Talking Point

Shipwreck?

Is shipping data indicating a China-inspired double-dip recession?

An industry that's not exactly in ship-shape condition

When it comes to shipping forecasts, few have proved as crucial as the one delivered by James Martin Stagg. The Briton, who served as General Eisenhower’s meteorologist for the D-Day landings, forecast that the bleak sailing conditions of June 5, 1944 would briefly improve the following morning at 6.30am.

The fate of 160,000 soldiers rested on Stagg’s interpretation of the data. Not everyone shared his opinion, including a German military convinced that the weather was too poor for an amphibious invasion. Its commander in Normandy, Field Marshall Erwin Rommel, even took a few days off to celebrate his wife’s birthday.

Just over 66 years later, and another shipping forecast has the experts divided. But this time their eyes are less on the English Channel, and more on the Chinese coastline. And the ships concerned are carrying commodities like iron ore.

What are they trying to forecast?

At the heart of the matter is the Baltic Dry Index. This is the key indicator in the shipping world – and by extension, one of the most important for global trade too.

The index measures the rates charged for chartering the huge vessels that carry coal, iron ore and grain. Worryingly, it fell recently for 34 consecutive days, declining 60% in its longest streak of consecutive declines for nine years.

What does that mean in practical terms? The Economist magazine says the cost of chartering a ship to carry iron ore and coal from Australia and Brazil has dropped to $18,000 a day, versus $48,000 in May.

If you want to understand why, look to China. David White of the Seeking Alpha blog calls the Baltic Dry “a good barometer of the strength of Chinese commodities buying”. As its economy slows, so too does the appetite for imported commodities.

For example, imports of iron ore dropped 9% to 47.2 million metric tonnes in June from 51.9 million tonnes in May, according to Chinese customs data.

That’s why the Wall Street Journal has pointed out, shipping forecasts are all the rage: “Bearish market pundits have spotlighted the Baltic Dry Index recently to argue there are troubling signs of a significant slowdown — and perhaps a double dip — afoot.”

The Stockhouse website offers another good example of the alarmist tone. It reckons the Baltic Dry has proven to be an historically accurate predictor of global slowdowns: “Back in May 2008, when global investors still expected economic growth to continue, a thinly followed index began to broadcast a ‘red-alert’ warning to those few who were watching.
The index proceeded to drop by more than 90% in the next six months. Today, the BDI is again flashing serious warning signs that not everything is as it appears. It may be warning us about the start of a ‘double-dip’ recession, or it may be telling us that something even worse is at hand.”

What do the shipping experts think?

“I’ve been in shipping for 26 years and I’ve never found it more difficult to make a call on the market.” That was the verdict of Tim Huxley when WiC interviewed him last year (see WiC24).

The chief executive of Hong Kong-based Wah Kwong Maritime Transport told WiC on Wednesday that it hadn’t got any easier. “There’s always a seasonal downturn in the summer,” he says, “but there is now this perfect storm of factors that have depressed the shipping market and the level of the Baltic Dry.”

The dry bulk carrier market is predominantly driven by Chinese demand – Huxley says what propped it up last year was Beijing’s economic stimulus package. Shippers were kept busy because of all that construction and infrastructure spending – which resulted in China’s iron ore imports exceeding the shipping industry’s forecasts by 100 million tonnes.

However, Huxley says the Chinese demand situation has changed. He thinks that there are three reasons for sluggish demand for charters. The nation’s iron ore stockpiles are currently high; and they are not being added to because a lot of steel mills in China are losing money and have scaled back production. Then there is the price of iron ore. As WiC has reported repeatedly, the Chinese steel industry (represented by a body called CISA) is in dispute with the big iron ore miners over high prices. Sensing it currently has the upper hand, CISA has instructed steelmakers to hold off buying – in the expectation that the next round of quarterly iron ore prices should be substantially lower.

So steel is the key?

Bloomberg confirms that Jiangsu Shagang Group and Nanjing Iron & Steel have put off iron ore purchases, choosing to run down inventories. And it likewise reports that Chinese steel prices have fallen 17% from an 18-month high on April 15.

Steelmakers certainly face headwinds. A flagging housing market has led to a construction slowdown (i.e. less steel girders). Plus there has been weaker demand from auto and appliance makers, says Xu Lejiang, chairman of Baosteel Group. To make matters worse, steel exports are no longer eligible for chunky tax rebates, further hamstringing steelmakers and by extension their iron ore needs. That’s bad for shippers…

But China’s slowing demand is not the whole story?

No, the shippers’ problems – and the weakness of the Baltic Dry – are at least as much to do with another factor: excess supply. The last five years has seen a massive expansion of shipbuilding capacity. Huxley worried last year about the onslaught of new ships being launched – knowing that an excess supply would likely lead to lower freight rates.

Now he says we’re starting to see it happen: “In the first half of 2010, around 100 new capesize bulkers [ships of over 100,000 deadweight tonnes, mainly used in the iron ore trade] were delivered compared to 34 in the first six months of 2009. We have another 206 due in the second half of the year and 282 next year.”

The growth of the global fleet – up 23% in the first half (according to the Economist) – is bad enough. But adding to the supply problem says Huxley is the fact that in the boom times, congested ports tied up as much as 7% of the fleet – as ships waited to load or discharge. That figure’s dropped to 3%, meaning a lot more ships are available. All in all, it’s little wonder that shipowners have had to slash charter rates.

Which brings us back to the great debate on the Baltic Dry and what it’s telling us. Huxley reckons that its recent dire performance is more to do with these increases on the supply side (more available ships) and is driven less by declines in Chinese demand for commodities. In that respect, its usefulness as a prognosticator for the global economy is perhaps weaker than in 2008 – when it proved a very accurate leading indicator of recession.

And in his own Stagg-ish moment, Huxley also predicts that the Baltic Dry has bottomed out. On the demand side he sees a big boost from coal – much of which is to be shipped to India’s new power stations. On the supply side, the scrapping of ships has also started to get underway (eight capesize bulkcarriers have been sold for scrap in recent weeks). He qualifies his optimism by saying: “The key is going to be how the fourth quarter pans out. It’s a very sentiment-driven industry. We will know by mid-September how it is looking. That will be a crucial period.”

For the glass half-full camp, this week was reasonably positive: spot iron ore prices bounced 5% on Monday, and the Baltic Dry also rebounded 11% from its recent low. Then again, versus its pre-slump level of 4,209 – reached on May 26 – the index stands at just 1,901.


© ChinTell Ltd. All rights reserved.

Exclusively sponsored by HSBC.

The Week in China website and the weekly magazine publications are owned and maintained by ChinTell Limited, Hong Kong. Neither HSBC nor any member of the HSBC group of companies ("HSBC") endorses the contents and/or is involved in selecting, creating or editing the contents of the Week in China website or the Week in China magazine. The views expressed in these publications are solely the views of ChinTell Limited and do not necessarily reflect the views or investment ideas of HSBC. No responsibility will therefore be assumed by HSBC for the contents of these publications or for the errors or omissions therein.