Global Shipping Rates

The Baltic Dry Index dropped around 30% last week.  The Baltic Dry Index dates back to a coffee house in London in 1744.  It reflects input from shipbrokers around the world to collect data on 26 routes to ship commodities, including coal, iron ore, grain, and others.  We reference a chart from Wikipedia, below, that shows the four vessel types and both the percentage of vessels making up the dry bulk shippers as well as the percentage of tonnage carried over distance.

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The chart shows that the largest vessels, the Capesize (note the chart erroneously refers to them as Capemax) carry the vast majority of tonnage over the longest routes, even though they have the smallest percentage of vessels in the fleet.

There are Capesize vessels that are actually dropping anchor rather than sailing at rates below their operating costs (estimated to be between USD 7-8K daily).  Recent contracts to deliver cargo, known as fixings, have come out as low $9K daily on the spot market.  A newly built Cape size vessel fixed a 12-month contract at USD 27K daily.

Let’s take a look at the Index itself along with the price of gold as a reference:

We have data going back to January 2000, just before the bear market began when the tech bubble burst.  You will note that the price of gold has risen pretty steadily since early 2001.  What was the Fed doing during that time?  The Fed was aggressively, albeit belatedly, lowering rates to try to counteract the falling stock market and correct for the recession the U.S. economy was in.  That, of course, led to the overinflated prices for housing in the years where credit quality dropped along with rates and money was “cheap”

Shipping rates had moved lower before the recession was clearly understood, but accurately reflecting the diminished demand to ship commodities.  By late 2001, shipping rates began to improve.  But the economy was still in recession and the stock market continued to head lower for another year.  What gives?  Demand was increasing on a global basis for the commodities that were being shipped and the number of vessels that could ship the goods was inelastic.  It takes about two years to complete a new ship and they are so expensive you don’t tend to take them out of service except for maintenance or because they become too expensive to maintain, and then they are scrapped (now that’s a lot of scrap metal).

Now let’s take a look at the Index itself along with the price of crude oil as a reference:

You will note that there is little correlation of shipping rates and the price of crude oil.  So why would we use the space to put the chart in front of your eyes?  The operating costs of ships are based primarily on crew wages and bunker oil (the fuel that is used by the engines in these vessels).  Of course there are port charges, and cargo loading and unloading charges, but these are generally included as part of the fixing of the amount to be charged to the shipper to transport the goods.

What does it mean when the price of crude oil drops from above $147 per barrel to less than half of that as it did over the last three months?  The price of bunker oil fell from over $700 per metric ton in July to below $300 by the end of October.  That means operating costs will have dropped dramatically unless the operators were hedged for bunker oil prices.  Ships can hold months of supply of bunker oil so the effects of lower costs may only just be beginning to be felt.

There are rumors that some banks resumed lending in the past week to shippers.  Letters of credit are required by ship owners to guarantee payment at journey’s end.  With credit frozen, shippers couldn’t negotiate routes with ship owners, so supply of available vessels has been building.  This has caused spot rates to enter a free fall as supply of vessels increases while contracts that can be awarded declines.  With banks making loans, more contracts will be awarded, supply will diminish and rates may stabilize.

From a ship owners perspective, take a look at the numbers and timeframe.  Rates had climbed from 2001 to 2008, a period of six and a half years.  They climbed from around 850 to 11793 (nearly 1300 percent) in May 2008.  They have fallen to 851 (93% decrease) since May, a period of only six months.

That is the effect of diminished demand but more acutely, the lack of available credit.  With letters of credit, once again, beginning to be available, shippers can contract with ship owners to move goods and the Baltic Dry Index should begin to reflect this.