DRY BULK MARKET
Overview
The dry bulk shipping market has been rated as the principal source of goods transport in the world accounting for almost a third of all seaborne related trade. The Capesize market segment ranges between 100,000 and 200,000 dwt in size and is more popular and standard. The dry bulk shipping market is a volatile market that offers transport services for the movement of products such as iron ore, coal, bauxite, grains, phosphate rock and alumina among others.
The product offered by the dry bulk shipping industry is ton-miles whose price is the freight rate. The freight rate is determined by the supply of shipping tonnage and the derived demand for transportation of dry bulk commodities in a perfectly competitive market (Paul Per 2009). The dry bulk market is however cyclical in nature and the freight rates have a tendency of being generally highly unpredictable. It is therefore imperative to understand that increased economic growth leads to increased demand of dry bulk which positively impacts the dry bulk market and vice-versa.
The Capesize dry bulk market has witnessed extreme volatility over the period between 2005 and 2009. It especially experienced strong levels of fluctuations near the end of 2008 and the beginning of 2009 which raised concerns over the likelihood of market recovery. Its problems were compounded by the global economic crisis which saw a significant drop in demand for transportation services while supply continued to grow steadily with more new build ships expected while the existing fleets lay idle. This has therefore resulted to a significant dampening of prices resulting from oversupply.
Additionally, there arose a distorting factor fuelled by the introduction of new market segments besides the standard ones for example the post-panamax and the very large bulk carriers that created the impression of increased supply which however was not the case.
On the demand side, slower growth was experienced in 2006. Drewry in 2006 predicted demand growth to rise by 5.4 in the five year period from 2005 to 2009. This was expected to maintain a supply-demand balance especially with the impression of increased supply from the additional segments.
Demand Drivers
Demand in the Capesize dry bulk market segment is driven by growth of trade. The strong industrial development of Asian countries especially China, India, and South East Asia has acted as a major driver of demand in the dry bulk market. It has led to a significant increase in demand for dry commodities as witnessed over the period between 2005 and 2007 where imports to China alone enjoyed a steady positive growth rate. The demand for dry bulk commodities grew rapidly surpassing the deliveries of new building.
There are a number of other fundamental demand drivers which include the continued increase in the world population and changes in eating habits which have seen more growth in demand for grain. There is also the aspect of wealth creation which has been on a steady increase across the world as well as rapid urbanization especially in the developing countries for example China and India. Finally, there is infrastructure growth which is a continuous process in developing countries and there is need for overhauling the old infrastructure of developed countries.
The financial crisis dealt a major blow to the dry bulk market and although it had been predicted, it hit earlier than expected. This presented a serious problem because fleet growth was still very high while demand on the other hand was expected to decline rapidly. This explains the weak nature of the dry bulk market throughout 2009. If the growth rate of tonnage supply exceeds the growth rate of demand, the easing of freight rates is inevitable.
The global economic turmoil caused a serious destruction in the demand of dry bulk which resulted in a significant decline in freight rates especially in the fourth quarter of 2008 which saw them reach record lows. The stimulus packages that have been employed by governments such as China so as to boost economic growth have aided in the slow recovery of the dry bulk market (Al Rajhi 2009).
The extensive proactive government policies that followed during the year are credited for the strong economic growth in various markets especially China. The analysis of fleet supply and the order book was usually inaccurate and incomplete as some elements such as cancellations and order deferrals were difficult to measure (Sabine, Shashi Anna 2007). These factors have resulted in a recovery in freight rates and stabilization of costs of second hand vessels and later their increase is expected.
Supply Drivers
Supply in the dry bulk market is driven by orders of new ship building, the delivery schedule and the retirement or scrapping of existing old tonnage. Another factor that can affect supply is port congestion which causes delays and can affect the availability of the dry bulk fleet thereby affecting freight rates. Ship building in the year 2008 reached its fastest expansion period in response to increased demand for transportation services (Al Rajhi 2009). The year earlier had seen a modest growth in ship building which was in line with the growth rate of demand. Approaching the fourth quarter of 2008 however, the market was hit by the global economic turmoil which caused a significant decline in demand.
Problem is that it takes approximately 2 to 3 years for delivery of completed vessels after signing a contract and this means that there were a lot of orders of ship that were in the lime line of delivery which guaranteed continued supply growth rate (Al Rajhi 2009). This against a decline in demand was bound to push freight rates down inevitably. Most of the ships would be laying idle in docks due to decreased demand in transportation. It also saw multiple cancellations and deferrals of ship orders in a bid to capture the growth rate of supply.
Cost of New Build and Second Hand vessels
The activities of the order books of Capesize dry bulk vessels reached a record high in the year 2007 and 2008. This was fuelled by the increased demand for transportation which portrayed a steady growth rate up until 2008 with minor fluctuations (Al Rajhi 2009). So as to meet this increased demand, numerous orders were placed on Capesize vessels new buildings. There was also no scrapping of vessels in 2007 which led to an increase in the total fleet of Capesize vessels.
