Analysis of Economics

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Understanding the dry bulk market

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Anyone applying their crystal ball in the wet and dry freight markets--whether they be shippers, traders or brokers--need to keep several fundamental factors in mind when trying to analyse how the market will behave.

The freight market is subject to a wide range of external variables including politics, weather, catastrophes and war. But it is fundamentally driven by commodities--and an understanding of the major commodities being shipped around the world and their markets is vital in analysing the freight market.

The three major factors which determine the freight market are:

Fleet supply--How many different types of ships are available? How many vessels are being delivered by shipyards and how many are being scrapped? Which routes are ships taking? For instance, an Australia to Rotterdam route has a longer sailing time than Poland to Rotterdam and differences in distance affect the quantity of shipping available.

Secondly, there is trade demand for freight. Is this growing or declining? In looking at demand drivers, it is important to note that it is not whether a country's economy is booming or in recession which is the key factor. With the freight market, there is a far closer correlation with industrial production. If coal is needed for power stations, then coal will be imported. If the grain harvest is big, the country is likely to export more grain.

Thirdly, there is market sentiment. Because only 40-50% of the demand side is known in a timely fashion, market opinion will affect things just as much as actual underlying supply and demand.

Dry bulk market

So much for general market drivers, how about the dry bulk market in particular?

The dry bulk freight market generally has been bumping along the bottom for most of this year. By sector, Panamaxes have been weakest followed by Capesizes and Handymaxs. Handysize vessels, which constitute the largest sector by number of ships, have had a year of mixed fortunes with limited overall change. For most size ranges, average hire rates this year have typically been some 10-20% lower than last year.

Dry bulk demand

Last year was a record one for dry bulk demand. Average distances for some commodities fell as China, in particular, expanded its exports, including a 45M tonne increase in coal exports. This had the effect of displacing long-haul suppliers; South Africa and Australia were hit very badly.

This year, dry bulk demand has fallen by 2% (as at the end of May).

Total seaborne dry bulk trade is around 1.8bn tonne (see Table 1, opposite page) but, due to numerous problems of comprehensiveness and reliability, perhaps only 60% of this total is actively monitored. In addition, around 50% or less of this information is available in a timely fashion. It should be noted, too, that many of the trades that are lacking in coverage are those at the smaller end of the bulk shipping market, ie vessels below 40,000 dwt--the sector of major interest to shippers of oilseeds. Unfortunately, this is a sizeable chunk of the bulk carrier fleet, accounting for nearly 2,900 vessels. In terms of carrying capacity, these vessels account for roughly one-quarter of the total dry bulk fleet.

Although traders and shippers of oils and fats may feel they have no interest in the steel market, this would be a fundamental mistake. In fact, steel-related trades (iron ore, coking coal, steel, scrap etc) collectively account for almost exactly half of all seaborne bulk cargoes, and the owners of vessels employed in oilseeds (and other bulk trades) will almost certainly be casting one eye over their shoulder towards the steel industry whatever cargo they happen to be carrying today.

Iron Ore: Steel production continues to grow, albeit supported largely by China, the world's largest producer. Up to the end of May, global crude steel production was ahead of the same period last year by 3.1%. However, if China were taken out of the equation, then total production in all other countries would have fallen by 1.5%. As China only has low grade iron ore reserves, it has to import the bulk of its needs. Just 10 years ago China's imports of iron ore amounted to 18M tonne while Japan's imports were 127M tonne. Today, Japan's imports are unchanged but China's requirements have rocketed to more than 100M tonne. The impact on shipping demand has been tremendous, especially when combined with the imports of the other big importers in the region--South Korea and Taiwan. This is in the context of stagnant European demand.

A feature of bulk trade over the past 10 years has been the shift of cargoes towards the Asia/Pacific region and away from Europe and the rest of the world. In 1980, for example, dry bulk trade (five major bulks only) into Europe amounted to 369M tonne while Japan and other Asian countries together took 280M tonne. However, by the year 2000, Europe's imports were almost unchanged at 385M tonne (+4%) while Japan and the other Asian countries took 657M tonne (+135%). In percentage terms, Europe took 46% of these trades in 1980 and now takes 30%, while Japan plus other Asian countries took 35% in 1980 but 51% of all cargoes in 2000.

Grain trade is currently flat in overall terms albeit with the usual seasonal variations. The outlook for the year remains much the same, according to the International Grains Council (IGC). As at the end of June, the IGC expected wheat trade to fall by 2M tonne to 104M tonne in the year July 2002-June 2003 and coarse grain trade to decline by 1M tonne to 105M tonne. Total seaborne grain trade (including soyabeans and meal) is around 260M tonne. It is expected that Brazil will be the largest wheat importer this year taking around 6.6M tonne. Coarse grain trade remains dominated by Japan with its annual requirement of around 19M.

