Ships and Shipbuilding

Vice-Admiral Peter W. Cairns, RCN (Ret'd)
President, Shipbuilding Association of Canada

The subject of this paper is "Ships and Shipbuilding", broadly defined. Fundamentally, a viable shipbuilding and ship repair sector depends upon a healthy overall maritime industry. A shipping company will not invest in a new ship unless there is a valid business case to do so and the competitive price of one shipbuilder over another is just one of the many factors shippers must consider. The new building demand, the existence or non-existence of government subsidies or other forms of government support, the world's shipbuilding capacity and utilization rates, shipbuilders' costs, costs imposed by increased regulation, inflation and exchange rates, freight market trends, and owners' revenues are just some of the things that will affect a decision to build. Suffice to say that the decision to build a new ship is extremely complex and the shipbuilder himself represents only one of the branches on the decision tree.

Historically, the world's shipping markets have been characterized by a series of boom and bust cycles mainly influenced by the world economy and the availability of ships. This would seem to be holding true through the 1990s. According to DREWRY shipping consultants, the tanker fleet comprises the largest single segment of the world merchant fleet and the level of new building demand in the oil and dry bulk trades will be largely determined by trends in the world's major bulk shipping markets. Growing prosperity in many parts of the world and the demand for manufactured goods that accompanies it will be important in determining the demand in the general cargo and passenger sectors. The volume of containerized cargo is forecast to continue to expand at an annual average rate of about 4.3 percent until the end of the decade.

In December 1996, there were some 2,589 ships (300 gross tonnes (GT) or more) on order. The market share in terms of compensated gross tonnage looks like this: Japan and South Korea 25 percent each; Western Europe 20 percent; Eastern Europe 10 percent; and the rest of the world 20 percent. By the year 2000, this market share is forecast to alter with the shares of Japan, South Korea and Europe reducing to 20 percent, 15 percent and 18 percent respectively. China will become a major player with 17 percent of the market and the rest of the world will increase its share to 30 percent. Since 1990, new building has seen an upward trend in terms of both numbers and tonnage. With the exception of container ships, 50 percent of the world's merchant fleet is in excess of 15 years old and this should bode well for future replacement. Complicating the issue is that more and more cargoes are being containerized which will reduce the demand for other types of ships. The long-term trend has been to more containerization and now containers account for 55 percent of the total liner trade compared with 31 percent ten years earlier. The trend is also to larger container vessels and of the 544 container ships on order (capacity approximately 896,000 TEU), 25 of these have a capacity of 5,000 TEU or more. Container ships of 8,000 TEU could be ordered this year or next. The Organization of Economic Cooperation and Development (OECD) has reported that 20 percent of containers move empty. This coupled with the influx of larger container vessels could result in over-capacity in the container market. Nevertheless, the shipbuilding outlook across the board is cautiously optimistic.

The days when a shipowner financed a new ship from his own resources are long past. Ships are now built with credit in the form of loans using prospective revenue as collateral. There are normally four external sources of funding available to an owner:

• bank loans;
• equity funding;
• lease packages; and
• shipyard credit or subsidy.

The financial package that is put together almost always contains some form of government assistance. Every successful shipbuilding country owes its success to well-targeted government assistance. Virtually all shipbuilders, with exceptions in the United States and Canada, receive some direct subsidization. In the Asia-Pacific region and India subsidies can be in excess of 30 percent. European subsidies are generally about nine percent and recently Australia has decided to continue paying shipbuilding subsidies of five percent until 1999.

The subsidies provided by governments to the shipbuilding industry constitute a major distortion in the marketplace. Recognizing this, in 1976 the OECD began a campaign to eliminate subsidies worldwide and an agreement has finally been produced. Regrettably, the United States has thus far failed to ratify it. Strange as it may seem, both the United States and Canada eliminated subsidies in the mid-1980s and their shipbuilding industries have suffered unduly because of it.

