2003 Q4 | Next Wave | Portcalls - the Philippines only Shipping and Transport Guide

Today, 40% to 45% of the total value of our Intra-Asia and global imports and exports are carried on ships while 55% to 60% is carried by air. Of the goods carried by sea, 96% is carried on foreign registered vessels and only 4% are carried on Philippine flag vessels. This represents 1.5% of our total worldwide trade.

Total outward dollar remittances paid to non-Philippine shipping companies annually approximately reaches US$1.27 billion.

The Practice Present Philippine trade practices have institutionalized the use of foreign flagged ships in the carriage of our import and export trades. Our imports are bought CIF while our exports are sold FOB giving control of freight to our vendors and customers. CIF and FOB When foreign goods are bought CIF, the price quoted by the seller abroad includes the cost of goods, the cost of insurance and the cost of freight to land such goods in the Philippines. This gives the seller the free hand to nominate and negotiate with his preferred carrier for the carriage of goods to the Philippines.

In the same way, when our exports are sold FOB, the price quoted by our exporters to the buyer means the goods are brought free on board the vessel and thus excludes insurance and freight. The responsibility to pay for insurance and freight is given to the buyer together with the freedom to contract with his preferred carrier. Changing the Practice To gain greater control of our trade and manage our freight bills, we should change current practices and encourage our importers to buy FOB at the port of origin and our exporters to sell CIF at the port of destination. This will give the opportunity for Philippine registered tonnage to bid for the carriage of goods and the government to reduce the outflow of foreign currency. It would also allow Philippine companies to negotiate freight terms with local shipping companies.

The total value and the total aggregate volume of Philippine import and export goods is as follows:

Worldwide Trade Philippine import trade for 1999 posted an FOB value of U.S.$30.7 billion and a CIF value of U.S.$32.5 billion.

Worldwide exports for 1999 were reported to have an FOB value of U.S$35.0 billion and a CIF value of U.S.$36.6 billion.

For 2000, total import trade of the Philippines posted an FOB value of US$31.4 billion and a CIF value of US$33.8 billion.

Its total export trade, on the other hand, posted an FOB value of US$38.1 billion and a CIF value of US$39.9 billion.

The difference between the FOB value and the CIF value equivalent to an average of US$3.8 billion, or about 5% of total trade bills, represents the cost of insurance and freight paid to foreign companies. ASEAN trade Philippine trade with ASEAN countries comprises approximately 15% of our total worldwide import and export trade. Our major trading partners among the ASEAN members are Indonesia, Malaysia, Singapore, Thailand and Vietnam.

Total goods traded between the Philippines and the different ASEAN member countries in 1999 showed a total FOB value of U.S.$4.46 billion for imports and U.S.$4.99 billion for exports. If 5% were to represent freight and insurance, then the amount paid would approximately be U.S.$223 million for imports and U.S.$249.5 million for exports or a total of U.S.$472.5 million for 1999. Philippine import and export trade for the ASEAN region in 2000 totaled U.S.$10.94. Insurance and freight for this period would approximately be U.S.$546.9 million.

The bulk of the import and export goods traded between the Philippines and the different ASEAN member countries are carried by foreign flagged carriers. Carriage of goods by Philippine flag vessels should be encouraged because this will translate to savings in foreign exchange paid for freight to foreign ship owners. The following table will show total value of commodities traded by the Philippines worldwide versus that traded with our ASEAN neighbors and those within the ASEAN region covering a period of five years.

High cost of low port productivity A vessel's operating cost is highly affected by low port productivity in our domestic ports. This results in longer port stay. Our domestic ports lack the necessary terminal facilities and equipment that will allow domestic ship owners to operate their vessels efficiently. Since few ports can serve large ships, added delays are caused on vessels when they must wait for the tide to rise before they can enter or leave the port.

Below is a comparison of vessel discharging rates for cargo carried containers and for corn carried in bulk.

Most shippers look at total transport cost as freight cost. However, when one scrutinizes the components of transport costs, it will be seen that freight due a shipping company comprises only a part of the total transport cost paid for by the shipper.

Following is a breakdown of the various components comprising total transport cost against the portion to be paid to the shipping company.

As of January 2003 Exports through FSL/AISL (as transshipment cargo) Via North Harbor

Amount paid as transshipment charge to foreign line: US$450.00 Freight as a component of retail price

The next two tables show a comparative study of the ratio of sea freight to retail price of certain commodities shipped from Mindanao to Manila and from Manila to Cebu.

Mindanao to Manila (as of January 2003) Freight per Ratio to Per unit unit Retail Price

Manila to Cebu (as of January 2003) Commodity Retail Price Freight per Ratio to Per unit unit Retail Price

Need for a clear national maritime policy Successful maritime nations have clear policies supporting their shipping industry. The support comes in the form of clearly defined laws including those on foreign investment and mortgages, tax incentives, access to finance including equity, and simple delineation of jurisdiction by government. A clear policy is required outlining Philippine shipping as a vital industry that must be supported.

