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Daily Market report: http://www.dryships.com/pages/report...

The Baltic Dry Index is a daily average of prices to ship raw materials.

It represents the cost paid by an end user to have a shipping company transport raw materials across seas on the Baltic Exchange, the global marketplace for brokering shipping contracts. The Baltic Exchange is similar to the New York Merc in that it is a medium for buyers and sellers of contracts and forward agreements (futures) for delivery of dry bulk cargo. The Baltic is owned and operated by the member buyers and sellers. The exchange maintains prices on several routes for different cargoes and then publishes its own index, the BDI, as a summary of the entire dry bulk shipping market. This index can be used as an overall economic indicator as it shows where end prices are heading for items that use the raw materials that are shipped in dry bulk.

The BDI is one of the purest leading indicators of economic activity. It measures the demand to move raw materials and precursors to production, as well as the supply of ships available to move this cargo. Consumer spending and other economic indicators are backward looking, meaning they examine what has already occurred. The BDI offers a real time glimpse at global raw material and infrastructure demand. Unlike stock and commodities markets, the Baltic Dry Index is totally devoid of speculative players. The trading is limited only to the member companies, and the only relevant parties securing contracts are those who have actual cargo to move and those who have the ships to move it. [1]

Composition of the Index

The index is maintained by the Baltic Exchange. The cargoes being moved are raw material commodities such as coal, steel, cement, and iron ore. The prices are determined by the buyers and sellers, and then the exchange takes 26 different routes throughout the world for various materials and averages them into one index. The index does not concern itself with finished goods or container ships, only raw materials and dry bulk specific ships are factored into the calculation.[2] It also factors in all four sizes of oceangoing dry bulk transport vessels:

A chart of the Baltic Dry Index is above, in the top right of the page. As you can see, the index can be quite volatile. The run up from 2005 to the end of 2007 was primarily due to Chinese demand for industrial precursors to production and its shift from coal exporter to importer. There was also a shortage of supply for dry bulk cargo ships and a large backlog at shipyards. The combination of these two factors caused a nearly 200% gain in the index. In the past 6 months, the index has lost 85% of its value as demand for shipping is plummeting. This is due to a simultaneous convergence of several factors. Chief among these is the rapid slowdown in the "global growth" phenomenon. In addition to this, credit has been nearly impossible to get for the purchase of goods and the payment of time charters on the vessels.

Economic Implications

This index is one of the purest leading indicators of economic activity. It measures the demand to move raw materials and precursors to production. Consumer spending and other economic indicators are backward looking, meaning they examine what has already occurred. The BDI offers a real time glimpse at global raw material and infrastructure demand. This could also be gleaned from looking at commodity prices, but there are substitution effects and futures contracts that make it difficult to interpret the impact of commodity price fluctuations. Additionally, nearly all commodities are seeing severe increases in prices in 2008 regardless of supply situations as investors seek to hedge their inflation exposure with hard assets.

Unlike stock and commodities markets, the Baltic Dry Index is totally devoid of speculative players. The trading is limited only to the member companies, and the only relevant parties securing contracts are those who have actual cargo to move and those who have the ships to move it. [5] The BDI will show how much a company or country is willing to pay to import raw materials immediately. For example, if a Chinese company has contracted out coal prices for the next year from Rio Tinto (RTP), then the spot price of coal increasing after a mine accident will not impact that established contract. However, when this company is willing to pay more per ton to ship the coal than to actually purchase it, an investor can see that price growth is accelerating.

Key Trends and Forces

• Commodity Demand - This is determined mainly by industrial production and energy demand. If commodity demand is strong, BDI rates will increase regardless of spot rates for those commodities. Companies that have contracted out spot rates will show increased demand through paying more for shipping of the materials. As more coal and steel are being demanded by China, so will the rates for dry bulk shipping increase.

• Fleet Supply - This is determined by the number of available ships, their capacity, and the utilization rates. Additionally, the average age of the fleets will determine where they are in the life cycle. The average ship lasts 25 years. If the average is closer to that number, supply will be decreasing in the short term. Also, supply is greatly determined by delivery of new vessels. Currently, there is significant back logged demand for new vessels. No new orders are being taken for delivery before late 2009. With this backed up supply, BDI prices soared in 2007. With rates for the largest dry bulkers fetching nearly 10x that of a comparable VLCC Oil Tanker, many companies converted tankers into dry bulk carriers.[7] As conversions and ships contracted to be built at the beginning of the price run up in 2006 come on line, the upward pricing pressure of a fleet in which 41% of its ships are over 20 years old will be held at bay.[8]

• Seasonal Pressures - Weather has a major impact on both demand and logistics. For demand, cold weather may increase the demand for coal and other energy creating raw materials. For logistics, cold weather may cause ice to block ports and low rivers to prevent travel. Both of these cause increases in the BDI. Conversely, a mild winter or early ice breakup in cold water parts will cause decreases in the BDI.

• Bunker Prices - Bunker oil is the name for the oil a ship uses for fuel. Bunker fuel accounts for between a quarter and a third of vessel operating costs. These higher oil prices will be reflected in higher BDI prices. So just as higher oil prices will put a damper on Airline company margins, they will squeeze margins for dry bulk operators.

• Choke Points Nearly half of the world's oil passes through a few narrow shipping lanes. This includes the straights of Hormuz and Malacca, the Bosporus and the Suez and Panama canals. These choke points cause natural caps in ship supply; i.e.- only a certain number of ships can pass through them each day. If something disrupts this flow, the BDI will increase.

• Market Sentiment - Because of the time lag in forecasting demand for raw materials, market opinion can greatly affect the freight exchange. [9] The recent halving of the index's value can be attributed to many companies forecasting lower global growth and cutting their production/demand targets.

• Port Congestion -This acts as another great buffer against supply increases lowering index prices. The actual infrastructure of these ports prevents more ships entering the market. The ports simply cannot handle more traffic. Until major changes occur at these vital terminals, there will be upward pressure on dry bulk prices. Shipping industry analysts [1] are actually developing an index to standardize and make available this incredibly vital data.[10]

Example of Global Ports Congestion Index Report

Other Indices

Shipping industry publication "Lloyd's List" publishes a comprehensive list of input and route specific indices. These can be used to gauge demand on certain inputs. Economic activity can also be extrapolated by examining where rates are rising/falling on specific routes.

Lloyd's List Indices and Route/Cargo Info[11]

Winners/Losers

When the BDI increases, dry bulk shippers win. The increase in the index directly increases their margins and revenues.

When the BDI decreases, every other consumer/producer in the global value chain wins. Since the BDI measures procurement costs, when these costs go down, producers benefit from increased margins, and consumers benefit from lower prices for finished products.

Dry Bulk Shipping Stocks

When an investor buys a dry bulk shipping stock, they are effectively buying into the Baltic Dry Index. The amount of exposure depends on the individual stock. Some companies, such as DryShips (DRYS), have most of their ships contracted out at the spot Time Charter Equivalent. This means that the contracts are directly correlated to the daily price of the BDI. Thus, their revenues are directly tied to the index. In times of increasing prices, this set up will yield greater profits for the shipper. Other companies, such as Diana Shipping (DSX), have contracts set at the period Time Charter Equivalent. This means that they enter into a contract, usually 2-5 years in length, which pays a fixed daily rate. This set up provides less volatility, hedges risk against falling BDI rates, and guarantees cash flows.

List of U.S. Listed Dry Bulk Shippers

Regards,

Highgrader