A Primer on Dry Bulk Freight Rates


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This is a brief presentation that I created to describe freight rates trading (OTC forward swaps and options)

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A Primer on Dry Bulk Freight Rates

  1. 1. A Primer on Dry Bulk Freight Rates
  2. 2. Produced by - Amar Ehsan, CFA 2 Three Main Types of Freight • Refers to any type of cargo that can be stored without any need for sorting, packaging or special climate control • Can be further subdivided into “major” bulk (iron ore, coal and grains) and “minor” bulk (finished steel, cement, forest products, misc. metals, intermediate minerals etc.) • Measured in deadweight tons (dwt) • Refers to crude oil, petrochemicals, LNG, LPG and industrial chemicals • Measured in deadweight tons (dwt) or barrels (bbl) • Refers to containerized cargoes of finished products including consumer goods like Refrigerated Perishables, Home Electronics, Clothes and Automobiles. Also includes industrial goods like fabricated machine parts, spare supplies etc. • Measured in deadweight tons (dwt) or Twenty Foot Container Equivalent (TEU) DRY BULK WET TANKERS CONTAINERS AND GENERAL CARGO
  3. 3. Produced by - Amar Ehsan, CFA 3 Main Vessel Classifications • MAJOR BULK – VLOC (225k+ dwt) – Capesize (80-225k dwt) – Panamax (50-80k dwt) • MINOR BULK – Panamax (50-80k dwt) – Handymax (30-50k dwt) – Handysize (<30k dwt) • Other specialized classes exist as subsets of these main classes DRY BULK WET TANKERS CONTAINERS AND GENERAL CARGO Vessels are classified on a combination of size, functional capabilities and most frequented trade routes. However, overwhelmingly vessels are contracted based on size. • CRUDE OIL – VLCC (200-330k dwt) – Suezmax (120-200k dwt) – Aframax (80-120k dwt) • REFINED PRODUCTS – LR Tanker (120-150k dwt) – MR Tanker (80-120k dwt) – SR Tanker (50-80k dwt) • Other specialized classes exist for LNG/LPG • CONTAINERS – Large (5000 TEU+) – Medium (2-5000 TEU) – Small (<2000 TEU) • GENERAL CARGO – Mo/Mo – (Multimodal) – Ro/Ro – (Roll on/Roll off) – Reefer – (Refrigerated) – HLV – (Heavy Lift Vessel)
  4. 4. Produced by - Amar Ehsan, CFA 4 Shipping Contracts • Negotiated rate for the vessel is highly dependent on: – Size of Cargo – Available vessels of size – Distance (Ton-miles) – Age of vessel – Port of destination • Main users of spot market vessels are: – Steel Manufacturers – Crude Oil Producers – Ship Brokers – Speculators Spot Market Time Charter Market Vessels are generally hired for a charter on a voyage basis (single round-trip AKA “Spot” market) or on a longer term (AKA “Time Charter”) contract. Most of the global fleet is owned and operated by the same party and thus operates on a private contract basis. • A vessel contract can range from a short term contract of 0-6 months to a long term contract of 5+ years • Vessels can be contracted with or without a crew and the contracting party can “sublet” the vessel while it is under their control • Most dry bulk and wet freight operates on private long term contracts. Nearly all container traffic operates on private long term contracts
  5. 5. Produced by - Amar Ehsan, CFA 5 Freight Indexes • Baltic Dry Index – Rates on major global routes are independently collated from a panel of brokers around the world – Good leading indicator for economic growth – Robust index widely quoted throughout the shipping industry – Index is not currently tradable • Baltic Forward Assessment (BFA) – Published on a daily basis and provide market users with a forward curve out to 3 years (rolling calendar Qtr) to act as a mark to market curve – Quoted in US $/day to match vessel charters (but certain routes can be quoted in $/ton or $/bbl) – Trading on individual vessel routes is made possible, but a 4TC market (average of 4 individual routes) is also provided that closely correlates individual routes and is far more liquid The Baltic Exchange is an independent trade group comprised of Ship-owners, Shipbrokers and Ship Financiers who share a common goal of disseminating the most accurate information available on global dry bulk fleet demand and supply. They are responsible for publishing the Baltic Dry Index and providing the Baltic Forward Assessments (BFA)
