Baltic Dry Index - BDI (BALDRY)

The Baltic Dry Index is a daily average of prices to ship raw materials. It represents the cost paid by an end customer to have a shipping company transport raw materials across seas on the Baltic Exchange, the global marketplace for brokering shipping contracts. The index is quoted every working day at 1300 London time. The Baltic Exchange is similar to the New York Merc in that it is a medium for buyers and sellers of contracts and forward agreements (futures) for delivery of dry bulk cargo. The Baltic is owned and operated by the member buyers and sellers. The exchange maintains prices on several routes for different cargoes and then publishes its own index, the BDI, as a summary of the entire dry bulk shipping market. This index can be used as an overall economic indicator as it shows where end prices are heading for items that use the raw materials that are shipped in dry bulk.

The BDI is one of the purest leading indicators of economic activity. It measures the demand to move raw materials and precursors to production, as well as the supply of ships available to move this cargo. Consumer spending and other economic indicators are backward looking, meaning they examine what has already occurred. The BDI offers a real time glimpse at global raw material and infrastructure demand. Unlike stock and commodities markets, the Baltic Dry Index is totally devoid of speculative players. The trading is limited only to the member companies, and the only relevant parties securing contracts are those who have actual cargo to move and those who have the ships to move it.

Economic Implications

This index is one of the purest leading indicators of economic activity. It measures the demand to move raw materials and precursors to production. Consumer spending and other economic indicators are backward looking, meaning they examine what has already occurred. The BDI offers a real time glimpse at global raw material and infrastructure demand. This could also be gleaned from looking at commodity prices, but there are substitution effects and futures contracts that make it difficult to interpret the impact of commodity price fluctuations. Additionally, nearly all commodities are seeing severe increases in prices in 2008 regardless of supply situations as investors seek to hedge their inflation exposure with hard assets.

Unlike stock and commodities markets, the Baltic Dry Index is totally devoid of speculative players. The trading is limited only to the member companies, and the only relevant parties securing contracts are those who have actual cargo to move and those who have the ships to move it. [5] The BDI will show how much a company or country is willing to pay to import raw materials immediately. For example, if a Chinese company has contracted out coal prices for the next year from Rio Tinto (RTP), then the spot price of coal increasing after a mine accident will not impact that established contract. However, when this company is willing to pay more per ton to ship the coal than to actually purchase it, an investor can see that price growth is accelerating.

Price Increases Passed To Businesses/Consumers

As the BDI increases, so effectively does the cost of raw materials. This cost associated with procuring the materials must be passed along the value chain by producers and refiners. In the end, consumers will see higher dry bulk rates in the higher prices they pay for goods derived from these raw materials. For example, when Folgers pays an extra $10/ton to import coffee beans, they will pass along this increased procurement cost to consumers to maintain margins.

Additionally, imported goods may often carry a BDI factor in the prices. An example of this would be the average Chinese imported good. As China transformed from coal exporter to importer, they began buying coal from nations such as Russia, Brazil, and Australia. The coal from the latter two must be shipped using dry bulk carriers. As the rates for the BDI went up in 07, so did the cost of coal to China. Since coal is used for 70-80% of China's energy generation, [6] overhead costs for factories increased with the price of coal. As the overhead costs increase, so must the price of the end good to maintain the margin of profit. As this end price increased, an American paid more for a t-shirt or toy at Wal-Mart.

Key Trends and Forces

* Commodity Demand - This is determined mainly by industrial production and energy demand. If commodity demand is strong, BDI rates will increase regardless of spot rates for those commodities. Companies that have contracted out spot rates will show increased demand through paying more for shipping of the materials. As more coal and steel are being demanded by China, so will the rates for dry bulk shipping increase.

* Fleet Supply - This is determined by the number of available ships, their capacity, and the utilization rates. Additionally, the average age of the fleets will determine where they are in the life cycle. The average ship lasts 25 years. If the average is closer to that number, supply will be decreasing in the short term. Also, supply is greatly determined by delivery of new vessels. Currently, there is significant back logged demand for new vessels. No new orders are being taken for delivery before late 2009. With this backed up supply, BDI prices soared in 2007. With rates for the largest dry bulkers fetching nearly 10x that of a comparable VLCC Oil Tanker, many companies converted tankers into dry bulk carriers.[7] As conversions and ships contracted to be built at the beginning of the price run up in 2006 come on line, the upward pricing pressure of a fleet in which 41% of its ships are over 20 years old will be held at bay.[8]

* Seasonal Pressures - Weather has a major impact on both demand and logistics. For demand, cold weather may increase the demand for coal and other energy creating raw materials. For logistics, cold weather may cause ice to block ports and low rivers to prevent travel. Both of these cause increases in the BDI. Conversely, a mild winter or early ice breakup in cold water parts will cause decreases in the BDI.

