Vessel overcapacity is largely to blame for the continuing slide for the Baltic index. Deliveries of vessels that were ordered before the 2008 economic crisis are still outpacing demand for materials. Outside the shipping industry, the latest drop may have more severe ramifications for the overall health of global trade.
But two key factors may keep this from spelling disaster. In terms of forest products logistics, the majority of shipping rates are set by long-term contracts between carriers and shippers, buffering the peaks and valleys of spot rates. For the larger economy, the Baltic index has been losing its lock as a leading economic indicator, with some analysts arguing there are better measures for commodities and global trade.
The latest drop of the Baltic Dry Index may not spell complete disaster for forest products shipping, which is buffered by its fluctuations.
Many analysts had predicted a recovery for shipping rates in 2012. After the Baltic index hovered around the 1,500 levels in 2011, analysts' consensus was a 20 - 25% recovery in rates for the year. Instead, the index has turned in the opposite direction, plunging more than 60%.
Causing the index's decline is a combination of lower demand and an increasing oversupply of dry bulk carriers for the market. According to London-based Clarkson Plc, the world's largest shipbrokers, the fleet of dry-bulk commodity carriers will expand 14% this year, compared to an expected 3% gain in seaborne volumes. Last month, shipyards delivered a reported 146 new dry bulk vessels. Clarkson estimates that shipping demand will increase 5.5% this year, while vessel capacity is expected to grow by 12%.
Across the BDI, dry bulk carriers are not the only ship types seeing expansion, but they are leading the pack. Comparing vessels in service to those in build, according to the website grosstonage.com, dry bulk carriers are facing a 31% expansion, with gas carriers and tankers expecting a 11% increase. Making matters worse is that existing vessels are not coming off line.
"In many cases, the new build is not because of higher demand - but higher efficiency (hull and propulsion) to reduce costs," writes Steve Hansen, an international transport analyst. "Unfortunately, most of the less efficient ships are not being scrapped but just sold off. This just adds more tonnage to an already oversupplied market place."
Analysts are scratching their heads when trying to make sense of the Baltic index's moves and the recovery in the larger economy.
The biggest question that has analysts scratching their heads is how to read the Baltic index when compared to the overall economy. World trade overall is making significant gains. Although the International Monetary Fund cut its 2012 forecast from 4% to 3.3% for global economic growth, the IMF expects a third annual gain in world trade this year as economies recover. Global trade is up 21% from recession levels, reports the IMF.
Because ship orders were placed before or at the beginning of the financial collapse, owners are obligated to take delivery now when they are right in the middle of a recovery. But since these new vessels will offer significant savings in terms of fuel and operating costs, not to mention meeting new and coming environmental requirements, the benefits will not be seen for the next few years.
Compounding problems for the Baltic Dry Index is its lack of prediction power. This is not the first time the index has tanked, of course, but cause has not been easily associated with the larger economy. The index dropped in 2009 and 2010, including another 63% in 2010, without foretelling weakening economic conditions.
During the last crash for the BDI, many analysts called the index a "rubbish indicator" for commodities prices. In other words, the index was not originally designed as a predictor of commodity demand, merely the marker of spot rates across a spectrum of bulk materials. At best, these rates are an indirect indicator of commodity demand, as well as an mild predictor of overall carrier profitability.
The shipping industry has been aware of the coming onslaught of overcapacity for at least the last 18 months to 2 years. Many carriers and shippers have made strategic decisions in terms of their fleets, including taking into account a falling spot rate. At worse, say some carrier owners, this places some downward pressure on the negotiation of contract rates.
Finally, the most alarming concern of the Baltic index's movement is how it will affect the European debt crisis. With European banks holding most of the loans for these new ships, the potential insolvency of carrier owners to pay back their loans, or their need to renegotiate new terms, will only place more pressure on the banks. In these terms, the best reading of the Baltic index is to signal a worsening of the European recession already taking place.