Freight rates plummet
December 01, 2008
by Meyer Sosland
No one would deny the grain industry has suffered its share of peaks and valleys during the past two years. The rapid price increases of 2007-08, which saw the cost of food soar and left many people in poorer countries facing the threat of unaffordable supplies, have been followed by bumper global crops and rapidly falling world prices.
The declining cost of oil and other commodities might now be spurring the downward trajectory of grain prices by cutting input costs such as fertilizer and fuel, but this was preceded by rampant inflation. Traders and producers have also been plagued by a welter of credit issues amid the fallout of the global banking crisis, which has also affected both futures markets and currency planning.
But the flux that has taken place in the international grain markets is relatively mild compared to the volatility being experienced in the bulk shipping sector, the "facilitator" of global grain trade. The export prices of wheat, maize, rice and soybeans on some routes have almost halved in the last six months, but that loss in value is nothing compared to the cataclysm which has astonished owners and operators of bulk carriers who, it should be said, had been enjoying a five-year run of unprecedented earnings and corresponding hikes in asset values.
BALTIC INDEX FALLS 90% Bulk carrier freight rates have, quite simply, fallen off a cliff. The Baltic Exchange Dry Index (see chart), which tracks freight rates for the entire bulk carrier fleet of almost 7,000 vessels, lost some 90% of its value between the record highs of May and the nine-year low recorded in early November.
Capesize ships, the largest vessels in the fleet, are usually used for hauling coal and iron ore, but rate declines in this sector are important because charter costs for the smaller vessels used for grain shipments — panamax, kamarmsax, supramax, handymax and handysize ships — have historically followed in the wake of their larger cousins, and this has been the case in the recent collapse.
Capesize spot rates fell from more than $230,000 per day in June to less than $5,000 per day in November, a figure well below the daily operating cost of such a vessel, which is in the $10,000 to $12,000 range. As a result, a large chunk of the fleet has been laid-up or put to anchor, and this has been reflected among the smaller vessel classes.
The Baltic Exchange Panamax Index fell from close to 12,000 points a year ago to barely 500 points in November, while the Supramax Index collapsed from 6,700 points in May to around 500 points in early November.
"There is no confidence, no cargoes and no fixtures," said Simon Stonehouse, a leading market analyst with Brit Insurance Holdings. "Ship brokers are talking about ‘zero dollar’ deals, which means the freight only covers the cost of the bunkers and the port costs."
Secondhand and newbuilding sale and purchase markets had all but ceased to function as World Grainwent to press in
late November. Brokers were estimating that older vessel values had contracted to just 10% of their summer value, while newbuilding values had fallen 40% to 50%, although both judgments were difficult to quantify because of the dearth of benchmarking transactions.
With shipping costs a core component of the landed price of international grain shipments, much of this has been good news for traders. Lower rates have spurred trade, reined in exorbitant demurrage charges and brought to an end the anomaly of grain being containerized to avoid high ocean freight rates. The International Grains Council’s October Grain Freight Index was down almost 60% from May.
But where do rates go from here? The health of the global economy will be a key factor, of course, but the roles of market sentiment and the bulk carrier orderbook in both the freight rate collapse and any recovery should not be overlooked.
The recent disintegration of freight rates does not, at first glance, seem to be anything unusual for shipping. Historically, the highly fragmented bulk carrier market has been characterized by impossible highs followed by deep troughs as owners have splurged on new vessels, rapidly undermining any prospect of a stable supply-demand balance being reached. But the collapse of the market this time has been both more sudden and far harsher than any previous trough, including the mid-1980s.
Since 2003, China’s insatiable demand for raw materials, a growing world economy, rising port congestion and the emergence of new long-haul supply routes — most notably South America to Asia, which sucked capacity out of the fleet — helped push bulk freight rates to new peaks as vessel and infrastructure supply struggled to keep up with demand. The upshot for international grain trades was ever higher ocean freight costs.
As recently as June, just a few months after the first signs of a credit crunch emerged, most analysts were predicting that rates would remain at a "higher plateau" for some time to come, with some asking if charterers "might see any respite."
MANY REASONS FOR SLUMP A number of factors have colluded to prompt such a rapid slump. The economic slowdowns in Europe and the U.S. have affected demand for many goods, and this has filtered through to raw material markets. A widely anticipated bounce-back in demand from China in the aftermath of the Olympics failed to materialize, and the credit crisis then froze markets, with importers and exporters afraid to commit to cargoes without receiving cast-iron assurances from banks, which is no easy task in the present financial maelstrom. The fall-off in demand also allowed many load ports to clear backlogs, which, given that for the last few years about 10% of the capesize fleet and large chunks of vessels in the smaller categories have been stuck in port queues at any given time, had the effect of freeing up a large amount of capacity just as demand fell away.
