September/October 2004
Scrap exporters have faced record freight rates and ongoing volatility in the ocean shipping market. Fortunately, there are ways to manage the risks.
By Barry Parker
Volatility is the one constant in the topsy-turvy world of ocean freight. The big question for scrap shippers is: How can I better manage my exposure to the notoriously fickle freight markets?
Given the recent record highs in freighting costs, movers of dry bulk cargo—such as ferrous scrap—do indeed have reason to worry. Such costs, after all, can account for 25 to 35 percent of the delivered commodity price in ferrous export trades.
Fortunately, freight is not a completely uncontrollable cost. Focusing some management attention on this cost center can be beneficial in both making overseas sales and maintaining margins. Here’s a look at the dynamic forces at play in today’s freight market and some advice on how to minimize your risks in this area.
What’s Driving the Market?
At the end of the summer of 2003, the freight market for dry bulk shipping, including scrap metal, was at the beginning phase of a so-called “upward explosion.” Shipping economists started using words like “vertical” to describe their freight-rate graphs, which needed to be recalibrated. According to R.S. Platou Shipbrokers a.s., an Oslo, Norway-based ship broker, “Freight rates more or less doubled over a few weeks and reached levels never experienced before. The new freight levels were maintained throughout the rest of the year.”
Freight rates are determined by a complicated and often volatile mix of ingredients on both the supply and demand sides. As 2003 waned, though, it became clear that the Chinese economy and the global steelmaking boom were the driving factors in the shipping markets. China, in particular, had become the dominant ingredient and was expected to retain that role in the future.
On the scrap side, China certainly has increased its imports of ferrous scrap in dramatic fashion in recent years. In 2003, for instance, China imported 2.5 million mt of ferrous scrap from the United States plus 7.5 million mt from other origins. This rising scrap demand was part of the burgeoning freight market, but it was hardly the driver behind it. The surge in overall freight rates resulted from the increases of tens of millions of tons of overall iron ore and coal shipments, particularly into China. Additional demand came from tightening in other bulk commodities as well as from trade patterns that required longer voyages, which meant that the same supply of vessels delivered fewer tons of cargo.
Without a doubt, the worldwide coal and steel markets have a huge effect on freight demand, with strong coal and steel demand yielding a strong freight market and higher freight prices. Overall, an estimated 2.2 billion mt of dry bulk commodities is shipped by sea worldwide each year. Of that total, the leading individual commodities are coal (accounting for about 700 million mt), iron ore (500 million mt), grains (300 million mt), and forest products (200 million mt).
Other “minor bulks,” including scrap metal, add another 500 million mt to the mix. Ferrous scrap’s share of that total was about 50 million mt in 2003, says Erik Andersen, head of R.S. Platou’s research department. Drewry Shipping, an independent London-based shipping analyst, estimates that about 33 million mt of ferrous scrap was shipped that year. Either way, scrap obviously represents a small percentage of bulk ocean shipments worldwide.
The lesson for scrap shippers is that the broader trend in freight rates, while full of spikes that may be reflected in delivered prices of ferrous scrap to export destinations, is ultimately determined by macro trends outside of the scrap market. These trends may be captured in the prices of commodities shipped in bulk, like ferrous scrap. As Stefan Topalovich, logistics manager for Hugo Neu Corp. (New York City), a leading U.S. ferrous scrap exporter, notes, “On most of our business, the price of the commodity quickly moved up to reflect the strong freight costs.”
Going forward, a positive trend for scrap metal is that ocean shipments of the commodity are forecast to grow, with Capt. Saurah Nakra—a consultant at Drewry—stating that “this commodity is expected to flourish more in the near future.”
Reviewing the Run-Up
While the major scrap metal trades march to their own tunes, all are tied to freight levels generally. The Baltic Exchange (London) publishes several indices of dry bulk markets, including the Baltic Handymax Index (BHMI). The BHMI, which represents vessels closest in size to those that haul ferrous scrap, is based on quotes from leading ship brokers on six particular trade routes for a notional 45,000-ton (deadweight) bulk carrier with five holds/five hatches and four cranes with 25-ton capacity. Also, the vessel age is less than 15 years for time charters quoted in the BHMI.
The BHMI mirrors freighting costs on a “time-charter” basis, valued in terms of dollars per day. Conversely, scrap shippers can charter on “voyage” terms, paying on a dollars-per-mt basis. In this case, the actual freighting costs reflect the broad time-charter freight levels plus the fuel, port, and canal costs that a shipowner must factor in when quoting a rate.
In the third quarter of 2003, the freighting market exploded in both time-charter and voyage terms. In the summer, before the run-up in rates, voyage freight costs of $40 per mt were typical for the bellwether U.S. East Coast/Korea route for Handymax scrap cargoes and less than $30 per mt for the U.S. West Coast/Korea route. At the same time, time-charter rates were around $18,000 a day and $13,000 a day, respectively, for those same routes.
