Second report from the Commission to the Council on the situation in world shipbuilding
Date: 2000-05-03
Institutions: European Commission
Subjects: international market, market supervision, report, shipbuilding

COMMISSION OF THE EUROPEAN COMMUNITIES

Brussels, 3.5.2000
COM(2000) 263 final

SECOND REPORT FROM THE COMMISSION TO THE COUNCIL

ON THE SITUATION IN WORLD SHIPBUILDING

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SECOND REPORT FROM THE COMMISSION TO THE COUNCIL

ON THE SITUATION IN WORLD SHIPBUILDING

TABLE OF CONTENTS

1. Introduction ................................................................................................................. 5

1.1.

Follow-up to the First Report from the European Commission on the Situation
in World Shipbuilding ............................................................................................ 6

2. General market analysis ............................................................................................... 8

2.1.

2.2.

2.3.

2.4.

Market shares ............................................................................................... 8

Price developments..................................................................................... 13

The market segment of containerships ........................................................ 14

Conclusion ................................................................................................. 15

3. Detailed market monitoring and analysis.................................................................... 16

3.1.

3.2.

3.3.

3.4.

3.5.

Study on shipbuilding market monitoring ................................................... 16

Update of previous investigations ............................................................... 17

New investigated orders ............................................................................. 19

Impact on EU yards .................................................................................... 21

Conclusion ................................................................................................. 22

4. Conclusions and recommended actions ...................................................................... 24

5. List of tables and graphs ............................................................................................ 26

6. References ................................................................................................................. 27

Annex: The shipbuilding industry in the People's Republic of China .............................. 28

Restructuring of CSSC ............................................................................................. 30

The cost base in Chinese shipbuilding ...................................................................... 32

Labour costs, working practices and performance..................................................... 32

Material costs ........................................................................................................... 33

Interest rates ............................................................................................................. 33

Exchange rates ......................................................................................................... 33

Executive summary

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Under Council Regulation 1540/98 establishing new rules on aid to shipbuilding the
Commission is required to report on the situation of the world shipbuilding market. The
first report (COM(1999) 474 final) was presented to the Council in October 1999 and was
the subject of Conclusions by the Council in November, which invited the Commission to
continue its examination of the situation. This is the second such report.

The world market for merchant ships continues to be in crisis. Supply clearly outstrips demand
and there are only few indications that this situation may improve.

Consequently the comparatively stronger demand for ships in the period 1998 to 1999 has had
no positive impact on prices. Rather prices for nearly all shiptypes have continued to decline.
The on-going depression in prices is caused by extremely low offer prices from Korean yards
and at current price levels EU and Japanese market shares continue to shrink, although this
effect is less pronounced for the EU.

The new detailed cost investigations for shipbuilding orders reported in this document have
once more revealed the extent of the losses which Korean yards are willing to take in order to
assure market share and cash flow. The calculated losses are between 11% and 32% of the
actual building costs. This is slightly less than for the cost investigations contained in the
Commission's first report on the situation in the shipbuilding market (COM (1999) 474 final)
where losses were calculated to be between 13% and 40%, although this slight decrease is likely
to be a result of a different selection of investigated orders. Moreover, with the exception of
cruise vessels, all market segments are targeted by Korean yards, leaving only small domestic
orders and highly specialised tonnage to EU yards. Therefore, this second report by the
European Commission on the situation in the world shipbuilding market confirms the findings
from the Commission's first report.

All lines of action to address the problem (as requested by the European Council of Ministers in
its meeting of 9 November 1999) are currently being pursued (see chapter 1). In particular,
strenuous efforts have been made by the Commission to secure binding commitments from the
in relation to its non-intervention in the financing of shipbuilding
Korean Government
activities. After several rounds of consultations, the European Commission and the Korean
Government finalised their talks and initialled on 10 April 2000 "Agreed Minutes relating to
the World Shipbuilding Market". These Agreed Minutes are focusing on non-subsidisation,
transparency (with regard to international accounting standards),
banking,
commercial pricing practices and an effective consultative mechanism. The overall aim is to
promote fair and competitive market conditions in the world market and to work together to
stabilise the market and thereby help raise the level of ship prices to ones that are
commercially sustainable.

financial

The evidence gathered within the framework of the market monitoring undertaken by the
European Commission has helped the EU industry to compile sufficient elements which could
lead to a complaint under the Trade Barriers Regulation and industry has recently announced
its readiness to file such a complaint. The European Commission will continue with its market
monitoring exercise.

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It is recommended to

–

–

–

–

–

continue to exercise pressure on Korea to fully implement the "Agreed Minutes" and
assume responsibility to work towards an improvement of the market situation, in
particular concerning price levels and newbuilding capacities;

full apply the provisions of the "Agreed Minutes" once they have entered into force,
invoking the consultation mechanism whenever necessary;

collect further and more detailed evidence on possible injurious pricing and other non-
market oriented behaviour in order to launch and support a complaint under the Trade
Barrier Regulation if required;

keep the IMF informed about the findings and request that the promised industrial
restructuring in Korea is closely monitored and assessed;

encourage the EU shipbuilding industry to further improve its competitiveness.

4

1.

INTRODUCTION

This report by the European Commission on the situation in the world shipbuilding
market is the second of a series and it presents a follow-up and extension of the first
report which was submitted to the European Council of Ministers on 9 November 1999
as COM (1999) 474 final. This initial report responded to Council Regulation (EC)
No. 1540/98 establishing new rules on aid to shipbuilding which requires the European
Commission to present to the Council a report on the market situation and appraise
whether European yards are affected by anti-competitive practices. If it is established
that anti-competitive practices of any kind are causing injury to industry, the European
Commission is, where appropriate, to propose to the Council of Ministers measures to
address the problem.

The second report is based on the approach and the findings of the first report.
Therefore certain elements of the first report are not repeated. These references cover
the longer term supply and demand analysis, general remarks on the nature of
shipbuilding contracts and on the underlying study works, the analysis of the financial
sector in South Korea, details of certain investigated shipyards and the description of
the applied methodology. However, the information contained in the first report is
updated where appropriate. This concerns in particular the detailed cost investigations
for shipbuilding orders awarded to Asian yards as the underlying cost model is re-run
each time new or better information is obtained.

The key findings of the first report were the following:

–

–

–

–

–

–

Significant over-capacities in the shipbuilding market exist and are very likely to
grow due to both decreasing demand and increasing supply.

South Korean capacity expansion, especially in the period 1994 to 1996, has
been the main reason for the continuing and growing imbalance between supply
and demand, and Korean yards have great difficulties in attracting a sufficient
number of orders to secure cash flow. Nevertheless further capacity expansion is
undertaken in Korea.

Ship prices have plummeted by 15% to 30% since 1998, in particular for ship
types for which Korea competes, bringing forward demand and shifting market
shares to Korean yards.

The shipbuilding market monitoring study has provided a stable cost model
which is suited to analyse the true costs of shipbuilding in Korean yards (the
only ones investigated in the first report).

None of the 9 investigated orders for new vessels was clearly profit making and
there are convincing indications that Korean yards offer ships at below cost
price.

Two Korean yards, both under bankruptcy proceedings since 1997, exhibit
business behaviour which would be considered as unacceptable in the EU. Of
particular concern are past and current debt forgiveness and debt moratoria, as
well as advantageous interest rates, fresh credits and guarantees for new ship
construction projects.

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–

The financial system in South Korea, as far as it is used for the financing of
shipyards and shipbuilding projects, remains opaque and, as there is substantial
scope for government intervention with large parts of the banking sector being
owned by the state, interference in financial and organisational matters could
have occurred.

This second report from the European Commission extends the price investigations to
shipyards in the People's Republic of China which have achieved a significant increase
in market shares in 1999. Four particular orders are analysed and the findings are
presented in chapter 3. Although China is widely considered as an important
shipbuilding country in the future, the economic structures in China in general and in
the shipyards in particular seriously constrain industrial competitiveness. Therefore,
limited to shiptypes where labour costs are a
Chinese yard activities are still
dominating factor and currently Chinese yards do not appear to pose a general threat to
EU yards, similar to that from Korean yards. More detailed information on the
structure of the Chinese shipbuilding industry is provided in the annex.

