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Agriculture Weekly: Grain freight is coming back: buyer beware

11 Oct

Agriculture Weekly: Grain freight is coming back: buyer beware

A brave new world for grain freight

Since 2007 the world has had to deal with tighter and tighter agricultural supply and demand balances; the same cannot be said for the ocean freight market. Over the past six years the freight market has gone from a chronic shortage to a market that is grossly oversupplied. The world’s importers have reaped the benefits as freight rates have traded at, or sometimes under, operating cost for prolonged periods. All this may be about to change.

Today, there are tentative signs that this oversupply is coming to an end. Any rebalancing will have important implications for grain buyers and merchants. A more ‘normal’ market means that the freight component of any delivered cargo must be re-rated from the perspective of pricing risk. More attention must be now paid to freight fundamentals. Moreover, the world’s logistical grain network is not what it was six years ago. Altogether, a more normal freight market presents a distinct challenge to all market participants.

Freight’s feast or famine

Freight’s boom and bust is nothing new. Any change in the seaborne demand – rising demand or an opening up of new trade routes – will only elicit a slow and incremental response in supply. The world’s largest importers and consumers are relatively price inelastic. Quite simply, if a charterer needs a vessel, having forward sold a cargo, it must pay the market rate. Thus, freight rates can appreciate significantly before there is any material of supply response.

This is exactly what happened between 2000 and 2007 for all dry bulk vessels. Shipping rates started to rise from 2002, as represented by the Baltic Dry Index. But it was only by 2007 that shipyard order books began to fill up. Investment went into all vessel types from capesizes (+110k deadweight tonnes, or dwt); to panamaxes (60-109k dwt); to handymaxes (40-59k dwt). Delivery times for new ships grew from eighteen months to three to four years. With such an inadequate supply response, time charter rates surged. The cost of leasing a panamax vessel per day rose from $40,000/day in 2007 to $80,000/day in 2008. When supply arrived en masse, market rates collapsed to $4,600/day during 2012. Throughout this, lagged supply kept on coming. According to the United Nations Conference on Trade & Development (UNCTAD), the order book at the end of 2011 equated to 55% of the existing dry bulk fleet.

Throughout, seaborne demand has not been in question. Year on year growth in the dry bulk trade has mopped up some of this surplus. Yet, the market has attempted to rebalance in other ways. Prospective shipowners have cancelled or delayed orders, while older vessels (nearing 20 years of service) are being sold for scrap. The industry is self-correcting, albeit with a time lag of between 12-36 months. Such efforts to rebalance make sense if the estimated daily operating cost (inclusive of financing) of a standard panamax vessel is $10,000/day.

Looking at panamax supply, the vessel order book should peak in 2014, according to Reuters. Considering this is a projected 1% year on year increase then we may already be nearing the end of this oversupply. The freight forward agreement (FFA) market may already be flagging this. According to Bloomberg, the prompt month panamax time charter is trading $16,100/day: a 101% rise year on year. It must be noted there is always a risk that a rebound in rates will lure back more supply.

If the freight market is finally rebalancing, then what will its effect be on seasonal grain flows?

Grain seasonality on the panamax curve

Panamax vessels are not solely used for grain but, instead, remain the mainstay of the seaborne coal trade. While grains, feed grains and oilseeds can be shipped on smaller vessels, panamaxes dominate the main grain supply routes. Importantly, while seaborne coal sets the support for time charter rates, the grain trade has a distinct impact on the pricing of panamax rates in two ways:

  1. Highly seasonal – panamax rates move in step with the global grain harvests in the US (October to December) and South America (March to June).
  1. Ton-miles – Seaborne grain trading routes are some of the biggest contributors to ton-mile demand due to the longer distances travelled. Rising ton-mile demand ties up vessel availability for longer and can be exacerbated by any delays or congestion.

For a shipowner, the positioning of available vessels in producing regions just prior to the start of harvest can prove very rewarding. Conversely, any delays or logistical problems while waiting can prove costly.

What a difference six years makes

Much has changed since 2007. While the US remains the dominant total grain exporter, Brazil is catching up. Brazil’s larger exportable surplus of corn and soybeans means that larger volumes must be shipped over a shorter period of time. This is most evident in soybeans.