In terms of ship financing, both France and Germany have innovative ship share schemes. In Germany, for example, buyers of ship shares receive tax reductions of 100 percent of total investment for ships ordered after April 1996. These tax shelters appeal to those in the high income brackets and can be likened to the tax breaks Canada gives to its mining and movie industries. Norway is using tax incentives to encourage its ship operators to build and repair in Norway. However, while subsidies and tax incentives will help to put you in the game, they will not ensure flag loyalty.

There is no loyalty to one's country when it comes to building ships. An owner will go to the builder that provides the product at the best price with the most benefits. Thus what might seem as anomalies (the Danish building vessels for Russia, Dutch shipping interests ordering REEFER ships from the Japanese, Canada's FEDNAV ordering two 35,000 ton Liberian-flagged ships from China, and the Western Canada Marine Group designing, supplying the equipment and doing the project management for the construction of a patrol vessel for Mauritius that was physically constructed in Chile) are really everyday, "business as usual" occurrences in this highly competitive and very volatile marketplace.

While the competition for new building is fierce, the battle for repair and overhaul contracts is no less so. The age of the world fleet continues to create a growing market for repair and maintenance services, especially as regulations become tougher and port state inspections get stricter. Canada inspected 1,185 ships in 1996 and detained 118. The international offshore industry is producing an increasing demand for upgrade and conversion contracts. In this, the Asian yards are big players. Singapore's total dry-dock capacity is now 3.5 million DWT after last year's opening of 360,000 DWT and 400,000 DWT facilities. Both are wide enough to handle double-hulled Ultra-Large Crude Carriers (ULCCs). Dockyards in the Netherlands and Germany have carved niche areas of specialization and are relying heavily on new technology and more efficient work processes to create a competitive edge for themselves. China meanwhile is aiming to secure 10 percent of the world ship repair market by the year 2000, compared to the five percent it has now.

Canada's shipbuilding industry is profiting in the ship repair market. It has good docking facilities, with several docks of exceptional length. Esquimalt's Graving Dock is still the longest on the west coast of North America, but must have recesses cut in the dock walls before large cruise vessels can be accommodated. Canadian Shipbuilding and Engineering Company is one of the world's experts in converting bulk carriers to self-unloaders. Davie Industries has recently fitted a new bow section on a Turkish tanker and I understand that the floating dock in Vancouver is booked for the next 12 months.

Canada's natural market for ships is the United States, and Canada's shipbuilding industry would clearly like to penetrate it. Both countries have eliminated subsidies and the pre-1988 tariffs are being dismantled under the free trade agreement between them. In 1998 these tariffs will be eliminated completely. Those factors would seem to open up each other's market. Regrettably the Jones Act destroys any possibility of this. The 1920 Merchant Marine Act, commonly known as the Jones Act, states that cargo carried between US ports must be carried aboard US ships that are built, crewed and owned by US citizens. Another law, the 1936 Merchant Marine Act, forbids ships built with subsidies to ply trades covered by the Jones Act. The Jones Act is presently under attack within the United States but it would appear at this writing that the pro-Jones forces will carry the day. The US domestic fleet has prospered under the Jones Act; not only are there more vessels, but they are larger, faster and more productive. Of major concern to the Canadian shipbuilding industry is that in 1998, when all tariffs are eliminated, the Canadian market will be open to American shipbuilders but, without amendment, the Jones Act will prevent Canada access to the American market.

As you can see from the discussion up to now, the global shipbuilding industry is fiercely competitive, extremely complex, politically influenced and very volatile. Is there a place for the Canadian shipbuilder? If so, where is it? It is certainly clear that Canada';s shipbuilders will have to create their own destiny! However, they would like a little help from their friends! As Peter Haydon points out in a paper written in 1993 "one must accept the reality of the situation that the Canadian shipbuilding industry has become part of the political process"{1}. It has arrived in its present state not by natural market forces but by political manipulation and the regionalism that permeates this country. However, the government attitude today seems to be one of indifference and apathy toward the industry.

