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Freight index does not herald end is nigh: John Kemp |
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Friday, 24 October 2008 |
 The Baltic Exchange's dry freight index has now fallen 90 percent from its recent peak at the end of May. It has beaten tough competition to claim the title of worst-performing financial or commodity market in 2008. Because ocean shipping plays a central role in an increasingly globalised economy, analysts often use freight rates as a proxy for world trade volumes, and b
extension a leading indicator for the health of the manufacturing system and world economy.
The dramatic slump in freight rates in less than five months has
coincided with anecdotal reports of importers and exporters unable to
secure trade credit from a crippled banking system, leaving goods
unshipped by the quayside.
Some commentators have concluded the trading system is seizing up and
the world economy is on the brink of a deep and prolonged depression.
But before we rush to conclude the end is nigh, it is worth taking a
closer look at the very specific dynamics of this market. The decline
in freight rates to date has more to do with specific factors than a
general slowdown in trade volumes.
In particular, clearing queues at the massive commodity export harbours
in Brazil and Australia have returned millions of tonnes of bulk
carrying-capacity to the market. Clearing queues rather than a sudden
downturn in trade volumes provides the best explanation for plummeting
rates.
It is of course highly likely the global expansion will slow, or even
reverse, over the next 18 months as the financial crisis works its way
through the real economy. But the impact on freight demand is mostly in
the future and does not explain the collapse of freight rates this
summer and early autumn.
First, it is worth noting the Baltic index reflects spot market
transactions - "distressed" prices paid by charterers and ship owners
who find themselves goods to move or vessels to hire out and no regular
contract to move them. The index reflects terms on only a few vessels
each day that represent only a small volume of shipping.
Ocean-going ships are expensive to build and maintain, and usually
financed with large quantities of debt. Owners therefore have a strong
incentive to charter them out rather than have them standing idle for
any length of time. Even a handful of ships on offer hunting cargoes
are enough to depress quoted spot rates on particular routes, and
week-to-week changes of 10-15 percent have not been uncommon.
Gyrations in the spot market index overstate changing terms in the
wider market, where most commodities are carried on much longer-term
contracts.
Second, it is worth noting the index peaked at 11,771 points in May and
had already suffered a retracement of 52 percent to 5,663 points on Sep
5. More than half the decline in the index thus occurred before the
credit crisis intensified.
Freights had already halved when the Dow Jones was still above 11000,
crude oil was well above $110 per barrel, and most commentators were
still optimistic for continued growth in the advanced economies and
emerging markets in the remainder of 2008 and throughout 2009. Credit
problems and the prospect of a sharp slowdown in the economy are thus a
very poor explanation for the decline.
Spot rates have actually peaked twice, in H2 2007 and then again in H1 2008.
The first spike occurred after the worst storm in 30 years hit
Australia's massive coal loading terminal at Newcastle in June 2007,
grounding the MV Pasha Bulker and closing the port for several days.
The number of vessels queued up in the roads waiting to enter the port
surged from an already high 55 to almost 80, taking almost 4 million
tonnes of carrying capacity out of the market compared with the same
period a year earlier.
When the resultant backlog of vessels proved slower than expected to
clear many shippers who had expected rates to ease in the second half
of the year were forced to enter the spot market to cover cargoes -
driving rates higher instead. By the end of 2007, queues at Newcastle
had been reduced to a more normal 35 vessels. But the market tightened
again when strike action, poor weather and heavy demand resulted in
lengthening queues off Brazil's two main bulk export terminals at
Tubarao and Ponta da Madeira in spring 2008.
The number of vessels committed to the two Brazilian terminals (already
loading in port, moored in the roads, or scheduled to arrive within 30
days) surged from 107 at the end of Feb to 148 by the start of July.
More than 4.3 million tonnes of carrying capacity was taken out of the
market.
But from July onwards, Brazilian queues have fallen. The total number
of vessels committed to the two ports had fallen from 148 to 110 by
early September and less than 90 a month later. The number of vessels
moored in the roads at Ponta da Madeira has fallen steadily from more
than 20 in late May; on Oct 16 the roads were empty.
With both Newcastle and the Brazilian ports increasingly free from
delays over the summer, more than 4 million tonnes of additional
carrying capacity has been returned to the market, the equivalent to
around 20-25 of the giant capsize bulk iron ore carriers or more than
40 smaller and more versatile panamax class vessels capable of carrying
ore or grain.
It is no accident the run up in freight rates during H1 2008 was led by
surging rates for panamaxes and capsize ore carriers, especially on the
routes from Brazil to China, which pushed Brazil-China freight rates to
an unusually high premium over rates on comparable routes from
Australia to China. The steepest declines since then have been for the
same cape-carriers serving these massive bulk ports.
There is no doubt some of the congestion which built up around
Australia and Brazil over the last two years was caused by China's
voracious demand for iron ore. Delays were worsened by speculative
importing by local merchants which led to the build up of substantial
stockpiles in China's east coast ports and resulted in a government
crackdown. Upward pressure on rates was intensified by intense
speculative activity in the chartering market, with vessels chartered
by paper companies and then re-chartered multiple times for higher
rates until they found their way to an end physical user.
As China's speculative imports have slowed and steelmakers work down
the excess stocks demand for carrying capacity has slackened, at least
temporarily. Like many other forms of speculation, multiple chartering
has fallen victim to declining markets and tightening credit. And no
doubt some shippers are also now experiencing problems with trade
credit. All of which is intensifying downward pressure on the freight
market and has cut rates by another 75 percent or more in the last
month.
But it would be wrong to infer that the world economy was on the brink
of a severe recession or had already entered one from the 90 percent
decline in spot freights over the last five months. More than half the
decline occurred before the crisis hit and reflects an improvement on
the supply side of the market rather than deterioration on the demand
one.
Freight rates have now returned to more typical levels after a period
in which the market was unusually elevated. Most analysts have been
predicting a sharp fall in rates during 2009 and 2010 as shipyards in
China, South Korea and Japan begin to deliver the record number of new
vessels on their order books commissioned as a result of the recent
boom.
The outlook over the next 12-24 months depends as much on how many of
those orders are now cancelled because of the credit crisis and slowing
economy, as much as global trade volumes.
Source: Reuters
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