Market switching in shipping — A real option model applied to the valuation of combination carriers

Abstract

This paper derives a real options model of flexibility and applies it to shipping, valuing the option to switch between the dry bulk market and wet bulk market for a combination carrier, a ship type that is capable of operating in both markets but that has fallen out of favor due to high price tags. The model is a mean-reverting (Ornstein-Uhlenbeck) version of a standard entry-exit model with stochastic prices. A closed form solution for the value of flexibility is derived, expressed in terms of Kummer functions. The estimated value of flexibility is related to historical price differentials between combination carriers and oil tankers of comparable size. Based on numerical experiments it is concluded that new combination carriers may enter the market in the near future.

Optimal investment timing in the dry bulk shipping sector

“…Goncalves (1992) extends this notion to chartering and ship investment decisions. Sødal et al (2008Sødal et al ( , 2009 derive a real options model to valuing the option to switch between the dry bulk market and wet bulk market for a combination carrier. Ryaard (2009) uses dynamic programming to develop a valuation model for time charter contracts for ships.…”

Assessing flexible offshore construction vessel designs combining real options and epoch-era analysis

“…A mean-reverting process embed these business cycles by generating random motions that tend to revert back to a mean value over time (De Neufville & Scholtes, 2011). Mean-reverting stochastic processes have previously been used to study market switching flexibility in combination carriers that can operate either as an oil tanker, or as a dry bulk carrier (Sødal, Koekebakker, & Ådland, 2008).…”

Handling commercial, operational and technical uncertainty in early stage offshore ship design

“…Valuing flexibility with real options analysis can then be used to assessing which options should be included in a design. A real option example can be market switching in shipping [23], introducing the option to switch between wet and dry markets. The flexible ship will be able to operate in the most profitable of those markets, hence this option increases the expected lifecycle performance of the ship.…”