Coal trade is expanding at the moment--mainly due to steam coal and power station requirements--but a full recover, in coal trade requires the participation of the steel industry. Currently, with the exception of China, there are no imminent signs of this happening. Coal is, however, the largest single dry bulk trade, accounting for some 550M tonne/year, and remains highly influential in determining the overall demand-side outlook. The fact that coal trade growth is expected to slow down (although the trade will continue to expand) over the next few years--in the context of ever expanding new sources of oil supply--is not surprising given emissions legislation. But much of coal trade growth over the past 25 years has been about restructuring entire industries and setting up alternative, mostly overseas, sources. This, in turn, was driven by a combination of simple economics (cheaper, albeit more distant, supplies) and growing environmental concerns which perversely led to an expansion in coal trade at the expense, in many cases, of domestic industries.

Steel trade is currently mired in the US imposition of tariffs on certain steel imports and the threat of retaliation from European and other exporters. Currently, it seems the overall effect on steel trade will be to mute trade volumes rather than lead to further escalation of the dispute into other commodities.

As global dry bulk trade continues to expand, so the fleet supply will gradually come back into balance (from the oversupply position, which currently is causing the low freight rates). The key question is when will this balance (or at least shift towards balance) occur? For this part of the analysis, we need to consider the supply side of the equation in relation to fleet developments.

Fleet supply

The dry bulk fleet continues to expand both in terms of numbers of ships and in carrying capacity. Vessels are, on average, becoming larger as shipyards optimise cargo space to fit the dimensions of the Panama Canal.

The average size of Panamaxes used to be 55,000-65,000 dwt and this has risen to 75,000 dwt. Capesizes are now around 170,000 dwt compared with 120,000 dwt.

Compared to a year ago, the fleet is some 4% larger in terms of its earning capacity, Of this expansion (amounting to some 11M dwt), there was a net reduction of 1.7M dwt in Handysize, an expansion of 4.1M dwt in Handymax, an expansion of 5.5M dwt in Panamax and an expansion of 3.1M dwt in Capesize. So the impact on each size varies according to the existing size of that sector.

Daily Capesize hire rates fell to US$9,500/day in June; for comparison, aver. age rates in June last year were typically US$9,750/day, so superficially there is little difference in absolute levels, However, this is to forget that owners have had to live with these rates--which are well below running and financing costs--over the past 12 months. Some flurry of activity was seen in Cape rates at the end of the first quarter of this year but in the absence of clear-cut demand conditions, most of this rise was attributed to the manoeuvrings of one or two major players including Cape International. Since then, rates have languished at these cut-throat levels.

Panamaxes currently find themselves at the back of the queue when it comes to profits. But how could it be otherwise? With record deliveries last year amounting to some 110 new ships and a net increase in this fleet of 82 ships--after scrappings had been removed--it was no surprise that freight rates declined. The legacy of these new vessels will be with us for some time. As scrapping of older vessels counteracts the effects of this steep increase in supply and trade growth slowly absorbs the surplus capacity, so too, will the balance come back into the market.

Super-Handymax (50-54,000 dwt) rates have typically averaged around US$8,700/day this year. Conventional Handymax rates (45,500 dwt) have typically only managed around US$7,600/day. The Handysize group comprises the largest sector in terms of numbers of ships--around half of the entire fleet--but contributes only a quarter of its carrying capacity due to the smaller size of the units. At the same time, it is a sector that has been in slow decline for many years. Handysize rates this year have averaged around US$6,400/day and seem unlikely to vary much for the remainder of this year.

This year should see the bottom of the dry bulk freight market in terms of its current cycle. However, this does not alter the key question, which is not how much lower the market will go but how long freight rates will stay at this level.

If market fundamentals are in a corrective phase, then some signs of a recovery should be detected later this year. The low level of newbuildings to be delivered next year, coupled with the limited opportunity to place orders for delivery within next year, are setting the tone of the market over the next 18 months.

Demand recovery will generally be slow, steady and positive. The fleet continues to expand for this year and 2003 but at a much more modest pace than the 8% expansion of last year. The expansion in demand continues to be led by steam coal, and recovery will be in the sectors which carry most coal--Capesize and Panamax. However the surplus of Panamax vessels means that recovery in this sector is still fragile and will lag behind other types. For sub-Panamax sizes, the continuing weakness in the global economy and the time lag inherent in translating from economic conditions to bulk freight means that any recover will be muted.

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TABLE 2: DRY BULK FLEET DEVELOPMENTS

1996 +8.1
1997 +10.5
1998 -0.3
1999 +3.5
2000 +8.8
2001 +11.8
2002 +7.6
2002 +0.3
2003 -0.9

Note: Table made from bar graph.