High and dry

Freight rates for dry bulk shipping have been soaring over the last few years, but experts have warned that the market could soon run aground.
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WAITING TO BE SHIPPED: Coal and other dry bulk goods may become cheaper to transport as analysts predict a fall in the Baltic Dry Index.
WAITING TO BE SHIPPED: Coal and other dry bulk goods may become cheaper to transport as analysts predict a fall in the Baltic Dry Index.
INFLATED: A bulk carrier is filled with wheat in Rosario, Argentina. Freight rates for grain have been outstripped by iron ore, but the market as a wh
INFLATED: A bulk carrier is filled with wheat in Rosario, Argentina. Freight rates for grain have been outstripped by iron ore, but the market as a wh

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Freight rates for dry bulk shipping have been soaring over the last few years, but experts have warned that the market could soon run aground.

Firms rushing to cash in on inflated freight rates for dry bulk shipping could eventually cause the market to crash, say industry analysts.

Ship owners in the region have filed a large number of new ship orders in a bid to capitalise on the rapid market growth.

However there are signs that this opportunism could cause rates to come tumbling as supply outstrips demand.

The demand imbalance will be absorbed and we will move into an oversupply situation much like we have seen with containers. - Tim Jones

It is said that there are just a handful of economic indicators which determine the outlook for the entire global economy. One of them is the Baltic Dry Index (BDI).

Though unstated, the index measures demand for dry bulk shipping - or the movement of commodities such as iron ore, cement, grain and coal. These four products underpin much of the industry's activity and without them the global economy would undoubtedly grind to a halt.

The BDI is determined by the supply of ships and the supply and demand of raw materials. It comprises the average indices of Capesize, Supramax and Panamax carriers.

And of late, things have been looking up for ship owners. Dry bulk freight rates - the rate at which ships are chartered - have been soaring since the market underwent a minor correction in 2002. Demand for iron ore and coal in particular has outstripped the supply of ships in recent years.

"The BDI has witnessed some significant peaks over the past two years," says Krishna Prasad, CEO of Tradex Marine in Dubai. "For example, 2007 was termed as a ‘super year' by some analysts and even though the BDI started at 4421 points, it eventually peaked at 11,039 in November.

These are levels beyond a market watcher's wildest dreams in 1986, when figures touched a low of 554."
 

The main drivers of freight rate are fleet supply, trade demand and market sentiment. In terms of fleet supply, on a simplistic level this depends on how many ships are on order and how many are being scrapped.

It also depends on which routes ships are taking. For instance, an Australia to Rotterdam route has a longer sailing time than Poland to Rotterdam, and differences in distance affect quantity of ships available.

Demand for raw materials is also a big factor. Industrial growth is also a driver - if coal is needed for power stations, then it will be imported. The third factor is market sentiment.

Only 40%-50% of the demand side is known in a timely manner - meaning that market sentiment will affect things just as much as underlying supply and demand.

So what is driving actual demand? In a word - China. The country has, barring a month's blip while the Olympics took place, imported iron ore for its steel production at an unprecedented rate.

China has only low grade iron ore reserves and has to rely on imports to fulfil its needs. Around 15 years ago the country's imports of the commodity amounted to 18 million tonnes while Japan's imports stood at 127 million.

At present, Japan's imports are relatively the same but China's have rocketed to close to 100 million tonnes.

In recent years the bulk trade has shifted away from Europe to the Asia-Pacific region. In 1980 for instance, dry bulk trade into Europe came to 369 million tonnes while South East Asian countries took only 280 million tonnes. By 2000, European imports were unchanged while Asian countries took 657 million tonnes.

"China's steel industry has been the major factor with increases in imports of iron ore year on year," says Tim Jones, commercial vice president of global ship broker Barry Rogliano Salles. "Other bulk commodities have been strong but at an anticipated and reasonable rate."

This has meant that ship owners have largely been able to dictate terms to charterers. Because business is booming, few have the luxury to wait until freight rates fall. "As most industry has been working at full capacity they have been obligated to take cover and couldn't afford to wait," says Jones.

"With a market that has moved from US$15,000 a day to $150,000 for the large carriers, the only way many industrialists could continue was to propose medium or longer term business in order to get discounted rates. The cargos needed to be moved and thus charterers had to take positions with their freight cover."

However all this could change in the near future. There is currently a raft of new builds on the horizon and this could cause a dramatic correction in the market.

"There is an unprecedented bulk carrier order book which picks up speed this year, goes into full swing in 2009 and then overdrive in 2010," says Jones.
 

"The demand imbalance will be absorbed and we will move into an oversupply situation as we have seen with tankers and container vessels.

Asian countries have a huge shipbuilding capacity and this will continue to produce ships.

"With the impending over supply some major charterers are trying to take shorter term deals but the spot market levels are significantly higher which obligates them to continue to contract."

 

Last month a report suggested that China's shipbuilding industry has been growing at a torrid pace. According to the publication by ResearchInChina, new orders reached 64.34 million DWT in the first three quarters of 2007 - a 120% increase over 2006.

In addition, China has a global market share of 20.1% in shipbuilding output, 38.7% in new shipbuilding orders and 29.5% in handheld shipbuilding orders.

But despite the glut of new builds about to enter the market, some analysts remain bullish. "Taking into account a number of factors, it seems that the shipbuilding market will continue to prosper, supported by rapid growth in the sea freight sector," says Liao Yan, who authored the report.

Furthermore, it is believed that a lot of new orders will be defaulted upon and many existing ships will be scrapped, causing rates to remain steady or undergo only a slight correction.

Moreover, China's industrial growth looks set to continue, albeit at a slower pace.

This, coupled with a 6.3% global increase in steel usage next year means that freight rates may be buoyed slightly.

"There is a school of thought among analysts who believe that the market for dry cargo transportation is now overheated and needs a correction in the near future," says Prasad.

"However, even if this theory is proved true, as long as the commodity prices remain high and the underlying demand for shipping is strong, there is less chance of the freight rates easing up substantially in the coming days."

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