New build prices are a function of a number of factors which include the prevailing freight market condition, availability of delivery slots, competitive environment as well as future expectations of the freight market development among others. The argument for inclusion of future market developments as a factor of new build prices is because it usually takes 2 to 3 years after contract signing to deliver a new built vessel.
The dry bulk market had demand for transport reaching unprecedented levels in October 2007 with freight rates reaching as high as 200,000 a day. Ship owners were therefore compelled to search for new tonnage so as to meet the rising demand of Capesize dry bulk vessels. This prolonged boom also had a profound effect on costs of second hand vessels. According to Clarkson data (2010), there is a significant increase in the order book in million deadweight tonnes of Capesize fleets between 2007 and 2008 from 123.1 to 160.3.
The cost of new building had continued to go up which has been credited to the increased price of steel as well as the decline of the U.S dollar. With this increase in the cost of new buildings, ship owners had to rethink their acquisition plans and this consequently impacted the resale price of second hand vessels which is the next best viable option. Costs of second hand vessels therefore also went up significantly and plans of scrapping were deferred with owners opting to use vessels for longer (Sabine, Shashi Anna 2007).
With the level of earnings very low in 2009 and with lack of support from other ship types the prices were bound to come down significantly. This decline in prices also affected the significant increase in international new shipbuilding from 2005 to 2007 as well as increase in ship equipment vendors. The cost of new ship building dropped significantly following the global economic crisis which led to decreased demand hence there was a situation of over supply and ship owners stopped placing more orders for new vessels which made the ship builders to lower the cost of new vessels.
The weak demand for new ships coupled with the increased new shipbuilding ability and reduced costs are bound to push the price of new build ships on a downward trend. The cost of second hand vessels was also affected and it decreased significantly. The cost of second hand vessels continued to weaken reaching a record low at the end of January 2009 (Pierre 2010). It was later that the market showed certain volatility as a result of fluctuations in freight rates but not again reaching the lows recorded at the start of the year.
Freight Rates
Freight rates are primarily a function of demand and supply in the market. This demand is affected by the global economic conditions while the supply is affected by the size and availability of the global Capesize dry bulk fleet. Fundamentally, a higher degree of demand over supply tends to push freight rates on an upward trend while oversupply pushes freight rates on a downward trend.
From Clarkson data (2010), freight rates slightly decreased between 2005 and 2006 but experienced a most notable increase in 2007. It then began a downward trend again reaching a record low in 2009. Between 2006 and 2008, the earnings of the dry bulk market increased tremendously with the Capesize prices increasing by approximately 60. The increase in prices was fuelled by the strong nature of the dry bulk shipping market that exhibited record high freight rates.
It is therefore clear that the increase in freight rates that occurred in 2007 coincide with the period that there was increased demand for transport services and this was also when many orders were made for new buildings and scrapping temporarily deferred. Delivery of new buildings could not match the rapid growth in demand and this therefore pushed the freight rates up.
The economic downturn as a result of the global crisis then brought about a decrease in demand which saw a very high degree of over supply that exert downward pressure on freight rates. This is the decline in freight rates that was experienced after 2008 which was as a result of the global financial meltdown which affected demand. There still were deliveries of new buildings and scrapping of older tonnage had not been keeping pace with the increasing supply. Due to increased costs of new buildings, most ship owners had opted to prolong use of older vessels hence the over supply.
Conclusion
In conclusion, the Capesize dry bulk market is finally out of the woods having recovered and freight rates and earnings getting back to healthy levels by mid 2009. This can primarily be attributed to Chinas economic growth which saw a significant increase in their imports. The demand for transportation services is also slowly recovering and the cost of new buildings and second hand vessels has slowly stabilized following the sharp decrease in 2008 (Ralph 2009).
On the supply side, the growth rate of the fleet size is decreasing aided by scrapping which had been temporarily halted. Scrapping is the measure through which supply is kept on check as the older tonnage is removed from the market to pave way for new vessels. This decreasing fleet growth coupled with the increasing sustainable demand is bound to evolve into a strong Capesize dry bulk market.
These developments are also bound to have a positive effect on the cost of new building as well as the cost of second hand vessels. This is made possible through scrapping as it removes old vessels and creates demand for new ships. The increased demand is also another factor as it creates the need for other ships and once the cost of new building stabilizes, the cost of second hand vessels is bound to follow (Ralph 2009).
Finally, freight rates which are dependent on demand and available supply are bound to remain stable especially with the decreasing supply of new vessels following the cancellations and deferrals of new ship building as well as the scrapping of a significant number of old vessels (Nicolas 2006). The gradual increase in demand means that eventually it will strike a balance with supply which positively impacts the freight rates.