Financial reasoning for choosing a supply route under uncertainty: the case of Russian coal exporting company
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ЗАЯВЛЕНИЕ О САМОСТОЯТЕЛЬНОМ ХАРАКТЕРЕ ВЫПОЛНЕНИЯ ВЫПУСКНОЙ КВАЛИФИКАЦИОННОЙ РАБОТЫ 2
STATEMENT ABOUT THE INDEPENDENT CHARACTER OF THE MASTER THESIS 2
АННОТАЦИЯ 3
ABSTRACT 5
Introduction 11
Chapter 1. Literature Review 14
Decision making under uncertainty in supply chain management 14
Risks and uncertainties in supply chains 14
Supply chain risk management 15
Types of supply chains risks 16
Measurement of risks in supply chains 17
Real options approach in supply chains 17
Approaches to find the route 22
Deterministic models 22
Stochastic models 23
Chapter Conclusion 27
Chapter 2. Coal Exporting Industry Overview 28
General concepts of coal production industry 28
Worldwide production coal industry 29
Russian coal production industry 30
Coal exports transportation problem statement 33
Far East Route 33
Southern Sea Route 34
Northern Sea Route 35
Chapter Conclusion 39
Chapter 3. Research Methodology 40
Transportation costs model 40
Route choice model 42
Deterministic model 43
Stochastic model 44
Route choice criteria 47
Mean-variance criterion 47
Value at Risk (VAR) criterion 48
Real Option valuation model 49
Data gathering and forecasting 51
Data gathering sources 51
Data description 53
Data forecasting 65
Chapter Conclusion 88
Chapter 4. Case Study Results 91
Descriptive statistics 91
Constructed freight cost variable for Vanino route 91
Constructed freight cost variable for Murmansk through Suez Canal route 92
Constructed freight cost variable for Taman route 93
Constructed freight cost variable for Northern Sea Route in summer 94
Constructed freight cost variable for Northern Sea Route in winter 95
Transshipment and rail tariffs parameters estimation 96
Summary data for Markowitz portfolio construction 97
Deterministic model construction and analysis 98
Markowitz portfolio construction and analysis 99
Portfolio construction results 99
Criteria for route choice 102
Real Option valuation results 103
Discussion 105
Summary of results 105
Academic implications 106
Practical implications 107
Limitations and further research directions 107
Chapter Conclusion 109
Conclusion 110
References 112
Appendix 122
STATEMENT ABOUT THE INDEPENDENT CHARACTER OF THE MASTER THESIS 2
АННОТАЦИЯ 3
ABSTRACT 5
Introduction 11
Chapter 1. Literature Review 14
Decision making under uncertainty in supply chain management 14
Risks and uncertainties in supply chains 14
Supply chain risk management 15
Types of supply chains risks 16
Measurement of risks in supply chains 17
Real options approach in supply chains 17
Approaches to find the route 22
Deterministic models 22
Stochastic models 23
Chapter Conclusion 27
Chapter 2. Coal Exporting Industry Overview 28
General concepts of coal production industry 28
Worldwide production coal industry 29
Russian coal production industry 30
Coal exports transportation problem statement 33
Far East Route 33
Southern Sea Route 34
Northern Sea Route 35
Chapter Conclusion 39
Chapter 3. Research Methodology 40
Transportation costs model 40
Route choice model 42
Deterministic model 43
Stochastic model 44
Route choice criteria 47
Mean-variance criterion 47
Value at Risk (VAR) criterion 48
Real Option valuation model 49
Data gathering and forecasting 51
Data gathering sources 51
Data description 53
Data forecasting 65
Chapter Conclusion 88
Chapter 4. Case Study Results 91
Descriptive statistics 91
Constructed freight cost variable for Vanino route 91
Constructed freight cost variable for Murmansk through Suez Canal route 92
Constructed freight cost variable for Taman route 93
Constructed freight cost variable for Northern Sea Route in summer 94
Constructed freight cost variable for Northern Sea Route in winter 95
Transshipment and rail tariffs parameters estimation 96
Summary data for Markowitz portfolio construction 97
Deterministic model construction and analysis 98
Markowitz portfolio construction and analysis 99
Portfolio construction results 99
Criteria for route choice 102
Real Option valuation results 103
Discussion 105
Summary of results 105
Academic implications 106
Practical implications 107
Limitations and further research directions 107
Chapter Conclusion 109
Conclusion 110
References 112
Appendix 122
Due to the geopolitical situation, a number of sanctions were imposed on Russia in various industries, which radically changed the supply chains in the country. Russia had to reorient a significant part of supplies from the European market, mainly to the Eastern one1. This situation has greatly increased the load on the railway infrastructure of the Far East Road, which even until 2022 was a bottleneck for cargo importers and exporters.