  6. 6. Produced by - Amar Ehsan, CFA 6 Trading Freight Derivatives (FFA) Freight derivatives provide a means of hedging exposure to freight market risk through the trading of specified time charter and voyage rates for forward positions. Settlement is effected against a relevant route assessment, usually one published by the Baltic Exchange The main terms and conditions set forth in a contract agreement cover: (a) The agreed route. (b) The day, month and year of settlement. (c) Contract quantity. (d) The contract rate at which differences will be settled Freight Rate Trades can be set up to: • Hedge a position in an equity that is synthetically “short” freight rates (i.e. steel, coal) • Take a “long” position in a specific trade route (i.e. API#2 vs. API#4) • Design a spread trade between two individual routes or a route versus the published T/C average (i.e. Iron Ore from Brazil to China [C3] vs. Iron Ore from Australia to China [C5]) • Take advantage of convictions about port congestion or other infrastructure bottlenecks (i.e. DRYS vs. Capesize 4TC Average, Short Xstrata [XTA LN]) The International Maritime Exchange (IMAREX) is the only authorized and regulated marketplace for trading and clearing of maritime derivatives contracts (through Nordic Options Exchange), and provides an accurate market for Dry Bulk and Wet Freight Futures
  7. 7. Produced by - Amar Ehsan, CFA 7 Main Dry Bulk FFA Routes Capesize Vessel (Iron Ore, Coal) IRON ORE C2 - Tubarao (Brazil) to Rotterdam (Netherlands) C3 - Tubarao (Brazil) to Beilun/Baoshan (China) C5 - Newcastle (Australia) to Beilun/Baoshan (China) COAL C4 – Richards Bay (South Africa) to Rotterdam (Netherlands) C7 – Bolivar (Venezuela) to Rotterdam (Netherlands) C12 - Gladstone (Australia) to Rotterdam (Netherlands) Panamax Vessel (Iron Ore, Coal) IRON ORE, COAL, GRAIN P1a – Transatlantic (Primarily Latin America to Europe) P2a – Europe to Far East (Primarily China) via Suez Canal P3a – Pacific Round Trip (Primarily Australia to China) P4a – Far East to Europe via Panama Canal (Japan Eastward)
  8. 8. Produced by - Amar Ehsan, CFA 8 Main Wet FFA Routes Crude or “Dirty” Tankers (VLCC, Suezmax, Aframax) TD1 – Arabian Gulf to US Atlantic Coast TD3 – Arabian Gulf to Far East TD5 – West Africa to US Atlantic Coast TD7 – North Sea to UK Coast Refined Products or “Clean” Tankers (Aframax, LR, MR, SR) TC1 – Arabian Gulf to Far East TC2 – UK Coast to US Atlantic (North Sea Arbitrage) TC6 – Cross Mediterranean
  9. 9. Produced by - Amar Ehsan, CFA 9 Future Drivers of Freight Rates • Commodity demand. Headline story is always China – massive importer of raw materials but increasingly becoming an exporter as well. Our trip realized mixed indications of whether a slowdown was imminent post 2008 Olympics. Globally, What are the levels of industrial production? Are power stations importing more coal? How is the steel industry performing? • Fleet supply. How many different types of ships are available? How many vessels are being delivered and how many are being scrapped? Newbuilding is a 2-3 year process and forward order books for shipbuilding yards indicate a large amount of tonnage becoming available in 2010; how accurately is this reflected in forward rates? Scrapping is at an all time low despite attractive scrap prices; how long will vessel retirement be deferred? The age profile of the global fleet is heavily weighted to older vessels. IMO standards require all single hull VLCC (33% of global crude fleet) to be retired by 2010; with port standards being widely varied, will this deadline be met? • Seasonal pressures. The weather has a big impact on the shipping markets from the size of grain harvests to icing over in ports to demand for commodities and even river depth (draft) levels. Weather can also lengthen loading, unloading and voyage times. Finally, weather can severely impact port efficiency • Bunker prices. With bunker fuel accounting for between one quarter and one third of the cost of running a vessel on the spot market, oil price movements directly affect ship-owners, the cost of marginal shipments and contracting activity. • Choke points. This factor can particularly affect tankers with almost half of the world’s oil passing through a handful of relatively narrow shipping lanes. These points include the straits of Hormuz and Malacca, the Suez and Panama canals, the Bosphorus (Istanbul) strait and other important channels whose closure – either from conflict, terrorist attack or a collision in the overcrowded shipping lanes - would change the world’s supply patterns. Recently, we have also seen significant congestion at iron ore and coal exporting ports as weather has hampered operations. Looking ahead, port congestion and lack of infrastructure capable of supporting larger vessels may create a demand/supply imbalance regardless of vessel availability.
