carlosG1

Baltic Index Weakness Due to Additional Capacity, Not Drop in Commodities Demand

I am confused about your statement. You said that the recent drop in BDI is NOT due to drop in global commodities demand, and your supporting argument is that prices of commodities have not dropped. Yet no supply data was provided to back your case.

Let's just say that you're right - supply did go up and now there's a glut of new ships. But have you seen the latest spot iron ore prices, or the latest newsflow coming out of the shipping business?

www.steelguru.com/news...

www.steelguru.com/news...

Also:

China’s wire rod price drops to 4-month low
07-09-2009
Having risen steadily from May to August, the price of wire rod in China has been in retreat for the last four weeks. The FOB price fell by 6% last week to a 4-month low of $496/t. This is now 21%


The only saving grace at this point is that the Panamax owners are banding together to hold up spot rates, which is why the BDI is in a holding pattern at this point - but how long can that last?

lloydslist.com/ll/news...

Now, please note that I am not trying to argue that the current decline in BDI means that another global economic downturn is imminent. That's a foolish argument. The BDI is highly dependent on Chinese raw material demand at that particular point in time, and right now the Chinese are not ordering as much as they were a few months ago. Why is this happening? It's because both Coal and Iron or inventory remains near all time high - so no need to go crazy with the orders at this point.

However, saying that the recent decline in the BDI is due to additional capacity coming on line alone is just as valid an argument as saying that the reason why BDI went up during 1H09 in the first place is because of scrapping. It takes two (both supply and demand) to tango.

Baltic Dry Index: Worst Week Since October 2008

The problem with the BDI is that it is heavily influenced by China's demand for OVERSEAS iron ore (note the word overseas, and not aggregate demand). Subsequently, freight rate is influenced by 1) disparity between local iron ore and Australian/Brazilian iron ore prices + freight 2) current iron ore inventory 3) perception of future demand as a result of Chinese stimulus spending 4) availability of Capesize vessels and 5) port congestion.

These conditions are now turning negative for the BDI. Local and overseas spot iron ore price (+freight) is roughly at the same level - so there is little reasons for the Chinese to continue to import from the Aussies. Inventory has reached an all time high. Port congestion is easing. Meanwhile, demand from Middle East and Europe remains lackluster. Worst, more and more Capesize vessels are being delivered in second half, whilst previously laid up vessels are being put to seas - adding supply pressure. So as soon as the reality of the actual impact of stimulus spending kicks in (i.e, it did not generate as much steel demand as the Chinese mills thought it would), then rates can only decline further as the amount of iron ore import is slashed further by the steel mills. Hopefully, we'll see the index hit a low 2000 sometimes soon - may be even below that if we're lucky. Of course, with the equities market being so bubbly (no puns intended) about everything these days, all this may only translate to a small dent in drybulk stock prices...

From a bigger picture perspective - will the on-going BDI decline trigger a collapse in general equities market? Very unlikely IMO. For the most part of this year, the state of the BDI had more to do with China than the global economy (as you have rightly pointed out in your article) so a collapse in freight rate won't translate to 'meaningful' numbers like US job losses or spending. Besides, the bulls (who are firmly in control of the market at this point) will conveniently choose to ignore this data, as they often do with negative news. But is it a leading indicator for things to come? Only time will tell...

(Note that I do not have any position in drybulk stocks)

BDI Speculation: Beware the Unwinding of Inventory Build / Congestion

Good article Vincent. Agree with you on the follies of going long on BDI at this point - not much upside from here. However, I would really like to hear your opinion on whether you think there would be major structural changes in iron ore seaborne trade pattern if contract negotiation between the Chinese and the Australian miners finally breaks down, and the Chinese decide to do all their transaction on the spot market from now on. The trend seems to be moving towards that direction, with the CISA starting to make statements about reducing the duration of the contract to less than a year:

steelguru.com/news/ind...

Although fundamental iron ore shipment will probably not change, it should be interesting to see how short-term shipping demand dynamics that we all know and love (or hate, depending on how you made your bets with the BDI in the past) will be affected. How much would you contribute the recent Chinese inventory build up in the recent months to the annual contract negotiation? If we get, say, four contracts negotiation every year, should this result in more BDI volatility? (assume DWT supply remains steady - for the sake of keeping this equation as simple as possible).

BDI Falters; Stocks Vulnerable?