In particular, these changes have affected the coal production and export industry. In the first half of 2022, the European communities imposed an embargo on the import of Russian coal: The United States and the EU countries refused it2, which prompted Russian coal producers to look for new markets, and these markets became the countries of the Asia-Pacific region3. However, the key problem for coal exporters has become the delivery of exporting coal4: due to the capacity limitations of the railway infrastructure, companies cannot export the entire volume of cargo planned, and companies even have to adjust their production plans in accordance with the railway capacity5. This approach to planning production volumes has negative consequences not only for the financial performance of companies, but also for the economy of the producing regions6.
Also, in addition to the above-described restrictions on the capacity of the railway infrastructure at the Eastern Road, the natural monopoly - Russian Railways - also has a negative impact on the export of coal. Until 2022, the Rules for Non-Discriminatory Access of Carriers to Railway Infrastructure were in force, which are designed to provide all companies with equal access to transportation, and according to these rules, export transportation of coal through the Eastern Road was given priority7. However, in 2022, these rules were suspended8, since it is more profitable for Russian Railways to transport goods with a higher margin than coal has, such as containers and lumber. As a result, the ability to transport coal for export through the Eastern Road has become significantly lower than the volume that was planned to be transported according to the instruction of the President of Russia9.
Thus, in order not to lose revenue and curtail investment programs, Russian coal exporters are forced to look for new ways to transport coal, except for the Eastern Road, and these ways should be economically viable. Possible alternatives could be transportation through the Southern Sea Route (through the Suez Canal) and through the Northern Sea Route. Therefore, the question arises: which routes to choose to export coal, taking into account possible uncertainties?
There has long been a heated debate in the business and academic environment about the competitiveness of the Southern Sea Route and the Northern Sea Route, both in comparison with transportation through the Eastern Road, and among themselves.
According to some experts, transportation through the Northern Sea Route can be faster and cheaper than through the Suez Canal, and the Russian government has repeatedly emphasized the importance of developing this direction10. At the same time, transportation along the Northern Sea Route comes with a number of risks, and because of these risks, some experts argue that the Northern Sea Route "will never be an alternative route"11 and the programs for the development of the Northern Sea Route are considered as “nothing more than politics”.
However, there is still no consensus on the expediency of using the Northern Sea Route as an alternative route for the supply of goods, especially for low-margin goods such as coal.
Thus, we see the incredible practical value of an approach that would be developed for choosing the appropriate transportation route in terms of financial measures and taking into account possible uncertainties.
As for the academic relevance of such work, it is explained by the insufficient number of academic articles that would provide a specific tool for choosing a path, not only taking into account the financial justification, but also considering the uncertainties encountered along it. Moreover, there is a shortage of articles that take into account in their calculations of transportation route economic feasibility the uncertainty encountered along the Northern Sea Route. Thus, such work intends to close this research gap.
This paper is aimed to develop a method in the field of supply chain risk management theory. Thus, for researchers as well as for practitioners it should provide the methodological contribution as far as this approach is going to illustrate how a decision-maker can choose the appropriate transportation route considering uncertainties in this route as well as the measurement of these uncertainties by real data applicable to Russian coal exporters.