1.1.

Follow-up to the First Report from the European Commission on the Situation in
World Shipbuilding

The Industry Council took note of the Commission's first report during its meeting on
9 November 1999 and called on the Commission, Member States and industry to
pursue four lines of action, namely:

–

–

–

–

To engage representatives from the Republic of Korea in bilateral talks with a
view to halt the unfair competition.

To collect as much detailed evidence as possible of
competitive behaviour, in order to take appropriate action under the WTO.

the alleged anti-

To urge the IMF to continue to investigate whether the conditions and
assumptions under which the IMF-led rescue packages are given, are fully
respected.

To pursue the efforts to establish a level playing field for the sector in the
appropriate international fora, including the OECD, in order to enforce without
any delay fair competition rules.

The European Commission, Member States and the shipbuilding industry have
responded to these requests and related activities are currently pursued. Interim results
can be summarised as follows:

–

Three rounds of bilateral talks with the Korean Government and industry were
held in December 1999, February and March 2000. The European Commission
and the Korean Government finalised their talks and initialled on 10 April 2000
"Agreed Minutes relating to the World Shipbuilding Market". These Agreed
Minutes are focusing on non-subsidisation, banking, financial transparency
(with regard to international accounting standards), commercial pricing
practices and an effective consultative mechanism. The overall aim is to
promote fair and competitive market conditions in the world market and to
work together to stabilise the market and thereby help raise the level of ship
prices to ones that are commercially sustainable.

6

–

–

–

Evidence to support a possible complaint under the Trade Barrier Regulation
(EC) No 3286/94 is being actively collected and industry has announced its
readiness to file a complaint in the absence of a recognisable improvement in
Korean business practices. This could lead to a complaint under WTO later. The
it considers to file a
Japanese shipbuilding industry has announced that
complaint of its own against Korean competition practices to the WTO. The
Shipbuilders Council of America (SCA) representing ca. 50 smaller US
shipyards has requested the US Trade Representative to support the EU efforts,
because US yards are increasingly losing export contracts for small navy vessels
and offshore constructions to Korean yards. Although no detailed investigations
have been made in these market segments Korean offer prices are considered
unrealistically low.

Two meetings were held with IMF representatives, one on the request of the
German Government with the Director of the IMF Asia and Pacific Department,
and one in Korea between the Commission and the local IMF representative. In
both meetings the IMF representatives repeated the IMF's official position,
namely that the IMF does not monitor sectoral activities and therefore had no
evidence of unfair competition practices, directed lending or hidden subsidies to
shipyards in Korea. On the contrary, the IMF is convinced that Korea has shown
a remarkable recovery from the crisis in 1997 and that market-oriented economic
restructuring is basically on track. As agreed the European Commission provided
additional information to the IMF together with more specific questions which
could help the IMF to investigate the soundness of financial arrangements
between Korean yards and crediting banks. A reply from the IMF is awaited.

The current situation in world shipbuilding was also subject of the OECD
Working Party 6 meeting in December 1999 in Paris. Despite the efforts by the
delegation of the European Commission to come to a common understanding of
the problems with Korea no discernible progress was made. Discussions will be
taken up again in a further session in spring 2000, based on a proposal by Japan
to explore ways and means to stabilise the world shipbuilding market. The
European Commission supports this initiative by Japan.

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2.

GENERAL MARKET ANALYSIS

As regards the analysis of the existing gap between supply and demand in shipbuilding
capacities little progress has been made since the first report. The three major
shipbuilders' associations AWES (Association of European Shipbuilders and
Shiprepairers) and SAJ (Shipbuilders' Association of Japan) on the one hand, and KSA
(Korean Shipbuilders' Association) on the other, do not agree on the extent of this gap,
and predict future demand and supply at different levels. However, both sides agree
that the gap between supply and demand will widen in the coming years due to
increased yard productivity, the conversion of some repair yards to newbuilding and
the entrance into the market by new competitors such as the People's Republic of
China.

Whether this additional capacity can be partly compensated by increased demand is
extremely difficult to forecast. While the age structure of the existing fleet or the up-
coming European legislation on the earlier phasing out of tanker tonnage that is
considered technically unsafe seem to indicate rising future demand, this could be
offset by slow growth of the world economy or the US economy losing momentum.
Moreover, it cannot be assumed that all tonnage of a certain age will be replaced as the
construction of some of these ships was based on speculation and these ships should
never have come into operation. As mentioned in the first report the huge decline in
ship prices since 1997 has again led to speculative orders and it is obvious that this
additional tonnage will reduce future demand. Another important factor would be the
oil price which at a certain level may trigger energy saving measures and thus reduce
the need for sea transport.

The total new building capacity worldwide currently amounts to ca. 21 Mio. cgt
(compensated gross tonnes, a measurement combining ship size and shiptype-
specific building effort; source: OECD and AWES). Total new shipbuilding
production was 16.4 Mio. cgt in 1999 after 17.2 Mio. cgt in 1998 and 16.4 Mio. cgt in
1997 (source: Lloyd's Register of Shipping) which indicates that demand is indeed
considerably lower than supply and a significant increase in newbuilding prices due to
higher demand cannot be expected, at least in the short term.

2.1.

Market shares

A complete analysis of the market situation in shipbuilding requires to look a three sets
of data:

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–

–

Completed and delivered ships, as the indicator for the actual shipbuilding
output. These production related figures represent the execution of past orders;

Orderbooks, as the indicator for the expected mid-term output. These figures
show the yards' confirmed workload in the next 1 to 2 years; and

New orders, as the indicator for the expected long-term output. These figures
reflect the actual situation in the market, including for example speculative
movements, and can be used to analyse shifts in market shares.

As this report cannot cover the full history of the shipbuilding market, this specific
analysis is limited to the period 1997 to 1999 when the impact of the massive

8

expansion of Korean shipyards and the ensuing economic crisis began to be felt in the
world market.

The following graphs provide information on the development of deliveries,
orderbooks and new orders, based on cgt and per major shipbuilding region. Each
graph is followed by a short analysis.

Fig. 1 - Completions 1997-1999 in Mio. cgt and per region (Source: Lloyd's Register
of Shipping)

18

16

14

12

10

8

6

4

2

0

Rest of the
World

EU+Norway

South Korea

Japan

1997

2,685

3,452

4,018

6,15

1998

3,063

3,827

3,486

6,666

1999

2,642

3,225

4,4

6,142

As already mentioned in the first report 1998 was an exceptional year for world
shipbuilding as the financial crisis in South Korea hampered ship production and
order intake in Korea. However, the trend in completions appears to be an increasing
share for Korea while overall production output is comparatively stable but nowhere
near the estimated shipbuilding capacity of ca. 21 Mio. cgt. The "surplus capacity"
has to be seen at about 20 - 25% of the actual production.

9

Fig. 2 - Orderbooks 1997-1999 in Mio. cgt and per region (Source: Lloyd's Register of
Shipping)

40,00

35,00

30,00

25,00

20,00

15,00

10,00

5,00

0,00

Rest of the World

EU+Norway

South Korea

Japan

1997

8,39

8,93

8,31

9,80

1998

8,05

10,04

9,93

10,25

1999

8,49

9,38

10,57

8,77

Between 1997 and 1999 the overall volume of orderbooks has increased by ca. 5% and
it can be said that this increase has basically only benefited Korean competitors. Japan
is confronted with shrinking orderbook volumes while the EU has been able to keep its
share at a comparatively high level. Korea, however, has seen an increase in the
volume of orderbooks by some 27% while EU yards saw an increase in their
orderbooks along the general trend only in the period in question. A shrinking in the
volume of orderbooks is an indicator for a worsening business situation in the mid-
term future and if the additional information on new ordering is included, conclusions
on the prospective commercial situation can be drawn.