  10. 10. Produced by - Amar Ehsan, CFA 10 Main Ports of congestion Tubarao, Brazil Newcastle , Australia Richards Bay, South Africa
  11. 11. Produced by - Amar Ehsan, CFA 11 Port delays drove rates higher earlier this year – +41.5%$9.91$23.88$33.79Cost of Ore to Steel Producer 1.6x1.6xOre Demand* +41.5%$6.20$14.92$21.12Spot Px Chg (%)Chg ($)6/13/077/13/07C5 (AUS -CHN) +32%$20.90$64.80$85.70Cost of Ore to Steel Producer 1.6x1.6xOre Demand* +32%$13.06$40.50$53.65Spot Px Chg (%)Chg ($)6/13/077/13/07C3 (BRZ-CHN) Illustrative Impact on Steel Costs +27%$10.99$40.93$51.92Cost of Ore to Steel Producer 1.6x1.6xOre Demand* +27%$6.87$25.58$32.45Spot Px Chg (%)Chg ($)6/13/077/13/07C3-C5
  12. 12. Produced by - Amar Ehsan, CFA 12 Key Takeaways DRY BULK IRON ORE/STEEL COAL GRAINS/OTHER Main Vessels: VLOC (170k+ dwt) Capesize (80-170k dwt) Panamax (50-80k dwt) Handymax (30-50k dwt) Handysize (< 30k dwt) “Tweendecker” Main Routes: C3, C5 Trade Ideas: Hedge Steel Producers Substitution of Australian Ore in China with Brazilian Main Vessels: Capesize (80-170k dwt) Panamax (50-80k dwt) Supramax (45-60k dwt) Main Routes: C4, C7, P2a, P3a Trade Ideas: LatAm/S. Africa Coal Spread China Coal Imports/Exports Main Vessels: Panamax (50-80k dwt) Handymax (30-50k dwt) Handysize (< 30k dwt) “Tweendecker” Main Routes: P1a, P2a Trade Ideas: LatAm Import/Export China Grains Trade inter-Asia WET Main Vessels: VLCC (200-330k dwt) Suezmax (120-200k dwt) Aframax (80-120k dwt) LR Tanker (120-150k dwt) MR Tanker (80-120k dwt) SR Tanker (50-80k dwt) CRUDE / REFINED Main Routes: Crude – TD1, TD3, TD5, TD7 Product – TC1, TC2, TC6 Trade Ideas: Increasing Crude to China Diesel Shortage in China North Sea Gasoline Arbitrage Refinery capacity constraint in N. America
  13. 13. Produced by - Amar Ehsan, CFA 13 Current Dry Bulk FFA Curve (As of 10/24/07) $- $20,000 $40,000 $60,000 $80,000 $100,000 $120,000 $140,000 $160,000 $180,000 $200,000 Q407 Q108 Q208 Q308 2008 2009 2010 TC USD/Day Cape 6/07 Pnmx 6/07 Cape (NOW) Pnmx (NOW)