One policy is cabotage or the privilege adopted by most nations to support investments in this vital and strategic industry that serves trade and provides national security. In the event cabotage is lifted without any effort made to improve the shipping environment, Filipino shipowners will be forced to move their corporate jurisdictions to Singapore and Hong Kong, avail of incentives, charge freight in foreign currency instead of pesos, and stay committed to the domestic market only when viable.

Indonesia is the perfect example of a country that lifted cabotage with dire consequences. Lifting cabotage in response to pressure by Indonesian exporters killed the Indonesian fleet. They now have foreign lines carrying 97% of their foreign trade and 53% of their domestic trade without any significant decrease in freight.

Today, Indonesia has re-introduced cabotage and is trying to build up its national fleet to cure its trade imbalance, again develop a seafaring industry, and decrease its dependence on foreign ships.

Cost of Taxes Domestic ship owners are subject to taxes normally levied on domestic corporations while ship owners engaged in overseas shipping, as well as owners from competitive countries like Singapore, enjoy a relatively tax-free environment.

A difference in tax rates for income earned by domestic operators versus that of the overseas operators also increases the cost of freight. INCOME TAX Domestic Shipping 32% Computed on net income from all sources Overseas Shipping 1.5%-2.5% Computed on gross Philippine billings The same disparity in income tax treatment appears when one compares domestic airlines with domestic shipping operators. Airlines enjoy the following preferential income tax rates that allow them to offer lower passenger and freight rates.

INCOME TAX Domestic Shipping 32% on net profits or 2% minimum corporate income tax, whichever is higher Overseas Shipping 32% on net profits (subject to net loss carry over for five years) or 5% on gross profits whichever is lower Domestic ship owners are taxed for their fuel purchases while overseas operators are able to purchase their fuel tax free, whether such fuel is purchased in the Philippines or overseas.

The following table shows the difference in excise tax treatment between domestic operators and overseas operators for their purchase of fuel.

Domestic airlines enjoy a similar tax exemption on the purchase of their fuel requirements.

EXCISE (SPECIFIC) TAX ON FUEL Domestic Shipping Bunker P0.30/liter Diesel P1.63/liter Lubricants P4.50/liter Domestic Airlines Aviation Gas P0.00 Other Fuel P0.00 Freight paid to domestic ship owners are subject to the payment of the value-added tax and the carriage of passengers is subject to the payment of the common carriers tax. Freight paid to overseas ship operators are subject to the common carriers tax. VAT AND COMMON CARRIERS TAX Domestic Shipping: Overseas Shipping: Common Carriers Tax on Income from Passage 3% 0% VAT on income from freight 10% 0% Common Carriers Tax on Income from Freight 0% 3% Domestic airlines enjoy other tax exemptions. The following table exemplifies this.

OTHER TAXES Domestic Shipping: Transfer of vessel 10% Transfer of Real Property 6% Domestic Airlines: Transfer of aircraft 0% Transfer of Real Property 0%

Freight Rates in the Domestic Trade, Part II (October 27, 2003)

To address the persistent criticism suffered by locally grown corn, the domestic shipping industry has joined hands with stakeholders of the corn industry through the National Corn Competitiveness Board. The Board seeks to develop a strategic action plan and pursue a development program to reengineer the farming and trading practices of corn.

The program involves the planting of domestically grown corn to large tracts of aggregated land in specific provinces in Mindanao with climates conducive to corn growing. It will require the use of the same hybrid seed resistant to pests to allow co-mingling of products. It will encourage investments in drying facilities and silos to facilitate its shipment in bulk.

This program will increase productivity and generate volumes sufficient to substitute imported corn with domestically grown corn.

The domestic shipping industry is also working with vegetable producers, hog and poultry raisers and other

agricultural and industrial sectors to see how trade practices can be re-engineered to allow for more competitive transport services, lower costs and open new markets and opportunities.

As a result of its commitment to work closely with the different agricultural and industrial sectors, the domestic shipping industry is actively participating in the newly created National Swine Board.

Stakeholders of the corn, swine and poultry industries have come together in a joint workshop to determine strategic action needed to make these industries competitive within the next five years, aim at making domestic production sufficient to meet domestic demand and aspire for exportation to ASEAN and Asian markets.

Port Limitations
Many of our ports restrict the size of vessels able to enter due to draft limitations or cargo handling constraints even if trade volumes would warrant the use of larger tonnage.

An example of how port limitations restrict trade is the Manila North Harbor. Draft limitations of this port are between four to six meters. Present vessel sizes calling at North Harbor require drafts of eight to ten meters to allow the safe conduction of vessels into and out of the port without touching bottom.

The cargo handling capability and the presence or absence of terminal facilities at the port also restricts trade. The absence of adequate lifting equipment determines whether cargo will be carried in pallets or in containers. The presence or absence of silos will determine whether grains can be carried in bulk or in sacks. Our ports must be improved so that cargo may be carried in the most efficient and cost effective way.

Cost of Vessel Acquisition and Operation
The following factors contribute to higher vessel acquisition and operating costs for Filipino ship owners serving the domestic trade.

