What Is Demurrage?
In finance, the term “demurrage” has two main meanings. Its first meaning is in relation to currencies and commodities, where it refers to the costs of holding those assets. In this sense, it is analogous to the term carrying costs.
Its other meaning relates to the shipment of goods by sea. Here, it refers to the penalty paid by a charter company for failing to load or unload a vessel within the timeframe set out in its contract.
- Demurrage is a word with two meanings in business and finance.
- The first relates to the carrying costs of currencies and commodities, while the second refers to a penalty paid by companies who charter cargo ships.
- Charter companies are usually given three days to load or unload their ships before being required to pay demurrage.
In the context of currencies and commodities, demurrage refers to the various costs of owning the currency or commodity in question. For example, currency holders may need to pay account fees, whereas holders of commodities such as gold and silver may need to pay insurance and storage fees as well. Economically speaking, higher demurrage costs will likely increase the velocity of money by making it less attractive for investors to store their wealth in these types of instruments. Conversely, high demurrage should incentivize investors to place their wealth in yield-generating assets such as dividend-paying stocks or fixed-income instruments.
Depending on your perspective, high demurrage may be positive or negative for economic performance. For instance, some would argue that demurrage costs are helpful because they encourage investors to deploy their savings into the real economy rather than “hoarding” tem in inert assets. But others argue that, by storing wealth in assets such as cash and gold, investors help the economy by contributing to its base of quality collateral. After all, cash stored in bank accounts can be used as the bank’s collateral base, allowing them to extend more loans and thereby supporting the economy. Similarly, holders of precious metals can borrow against those assets or sell them at a later time to fund their investments.
The other main meaning of demurrage is in relation to international maritime shipping. When a chartered ship fails to load or unload its cargo in the timeframe set out in its contract, it may owe the owner of the vessel a penalty fee known as a demurrage. In this sense, the term traces its origins to the French word “demeurer”, which essentially means “to be late”. The typical timeframe to load or unload a chartered ship is three days. This timeframe is colloquially referred to as the ship’s “laytime”.
Real World Example of Demurrage
Markus is an investor who is actively involved in the international oil trade. He owns a fleet of cargo vessels and uses them to ship oil between oil production centers and refineries located in key hubs such as the United States, West Africa, and Europe. Rather than operating his vessels himself, Markus relies on a third-party charter company that operates his vessels on his behalf.
As part of his business operations, Markus purchases large quantities of oil and then stores them in large vats before they are ready to be loaded onto his ships. To be profitable, Markus must ensure that his ships are loaded and unloaded quickly so that he minimizes the time and cost of storing the oil. After all, storing the oil on land involves demurrage costs for transportation, labor, and insurance. Similarly, every hour’s delay in loading or unloading his ships costs him lost revenue due to production and shipping delays.
Thankfully, when the third-party charter company that operates his vessels takes more than three days to load or unload his vessels, they are required to pay him a demurrage fee. This helps to defray the cost of his lost revenues and additional expenses.