Sometimes the basic building blocks of economic analysis — supply and demand — appear entirely at odds with the markets. Despite an overhang of vessels due to be delivered, poor fundamentals in most commodity sectors, trade credit restrictions and the woeful global economic outlook, in recent months ocean freight rates for dry bulk carriers have risen significantly. Although rates were recovering from record lows, this rebound has still come as quite a shock to many dry bulk shippers, including those in the grain industry.
As 2008 drew to a close, grain traders were enjoying ocean freight rates which had fallen to their lowest levels in years. Moreover, they looked set to stay there, or thereabouts, offering the prospect of cheaper shipping and demurrage fees for an extended period after the previous five years of ever-rising freight costs.
At the end of 2008, the Baltic Dry Index (BDI), which tracks freight rates for the entire bulk carrier fleet of over 7,000 vessels, had fallen some 90% from the records set in May of that year to barely over 700 points. As 2009 dawned, a slight recovery started as cargoes began moving again, helping owners at least cover some of their operating costs. But there was little suggestion that rates could bounce back given the poor demand outlook in most markets. Fast forward to the end of May 2009 and the BDI had climbed back up to almost 4,500 before declining to nearer 3,500 in the early weeks of June.
The capesize sector saw bigger gains than the fleet as a whole, with rates briefly threatening $100,000 per day in late May. The smaller grain-carrying vessels in the panamax, supramax, handymax and handysize categories all saw rates climb considerably as the first half of 2009 proceeded.
These gains were reflected in the International Grains Council’s October Grain Freight Index (GFI) which rose steadily from January, reaching $30 per tonne on June 10 on the U.S. Gulf-E.U. route. This was still a long way from the $87-pertonne cost of a year earlier, but significantly above the negligible shipping costs many had predicted.
WHY THE SUDDEN SPIKE?
As usual in the bulk markets, the freight rate increases facing grain shippers using smaller vessels can be traced to demand for capesize ships from the steel industry. Some 51% of total world dry bulk seaborne trade is related to the steel industry — steel products, scrap, bauxite, aluminum, coking coal and, most significantly, iron ore, which alone accounts for around 29% (817 million tonnes in 2008) of total demand, according to figures from brokers Barry Rogliano Salles (BRS). Grain accounted for 8.7% or 245 million tonnes of the bulk carrier trade in 2008.
In short, with some seasonal and trade lane exceptions, demand for capes is driven by demand for iron ore from the steel industry, with the other trades dragged along in their wake.
Since February, China’s steelmakers have re-entered the bulk markets with a vengeance. Chinese iron ore imports rose 27% in the first four months of the year, compared to a year earlier. In April alone, China imported some 57 million tonnes of iron ore. To put this into context, the total world soybean trade in 2008 totaled 72 million tonnes (2.6% of global dry bulk carrier demand).
A number of factors prompted the rush to purchase iron ore on international markets by Chinese steel producers: restocking following turn-of-theyear destocking; anticipation of higher prices once contracts with suppliers were resolved; a government stimulus package aimed at infrastructure; and import substitution as steelmakers looked to take advantage of lower import prices.
Queues of capesize vessels formed off China’s discharge ports from late March onward and, as capacity was taken out of the market by the sudden surge in demand, this quickly cascaded down the vessel categories driving up freight rates.
As one broker put it, the only consistent factor in bulk markets at present is their inconsistency. "If grain shippers want to know where the market is going over the next year, then they should watch China’s steel industry," he added.
WHERE NEXT FOR SHIPPING?
The key question for grain shippers is whether higher rates are sustainable for an extended period. The answer, with some short-term reservations, is almost certainly no.
On the demand side, although Chinese steel production levels have recovered after the pre-Christmas slump, benchmark contract negotiations should take away the attraction of spot markets and higher import costs will see pricesensitive steelmakers switch back to domestic supplies.
There are also question marks over international demand for Chinese steel. Imports and exports in 2009 are so far a fraction of last year’s levels, and the global construction recession means that relief is unlikely to come from abroad. Any subsidence in iron ore imports would quickly see port congestion ease, releasing many vessels back onto the spot market with freight rates sure to react downward.
However, perhaps far more significant than the short-term buying strategies of Chinese steelmakers is the global bulk carrier newbuilding orderbook. Figures from Braemar Seascope (see tables) updated in the final week of June revealed an active capesize fleet of 855 vessels. Yet a massive 660 capes were on the orderbook and 120 of them were scheduled to join the fleet later this year. A further 279 were due in 2010 and 172 were expected in 2011.
Sizeable orderbooks were also in evidence in the mini-cape, post-panamax and panamax sectors while the 768 vessel-strong supramax fleet was dwarfed by the orderbook for that category with some 879 ships due to enter service in the next few years.
Most analysts contacted by World Grain predicted some slippage in delivery dates and cancellations. But the large majority of the vessels ordered will be delivered, putting tremendous downward pressure on rates over the next two years unless owners take unprecedented corrective action in the shape of mass scrapping and lay-ups.
Two-hundred-forty-one bulk carriers were scrapped between October last year and May 2009, but the rate of scrapping would have to increase dramatically to balance the equation.
And although commodities majors have been taking advantage of low vessel values to buy into the shipping business, the bulk carrier sector remains far more fragmented than, say, the container shipping industry, where even collective action has not prevented a sustained freight rate slump.
A survey of owners, charterers and traders at a shipping conference at the start of June saw 61% offer the view that the BDI would average around 3,000 to 5,000 points over the next 12 to 18 months. Fourteen percent said the BDI would average less than 3,000 points in the period. A large majority also believed panamax rates would fall from early-June levels, a prediction that has since started to materialize.
Time charter quotes support the presumption that owners’ early Indian summer is a false reflection of the real market.
The fact that ship owners are charging around twice as much now in terms of daily charter rates than the quotes offered for charters starting next year or in 2011 tells its own story.
With poor economic growth forecast for this year and next (with the exception of China and to a lesser extent India), there is little evidence that a demand-side rally can balance the market for vessel operators.
Fabrice Piard, a broker with BRS, predicted a "wobbly market" over the coming months, with supply-demand fundamentals eventually bringing some reality back to freight rates.
"At the moment, oversupply has not hit the market," he said. "But any slight fall in activity hits rates quickly. It could happen this year or next, but at some point these new deliveries will be felt."
With the overall market for dry bulk carriers looking decidedly bearish in the medium-term, and rates still significantly lower than 2008 levels, U.S. grain export patterns are now taking shape more clearly.
"Lower freight rates have erased the advantage Pacific Northwest elevators had over the Gulf elevators," Ken Eriksen, senior vice-president for transportation services at Informa Economics, said in mid-June. "The Gulf export share has improved this year as freight rates shifted volumes or market share back to the Gulf.
"For other reasons, and because lower ocean freight will be helpful, the U.S. likely will be in a situation to import soybean meal from South America. The U.S. has been exporting its soybeans at a rather fast pace to China because of crop problems in Argentina. Now soybean supplies in the U.S. are tight leading to a corresponding tight soybean meal situation, especially in the eastern areas of the United States. Given local cash differentials between the U.S. feeding areas and the cash price in South America, ocean freight has fallen enough to make soybean meal imports nearly competitive with U.S. soybean meal.
"Volatility is the operational word for ocean freight rates, and this is leading to altering grain flows."
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