Commodity Online
The collapse of the Baltic Dry Index by 60% in just 35 days and recovery by just 8% thereafter has been attributed to the economic slowdown in the US, Europe and China. The Baltic Dry Index (BDI), representing freight rates that transport iron ore, coal, cement and grains, is already down almost 40% year-to-date, while Capesize vessels, hauling the most tonnage of the dry bulk fleet, have fallen by nearly 60% this year. The average spot earnings achieved on Capesize ships crashed from almost $55,000/day at the start of June to just $9,300/day in mid July.

A combination of lower iron ore imports into China, slower coal activity, easing port congestion and heavy fleet delivery schedule pushed dry freight rates lower, according to an analysis by Bank of America-Merrill Lynch (BofAML).

The decline has been described as the longest consecutive decline since 1995.

While freight rates could rebound from the current very low levels, BofAML said the upside to the BDI is likely capped near-term. A weaker than- expected economic recovery and excess shipping capacity argue for low spot freight earnings relative to historical levels, at least for the next 6 months.

The sharp reduction of China’s iron ore imports has been weighing on freight  prices. Iron ore imports into China fell by 15% YoY in June, relative to 80% yearly  growth last December. This demand slowdown is not just confined to China.

Reflecting the more sluggish demand environment and the expiry of fiscal stimuli, steel prices across the world have turned south. Moreover, the seaborne thermal  coal market also started to weaken lately.

BofAML said that the current demand deceleration is temporary and expect seaborne coal and iron ore imports into China to improve given the high cost of domestic production.

Prospects for 2011 and beyond
The prospects for 2011 and beyond will depend on whether double dip recession occurs and demand situation in emerging markets.

While short-term fundamentals are poor, ships can barely break even at the current rates and we expect a high slippage rate for 2011. Hence, long-dated freight contracts are likely to be on a gradual appreciation trend. The current environment could serve as a good entry-point for long positions in the back of the curve. While the capsize curve is in steep contango in the front, long forward freight positions benefit from backwardation, BofAML analysis said.

BofAML analysis points out that prospects for near-term upside are limited for Baltic Dry Index due to prevailing economic conditions with 90% of the world’s traded goods volumetrically transported by sea.

As the world’s top producer and consumer of iron ore, the sharp slowdown of Chinese iron ore imports has been, without doubt, weighing on freight prices. China imports roughly 65% of global seaborne iron ore imports. Ore imports into China for the month of June fell by 15% YoY. China’s seaborne iron ore imports have declined as domestic ore production has boomed while crude steel production has declined indicating slowing property and infrastructure investment .

Additionally, imports from India fell 21% in June compared to the previous month on weaker demand and weather-related supply disruptions.

The falling steel markets in emerging markets of India and Europe have also impacted the Baltic Dry Index, according to BofAML analysis. Steel prices are also heading south.

China’s appetite for coal is also lower, thermal coal imports have declined more sharply by 25% on year-on-year.

There are reasons for optimism still, since the beginning of the year, about 35 million DWT or 390 vessels have been added to the global dry bulk fleet, net of scrappage, bringing the total fleet to over 7,600 vessels representing close to 490 million DWT. This equates to an increase of almost 8% in the first half of the year alone, with another 7% expected for the second half of the year, BofAML analysis said.

Fundamentals will start to improve in 2H11
While short-term fundamentals are poor, BofAML equally do not expect dry bulk freight rates to go substantially lower from here. Ships can barely break even at the current rates. For instance, Capesize needs about $25,000-30,000 per day in earnings to break even given the current costs of shipbuilding. Moreover, BofAML expects to see further postponements and cancelations, helping industry consolidation. The slippage rate could rise further, helping to clean up the market.

In fact, it is not inconceivable for ships to be laid up next year and parked, hence taken off the market.

Moreover, while the global economic recovery is now expected to take longer to unfold, the relative strength of emerging markets will continue to support seaborne imports of iron ore and coal at high levels. Assuming we can avoid a double-dip now, strong emerging market fundamentals will provide a catalyst for a strong rebound in dry bulk trade, BofAML analysis said.