...
In particular, these changes have affected the coal production and export industry. In the first half of 2022, the European communities imposed an embargo on the import of Russian coal: The United States and the EU countries refused it2, which prompted Russian coal producers to look for new markets, and these markets became the countries of the Asia-Pacific region3. However, the key problem for coal exporters has become the delivery of exporting coal4: due to the capacity limitations of the railway infrastructure, companies cannot export the entire volume of cargo planned, and companies even have to adjust their production plans in accordance with the railway capacity5. This approach to planning production volumes has negative consequences not only for the financial performance of companies, but also for the economy of the producing regions6.
Also, in addition to the above-described restrictions on the capacity of the railway infrastructure at the Eastern Road, the natural monopoly - Russian Railways - also has a negative impact on the export of coal. Until 2022, the Rules for Non-Discriminatory Access of Carriers to Railway Infrastructure were in force, which are designed to provide all companies with equal access to transportation, and according to these rules, export transportation of coal through the Eastern Road was given priority7. However, in 2022, these rules were suspended8, since it is more profitable for Russian Railways to transport goods with a higher margin than coal has, such as containers and lumber. As a result, the ability to transport coal for export through the Eastern Road has become significantly lower than the volume that was planned to be transported according to the instruction of the President of Russia9.
Thus, in order not to lose revenue and curtail investment programs, Russian coal exporters are forced to look for new ways to transport coal, except for the Eastern Road, and these ways should be economically viable. Possible alternatives could be transportation through the Southern Sea Route (through the Suez Canal) and through the Northern Sea Route. Therefore, the question arises: which routes to choose to export coal, taking into account possible uncertainties?
There has long been a heated debate in the business and academic environment about the competitiveness of the Southern Sea Route and the Northern Sea Route, both in comparison with transportation through the Eastern Road, and among themselves.
According to some experts, transportation through the Northern Sea Route can be faster and cheaper than through the Suez Canal, and the Russian government has repeatedly emphasized the importance of developing this direction10. At the same time, transportation along the Northern Sea Route comes with a number of risks, and because of these risks, some experts argue that the Northern Sea Route "will never be an alternative route"11 and the programs for the development of the Northern Sea Route are considered as “nothing more than politics”.
However, there is still no consensus on the expediency of using the Northern Sea Route as an alternative route for the supply of goods, especially for low-margin goods such as coal.
Thus, we see the incredible practical value of an approach that would be developed for choosing the appropriate transportation route in terms of financial measures and taking into account possible uncertainties.
As for the academic relevance of such work, it is explained by the insufficient number of academic articles that would provide a specific tool for choosing a path, not only taking into account the financial justification, but also considering the uncertainties encountered along it. Moreover, there is a shortage of articles that take into account in their calculations of transportation route economic feasibility the uncertainty encountered along the Northern Sea Route. Thus, such work intends to close this research gap.
This paper is aimed to develop a method in the field of supply chain risk management theory. Thus, for researchers as well as for practitioners it should provide the methodological contribution as far as this approach is going to illustrate how a decision-maker can choose the appropriate transportation route considering uncertainties in this route as well as the measurement of these uncertainties by real data applicable to Russian coal exporters.
...
This chapter describes the results of calculating a deterministic route selection model, a stochastic route selection model (the Markowitz model was chosen as a model form for a portfolio of routes by analogy with a portfolio of financial instruments), consisting of transportation through Vanino, the Southern Sea Route (through the ports of Murmansk and Taman) and through the Northern Sea Route (summer and winter navigation periods are considered separately). Also, the criteria for choosing the optimal route are calculated: the "mean-variance" criterion and the VAR criterion, which is widely used in risk management. Despite the fact that shipping along the Northern Sea Route is the riskiest option of all proposed (with the highest standard deviation for the total costs per route), according to both of the above criteria, the optimal portfolio of the Markowitz model will be the route according to which the entire volume of traffic, who will not be able to go on the route to Vanino, should go along the Northern Sea Route in the summer.