By the end of 2003, material was being shipped to the Far East for more than $100 per mt off the East Coast and $70 per mt off the West Coast. Time-charter rates, meanwhile, climbed to $30,000 a day and $25,000 a day for those respective routes. At the freight market’s zenith earlier this year, the BHMI reached 35,000 index points, equating to nearly $50,000 daily for vessels on trips from the Atlantic to the Far East and $32,000 daily for vessels in the Pacific.
The market backed off briefly in the spring of 2004. At that time, 25,000-mt cargoes of shredded scrap with faster terms were done for $80 per mt off the East Coast and a sharply lower $43 per mt from the West Coast, according to brokers at MIDShip Marine’s world hub in Port Washington, N.Y.
This summer, freight costs started to climb again. In July, “the scrap price and freight rates were both moving sharply upwards,” notes Hugo Neu’s Topalovich. In his view, however, a firming of scrap demand in the domestic market could restrict the number of export cargoes for the remainder of 2004.
Managing Your Risk
What all scrap shippers want to know is when—or if—the freight market will soften again. Long-term forecasters, whose success in divining future ocean freight costs is spotty at best, predict a reduction in rates as new vessels—ordered in response to the present boom—are delivered. While the exact timing of this reduction is anybody’s guess, some sources suggest early 2007.
Rather than trying to forecast the market, the more important question is: How should shippers manage their freight costs and handle the volatility?
The first step in managing freight risk is to have a freight coverage plan in place, building in as much flexibility as commercial arrangements with export customers will allow. The ability to vary a shipment’s origin, exact shipment window, and cargo size, for example, can enable shippers to tame the freight beast.
Backing away from a rising vessel market is usually not the answer. Last year, exporters with material to move followed their first instinct when they saw freight rates rising—they held back their cargoes. This strategy was unsuccessful, as buyers demanded that the material be shipped. As talk of possible export controls spread through the market, overseas buyers were quick to raise their offers for material, while sellers continued to be snared in the rising freight market.
Another strategy of managing your shipping risk—trying to call a bottom in the market before pouncing—is akin to “catching a falling knife.” Some charterers learned this the hard way in the second quarter of 2004 when the market dipped. A brief window of lower rates opened in May and June this year after China’s announcement in late April that it would tighten credit to slow the flow of imports to its steel industry. A few lucky cargo shippers timed their entry and captured the lower levels, but many ship owners pulled back, with the result being that little business was transacted.
Many ship brokers can advise on freight strategies and often have access to specialized analytical software that can produce translations between time-charter and voyage rates after digesting updated freight market information for different ship sizes and ocean regions. Such translations can show, for instance, that the value of ships in the Pacific dropped more sharply than elsewhere, offering an attractive value, if only briefly. A good broker would point this opportunity out to clients. Shippers who could shift the origin of their shipment from the Atlantic to the Pacific could then garner substantial savings.
Brokers can also help their clients by advising them when it’s prudent to ship their cargo in different vessel sizes. For example, Handysize rates, on 25,000 to 35,000 mt sizes, were first to get caught in 2003’s tightening freight noose, and brokers advised their clients to move into Handymax vessels that could take 40,000 mt per shipment.
Currently, freight risk management is increasingly being drawn from the financial traders’ playbook, where market timing and chart analysis play an important role. When rates drop to relatively attractive levels, ship owners are notoriously reluctant to enter into contracts for freighting multiple cargoes. However, vessel owners may consider entering into floating-rate contracts that are indexed to the Baltic Handymax Index or the new Supramax Index, which will replace the former index in 2006.
Physical market ship brokers are also monitoring the growing forward markets, where traders can use the Baltic indices to lock in forward freight rates. The cornerstone of a workable strategy stems from the relationship of forward curves—the future index prices compared with spot prices—which are currently below the spot indices. If the forecasting gurus are correct about strong freight markets through 2007, then forward freight coverage, either directly by scrap shippers or through chartering deals indexed to Baltic’s indices, may well seem like a bargain when contracts settle. Such tools are gaining importance in other industrial cargo sectors, such as coal, oil, and grain.
Despite these new risk management tools, shipping is a relationship business. As such, the role of independent brokers in “nurturing relationships with literally hundreds of counterparties can provide the leverage when a vessel is needed in a tight market,” as Bob Diamond, MIDShip’s COO, points out.
A New Index for Ship Scrap
In June 2004, the Baltic Exchange announced plans to launch an index of ship scrap prices based on broker quotes for a handful of vessel types delivered to ship demolition points in either China or the Indian subcontinent. The exchange hopes that this new index, to be called the Baltic Demolition Assessment (BDA), will be a benchmark for pricing deals for ferrous scrap from retired vessels. In its view, buyers, sellers, and intermediaries in the ship scrap trade will benefit from the ability to manage price risk, while the market will benefit from the improved price visibility provided by weekly quotes.
Barry Parker is principal of bdp1 Consulting Ltd., a New York-area firm that advises shipping clients on freighting and maritime business issues. He can be reached at 516/606-9088 or bdp1@conconnect.com.
Scrap exporters have faced record freight rates and ongoing volatility in the ocean shipping market. Fortunately, there are ways to manage the risks.