10

Fig. 3 - New orders 1997-1999 in Mio. cgt and per region (Source: Lloyd's Register of
Shipping)

25

20

15

10

5

0

Rest of the World

EU+Norway

South Korea

Japan

1997

3,49

4,153

6,764

8,791

1998

3,06

4,854

4,682

6,225

1999

4,47

3,265

6,326

4,935

As regards reported new orders which are the key indicator for the actual market
situation the picture changes significantly: in particular Japan has lost market share to
Korea with fewer orders even in the exceptional year 1998 when Korean yards had
problems to compete for orders. The general trend clearly indicates that Korean
shipbuilders have conquered market shares in new orders and this has been mainly at
the expense of Japan (minus 44% in cgt in the period 1997-1999) while the EU saw a
decrease in new orders similar to the general development (minus 18% in cgt in the
same period). While EU yards may still have some "breathing space" due to their
comparatively good orderbooks (although the situation is very different for different
yards) and the lower value of the euro in relation to the US Dollar, Japanese yards
are generally facing a situation where orderbooks are increasingly running empty and
new orders are not received on a sufficient scale to maintain production at the
previous level. This would indicate a longer-term shift in market shares from Japan
to Korea and, to a lesser extent, from the EU to Korea.

It is obvious that the booming production of cruise vessels with their comparatively
high cgt values has stabilised the overall situation of the EU shipbuilding industry but
it needs to be noted that currently only 9 EU yards (out of some 150) are active in this
field and the number of yards which could easily turn to cruise ship construction is
limited by technical and commercial constraints. Moreover it is known that Korean
and Japanese yards are actively pursuing cruise ship orders (with Japan appearing to
try to compensate for orders lost to Korea in other market segments). Once the market
is confident that Asian yards can produce cruise ships in time and in sufficient quality
this European market niche will certainly be challenged and overall EU market shares
may shrink further. While the above analysis seems to indicate that EU yards still have

11

a comparatively good position (although this does not necessarily mean that operations
are profitable), the situation in particular Member States and for particular shipyards
may be dramatically different, depending on their product portfolio. Most threatened
are small to medium sized yards that have a focus on the production of merchant cargo
ships such as container ships, product tankers or gas carriers. These yards typically do
not have the option to compensate a loss in market share through the construction of
large cruise ships or navy contracts, even if their general competitiveness in terms of
productivity may be good, and some insolvencies have already occurred. The recent
developments at Harland and Wolff in Belfast indicate that bigger shipyards are facing
similar problems, especially when certain strategic orders cannot be secured and other
market segments have become inaccessible due to Korean competition.

Fig. 4 - Market shares in new orders in percent and based on cgt, 1997 - 1999
(Source: Lloyd's Register of Shipping)

100,00%

80,00%

60,00%

40,00%

20,00%

0,00%

1997

1998

1999

Rest of the World

15,05%

16,26%

23,52%

EU+Norway

South Korea

Japan

17,90%

25,79%

17,19%

29,16%

24,88%

33,31%

37,89%

33,07%

25,98%

Looking at the development in market shares expressed in cgt-percentages the sharp
rebound of South Korea after the problematic year 1998 is obvious. The EU yards
were not able to maintain their 1998 position when they benefited from the financial
insecurity in Korea. China has also taken more market share, but this has been
selective as discussed in the next chapter. In 1999 South Korea achieved 33.3% of all
new orders, Japan had 26.0%, the EU stood at 17.2% and the rest of the world had
23.5%. This makes South Korea now the world's largest shipbuilding country by far.

In January 2000 Korea saw an even more dramatic increase in order intake: 65% of all
world ship orders in January were awarded to Korean yards, representing 72% of the
entire cgt volume. The EU achieved a mere 7% in cgt terms and Japan stood at 10%
(source: Lloyd's Register of Shipping). In February 2000 the situation for the EU

12

improved significantly (29% market share in cgt) due to a number of orders for
specialised tonnage. Japan, however, was not able to gain more market share and it
should be noted that total ordering activity went down by 44% as compared to January.
The orders mainly concern Postpanamax container ships, a shiptype which has been
invented in Europe in 1988 and which until recently was a domain of EU and Japanese
yards. This shiptype is widely seen as the "work horse" of future container shipping
and it represents a new economic dimension in global sea trade due to its size and
efficiency. It should be in the EU's strategic maritime interest
to maintain the
competence for the construction of these vessels. Moreover Postpanamax container
ships are a product of the EU's most modern and technologically advanced shipyards
and if these yards cannot attract these orders the reasons must be sought beyond the
question of industrial competitiveness as such.

2.2.

Price developments

Table 1 - Evolution of prices for newly built ships (yearly averages in Millions of US
Dollars)

Panamax Container Carrier

1100 TEU Container Carrier

Very Large Crude Oil Carrier (VLCC)

Capesize Bulk Carrier

Panamax Bulk Carrier

Tweendecker 15,000 dwt

Source: Clarkson World Shipyard Monitor.

1997

53.0

20.0

83.0

40.5

27.0

16.5

1998

42.0

18.0

72.5

33.0

20.0

14.0

1999

38.0

17.5

70.0

37.0

22.8

13.0

Table 2 - Evolution of prices for newly built ships (annual changes in percent)

1997/1998

1998/1999

1997/1999

Panamax Container Carrier

1100 TEU Container Carrier

-20.75%

-10.00%

Very Large Crude Oil Carrier (VLCC)

-12.65%

Capesize Bulk Carrier

Panamax Bulk Carrier

Tweendecker 15,000 dwt

-18.52%

-25.93%

-15.15%

-9.52%

-2.78%

-3.45%

12.12%

14.00%

-7.14%

-28.30%

-12.50%

-15.66%

-8.64%

-15.56%

-21.21%

Looking at the average prices for certain important shiptypes in the years 1997 to 1999
it is clear that the increased demand from 1998 to 1999 (see Fig. 3) generally had no
positive impact on prices. On (numerical) average prices for new ships have declined
by 17% since 1997.

The notable exceptions are Capesize and Panamax bulk carriers which have seen a
slight price increase since 1998 by 12% and 14%, respectively. Nevertheless prices for
these shiptypes are still considerably lower than in 1997. The reasons for this
movement in prices for bulk carriers could be seen in the situation of the South Korean

13

Halla yard which has a focus on the production of these vessels. Halla has played the
role of a price leader, offering extremely low prices in order to fill the massive
capacities created at the Samho production site. As elaborated in Annex II of the first
report Halla has been in financial difficulties since 1997. To solve these problems and
save the yard, the Hyundai group has agreed to a management co-operation scheme in
which Hyundai would take over management responsibility in return for a fixed share
of future profits. Moreover, Halla would receive more debt reduction through the
domestic creditors (mostly government-controlled banks) before Hyundai would take
over Halla fully. In this context Hyundai has demanded from Halla to renegotiate ship
prices which were considered as too low even by Korean standards. It is not known in
how far Halla has been successful in the re-negotiation but this could have had an
impact on prices for these particular shiptypes.

All other important shiptypes have seen further price erosion and prices for the end of
1999 are again lower than the yearly averages for some shiptypes (Capesize bulk
carrier: 35 Mio. USD; Panamax bulk carrier: 22 Mio. USD; VLCC: 69 Mio. USD
[prices for December 1999; source: Clarkson World Shipyard Monitor]).

2.3.

The market segment of containerships

As discussed in the first report, container vessels represent the largest market segment
in commercial shipbuilding in terms of cgt and container ships have been a major
product of Japanese and EU yards in the past. The first report also stated that Korean
yards have made very significant inroads into the market for container vessels since
1997. This trend has continued and concerning this particular market segment the
situation presents itself as follows:

Fig. 5 - Market shares in new orders for containerships in percent and based on cgt,
1997 - 1999 (Source: Lloyd's Register of Shipping)

100,0%

80,0%

60,0%

40,0%

20,0%

0,0%

OTHERS

EU

SOUTH KOREA

JAPAN

1998

19,3%

15,3%

44,1%

21,3%

1999

10,9%

14,1%

64,8%

10,2%

1997

16,3%

23,9%

15,1%

44,6%

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South Korea has consolidated its dominant position in the building of containerships
and has further cut into EU and Japanese market shares. It has also taken market share
from the group of "others" which in this segment is represented by countries such as
China, Taiwan and Poland. Although most of the market share gained seems to be at
the expense of Japanese yards it should be noted that most of the orders in question
come from EU operators. In the meantime price levels have further deteriorated as
described above which has led two Japanese operators of container lines (K-Line and
NYK) to place major orders in Korea. Given the traditional preference of Japanese
owners for domestic ordering this clearly shows that Korea's low offer prices have
been changing the market dramatically. The EU position seems to weaken constantly
in this market segment, only slightly offset by the 20% decrease in the value of the
euro since January 1999. As the Yen has seen a significant appreciation in the past
year this has added to the problems encountered by Japanese yards. It should be kept in
mind that an appreciation of the euro would quickly bring the EU shipbuilding
industry into an equally dramatic situation as the yards in Japan. On the other hand an
appreciation of the Korean Won may not necessarily shift market share away from
Korea if it is not accompanied by a behavioural change on the side of the Korean
shipyards.

