[Fresh Ink] Shipping: Holed beneath the waterline

[Richard Menec]

<http://www.independent.co.uk/news/business/analysis-and-features/shipping-holed-beneath-the-waterline-995066.html>

Thursday, 6 November 2008

Shipping: Holed beneath the waterline

The staggering and sudden decline in the cost of chartering a cargo ship 
reflects both the global economic slowdown and the ongoing credit crunch.

Sarah Arnott reports

Hold on to your hat: the Baltic Dry Index was down at 826 points yesterday, 
a shattering drop from its high of 11,793 in May.

The index, which tracks the price of shipping bulk cargo, might not sound 
like a reason to choke on your cornflakes. But it is an unparalleled, if 
subtle, barometer of the global trade in economic building blocks like iron 
ore, coal and grain - and it is telling a worrying tale.

Put simply, the cost of shipping has dropped through the floor. Sending a 
tonne of iron ore from Brazil to China in early June would have set you back 
more than $100 (£62) per tonne, or around $15m per voyage. But freight rates 
have now dropped to only slightly over $10 per tonne, or just $1.5m for the 
70-90 day journey.

As if that wasn't dramatic enough, the drop in daily charter rates is even 
sharper. At the peak of the market, a 170,000-tonne Capesize bulk carrier 
was hired out at the eye-watering daily rate of $234,000. At the beginning 
of this week, it was $5,611 - a fall of nearly 98 per cent.

Peter Kerr-Dineen, chairman of Howe Robinson shipbrokers, said: "The scale 
of change in rate is utterly staggering - the market has come down from 
super-boom territory to pretty close to bust, effectively in two months."

Contracting demand for imports in recession-wary economies across the world 
is a factor, as are steadily falling commodity prices and the mechanics of 
supply and demand in the shipping industry itself. But the real trouble is 
less obvious, largely unprecedented, and potentially devastating.

The wheels of international shipping are greased with "letters of credit" 
issued to buyers of bulk cargo by their banks. These guarantee the value of 
the shipment once it is in transit but before it is delivered. The problem 
is that the credit crunch, with the resulting liquidity problems in the 
international banking sector, is taking its toll on the availability of 
these entirely routine instruments. "We have the hugely worrying and 
unprecedented development where there are perfectly credit worthy shippers 
and receivers unable to open perfectly standard letters of credit," Mr 
Kerr-Dineen said.

Cargos are sitting on docksides because the finance is not available to ship 
them, with the gravest implications for the future. "This is a nuclear bomb 
in the freight market, and in world trade," Mr Kerr-Dineen said. "Liquidity 
has to return because if there is insufficient money to provide standard 
finance, world trade will be sharply cut back and economic growth will 
implode."

This comes at the worst possible time, on top of a string of other 
adjustments already affecting the shipping market. After an unparalleled 
boom over the last five years - fuelled in large part by rocketing Chinese 
demand - it was to be expected that the overheated market would cool. And in 
the shipping industry itself, the number of vessels started to catch up with 
demand. Meanwhile ballooning commodity prices were being undercut as 
additional supply, fuelled by the high prices, started to come on stream.

Against such a background, more recent concerns over the economic slowdown 
in both the East and the West have pushed users of commodities to run down 
their existing stocks, rather than buy in new supplies at what are still 
relatively inflated prices.

These are all to some extent predictable economic adjustments, but a more 
sinister effect has been thatde-stocking is masking the shortages caused by 
the dearth of credit. Mr Kerr-Dineen says there are around three months left 
before stocks run out.

"If the problem is not resolved, there will be no way in which even the 
sharply revised economic growth forecasts for 2009 will be met, because 
without normal trade economies cannot function. Ultimately, flour mills will 
run out of wheat and power stations will run out of coal," he said.

So far, the most significant problems have been confined to the bulk 
commodities trade. Manufactured goods have been are less affected because 
there is less reliance on letters of credit, said a source in a large 
container shipping company. Large shippers like Walmart or Nike do not need 
the letters because they are, ineffect, sending to themselves. And even 
where trade is between companies, long-standing commercial relationships 
leave a lot more to trust than in the more volatile commodities market.

But firms using containers to ship bulk products such as bananas, meat or 
fish are feeling the pinch. "We are certainly seeing unusual delays 
inissuance of letters of credit forcommodity trades," the source said.

Banks are charging more to issue the letters, and nervous traders are 
requiring guarantees, where historically trust might have been enough.

Jeremy Penn, chief executive of the Baltic Exchange which runs the Baltic 
Dry Index, said: "Sentiment is also a key driver and has gone completely 
into reverse. People are also waiting for prices to fall further. There is 
no incentive to do today what they think will be cheaper tomorrow."

George Cambanis, head of global shipping at Deloitte, said: "Everybody can 
still hold their breath for the time being, but it is anybody's guess how 
long it will take for money to startcirculating again."

He added: "Trading has virtually come to a standstill, because there is no 
cargo for the ships. There has also been no trading of vessels in the last 
few weeks, so there is no market value out there for companies' capital 
investment in their ships."

No longer oiling the wheels

Freight cargo is not the only piece of the global economic infrastructure 
being hit by the on-going constriction of credit. Companies looking for 
forward hedging are also struggling to find banks willing to put up the 
cash.

Earlier this week, Michael O'Leary, the chief executive of Ryanair, admitted 
that his plans to hedge 2009's fuel requirements went awry because banks 
were not willing or able to take the risk. "We were originally planning to 
hedge about 50 per cent of our needs for the next 12 months but we just 
couldn't get there," he said. "Banks in hedging are withdrawing and fuel 
companies don't trust the banks as counter party risk."

The budget carrier was stung by soaring oil prices that reached $147 per 
barrel in July and more than doubled the airline's fuel bill, from $393m 
(£318m) to $789m (£638m) in the first six months of the year.

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