* Bunker Prices - Bunker fuel is a type of fuel oil a ship uses for propulsion. Bunker fuel accounts for between a quarter and a third of vessel operating costs. Higher crude oil prices also mean higher bunker fuel prices which will be reflected in higher BDI prices. So, just as higher oil prices will put a damper on Airline company margins, they will squeeze margins for dry bulk operators. High bunker fuel prices in 2008 caused many companies to instruct their crews to decrease ship speeds to conserve fuel, thereby increasing shipping times- which causes the BDI to rise. A new (2008) trend in the shipping industry is the recent development of a "skysail," a ship propulsion augmentation system consisting of a paraglider-type airfoil and an electronic deployment and control mechanism that uses wind to help propel ships and thereby save bunker fuel costs[9].

* Choke Points Nearly half of the world's oil passes through a few narrow shipping lanes. This includes the straights of Hormuz and Malacca, the Bosporus and the Suez and Panama canals. These geographic choke points cause natural caps in the number of ships that can pass through each day, month or year and therefore also limits the bulk tonnage capacity of certain shipping routes. If anything disrupts the flow of ships through the choke points, the BDI will increase. The narrow (52 mile wide) Bering Strait (also called the "Bering Gate" in the shipping industry) may soon become the world's newest strategic "choke point" for shipping [10].

* Market Sentiment - Because of the time lag in forecasting demand for raw materials, market opinion can greatly affect the freight exchange. [11] The recent halving of the index's value can be attributed to many companies forecasting lower global growth and cutting their production/demand targets.

* Port Congestion -This acts as another great buffer against supply increases lowering index prices. The actual infrastructure of these ports prevents more ships entering the market. The ports simply cannot handle more traffic. Until major changes occur at these vital terminals, there will be upward pressure on dry bulk prices. Shipping industry analysts [2] are actually developing an index to standardize and make available this incredibly vital data.

* Labor Relations - Nothing is loaded or unloaded from ships without labor. Labor relations at various ports around the world directly affects the BDI. For example, in the U.S. both the ILA (International Longshoreman's Association) and the ILWU (International Longshoreman's and Warehouse Union) exert enormous control over the labor at ports. Labor relations issues include: intentional work slowdowns, company lockouts, strikes and political boycotts. Labor unions have expressed their political power and influence in the past by boycotting products from apartheid South Africa, protesting the war in Iraq and even the Soviet Invasion of Afghanistan[13]. Labor relations impacts on the Baltic Dry Index should not be underestimated by the sophisticated investor.

* Piracy - Although piracy has been a constant factor affecting shipping for thousands of years, 2008 saw some significant piracy events including the capture and ransom of the MV Sirius Star, a Saudi owned oil supertanker seized by pirates off the coast of Somalia. Pirates are also holding crews hostage for significant ransoms as in the case of the MV Faina, a Ukrainian arms shipping vessel. Interpol and other global law enforcement agencies are investigating the connections of various organized crime groups that may be bankrolling and organizing pirate groups including those based in Somalia. Various nations including the U.S., Canada, France, U.K., Russia, Ukraine and China are now deploying warships to patrol the coast of Somalia. These factors put additional upward pressure on the BDI[14].

* New Arctic Shipping Routes - Shipping from Europe to China by means of the arctic offers a route distance savings of approximately 4000 miles, which is a large percentage of the non-arctic total route distance. Of course, the historical search for the Europe-China route was the reason for the discovery of the "New World" (America). With oil prices (Bunker Fuel) at 1st Q 2009 lows, arctic shipping may or may not be economical. But during mid-2008 oil prices, a 4000 mile route saving offered significant fuel and time savings. Discussion among scientists attending the March 2009 "Copenhagen Conference" suggests that the predictions by the 2007 UN- IPCC Report on Climate Change regarding the likely clearing of arctic sea ice has underestimated the rate of clearing and by 2013 arctic shipping may become feasible. Although the shipping industry remains highly secretive, the potentially significant economic advantages have caused many international shipping companies to begin analyzing and planning for potential new arctic routes. Shipping industry intelligence indicates that China is interested in potential deep-water ports in Iceland. Arctic routes do not currently affect the BDI but may in the near future[15].