2.4.

Conclusion

The general market analysis within this second report from the European Commission
confirms the findings of the first report, namely that

–

–

–

–

Over-capacities in the shipbuilding market exist but there is no agreed analysis
between Japan and the EU on the one side and Korea on the other about the
extent of these over-capacities and their impact on the market situation.
However, in the "Agreed Minutes" Korea for the first time acknowledges the
necessity to address the problem.

South Korean capacity expansion, especially in the period 1994 to 1996, has
been the main reason for the continuing and growing imbalance. Although three
Korean chaebols active in shipbuilding (Hyundai, Daewoo and Samsung) have
recently announced reductions in their exposure to shipbuilding in order to focus
more on other industrial activities and "improve the groups' profitability" this
does not mean cuts in production capacity, according to the Korean Shipbuilders
Association. At least for Hyundai Mipo the indications point in a different
direction with repair capacity increasingly being used for ship newbuilding.
Moreover Hyundai will expand capacity further through the inclusion of the
ailing Halla / Samho yard in the group's shipbuilding activities. It was recently
announced that Samho would re-open its second building dock following strong
demand for certain shiptypes.

Prices have declined further, in particular for ship types for which Korea
competes aggressively, bringing demand forward and massively shifting
market shares to Korean yards. Most significant is the shift in market shares
with regard to container vessels where Korea now holds a dominant position,
in particular as far as the biggest and technically most advanced vessels are
concerned.

Korean expansion has been at the expense of all other major shipbuilding
losses. The situation of the EU
regions, with Japan taking the biggest

15

shipbuilding industry remains critical, only slightly offset by the cruise ship
boom, the comparatively good orderbooks and the devaluation of the euro
against the US Dollar.

3.

DETAILED MARKET MONITORING AND ANALYSIS

3.1.

Study on shipbuilding market monitoring

In order to collect the necessary data, the European Commission has recourse to
consultants whose ongoing study has defined a cost breakdown model, including all
relevant cost components both of the direct ship production and the shipyard in general.
labour,
The model
equipment, etc.) and indirect costs (financing of the ship and of the production
equipment, overhead, insurance, etc.). The calculated building price also includes a
5% profit margin. More details of the cost model can be found in Annex I of the first
report.

is based on cost elements covering direct costs (materials,

The cost model does not represent an extrapolation of EU shipbuilding costs, as has
been suggested by the Korean shipbuilding industry and the Korean Government. It
is rather a methodical cost reconstruction for particular orders in particular yards.
Comparison data provided by the Korean shipbuilding industry on wage levels,
overheads or yard productivity confirm the assumptions used in the cost model.
While, for example, the Korean Shipbuilders' Association gives the average level of
overheads for Korean yards as 13% of operating costs, the cost model uses specific
figures for each investigated yard which are between 7.5 and 18%. For the major
Korean shipyards the overhead is estimated to be in the range of 10.2 to 10.9% (i.e.
lower than assumed by the Korea Shipbuilders' Associations itself).

As the study develops, additional information is gathered and used to validate
previous cost investigations. Consequently, the nine orders covered in the first report
have been recalculated where necessary and the updated findings are given below.
As already stated in the first report all parameters are kept on the "safe side" to
ensure that calculated minimum costs for particular projects cannot be challenged.
Currently the cost model does not include an assessment of inflationary effects as
this would be highly speculative for orders made now but executed in the coming
years (which is typical for shipbuilding contracts). However, any confirmed changes
in labour costs, exchange rates or the debt situation of yards under investigation are
taken into account. This is particularly relevant for yards which have benefited from
debt forgiveness and moratoria (e.g. Daewoo Heavy Industries or Halla Engineering
and Heavy Industries [now operating under the name Samho Heavy Industries]).

It is not within the scope of the study or this report to assess whether Korean or other
Asian shipyards are generally profitable. Given the limited availability of
consolidated accounts for Korean shipyards a statement of this kind is almost
impossible to make. To assume, however, that the continued operation of Korean
yards is ipso facto proof of profitability would be equally wrong as the structure of
the Korean economy in general and the chaebols in particular have offered many
possibilities to cover up losses. The proper implementation of newly introduced
accounting practices could, however, contribute to enhancing transparency. Only
where companies are solely engaged in shipbuilding and where the investigations
cover the entire yard portfolio (shiptypes produced) a statement on the overall

16

profitability can be made. This is the case for Halla and Daedong Shipbuilding Co.,
both yards being under court receivership since 1997 and not having shown any
profits since then. For more details on these two shipyards reference is made to
Annex II of the first report.

3.2.

Update of previous investigations

In the context of report COM (1999) 474 final the following orders placed at South
Korean shipyards were investigated:

–

–

–

–

–

–

–

–

–

Cable layer (series of 13 ships), 9,280 cgt, to be built at Hyundai Mipo yard

3,400 TEU container ship (series of 5), 27,750 cgt, to be built at Samsung
Heavy Industries

Passenger Ro/Ro ferry (series of 2), 25,200 cgt, to be built at Samsung Heavy
Industries

6,800 TEU container ship (series of 2), 52,390 cgt, to be built at Hyundai
Heavy Industries

3,500 TEU container ship (series of 2), 28,500 cgt,
Engineering and Heavy Industries

to be built at Halla

Panamax bulk carrier, 19,500 cgt, to be built at Halla Engineering and Heavy
Industries

Panamax bulk carrier, 22,600 cgt, to be built at Daedong Shipbuilding Co. Ltd.

Product carrier, 19,074 cgt, to be built at Daedong Shipbuilding Co. Ltd.

Very Large Crude Oil Carrier (VLCC), 47,100 cgt, to be built at Daewoo
Heavy Industries

The findings from the detailed investigations are summarised in the table below, the
updated figures are given in bold.

17

Table 3 - Comparison of order prices and calculated construction prices for selected
new ships (update)

Reported
order price
in Mio. US
Dollars

Calculated
building
price in
Mio. US
Dollars

Loss/gain in
percent of
calculated
building
price

Comments

Cable layer
(Hyundai)

37.3

45.4

Container ship 3.400 TEU
(Samsung)

36

56.4

-17.84% Price of 31 Mio. USD also
reported. If confirmed the
calculated loss would amount
to 31.7%.

-36.17% Price of 33 Mio. USD also
reported. If confirmed the
calculated loss would amount
to 41.5%

Passenger Ro/Ro ferry
(Samsung)

Container ship 6.800 TEU
(Hyundai)

Container ship 3.500 TEU
(Halla)

Panamax bulk carrier
(Halla)

Panamax bulk carrier
(Daedong)

Product carrier
(Daedong)

VLCC
(Daewoo)

69.5

73.5

90.9

-23.54%

86.9

-15.42%

38

52.3

-27.34%

18.9

18.5

21.5

68.5

31.8

-40.56%

24.9

-25.70%

24.9

-13.65%

84.3
(86.3)

-18.74%
(-21.11%)

Based on recent financial data
for the yard the contribution to
debt servicing for this order is
calculated at 18.0 Mio. USD
instead of 16.0 Mio. USD

There has been some criticism from the Korean Government and the Korean
shipbuilding industry of the validity of the above findings. It is claimed that for most
orders there is no genuine competition between the EU and Korea as both sides would
operate in different market segments. In practice this may be the result of Korean
pricing practices and unfair competitive behaviour but the above orders have in part
been selected because EU yards tendered and did not win the contracts.