Moreover, a case was considered with the restriction of transportation along the Northern Sea Route during the summer navigation period, caused by the assumption that the summer navigation period along the Northern Sea Route is quite limited in time. It was found that even taking into account this limitation, the optimal portfolio will be a portfolio that contains, in addition to the maximum possible transportation to Vanino, a route through the Northern Sea Route in winter.
At the end, the option to switch between each of the current routes to the route of the Northern Sea Route according to the Margabe model was evaluated. An analysis of real options showed that it makes no sense to switch from Vanino to the Northern Sea Route. However, switching from other routes has its value, and the analysis of real options showed what amount of investments in terms of dollars per ton of transported cargo can be done now in order to be able to switch to the NSR route in 5 years (both in winter and in summer).
Conclusion
This was aimed to answer the question of how to choose a route for transporting goods, taking into account not only the cost of transportation, but also uncertainties, encountered on routes. In particular, the case of transporting Russian coal for export to China was considered: a comparison was made between the current transportation routes and a potential route through the Northern Sea Route.
The route through the Northern Sea Route is a route that, despite the active support from the state and its cheapness of the relatively often compared Southern Sea Route (via the Suez Canal from the ports of Murmansk and Taman), is still not commercial. One of the key reasons is the uncertainties associated with the timing of cargo delivery along this route, which can significantly increase the cost of transportation.
Thus, transportation costs for 2023 were estimated for ships of 100 thousand dwt on the above routes, taking into account the uncertainty of delivery days according to data taken from professional sources: Argus, AXS Dry, Clarkson, industrial and company reports, as well as statistics from website of the Administration of the Northern Sea Route.
Although the Northern Sea Route is deemed the riskiest option among the proposed routes, with the highest standard deviation for total costs per route, it satisfies both criteria in the Markowitz model for an optimal portfolio. Therefore, during the summer season, it is recommended that the entire volume of traffic which cannot take the route to Vanino should be directed to the Northern Sea
Route.
...
Moreover, a case was considered with the restriction of transportation along the Northern Sea Route during the summer navigation period, caused by the assumption that the summer navigation period along the Northern Sea Route is quite limited in time. It was found that even taking into account this limitation, the optimal portfolio will be a portfolio that contains, in addition to the maximum possible transportation to Vanino, a route through the Northern Sea Route in winter.
At the end, the option to switch between each of the current routes to the route of the Northern Sea Route according to the Margabe model was evaluated. An analysis of real options showed that it makes no sense to switch from Vanino to the Northern Sea Route. However, switching from other routes has its value, and the analysis of real options showed what amount of investments in terms of dollars per ton of transported cargo can be done now in order to be able to switch to the NSR route in 5 years (both in winter and in summer).
Conclusion
This was aimed to answer the question of how to choose a route for transporting goods, taking into account not only the cost of transportation, but also uncertainties, encountered on routes. In particular, the case of transporting Russian coal for export to China was considered: a comparison was made between the current transportation routes and a potential route through the Northern Sea Route.
The route through the Northern Sea Route is a route that, despite the active support from the state and its cheapness of the relatively often compared Southern Sea Route (via the Suez Canal from the ports of Murmansk and Taman), is still not commercial. One of the key reasons is the uncertainties associated with the timing of cargo delivery along this route, which can significantly increase the cost of transportation.
Thus, transportation costs for 2023 were estimated for ships of 100 thousand dwt on the above routes, taking into account the uncertainty of delivery days according to data taken from professional sources: Argus, AXS Dry, Clarkson, industrial and company reports, as well as statistics from website of the Administration of the Northern Sea Route.
Although the Northern Sea Route is deemed the riskiest option among the proposed routes, with the highest standard deviation for total costs per route, it satisfies both criteria in the Markowitz model for an optimal portfolio. Therefore, during the summer season, it is recommended that the entire volume of traffic which cannot take the route to Vanino should be directed to the Northern Sea
Route.
...
