & new demand is coming

Global shipbuilding order book is only 30% of global fleet

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To be Considered… 4. Massive Restructuring• 2/3 of global yards has no orders for the past two years• Most 2nd and 3rd tiers are actually going under • No more new player thanks to EEDI regulations !!!

The number of yards with new building contracts is shrinking fast

Source: Clarksons, Mirae Asset Securities

405380

190162

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2007 2008 2009 20100

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No of yards with any contracts (yards, RHS) No. of ship contracted (vessels, LHS)