The Korean side also claims that the basic assumptions in the investigations are
incorrect and would not take into account the competitive advantages of Korean yards
(e.g. wage cuts, favourable Won/USD exchange rate, lower material costs). However,
all these elements have been factored in, using most recent data. Figures provided by
the Korea Shipbuilders' Association on lower wages (minus 4% from 1997 to 1998) or
a decreasing workforce (minus 3.2% from 1997 to 1998) are either misleading (1998
was a particular year for Korean shipbuilding as explained in chapter 2 and the
previous report; wages have actually increased in 1999 and it is doubtful that the
Korean figures reflect the full extent of bonus payments) or are insufficient to explain
the considerable gaps between production costs and offer prices.

18

3.3.

New investigated orders

In addition to the nine orders investigated for the first report, 13 more orders have been
analysed for this report. Nine of these orders were placed at six different South Korean
yards, four orders were placed at four yards in the People's Republic of China (PRC).
The Commission assured a balanced selection of cases while taking into account the
overall objective of the exercise, the relative urgency of the matter and the availability
of meaningful data for comparison. The new orders investigated are:

–

–

–

–

–

–

–

–

–

–

–

–

–

Capesize bulk carrier, 25,680 cgt, to be built at Halla (now Samho Heavy
Industries)

Product / chemical tanker, 22,597 cgt, to be built at Daedong Shipbuilding Co.
Ltd.

Passenger Ro/Ro ferry (series of 2), 22,500 cgt, to be built at Daewoo Heavy
Industries

Chemical tanker (series of 2), 5,980 cgt, to be built at Il Heung Shipbuilding
and Engineering Ltd.

Panamax bulk carrier (series of 4), 19,000 cgt, to be built at Daewoo Heavy
Industries

5514 TEU container ship (series of 3), 42,835 cgt, to be built at Samsung
Heavy Industries

Liquefied Natural Gas (LNG) carrier (series of 2), 88,500 cgt, to be built at
Hyundai Heavy Industries

5500 TEU container ship (series of 5), 43,875 cgt, to be built at Hyundai
Heavy Industries

5551 TEU container ship (series of 2), 43,875 cgt, to be built at Hyundai
Heavy Industries

Very Large Crude Oil Carrier (series of 5), 46,800 cgt, to be built at Dalian
New Shipyard, PRC

Ethylene carrier (series of 2), 10,320cgt, to be built at Jiangnan Shipyard Co.
Ltd., PRC

Ro/Ro paper trailer carrier (series of 6), 11,445 cgt, to be built at Jinling
Shipyard, PRC

Passenger Ro/Ro ferry (series of 2), 27,000 cgt, to be built at Guangzhou
Shipyard International, PRC

Not all of the selected projects are confirmed orders and in some cases the financing
may not yet be in place, which could lead to higher or lower order prices, depending
on the particular situation. The European Commission is, however, convinced that the
information entered into the analysis is at present the best available.

19

The following table summarises the findings for the above 13 orders.

Table 4 - Comparison of order prices and calculated construction prices for selected
new ships

Reported order price in
Mio. US Dollars

Calculated building
price in Mio. US
Dollars

Loss/gain in percent of
calculated building
price

Capesize bulk carrier
(Halla/Samho)

Product/chemical tanker
(Daedong)

Passenger Ro/Ro ferry
(Daewoo)

Chemical tanker
(Il Heung)

Panamax bulk carrier
(Daewoo)

5514 TEU container ship
(Samsung)

LNG carrier
(Hyundai)

5500 TEU container ship
(Hyundai)

5551 TEU container ship
(Hyundai)

VLCC
(Dalian New)

Ethylene carrier
(Jiangnan)

Ro/Ro paper trailer carrier
(Jinling)

Passenger Ro/Ro ferry
(Guangzhou)

32

24.5

80

10.5

22.5

55

165

54.3

56

70

22

22

56

47.25

29.5

96.1

12.3

27.3

69

186

64.2

69.5

76.1

-32.28%

-16.95%

-16.75%

-14.63%

-17.58%

-20.29%

-11.29%

-15.42%

-19.42%

-8.02%

not available*

-

28.5

61.4

-22.81%

-8.8%

* The financial data needed to calculate the vessel's contribution to debt servicing for
the building yard could not be retrieved. Total operating costs for this order are
calculated at 19.7 Mio. USD which would give some margin for debt servicing and a
small profit. Therefore, it appears that the vessel has been appropriately priced.

The results from the above case investigations are fully in line with the findings from
the first report. Korean yards continue to offer ships at prices well below cost. Low
prices are offered again by those yards which are in the most critical financial situation
(Daewoo, Halla / Samho and Daedong).

It is noteworthy that fierce competition between Korean yards continues to be a factor
that keeps prices down. As all Korean shipyards carry massive debts and ensuring
cashflow is extremely important for their survival, none of them can afford to raise
prices unilaterally. Where intra-Korean competition is limited, due, for example, to
licensing arrangements (as it is the case for the investigated LNG carrier) Korean yards

20

maintain higher price levels (the LNG carrier order would, according to the cost
calculations, not yield a profit but neither would it incur a considerable loss).

It appears that costs resulting from debt servicing are typically not included in the price
calculations. Prices seem to be set at levels where owners find it hard not to place
orders in Korea, and Korean shipyards apparently rely on favourable debt settlement
conditions later. With large parts of the Korean commercial banking sector under
Government control it is highly likely that the Korean Government has a decisive
influence on the financing operations related to one of Korea's major exporting
industries. The role of "commercial" banks in Korea needs further scrutiny as the case
of Daewoo in particular has shown. To avoid a bankruptcy of the Daewoo group
domestic banks have accepted huge losses on their outstanding loans and foreign
creditors were pressured to follow suit. Recent reports indicate that the government-
owned Korea Development Bank will assume 37% (other sources speak of 60%) of the
assets when the shipbuilding part of Daewoo is spun off. This would de facto amount
to a partial nationalisation of the Daewoo shipbuilding activities.

The analysis of contracts placed in China is significantly more complicated than for
Korea. The reasons are to be seen in the industrial structure and the absence of market
principles (see also annex). More investigations will be required to gain a better
insight. The four investigations made do not provide a consistent picture. One offer
seems clearly loss making, probably due to the technical sophistication of the vessels
in question and the lack of experience of the shipyard in this field. The other three
orders may be profitable, but again not all conditions of the orders are fully known. In
the case of the VLCC a barter agreement seems to be part of the contract (the National
Iranian Tanker Company paying for the ships partly with oil deliveries); the exact
conditions of this agreement, as well as the specific payment terms for this protracted
build programme, may have a severe impact on the profitability of the order for the
building yard.

3.4.

Impact on EU yards

As in the case of the first report on the situation in world shipbuilding, a negative
impact on EU yards is assumed when the order is made at a price which does not
cover costs and which is low enough to keep the order out of reach of EU yards. This
is particularly true if the owner has traditionally placed orders with EU yards.
However, even where Asian competitors had significant market shares in the past the
depressing effects of this pricing policy will have a negative effect on the market in
general and, on this basis, the price may be perceived to be injurious. Whilst an
individual contract may not take work directly from an EU builder there will be a
"trickle down" effect in the market as a whole, which will have a detrimental effect
on shipbuilding in the EU. As the facilities and skills to build ships for market
segments that have already been lost in the past are still available in EU yards, an
increase in prices would enable such yards to acquire contracts in these markets as
well.

Of the nine orders placed in Korea, covered in this report, six can be seen to have an
impact on EU yards. The other three orders concern shiptypes in which EU yards were
strong in the past but which are now rarely produced in Europe. The key elements for
the six cases are as follows:

21

–

–

–

–

–

The passenger Ro/Ro ferries to be built at Daewoo Heavy Industries will
operate in the Mediterranean for an Italian owner who previously had not
ordered ships in Korea. The shiptype is new to the building yard and intra-
Korean competition for these orders has been fierce. This resulted in a very low
price which is seen some 15% lower than the nearest European bid. This order
has also symbolic value for the building yard as the Mediterranean ferries
segment has been a European domain in the past.

