What about Fixed Price Long-Term Supply Contract for Oil?

Students of shipbuilding will be aware of the fact that as in most heavy industries, shipbuilding prices very rarely dip below variable costs. Variable costs for a shipbuilder are steel, equipment and direct labour hours, plus miscellaneous project related costs such as Refund Guarantees. Fixed costs are financial costs such as depreciation, overhead allocation and interest payments (or just “sunk costs” to put it bluntly). When the market is bad, the builder can choose to forego recovery of fixed costs, but they tend to refuse a project if it doesn’t even cover variable costs. There are some occasions where builders choose to undertake a project so the yard can be kept as a going-concern (labour redundancy has high costs too), particularly if there is hope of a rebound, but this suboperating cost experience won’t take place on sustainable basis so for our purposes such cases can practically be ignored. We maintain that variable costs form the natural bottom for newbuilding prices – it is the marginal cost of the shipbuilder.

On the contrary, prices for second hand vessels do not have to have anything to do with cost of construction or operation. It is decided strictly on a willing seller and willing buyer basis. Under cashflow pressure or in liquidation, when a seller can be more than willing, there is really no floor other than scrap value. There are costs associated with maintaining the asset (even for cold lay-up!), so the net value for an asset can even be negative if there is no productive deployment in sight (many buildings in Bangkok had negative value in the midst of the Asian financial crisis in 97).

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