Away from the public eye, the modern business of ship piracy is rapidly acquiring professional attributes
Your fuel prices are about to go up some more, partly also because a bunch of ragtag bandits and pirates in and around Somalia along with their highly-qualified "negotiators" in respectable cities across the Western Europe and Central Asian world, are making a fine business out of one of the oldest professions known to humanity.
And while we are fed with images of rabble pointing guns at television cameras, the real "business" of modern ship piracy and ransoms is rapidly acquiring professional attributes, as always, done so very quietly away from the public eye.
However, to understand this article, you may want to first of all take out an atlas or a world map, and see how a very large ship carrying crude oil would typically go from the Persian Gulf to the East Coast of the USA. The ship, which would be anywhere in size from 300 through 500 thousand tonnes in carrying capacity, would exit the Persian Gulf, hug the coast of Africa, and then after rounding the Cape, strike out across the Atlantic towards its destination on the East Coast.
To understand this article even better, you have to comprehend what is a very large tanker ship of this size, in relation to other tankers ashore. The typical single-axle tanker truck with "Highly Inflammable" written across its rear would carry about 10 tonnes of cargo, so just imagine 30 to 50 thousand such trucks. A tanker train would typically carry about 1,500 tonnes of fuel as cargo, so just imagine about 200 to 333 such trains.
Now imagine all this plodding across the globe at 12 to 15 knots, which would be about 20 to 27 km/h, round the clock. The tanker would be about 330 to 400 metres long, 60 to 75 metres wide, and about 20 to 25 metres deep in the water. Much bigger than an average-sized mall.
So big, these tankers can be seen from outer space with the naked eye. So big, in fact, that the effect of the Earth's rotation around its own axis impacts the direction these ships take, the only manmade items that are impacted by this phenomenon, also known as the 'coriolis effect’. These ships have about 15-25 men onboard.
All of which can be taken over and hijacked by a few men in high-speed boats, carrying less weapons than seen outside the average 5-star hotel lately, and then held for ransom. Or as in the case of some other ships, the cargo can be unloaded, and the ship itself used as a ‘mother vessel’ to range further deep into the sea. As is so common now, at the entrance of the Red Sea, between Somalia and Yemen.
Look at that map again, closer to the Indian coast. Recent hijacks and piracy incidents have been reported very close to the Indian coast, as well as deep inside the Indian Ocean, over 1,500-1,750 km away from Somalia's coast. The result, however, is always the same—the vessel is commandeered, and a few days later, it anchors off some small port in the Horn of Africa, while "negotiations" commence through well-defined channels in Europe and Central Asia.
Of late, seafarers, in their attempt to get away from the piracy menace, are exiting the Persian Gulf in an easterly direction, then hugging the Indian coast till almost 75 degrees East, and only then setting course heading due South to turn in towards South Africa well after going below 20 degrees South, well below Mauritius.
And despite all this, the 320,000-tonne, Korean-controlled, Marshall Island-flagged, American-chartered, Iraqi cargo-carrying and Filipino-crewed motor tanker Samho Dream was hijacked a few days ago, and then taken to the coast off Somalia, where it now awaits negotiations, with a South Korean destroyer following at a safe distance.
To give perspective, a ship of this size is worth anything between $20 million-$100 million. The cargo would be worth between $150 million and $200 million. The refined fuel from this crude would keep all of USA's automobiles going for a bit under a day. In standalone terms, therefore, this is really not all that much of a game changer.
But as a catalyst, this has the portents of a radical change in the way costs will impact the final product, and in only one direction—upwards. Here are a few reasons why:
a) The increased attraction this piracy and ransom "business" has worldwide. Already, ships have been hijacked from the North Sea, Mediterranean Sea, West African/Nigerian Atlantic coasts, and increased piracy activity reports are surfacing from the South China Sea and Malacca Straits. Somali area piracy now accounts for just about 50% of world sea piracy incidents.
b) The increased cost of a potential environmental disaster. If a ship like the Samho Dream was to be blown up, then the environmental impact would cost anything from $8 billion and $20 billion, by a variety of estimates. That cost would be loaded on to future customers.
c) As it is, wages on such ships are amongst the highest in the business. Add to this the cost of providing security and higher wages, and you have a scenario which impacts prices by multiples. Plus, people simply don't want to work on piracy-prone routes anymore.
d) And finally, there is the automatic hoarding mentality that has rapidly taken over, as worried energy companies and refineries stockpile additional amounts of crude oil worldwide—fearing a major breakdown in this supply chain. This ties up ships as offshore storage, as well as onshore storage areas, and further notches up the charter rates for such large ships.