The chemical tanker to be built at Il Heung Shipbuilding and Engineering Ltd.
for a Norwegian owner represents a smaller specialised vessel (with 3.650 dwt
only). The yard has not been active in the export business for this type of ship
and tried to gain access to the European market through a low-price offer. So
far the construction of these vessels has been the domain of smaller specialised
EU shipyards which find it difficult to diversify their portfolios.

The 5514 TEU container ship order at Samsung Heavy Industries has been
placed by a German owner. The ship will
later be operated by a major
European container line. It is one of the Postpanamax container ships for which
Korean yards actively tender because these orders are seen as more profitable
than orders for bulk carriers or tankers. As this particular investigation shows it
is difficult to see this order being profitable.

LNG carriers are highly specialised and expensive vessels. Considerable know-
how is required for the construction of the cargo tanks and the ship's
machinery, and EU yards have been a key player in this market segment in the
past. Looking at the period 1990 to 1998, 63% of all LNG carrier orders were
placed in Japan, with the EU holding 27% of the market and Korea standing at
10%. Currently the LNG carrier orderbooks show 43% for Japan and 57% for
Korea. No orders are placed in the EU. This is another example of Korea
making inroads into a high-value market segment previously held by Japan and
the EU and although the order could be marginally profitable the erosion of
another EU market niche should raise concern. It is noteworthy that the same
yard is building similar ships for the state-owned Korea Gas Corporation at a
reported price of 212 Mio. USD, compared to the price of 165 Mio. USD to the
non-Korean customer.

The two orders for Postpanamax container ships at Hyundai Heavy Industries
(5500 and 5551 TEU, respectively) have been placed by a Japanese and a
Taiwanese owner. The order from Japan is clearly at the expense of Japanese
yards (this is the first order this owner has placed outside Japan). The
Taiwanese owner has traditionally placed orders in Japan and at China
Shipbuilding Co. in Taiwan. His newbuildings at Hyundai will use a design
from China Shipbuilding Co. and the resulting fees explain the higher building
costs as compared to the Japanese order. While it can be assumed that even at
higher price levels these particular orders would have been placed in Asian
yards, it should be noted that some of the most advanced EU shipyards would
be keen competitors for this shiptype if price levels reflected building costs
appropriately.

22

3.5.

Conclusion

–

–

–

–

–

The shipbuilding market monitoring study commissioned by the European
Commission continues to produce tangible results. The cost model employed is
stable and suited to analyse the true costs of shipbuilding in Korean yards. For
the People's Republic of China more investigations are needed to arrive at a
consistent picture. This concerns in particular the financial situation of Chinese
shipyards.

The cost investigations now cover 22 orders (18 placed in South Korea, 4 in
the PRC) which - excluding options for additional ships - represent 65 vessels
(50 in Korea, 15 in the PRC) with a calculated value of 4.29 bn USD (3.616 bn
USD in Korea and 0.674 bn USD in the PRC).

None of the investigated orders for new vessels placed in Korean yards is
clearly profit making and there are now even more convincing indications that
Korean yards offer ships at below cost price; in many cases prices do not even
cover operational costs, let alone the servicing of debts. Losses taken are
calculated between 11% and 32% of the normal price (breakeven price + 5%
profit margin). For orders placed in China conclusions cannot be drawn yet: of
the three investigated orders two appear to be profitable and one is very likely
to be loss-making.

Korean yards continue to pursue orders in all market segments, in particular
those for large container ships and other high-value tonnage, but also smaller
specialised tonnage is sought. This leaves only cruise ships as a market niche
for EU yards. As many European yards are not active in this segment they are
now left without a sufficient volume of new orders.

The functioning of Korea's financial system with regard to the financing of
shipyards and shipbuilding projects, remains opaque and, as there is substantial
scope for government intervention with large parts of the banking sector being
owned by the State, public involvement in financial and organisational matters
is likely. Credits and guarantees given to shipyards do not follow global
risk assessment as has been
business practices, and such commercial
undertaken does not seem to follow the laws and logic of a market economy.

23

4.

CONCLUSIONS AND RECOMMENDED ACTIONS

The world market for merchant ships continues to be in crisis. Supply clearly outstrips
demand and there are few indications that this situation may improve (e.g. through
regulatory schemes in the area of maritime safety that would foster
tanker
newbuilding). Indeed, the opposite is more likely: all shipyards in South Korea
continue to operate, even those which have been under bankruptcy proceedings since
1997. Moreover Korean shipbuilders have announced the re-opening of idle dock
capacity, apart from converting repair facilities to newbuilding. The pending re-
structuring of the ailing Daewoo Group also does not seem to lead to any capacity
decrease. It should, however, be noted that the Government of the People's Republic of
China has announced a ban on yard newbuilding and on capacity expansion to avoid
further over-capacities.

The comparatively strong demand for ships in the last 2 - 3 years has had no positive
impact on prices. On the contrary prices for nearly all shiptypes have continued to
decline. This shows that normal market mechanisms do not apply in world
shipbuilding. The on-going depression in prices is caused by extremely low offer
prices from Korean yards which initially may have targeted Japanese and EU market
shares. Recent developments, however, have shown that intra-Korean competition, in
particular with regard to orders for large containerships, has a strong effect on
attainable prices. At current price levels EU and Japanese shipyards clearly cannot
compete.

The detailed cost investigations have once more revealed the extent of the losses which
Korean yards are willing to take in order to assure market share and cash flow. Despite
a certain narrowing of the gap between true costs and offer prices, the calculated losses
are between 11% and 32% of the building costs. Moreover, with the exception of
cruise vessels, all market segments are targeted by Korean yards, leaving only small
domestic orders and highly specialised tonnage to EU yards.

Therefore this second report by the European Commission on the situation in the world
shipbuilding market confirms the findings from the Commission's first report.

several

All lines of action to address the problem (as requested by the European Council of
Ministers in its meeting of 9 November 1999) are currently pursued. In particular,
strenuous efforts have been made by the Commission to secure binding commitments
from the Korean Government in relation to its non-intervention in the financing of
shipbuilding activities. After
the European
Commission and the Korean Government finalised their talks and initialled on 10
April 2000 "Agreed Minutes relating to the World Shipbuilding Market". These
Agreed Minutes are focusing on non-subsidisation, banking, financial transparency
(with regard to international accounting standards), commercial pricing practices and
an effective consultative mechanism. The overall aim is to promote fair and
competitive market conditions in the world market and to work together to stabilise
the market and thereby help raise the level of ship prices to ones that are
commercially sustainable.

rounds of consultations,

The evidence gathered within the framework of the market monitoring undertaken by
the European Commission has helped the EU industry to compile sufficient elements
which could lead to a complaint under the Trade Barriers Regulation and industry has

24

recently announced its willingness to file such a complaint. Therefore,
Commission will continue with its market monitoring exercise.

the

Contacts with IMF representatives so far have not led to results which could be used to
end unfair competition practices shown by Korean shipyards. It should be noted that
Korea is re-paying its IMF loans ahead of schedule, thereby limiting the IMF's ability
to influence Korean policy.

It is recommended to

–

–

–

–

–

continue to exercise pressure on Korea to fully implement
the "Agreed
Minutes" and assume responsibility to work towards an improvement of the
in particular concerning price levels and newbuilding
market situation,
capacities;

fully apply the provisions of the "Agreed Minutes" once they have entered into
force, invoking the consultation mechanism whenever necessary;

collect further and more detailed evidence on possible injurious pricing and
other non-market oriented behaviour
in order to launch and support a
complaint under the Trade Barrier Regulation if required;

keep the IMF informed about the findings and request
industrial restructuring in Korea is closely monitored and assessed;

that the promised

encourage the EU shipbuilding industry to further improve its competitiveness.

25

5.