The marine industry employs 40,000 people in Canada, handles 224 million tons of cargo a year, and adds $2 billion to our Gross Domestic Product (GDP), but it is not a popular industry in Canada. In part this is because ships are seen as environmentally unfriendly when just the opposite is true. Furthermore, government officials see shipbuilding as yesterday's industry, not an industry of the twenty-first century. For a country that thrives on exports, and is responsible for an ocean area larger than its landmass, this attitude is hard to fathom. It is clear that the marine industry must mount a concerted education campaign to show government officials, farmers, business persons and citizens what ships mean to this country.

With the elimination of subsidies, Ottawa put a three-pronged policy in place to assist the Canadian shipbuilding industry. The first element of this policy was the continuation of tariffs on most ships, except fishing vessels, over 33 million. Under Canada's Coastal Trading Act, the owner of a ship built or purchased abroad must pay a 25 percent tariff to have it flagged Canadian and operate in Canada's domestic trade. The second element of this policy was that the government fleets have to be renewed or repaired in Canadian yards. The third element allowed the government to help, on a cost-shared basis, with the rationalization of the Canadian shipbuilding industry. This rationalization is now complete and this part of the policy is no longer pertinent. As a result of rationalization, 10 shipyards have closed and our capacity has been reduced by 40 percent. Canada's shipbuilding capacity is now considered by government to be much better suited to the market prospects. Others have argued that there is still over-capacity among the major eastern yards. Time and the market should sort this out.

Key to the Canadian industry is for government to renew its fleets in Canada. It is from this base that the industry can make the investments in technology that it can use as leverage into the world's markets. Historically, government fleet renewal has represented either a feast or a famine and we appear to be entering a season of famine. Last year the navy received its twelfth and final Canadian Patrol Frigate (CPF) and the fourth and final Tribal Class Modernization (TRUMP). The Maritime Coastal Defence Vessel (MCDV) program is approximately 50 percent completed. The renewal plans for the other government fleets are conspicuous by their absence. From a shipbuilding perspective, a modest investment by government in its fleets on a more continuous basis would provide several advantages. First, the industry would benefit from more stable work forces and revenues. And, second, government cash flow problems would be eased, more Canadians would be working and the government fleets would be more modern and economical to operate. This could be done at no increased overall cost to government.

The 25 percent tariff is the only instrument in place to encourage operators of the Canadian domestic fleet to build in Canada. The Great Lakes fleet is approaching 30 years of age. Canada's aging fleet of single-hulled tankers are required by environmental regulations to be phased out of service during the period 1995-2010. There are approximately 25 vessels under 5,000 GRT and 22 over 5,000 GRT subject to these restrictions. This is an opportunity for Canadian yards in eastern Canada and the Great Lakes. One can expect the oil industry to begin to lobby strongly to repeal the tariff. To date the operators of these tankers have done little in preparing for this fleet replacement.

The Canadian shipbuilding industry has done much to make itself more competitive in the last 10 years. There is no doubt that it produces a quality product. The Canadian Patrol Frigate (CPF) is a glowing testament to the industry's ability to build innovative ships on the leading edge of technology. As a result of this program, Canadian industry now possesses automation and system integration skills that are world class. For the first time, Canadian industry has the ability to develop, design and build specialty vessels for niche markets. Some of the major yards have world-class facilities for modern and efficient ship construction, and shipbuilders have been replacing outdated processes. New contracts incorporating more flexible labour practices are the norm and the work force is quite skilled. At Vancouver shipyards, where they are constructing major sections of the all-aluminium 1,000 passenger fast ferries, the work force has achieved remarkably high skill levels in record time. It is also important to mention that Canada now has the indigenous capability to carry out basic research and development in many specialized areas such as naval architecture, ship design and production techniques.

While the work force is skilled, it is also greying. The average age of an employee at Victoria shipyards is 47. This is not unique to Victoria. The average employee age at Todd Shipbuilding in Seattle is also 47 years. The Japanese have also expressed concern about the aging of their work force.

Canadian chargeout rates are not an insurmountable obstacle. They are comparable to the United States, and in some cases less than European competitors. They are higher than the Japanese and significantly more so than South Korea and China. (In this, Canada is not unique.) What takes Canada out of the competitive system is a lack of government policies, particularly with respect to financing for new building, that could positively assist Canadian shipbuilding.