I would have thought that the end of the iron ore contract negotiation this time around would have the opposite effect on the BDI. My reasoning is this: When spot prices for iron ore fell in 1H09, along with a collapse in freight rate, it made more sense for the Chinese mills to import the higher quality ore from Australia than buy the inferior ones produced domestically which were just as costly, if not more (to put in simple terms, the CIF price of Australian iron ores was below the prices of locally produced iron ore). Subsequently, iron ore import demand held up well whilst the local mines ended up shutting down.

For this dynamic to continue, the contract iron ore prices should be discounted as much as possible, and freight rate kept low. The Chinese stated that would keep importing as long as CIF price is kept below 80 dollars/ton. The Chinese were therefore going for a 45% cut with the Australians - which would have put contract back to 2007 level.

But with the Japanese and Koreans mills bailing out of the negotiation table and agreeing to 33% cut (iron ore fines), and the Chinaco-Rio Tinto deal in disarray, the Chinese may have little choice but to agree to a lower than expected cut. Whether or not this new contract price will force the mills to source more iron ore from local mines remain to be seen - but one thing is clear, the more shallow the discount, the less likely the Chinese will import from abroad.

Not arguing that the end of negotiations has little effects on sea bourne trade, but these things are quite complex and I think we need to examine the context closely in order to determine which direction it will go. The 2008 China-Vale negotiation case would serve as an example of the 'BDI enhancement' effect you are referring to. Back in early 2008 iron ore shipment (and hence freight rate) dropped drastically because of the iron ore negotiation dispute between China and Brazil's based Vale which temporarily reduce seaborne trade (some have accused Vale of 'faking' an accident as an excuse to shut down its major port for several weeks in order to force the Chinese to agree to their price demand). When the Chinese agreed to 65% contract price hike, shipment resumed and the BDI recovered.

This time around, I think we may see the exact opposite...

Green Shoot Turning Red Hot: Baltic Dry Index Returning to Pre-Crisis Levels

Hmm... the BDI is such complex little creature that we may need to dig a little deeper to ascertain what is going on...

The recent BDI rise was driven mainly by Cape and Panamax spot charter market, which was in turn driven by both iron ore and coal demand in Asia. On the iron ore side, the Chinese are the ones doing most of the buying. Iron ore CFR from Australia during 1H09 was between $60-70/ton thanks partly to large drop in spot iron ore price, and cost of shipping (about $5/ton from Australia). To the Chinese, who last year was forced to sign a contract rate of US$200/ton for certain types of Australian ores, this is dirt cheap. Furthermore, Australian/Brazilian ore is of higher quality than Chinese ore. Subsequently, the Chinese mills decided that it's worth switching to import ore instead. The government stimulus spending in 2H09 also heighten the urgency to stock up as much as possible and at the cheapest rate. Finally, the whole stockpiling activity also gives CISA a good leverage in the annual iron ore negotiation - which is still to be concluded (end of June is deadline). On the Panamax side, that's mainly from higher coal demand in Japan and Korea - again likely due to cheap commodity prices. So is all this just speculative buying and completely disconnected to the state of the world economy? Probably not. After all, this is by future Asian demand, although whether that demand will materialize remains to be seen.

You are correct in pointing out that the skeptics were wrong about the supply side. What happened at the beginning of the year was that ship owners negotiated with shipyards to delay deliveries, or somehow managed to get themselves out of the deal altogether. Others have decided to cut their own capacity by scrapping or hot layups. To boot, you also had port congestion problems (Chinese ports are notoriously inefficient).

So what you ended up getting was nothing short of a perfect storm . ie. tight supply + congestion + cheap commodities + stimulus package = meteoric rise in freight rate and hence, the BDI.

But all good things must eventually come to an end. The problem is that there is only so much iron ore that you need for the next 6 months worth of production. Even if the Chinese decide to hold off buying for just a few months - freight rate could quickly collapse (see end of 2007). Secondly, once the iron ore contract is secured, there may not be such need to rush buying as contract price will be fixed until next year. Thirdly, with freight rate driven to the point where the cost of shipment is approaching the cost of the actual cargo, some of the buyers are going to start becoming hesitant. They may even switch back to using domestic ore.

So what I am saying is yes, this is a good sign that Asia still has the ability to drive up commodity and shipping demand, and the equity market back in November/December probably did not factor this fact in at the time. However, we may see the BDI pull back during the next few weeks for the reasons I cited above. So be warned that with the BDI, nothing is ever what it seems.