LIST OF TABLES AND GRAPHS

Fig. 1 - Completions 1997-1999 in Mio. cgt and per region ..............................page 9

Fig. 2 - Orderbooks 1997-1999 in Mio. cgt and per region .............................page 10

Fig. 3 - New orders 1997-1999 in Mio. cgt and per region..............................page 11

Fig. 4 - Market shares in new orders ..............................................................page 12
in percent and based on cgt, 1997 - 1999

Table 1 - Evolution of prices for newly built ships .........................................page 13
(yearly averages in Millions of US Dollars)

Table 2 - Evolution of prices for newly built ships .........................................page 13
(annual changes in percent)

Fig. 5 - Market shares in new orders for containerships ..................................page 14
in percent and based on cgt, 1997 - 1999

Table 3 - Comparison of order prices and calculated construction prices.........page 18
for selected new ships (update)

Table 4 - Comparison of order prices and calculated construction prices.........page 20
for selected new ships (new investigations)

26

6.

REFERENCES

Report from the European Commission to the European Council of Ministers on the
situation in world shipbuilding, COM (1999) 474 final

Council Regulation (EC) No 1540/98 of 29 June 1998 establishing new rules on aid to
shipbuilding, Official Journal L 202, 18/07/1998 p. 0001 - 0010

Council Regulation (EC) No 3286/94 of 22 December 1994 laying down Community
procedures in the field of the common commercial policy in order to ensure the
exercise of the Community's rights under international trade rules, in particular those
established under the auspices of the World Trade Organization, Official Journal L
349, 31/12/1994 p. 0071 - 0078

27

ANNEX: THE SHIPBUILDING INDUSTRY IN THE PEOPLE'S REPUBLIC OF CHINA

The shipbuilding industry in China is diverse but the majority of shipyards are state-owned,
primarily within the China State Shipbuilding Corporation (CSSC). State-owned enterprises
do not publish detailed accounts and it is questionable whether or not individual shipyards
actually know their true costs. Many of the state-owned yards are also heavily diversified and
it is difficult to analyse the businesses concerned even from on site.

1999 saw a massive re-structuring of CSSC that came about because the industry is not
developing according to expectation. While only a few years ago Chinese yards were seen as
a global threat, this threat has largely failed to materialise. he simple fact is that wages and
costs have risen considerably in recent years without the necessary performance improvement
to ensure competitiveness. The industry is characterised by over-manning and poor
performance and the total cost of building a ship in China is regarded by some analysts as
being higher than in both Japan and South Korea.

In 1996, CSSC stated that their plan was to double world market share by 2000 from 5% to
10%, achieving an export value of between $1.2 and $1.5 billion. In 1999 the actual share
achieved of both gt and cgt was 7%, although it appears that the revenue target may have been
accomplished. This is illustrated in the following table using statistics from the Chinese
Shipbuilding Industry Association.

Table A.1 Newbuilding orders in Chinese yards (Source: Lloyd's Register of Shipping)

1997

1998

1999

Orders from abroad

2.07 Mio. dwt

1.712 Mio. dwt

4.48 Mio. dwt

Total orders placed

2.29 Mio. dwt

8.55 Mio. dwt

Total ship export revenue

1.5 bn USD

1.73 bn USD

1.8 bn USD

Between the end of 1996 and 1999 the orderbook rose from 1.4 Mio. cgt to 2.5 Mio. cgt, an
increase of almost 80%. This is illustrated in the following chart presenting the orderbook
since 1990 in terms of cgt and showing the rate of delivery of new tonnage over the same
period.

28

Fig. A.1 - Orderbook and output in Chinese shipyards (Source: Lloyd's Register of Shipping)

T
G
C
m

3

2 ,5

2

1 ,5

1

0 ,5

0

1 9 9 0 1 9 9 1 1 9 9 2 1 9 9 3 1 9 9 4 1 9 9 5 1 9 9 6 1 9 9 7 1 9 9 8 1 9 9 9

O rd e r b o o k a t y e a r e n d
C o m p le tio n s a t y e a r e n d
L in e a r (O r d e rb o o k a t y e a r e n d )
L in e a r (C o m p le tio n s a t y e a r e n d )

Whilst the increase in the orderbook appears impressive it should be seen in context. China
has a massive shipbuilding industry (reputedly over 800 shipyards in total, including repair
yards) but the orderbook is only marginally ahead of that of Italy (2.1 Mio. cgt) or Germany
(2.0 Mio. cgt). It is also an order of magnitude behind the giant orderbooks of South Korea
(10.6 Mio. cgt) and Japan (8.6 Mio. cgt). The industry is still many years away from being the
global threat that many perceive it to be.

The difference in the rate of increase between the orderbook and deliveries should also be
noted from the above graph. Over the period shown, the trend line for increase in the
orderbook shows a growth rate of about 17.5% per annum, while for deliveries growth has
been about 7.2%. It is concluded from this that the ability to deliver increased tonnage lags
the ability to generate increased orders and this is likely to constrain expansion of the
industry. It is also likely to lead to production problems with growing backlog and inventory
putting increasing pressure on shipyards.

There has been significant capacity expansion in recent years both through the construction of
new facilities and the upgrading of existing shipyards. The new facilities are generally finding
orders hard to attract due to difficult market conditions and in particular very low prices. A
good example is the new VLCC facility at Dalian that has only just managed to attract its first
VLCC order, despite trying to get into the market for a number of years. The Chairman of
Dalian New Shipyard has lobbied strongly for the devaluation of the Yuan to try to improve
competitiveness and help his yard gain orders. These difficulties have not stopped the
expansion process, however, including a proposal to build what will be one of the world’s
largest shipyards at Wai Gao Qiao. There are reportedly five major shipyard projects under
construction and a further five in the planning stage.

Investment in new technology has not achieved the gains envisaged. Many shipyards have
installed automated panel lines and new construction equipment. The problem is that the
shipyards are not yet at a sufficient level of technology to be able to use such sophisticated
equipment. Such attempts to buy a way to lower costs are doomed to failure and equipment is
not the answer to over-manning and poor management, which are the root causes of low
performance in Chinese shipbuilding.

29

The industry in China is generally characterised by shortage of work and difficulty in
attracting new orders. In this respect it should be noted that Chinese shipyards are just as
much victims of aggressive Korean capacity as are shipyards in Europe and Japan. Having
said this, even without the Korean element it is likely that the yards in China would be short
of orders due to inefficiency.

1996 targets for the development of the industry have failed in one further respect of
significance to cost
investigations. It was stated in that year that by 2000 the use of
domestically sourced equipment would account for 80% of equipment used on ships
constructed in Chinese shipyards. This has simply not happened, however, with the actual use
of Chinese equipment being very limited. Even for vessels built for domestic owners the very
poor quality of Chinese equipment means that imported materials are used to a large extent,
although import taxes preclude this to some extent.

In summary, the industry in China is in a state of turmoil and actions are being proposed to
tackle the problems being faced. The Chinese government has recently announced measures
to ensure that ships for domestic operation are built
in home shipyards, along with an
abolition of taxes and duties previously levied on ships and equipment, to support the
industry. However, until the fundamental problems of efficiency are tackled, the industry is
unlikely to achieve its true potential.

Restructuring of CSSC

CSSC was founded in 1982 to run the shipyards formerly grouped separately under the 6th
Machinery Ministry and the Ministry of Communications
(MOC). MOC retained
responsibility for a number of smaller yards producing coastal vessels and repairing ships,
while CSSC undertook management of the major sectors of the industry.

Although accounts are not published, sources have confirmed that the main thrust behind the
restructuring of the state-controlled industry has been huge losses incurred since entering the
international market in the early 1980s. The main reasons behind this situation are seen (by
the Chinese authorities) to be:

–

–

–

–

–

Poor productivity due to the centralised system;

Poor management;

Inefficient planning;

Lack of knowledge of international practice;

Corruption.

The support of losses has been the main form of subsidy to the industry in China and the
Government has recognised that it needs to adopt truly commercial operations to achieve its
aims. To some degree this conflicts with ideology, such as that which precludes the shedding
of labour, and there is a long way to go to achieve the aims of the industry. There is also still a
long way to go in understanding commercial activity, particularly in state-owned enterprises.
For example, it is common practise to hire low cost subcontract labour to work on contracts
rather than using more expensive in-house labour, even though the workforce may be under-
utilised.