The Honourable David Anderson, Minister of Transport in a speech to Maritech 1997 in Victoria, BC, stated that he did not want to see the Canadian marine industry get out of step with the rest of the world. Yet since the elimination of subsidies, this is exactly what has happened. There have been no incentives to encourage Canadian owners to flag or build in Canada. Why is there no Canadian merchant marine? In my view, this is because the regulatory structure makes it difficult if not impossible for a Canadian to own and operate ships, and more importantly, to make a profit.

What can the government do to assist the industry that does not involve monetary subsidies and yet keeps Canada in step with the rest of the world? There are several possible actions that should not require major outlays of money. The Canadian government should first take a leaf from the province of Quebec's book. One year ago Quebec brought down a provincial marine policy with three major thrusts:

• a reduction of tax on capital for the acquisition of ships intended for navigation in international waters;
• a refundable tax credit for shipbuilders; and
• a tax holiday for Quebec sailors assigned to international freighters.

Building on this lead, one can put together a selection of similar initiatives for federal government consideration. These initiatives might include:

• tax credits for Canadian shipowners who build ships in Canada. This tax credit would be given to the shipyard in the case of foreign ship owners;
• tax credits for shipowners who have ships designed in Canada;
• tax shelter programs for high income earners or companies that invest in shipbuilding;
• tax breaks to Canadian sailors who sail ships in international waters;
• continuation of accelerated depreciation privileges;
• consideration of various measures to facilitate the financing of ships such as lease financing and loan guarantees; and
• level the playing field for Canadian shipowners with respect to their foreign counterparts with offices in Canada.

Canada must recognize the importance of its maritime industries and the thrust of its policies must be to allow Canadians to compete in the world market.

The industry would appear to be in a Catch-22 situation. The government apparently does not want to invest in the industry until it can show it is competitive internationally, yet the industry needs some government assistance to get to that state. The industry certainly realizes that monetary subsidies are a thing of the past and reliance solely on government contracts leads to insolvency. The failure of the government to pass Bill C-44, the Canada Marine Act, has left a bad taste in the industry's mouth. Many see this failure as a clear indicator of how government views the marine industry.

Madame Verreault of Verreault Navigation is quick to point out that one ship flying the Canadian flag brings in over $1 million per year to our governments.{2} Approximately 900 different ships use the St. Lawrence Seaway every year. If only 10 percent of those ships were Canadian-flagged, and/or built and repaired in Canada, the monetary and social benefit to Canada would be substantial. At present eight ships are being built offshore for Canadian interests. Three of these are too large to be built in Canada. The other five could have been built here had we been in a competitive position. Building these ships in Canada would have had a major positive impact on the industry.

Allied Shipyards in Vancouver has just completed a "century"-class car ferry for BC Ferry Corporation at a cost of $18 million. Ninety percent of this money will stay in Canada and approximately $5 million will go back to government in taxes. A viable industry means money in everyone's pocket.

The shipbuilding industry has looked hard at itself in the last few years. It has made a lot of changes in the way it does business. Leaders in the industry believe it can compete in specialized areas given well-crafted government policy. Yet the shipbuilding industry is only one cog in the marine transportation system of this country. Marine transportation is the most cost effective, safe and environmentally friendly transportation system available to us. Canada must protect and develop this system. Then all Canadians will prosper, including the shipbuilding industry.

Notes

1. Peter T. Haydon, "The Canadian Government's Role in Shipbuilding: Past, Present and Future" a paper presented to the Centennial Meeting and 1993 International Maritime Exposition of the Society of Naval Architects and Marine Engineers in New York City, 15 September, 1993.Back to Text

2. Denise Verrault, "Running with the wolves. Reinventing the Identity and Restructuring the Canadian Marine Industry to Prosper on the Global Scene." in Gregory L. Witol. ed., The NIOBE Papers Volume 8: The St. Lawrence Seaway and Quebec (Halifax: The Naval Officers' Association of Canada, 1997), 35-45. Back to Text