How Somalian Pirates are Funded? Pirates Financing

The TI Europe, one of the four largest ships in the world. And here’s a banana for scale. At 380 meters long, or twelve hundred feet, it’s 41% longer than the Titanic but still shorter than Titanic. In this business, efficiency is everything and every dollar counts. A ship made with twice the steel has much more than twice the capacity, with roughly the same size crew. Bigger boats, therefore, cost only a little bit more and yet make a lot more money. So, here we are, with supertankers that can hold three million barrels of oil. Which, at today’s going price, makes TI Europe a $174 million target for pirates. Last year, an attack was reported every other day, in some of the busiest, most well-patrolled routes, like the Gulf of Aden, the Singapore Strait, and the coast of Malaysia. But these are not parrot-wearing, sword-carrying outlaws. Today’s pirates operate a carefully planned, well-executed business - with investors, a stock market, chain of command, and experienced negotiators. All without the help of LinkedIn. Every part of an attack is a fascinating lesson in economics. And with profit margins of over 30%, even Apple should be jealous

Somalia is, by almost every metric, one of the hardest places to live on Earth. It's now three-decade-long civil war has led to drought and famine and left the country without a unified, central government. To the north are the independent but unrecognized states of Somaliland and Puntland. In the south, control is split between the federal government based in the capital, Mogadishu, and large, terrorist factions. This makes building infrastructure like schools and hospitals extremely difficult. Which, in turn, makes building a formal economy, nearly impossible. The result is a 55-year life expectancy, one of the lowest in the world, and a GDP that makes Ghana and Madagascar look rich.

While next-door Ethiopia makes money growing coffee, potatoes, and cereals, Somalia is not so lucky. Only 1.8% of its land is arable, compared to half of India, or 34% of Germany. Its two climates are hot and really hot. But, it does have one thing going for it: the longest coastline of any country in Africa. Fishing should be a huge source of income. But, you guessed it, there’s a catch. Foreign companies noticed the country seemed a little preoccupied at the moment and probably wouldn’t notice if they dumped toxic waste in its waters, killing thousands of fish in the process. Those who survived are now caught illegally by foreign fishermen, who steal $300 million every year, leaving Somalia with only a small share of its own tuna. So, just to recap: Somalis are given little education, face a constant threat of violence, have nearly zero healthcare, and a per capita GDP of $104, or twenty-eight cents, per person, per day. 

The average ransom, on the other hand, is 2.7 million, so piracy is not exactly a tough sell. It all begins by identifying a target. The ideal victim comes from a rich country, is traveling slowly, and near the coast. Or, in the case of luxury cruise ship Star Breeze which was attacked in 2005, all three. The next step is financing. A single attack may cost $30,000 up-front, which is already a lot but especially in Somalia. So the risk is usually spread between 3-5 investors who buy shares in an informal stock market. Now comes the attack. With one, the large mother ship, anywhere between 4 and 20 pirates follow their target up to 800 miles off the coast. Once they get close, they switch to one or two small chaser boats and use rope and ladders to board the ship. Of course, the crew is trying to speed up, or change directions, and fight back, but they also know they’re no match for the AK-47s, rocket launchers, and desperation of the pirates. 

The crew is gathered together, and their communications destroyed, making the ship go dark. The next step depends on their business model. In areas like South East Asia, the goal is often stealing oil, selling it to anyone smart enough not to ask why it’s so cheap. But here, in Somalia, pirates rarely touch the cargo. The crew is, by far, the most valuable thing on board. They steer the ship to a nearby port, where the densest part of the operation begins. With only one buyer and one seller, almost none of the rules of a normal negotiation apply. Neither party has all the information and both have a great incentive to lie. The owner of the ship wants to appear poor, driving down the ransom. The pirates, meanwhile, need to seem rash enough to deliver on their threats and yet patient enough to wait for a deal. Because the clock is ticking. As time goes on, the ship's value and cargo go down, and the average ransom generally goes up. Talks, therefore, can last three, four, five hundred days, all spoken through a translator, often with several different negotiators.

If the owner has Kidnapping & Ransom Insurance, negotiations are made by a professional, who reduces the chance of death from 9% to just 2%. But companies aren’t allowed to say they have insurance. In fact, many corporate travelers don’t know they have K&R insurance. If they did, it would be invalidated. Because of the incentives, an agreement is almost always reached. Pirates bring the crew up to the top deck, confirming their safety. And then, a helicopter flies overhead and drops a waterproof container full of cash. Finally, comes a pirate’s favorite job: accounting.

First, investors get their guaranteed cut of at least 30%, The port, who looked the other way while they parked the ship, gets 5-10%. And the rest is split between the attackers, with a bonus of around $10,000 for being first to board the ship. This scenario plays out hundreds of times a year, and costs shipping companies a total of 4.9 to $8.3 billion a year - including security and insurance. Even just speeding up from 13 to 18 knots costs an extra $88,000 in fuel, per ship, per day. And those costs are passed on to you and me. We all pay a hidden “Piracy tax”

So, what can be done? The obvious answer is fighting back. NATO’s Operation Ocean Shield greatly reduced attacks from 2009 to 16 by patrolling dangerous waters. And any shippers now hire private security companies to fill that role. But this creates a free-rider problem, other companies and countries benefit from that security without paying for it themselves. Likewise, everyone would be better off if no one paid ransoms, but it’s always in each company’s best interest to pay them. All of these solutions reduce piracy, but none of them solve it. For 30 - $75,000 per attack, there will always be someone willing to take that risk, no matter how high it becomes. The only real solution is economic, giving pirates alternative ways to make money. Rebuilding a country like Somalia is a major undertaking, but giving locals new skills and new opportunities really is the long-term solution.

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