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Until the middle of last year, the state-owned industry was primarily, although not solely,
under the control of the monolithic CSSC. The industry was basically run by civil servants as
a branch of the Government. Following restructuring, the industry will be split into two main
groups:

–

–

China State Shipbuilding Corporation (CSSC – southern shipbuilding group,
incorporating yards in Guangdong, Jiangxi, Anhui and Shanghai);

China Shipbuilding Industry Corporation (CSIC – northern shipbuilding group,
incorporating yards in Yunnan, Hubei, Tianjin, Shanxi and Liaoning).

These Corporations are ultimately answerable to the Chinese cabinet and will be regulated by
the Committee of Science, Technology and National Defence. The larger of the two units is
the Bejing based CSIC, having assets of Yuan 9.5 bn (ca. 1.15 bn USD). CSIC holds forty-
eight industrial enterprises including Dalian, Dalian New, Qingdao Behei, Liaoning Shipyard
and Tianjin Shipbuilding Corporation. This Corporation also operates twenty-eight science,
design and research units.

CSSC has assets estimated at Yuan 6.4 bn (ca. 0.8 bn USD). It operates thirty industrial
enterprises including Jiangnan, Hudong, Shanghai, Guangzou Guangdong Shipping and
Shanghai Global Container.

The main benefit of restructuring will be the subdivision of the industry into more
manageable groups. The main disadvantage is the introduction of competition between the
groups and it is not at all clear how this will be resolved. The reforms divide the industry
broadly along north/south lines. While the two groups have been given responsibility for
managing and increasing asset values for the State, it is left to individual units to determine
their product mix and pricing policies. The umbrella groups will not conclude contracts on
behalf of the members and will not intervene in day-to-day business unless an activity is
deemed to be damaging to the overall industry.

Outside the two main groups there are other commercial shipyards (mainly smaller and local
yards) which come under the control of the following organisations:

–

–

–

Shipbuilders operating under the Ministry of Communications;

Local shipyards operated by provincial governments in Jiangsu and Fujian;

Joint venture shipyards (Kawasaki-COSCO, Raffles-Shangdong and Samsung-
Ningbo).

In addition, there are a small number of privately owned yards, the main example being
Guangzhou Shipyard International. The Government has been reluctant to relinquish control
through privatisation and sales and has also been very reluctant to set up joint ventures,
having had a number of difficult experiences in this in the past.

There are essentially three main shipbuilding centres in China. Around 50% of shipbuilding
output is constructed by yards in the Shanghai region. At the present time, shipyards in
Shanghai are limited to building up to about Panamax size due to air-draught restrictions on
the Huang Pu river. The alleviation of this restriction is one of the main motivations for the
development of the new shipyard at Wai Gao Qiao, outside the restrictions imposed by the
river. Dalian is the second most important centre and was chosen as the site of the country’s
first VLCC yard. Guangzhou is the third important geographical centre and there are other

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yards located at various sites around the country. The geographical distribution of shipyards is
important with regard to costs because costs differ significantly from region to region in
China, with Shanghai and Guangzhou being the highest cost locations in the country.

The cost base in Chinese shipbuilding

Labour costs, working practices and performance

China has long been regarded as a low cost country, in particular with respect to wages. This
advantage has been eroded in recent years, however, due to increasing wages and standards of
living. Inflation has been relentless. Between 1980 and 1998 the annual increase in average
wage of staff in manufacturing across the whole country was 16% (source: China Statistical
Yearbook) and in absolute terms wages rose by over 400% in the decade between 1988 and
1998.

Wage inflation has not been uniform, however, and variation between regions is very large,
with the average earnings in Shanghai being around 90% higher than in Liaoning. There is
also a significant variation between different types of company (state-owned or other such as
joint ventures, private enterprises and wholly owned foreign enterprises). Of
these,
organisations with an element of foreign ownership tend to attract the highest payment
premiums.

It should further be noted that there is a big difference between rural and urban centres. For
example in 1996 average wages in urban centres were almost four times the average in rural
areas.

No official productivity statistics have been identified for industry as a whole in China.
However statistics on output per capita for eight major industries are available (source: China
Statistical Yearbook), which suggest that productivity has increased over the last decade by
only about 3% per annum. In other words, the development of productivity has lagged the
increase in the cost base by a significant amount and output prices have therefore risen.

In response to these economic changes and increasing standards of living, in particular in
urban centres, costs and prices have risen over the past two decades. The average year-on-
year rise in the consumer price index between 1988 and 1998 was 8% (source: China
Statistical Yearbook). Again, however, the overall average masks a significant split between
rural and urban areas, with the average rise in urban areas over the same period being 10%. In
absolute terms consumer prices rose by 2.5 times between 1988 and 1998. Increases have
slowed recently due to increased competitive pressure. 1998 saw the first fall in prices on
record with a 3% fall in consumer prices in general, although the fall was much less marked
in urban areas where a drop of only 1% was seen.

The ex-factory price of industrial goods has also risen in response to the rising cost base. In
the ten years between 1988 and 1998 factory gate prices rose by almost 100%, at an average
of 9.3% per annum (source: China Statistical Yearbook).

Chinese shipyards tend to be major employers. A typical traditional yard may employ 9000 to
12000 persons. Not all of these workers will be involved directly in shipbuilding, with many
yards being diversified, although even given this fact these are huge shipyards in the modern
context. Idle time is typically very high (measured recently at around 17% of hours paid in
one of the more productive yards) and this, along with inefficiency, means that Chinese yards
are in general substantially over-manned. This situation is not helped by the fact that it is not

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possible under labour law restrictions to lay-off staff as required. The actual rate of over-
manning depends on the level of orderbook. If it is assumed that the current relatively high
orderbook is associated with an appropriate level of manning, analysis shows that state-owned
yards have suffered from levels of over-manning up to double the required number of workers
in recent years. The over-manning is further exacerbated by the common use of low cost
subcontract labour (typically at about 60% of the cost of using the company’s own labour) to
take the place of higher cost shipyard workers to reduce the level of direct costs against
contracts. This is often done without shedding the labour that is being replaced.

Material costs

China is a major producer of steel and the majority of mild and high tensile steel is sourced
locally. Special steels may be imported from Japan or South Korea. Steel prices have been
rising steadily within China at an average annual rate of 6% over the last decade. The current
price for Grade A steel as used in shipbuilding is probably higher than the price at which steel
could be purchased from Korean mills but under the centrally planned system, shipyards are
often directed to purchase from local mills, in some cases irrespective of whether the steel is
needed or not. This has led to a situation where many of the traditional yards in the state
sector are choked with inventory and steel stocks.

Efforts to increase the amount of domestically produced equipment on ships built in China
have so far been fruitless. Chinese manufactured equipment, whilst cheap, is not regarded as
sufficiently reliable by most shipowners (including Chinese owners) and its inclusion is seen
as seriously jeopardising resale values. For this reason the vast majority of equipment is
imported. Equipment from Europe and Japan is favoured, with imports from South Korea,
with the exception of main engines, being limited. Research is ongoing to evaluate precisely
the level of cost advantage enjoyed by Chinese yards. Research to date indicates that
domestically sourced equipment is about 30% cheaper than imported, but its use is limited,
primarily to basic equipment and equipment built under licence.

Interest rates

The government aims to maintain economic growth at around 8% per annum and is trying to
create economic conditions to promote this, including measures to boost consumer spending
and infrastructure development. In light of this, and bearing in mind that prices have fallen
slightly, the People’s Bank of China (PBC) has continuously lowered interest rates in recent
years. Rates for working capital loans for state-owned enterprises have declined from about
10% to around 6% since the end of 1996. At January 2000 PBC rates for working capital were
5.85% on a 12-month basis and 5.60% on a 6-month basis. Interest rates for privately owned
companies attract a premium of about 30 points, currently standing at about 7.25%.

Exchange rates

Exchange rates have been steady in recent years, almost to the point that the rate between the
USD and the Yuan has appeared pegged. There has been a very gradual strengthening in the
currency against the dollar, however, which has further reduced competitiveness. Exchange
rate movements have, at least in dollar terms, provided little relief from rising costs despite
calls from exporting industries (including shipbuilding) to devalue. Loss in competitiveness
has been much more marked when the Yuan is measured against the currencies of Japan and
South Korea.

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