But a key factor in the downturn has been sentiment. For some time the bulk markets have been highly volatile, and lurking at the back of the equation was the looming orderbook of newbuilding vessels due for delivery over the next four years. Once the market turned, optimism over the forward supply-demand balance for bulk carriers turned to a deep pessimism.
For grain shippers, this meant freight rates fell in the space of just a few months to levels that were simply unimaginable in the summer. A welcome respite, no doubt, but the sight of a distressed shipping sector, which is vastly over-leveraged financially, does not bode well in the long-run for charterers who rely on safe and reliable services.
It is already becoming apparent that major defaults in the physical and paper shipping markets will be revealed by traders and operators in the months ahead, and this could bring further uncertainty for shippers. As many as 20% of shipping lines are at risk of breaching their loan accords because of the plunge in asset values, according to Tufton Oceanic Ltd., the world’s largest shipping-hedge fund group.
Heightened credit checks on counterparties, which are now a must for all in the supply chain, may be a barrier to the smooth flow of goods.
London, England-based Britannia Bulk Holdings Plc has already been placed into administration, and the Ukraine’s Industrial Carriers Inc. has filed for bankruptcy protection. More bankruptcies can be expected, which will undoubtedly threaten charter parties as well as players up and down bulk supply chains that rely on income from ocean shipping, either directly or indirectly, including ports and hinterland transport suppliers.
In short, at current freight rates, dry bulk shipping is unsustainable for many companies. However, there are signs that the market could find a semblance of balance faster than many are predicting.
The bulk carrier orderbook over the next four years is worth over $532 billion. According to World Yards, 26.27% of these orders are due to be delivered by greenfield yards in China, some of which do not even exist yet.
With banks around the world tightening credit lines, a falling shipping market will not be a priority, a financing fact that will affect both owners and yards. So, it is quite possible that many of these vessels will not be built. "Newbuild activity has already started to slow due to high yard prices, the shortage of available berth slots, less than promising trade prospects and the lack of refund guarantees," said Stonehouse. "It will be interesting to see whether the green field yards in China, which equate to 30% of the newbuilding program, actually deliver."
None of the brokers contacted by World Grain would predict how many newbuilding orders will not materialize, but with little to gain from receiving delivery of vessels which cannot be deployed at a profit, owners will be doing their utmost to escape newbuilding contracts, even if they can afford the purchase.
Nigel Anton, managing director and head of shipping finance at Standard Chartered Bank, said that the number of traditional ship finance banks with capacity to look at new transactions had already diminished.
"Without doubt, the global lack of liquidity combined with the recent downturn in the dry and container markets will affect banks’ appetite for certain ship finance transactions," he said.
"Those banks which are ‘open’ for new business will prioritize the stronger names, which has to have a negative impact on shipping companies with weaker cashflows or financials. This will mean orders will be canceled at shipyards, some of whom are already struggling to source Refund Guarantees, which is an absolute essential requirement of ship owners when sourcing finance."
Further capacity will also be taken out of the equation as vessels are laid up and older vessels, which should have been scrapped years ago, will now be sent to the breakers.
Stonehouse said there were 50 bulk carriers in the panamax fleet of about 1,500 vessels built before 1980 and more than 330 vessels over 20 years old, while almost 800 ships in the 2,890-strong handysize fleet were built before 1980, and some of them dated back to the 1960s. "These vessels will be scrapped because of the cost to maintain them," he said. "They will be heavier on fuel and the charterers will prefer to charter newer ships, which are more reliable."
The supply side of the shipping equation will soon look very different than it does now, or than it has looked for the last year or more, a fact that is only now starting to seep in.
And let it not be forgotten that the bulk shipping business is about the core raw materials demanded by industry and society. Steel and cement trade flows cannot cease, power stations still need coal, people must eat and, surely, the credit markets will have to ease at some point.
Whether the global economy enters a recession or not, cargo demand will eventually pick up once more. When it does, charterers in the grain business should expect the negative sentiment, which has propelled freight rates downward, to ultimately help push them back up. WG
Michael King, a freelance journalist and editor, has been writing about shipping, transport and commodities for more than a decade. Currently based in Indonesia, he can be reached at Michael@borderline.eu.com.