Import Costs
Vessels in the domestic trade seldom exceed 5,000 GRT. As such, vessel owners in the domestic trade must pay the value added tax due on vessel importations. The larger vessels in the overseas trade, generally are not subject to this tax.

Domestic airlines enjoy a similar exception, thus, aircraft imported for use in domestic operations are likewise exempt from such tax.

The following table compares the tax treatment for importations of each transport mode.

	Domestic Shipping	Overseas Shipping	Domestic Airlines
Vessel (5,000 GRT & Below) or Aircraft Importation	10.0%	0.0%	0.0%
Lease or Charter of Vessel or Aircraft	4.5%	4.5%	0.0%

Cost of Repairs and Maintenance
A domestic ship owner is liable to pay taxes on vessel repairs and customs duties on spare parts used to repair the vessel. Overseas operators are exempt from the payment of such taxes and duties when they have their vessels repaired in the Philippines. This makes repairs on domestic vessels more expensive.

	Domestic		Overseas
	VAT	DUTIES	VAT	DUTIES
Vessel Repairs	10%		0%
Steel Plates	10%	3%	0%	0%

Spare Parts

10%

1-15%

Cost of Money

Domestic shipowners are prevented from sourcing lower interest on foreign loans because foreign banks, generally, do not accept a ship mortgage constituted under Philippine law. Foreign banks question the difficulty of foreclosing a ship mortgage under Philippine law and the concurrence and preference of credit provided by our Ship Mortgage Decree.

The unacceptability of a Philippine ship mortgage has forced ship owners to either register their vessel in some other jurisdiction so that they can use the vessel as a security for the loan, or source loans domestically through the DBP or through other commercial banks. The loan facility available at DBP is provided by the Japanese government to the Philippine government as official development assistance. It is lent to the Philippine government at 3% per annum. However, because of the foreign exchange risk cover, the normal bank spread, and other financing charges, this is re-lent to the industry at 11% to 14% per annum.

The difference in financing cost is shown in the next table:

VESSEL ACQUISITION COST AND FINANCING COST
Domestic versus Foreign Owned Ship
As of January 2003

	Domestic	Foreign	Difference
Vessel Cost (10-yr old bulker)	3,200,000.00	3,200,000.00	0
Equivalent Value in Philippine Peso (at PHP 54/US$1)	172,800,000.00	172,800,000.00	0
10% VAT/3% import duties	22,464,000.00	0	22,464,000.00
Vessel Acquisition Cost	195,264,000.00	172,800,000.00	22,464,000.00
Interest Expense:
90-day- T-bill rate/LIBOR	5.248%	2.53%
Normal Bank Spread	2.50%	1.30%
Base Rate	7.748%	3.83%
Add: Gross Receipts	0.27%	0.0%

Tax(3.5%0%) Effective Rate	8.019%	3.83%	4.189%
Annual Amortization Cost	47,788,927.66	38,139,363.28	9,645,564.48
Total Interest Expense (Over 5 years)	43,680,638.31	17,896,816.41	25,783,821.90
Total Vessel Acquisition Cost (PHP)	238,944,638.31	190,696,816.41	48.247,821.90

Freight Rates in the Domestic Trade (October 13, 2003)

What influences freight rates?

Economies of scale are the best way to achieve a lower per unit cost. Vessel owners respond to demands of the trade by providing the kind of service that best responds to such demand. Philippine domestic trade does not warrant large vessels. Port conditions also place a limitation on the size of vessels able to enter our domestic ports.

When domestic container freight costs are compared with the cost of freight on a feeder vessel from Manila to Singapore, it is important to note that feeder vessels to the hub ports of Singapore, Kao-hsiung and Hong Kong carry in excess of 1,500 TEU containers while the capacity of pure cargo vessels in the domestic trade seldom exceed 300 TEUs.

The problem is compounded by the fact that in some domestic routes, operators must use passenger-cargo vessels to respond to public demand for passenger service and thus carry even fewer containers.

The per TEU cost of a 300 TEU cargo vessel is double the cost of the 1,500 TEU cargo vessel because more cargo is carried by the larger vessel which can share in the total operating cost of the vessel. The operating cost does not rise as quickly as vessel capacity, thus larger vessels are able to offer cheaper rates.

Most countries ship corn in bulk using 60,000 metric ton lots. Thus, they are able to enjoy cheaper rates per metric ton of corn. In the Philippines, corn is not carried in bulk. It is shipped in containers from Mindanao to Luzon for use as feed. This practice is prevalent in the Philippine domestic trade for the following reasons:

The following chart shows the comparative freight rates for corn carried in containers versus that carried in bulk carriers. It is clear that freight rates decrease over comparable distances as volume carried increases and mode

If one were to determine total logistics cost for corn from Cagayan de Oro to Manila, the cost per kilo to transport the corn is P1.57 with only P0.49 or 31% of total logistics cost pertaining to sea freight. This assumes that only 18,000 kilos is loaded into the container. It has been revealed, however, that as much as an average of 21,500 kilos