What Is Demurrage?
Demurrage refers to two separate topics in finance and business. It is a term that refers to payments made to the owner of a chartered ship by the charterer when there is a delay in the loading or unloading of goods, or any other form of break from the original charter contract.
A demurrage can also be used when talking about currency trading and the cost of owning and storing the currency, or other commodity. It is considered to be the cost of carrying money or a commodity and it stimulates currency circulation and economic growth.
- Demurrage is a term that applies both to the financial markets as well as to the shipping industry.
- In the financial world, demurrage refers to the cost or fee of owning and storing currencies or commodities.
- In the shipping industry, demurrage refers to a penalty fee charged for cargo that is not loaded or unloaded within the specified timeframe agreed to in the charter contract.
- Demurrage in the financial markets prevents investors from hoarding currencies or commodities and ensures there reintroduction into the economy.
- Demurrage on currencies is usually in the form of a tax and for commodities usually as a storage cost.
- In the shipping industry, demurrage compensates the owner of the vessel for the additional time the vessel is needed for loading or unloading cargo.
When it comes to currencies, the demurrage can be in the form of a tax. When it is used in reference to commodities such as gold, it is the cost of storing the gold. These fees are generally periodic and can happen anywhere from hourly to annually, for longer term storage.
The objective of a demurrage is to prevent people from holding onto currencies and commodities for long periods of time without reintroducing them back into the economy. A single entity holding large sums of cash or gold will not have any positive impact on the surrounding economy. Also, the value of the items that are being held may shift due in part to the hoarding. The demurrage acts as a natural deterrent from these situations.
Regarding shipping, demurrage occurs when a chartered ship is not loaded or unloaded within the specified time period agreed to in the charter contract. The typical timeframe to unload a chartered ship is three days and is known as the laytime.
When the laytime runs out and the cargo has not been loaded or unloaded, then the responsible party will be charged a demurrage, which is basically a penalty fee. It ends up being a fee for additional use of time for the vessel because the cargo is still on the ship or needs to be put on the ship. This compensates the owner of the vessel for the time it could have chartered the vessel to another party.
Example of Demurrage
Take for an example Edward Jones, head of the Zero Institute. Over the years he has amassed a large stockpile of gold and silver. He keeps these bars stored with a third-party company, Home Securities, LLC. Home Securities secures Jones's gold and silver for a fee and insures its safety; however, there is a demurrage attached as well, which is charged monthly.
The demurrage is a fixed percentage rate of 2% that is tacked onto the security and storage fees. It is based on the volume and value of the bars. The value of the gold bars is $50,000 and the value of the silver bars is $20,000. The demurrage Jones pays on the bars is ($50,000 + $20,000)*2% = $1,400 a month. Because Jones feels that the cost to store these bars, including the demurrage, is a good investment given the high value of gold right now, he continues to store it.
However, the value of silver is declining, and Jones does not feel that it is worth the fee to keep holding onto the silver, so he sells it. He then takes the proceeds from that sale and buys a large portion of stocks on the stock market. Now that he has reentered this money into the economy, it is earning him a return on his investment. Jones also turns a profit since he is no longer paying fees for a depreciating commodity.