All this, happening on a coastline where traditional trade from the west coast of India has carried on for centuries. And now, these huge super tankers, in the category of ‘very large’ and ‘ultra large’, are sailing within Indian waters, to avoid piracy attacks further west.
There is a major issue brewing. For those who have seen the wreck of the ship lying outside Otter's Club in Bandra (a Mumbai suburb), or the one off Aguada in Goa, the Samho Dream would be about 20-30 times as big. And loaded with crude oil.
And what is governance in India doing about this, then?
The definition of corporate governance is relative, depending on the situation, and who is talking about it and where
Investors, economists and financial analysts assume that the deluge of corporate information is accurate. It is the basis of their decisions, their forecasts and their analysis. But is this correct? Are managers actually acting in the best interest of their shareholders and providing accurate information?
Amid the financial carnage of the recent recession, many countries are considering financial reform. In the United States Senate, a new Bill has just been introduced and is under debate. Even emerging markets have introduced reforms. For example, in Bahrain, a code of corporate governance has not yet been implemented, but may be close to being finalised. In the UAE, the Ministerial Resolution No (518) of 2009 Concerning Governance Rules and Corporate Discipline Standards (Rules) has been introduced and will become effective at the end of April.
To determine what these Bills are supposed to do and the probability of their success, it is wise to look at the concept of corporate governance. Corporate governance is one of those phrases like ‘rule of law’. Its definition is relative depending on the situation and who is talking about it and where.
Rather than try to define what ‘corporate governance’ is, it is more profitable for investors to understand what it is trying to do. What is its economic purpose? The whole point of corporate governance is to solve the principal-agent problem. Principals and agents are a short hand for all sorts of legal relationships. These include management and shareholders, employers and employees, partners and even citizens and their government.
The principal-agent problem is best described in game theory. It is simple. Agents cheat. Or at least that is the view of the principals. Agents are supposed to act for the benefit of their principals. Their economic incentives are for them to act for themselves. Anyone looking at the outrageous pay packages of investment bankers will see a perfect example.
It is not only in business. In government, the problem is especially severe. In almost any country with a vaguely free press, there are constant stories about government corruption. Even the most powerful dictator is not immune. All government leaders have to act through agents. Over time these agents, even in police states, will act for their own benefit.
The struggle between principal and agent is also very unequal for the simple reason that the agent has the information and the principal does not. This asymmetry of information means that the agent’s incentive is to spin, distort or even falsify the information in his favour. So all principals—including the most powerful dictator and every investor—have to assume that some of the information they receive is not accurate.
Large swaths of any legal system are devoted to solving the principal-agent problem, especially in corporate law. But law is not the only disincentive. The markets also provide incentives and disincentives. Generally there are six categories that help control the actions of managers. Three are economic. They include: (1) Business failure. If the manager manages incompetently, the firm will go bankrupt. (2) The market for corporate control. If the manager fails in his duties, the company could be taken over or sold. (3) Direct managerial financial incentives. If the manager does well, he will be rewarded, if not fired. Three are legal. (4) Managerial duties. Most corporate codes impose certain duties, which can be enforced either by private individuals or the State. (5) Corporate governance oversight. This usually means oversight by a board of directors or something similar that have both the power and responsibility to control management. (6) Shareholder empowerment. Depending on the design of corporate structures, shareholders at least theoretically have the power to remove management. Often shareholders are too diverse and disorganised to exercise power although the so-called corporate raiders often fulfil this role.
Emerging markets including the Middle East and Gulf have special problems. The legal systems in these countries are still developing. Both laws and courts are often new and untested. Enforcement lacks expertise, sufficient budgets and is often uneven. Then there is the problem of corruption and government interference. In these situations, businesses rely less on law and more on trust. In these systems without strong rules, family firms and state-owned firms predominate.
For investors, the problem is that the normal mechanisms of control basically don’t work. Although family-owned companies can go under, state-owned companies can’t. Neither state nor family-owned companies can be sold. Family-owned companies are usually managed by family members and state owned companies by political appointees. So neither can really be fired nor are they motivated by pure financial gain. Corporate codes might be enforced against family companies, but state-owned companies are usually exempt. Neither the family nor the state as majority owners are likely to use their shareholder votes to change directors or management. Management in these firms is also more likely to use their advantage over information to either limit or distort.
Information is essential for investors, but the most important information is whether the information itself is true.