Brazil has now overtaken the US as the world’s largest soybean exporter. While recent US output has been limited disproportionately by harsher growing weather, Brazil has continues to add more and more hectares. Over the past ten years, Brazilian soybean and corn area increased by 29% and 27% respectively, according to the USDA.

A larger and larger crop every year places its own strains and demands upon Brazilian infrastructure. Given the inland bottlenecks that Brazilian farmers face when moving their crop to the main ports of Santos and Paranagua, any disruption will impact vessels that are queuing (See Agriculture Weekly, August 8 & September 25). Even then, the sheer volume of the arriving crop can overwhelm normal port operations. Weather, in particular heavy rain, can also be a disruptive influence. Further complications and disruptions will increase the cost and delay the final arrival of the customer’s cargo. With a bigger Brazilian crop to come in 2014, more problems should be expected.

While China has long accepted that it not self-sufficient in soybeans, many ask the same question of corn and wheat. Only in the past three years have Chinese grain imports started to rise from mere negligible levels.

With continued rising Chinese import demand being met by Brazilian supply, more and more grain vessels will be sailing from Southern Brazil to North Asia and back. Such a round trip journey can take 70 days. So any one panamax vessel may only have one real opportunity to ply that harvest route – as well as capturing the higher seasonal freight rates that go with it.

One significant difference between 2007 and today is the higher cost of transport fuel, or bunker fuel, that charterers must absorb. While it is not reflective in the cost of any time charter quote, it is a component of the actual journey cost per metric tonne that the charter must pay. According to Bloomberg, Singapore 380cst fuel oil is trading $594/mt today whereas back in 2006 and 2007 it averaged $306/mt and $367/mt respectively. Ships can sail at a slower speed to reduce fuel costs but such efficiencies have already been implemented. Increasing seaborne trade as well as ton-miles travelled will ensure continued support for bunker fuel prices for the foreseeable future.

Implications for risk

While we do not expect the freight market to return anywhere near the highs last seen in 2007 – we do expect a more normal market. The low freight rate environment of the past six years is coming to an end – but that does not mean freight will become prohibitively costly once again. The freight market will, instead, become much more volatile.

A rising freight market will impact first and foremost grain consumers. But a more volatile market will impact merchants who sell to either end-consumers or other merchants. Established global importers and end consumers may buy ‘free on board’ (FOB) where they organize their own freight handling. Smaller, generally private, consumers will buy on a ‘cost, insurance and freight’ (CIF) basis. The responsibility for organizing the freight is left up to the seller. Any disruption or misalignment of available ships within a particular basin during the harvest period could expose the market to extreme physical tightness where charterers must pay-up to fix cargoes to meet contracted demand.

Grain export windows are lasting longer. Larger volumes are not solely to blame. Inclement weather, delayed harvests and infrastructure bottlenecks are real risks to a timely global supply. An example of this was Brazil’s long tail of exports in 2012/13. We expect a repeat in 2013/14 as there is no simple and quick solution to Brazil’s unique problem, or its ‘long tail’.

Over the medium term, increasing grain supply may pressurize agricultural prices. Such a structural change combined with a volatile freight market may erode the merchant’s margin if the freight component of the landed price (CIF) rises.

A more balanced freight market should impact the structure of the panamax FFA curve. Overall, expect the grain seasonality along the forward panamax curve (Q2 and Q4) to become more pronounced. Though, delays or ‘long tails’ could see these quarter on quarter premiums/discounts erode considerably as hedging activity rolls into the next quarter.

Rising freight rates do signal the market is rebalancing. But a market that rises too far, too fast will incur less cancellations and less ship scrapping. Higher shipping rates will also boost the asset prices of second hand ships, which in turn could spur a fresh round of orders for new vessels.

Lastly, it is the seaborne trade in coal that supports panamax rates all year round. Any decline in seaborne volumes or ton-miles traveled for coal will weigh on panamax rates. For example, a decline in US long haul coal exports or rising Indonesian coal exports that travel a shorter distance to China will act as a drag on ton-mile demand.

A more balanced freight market grants itself more influence in commodity markets that are either rising or falling. Merchants and importers must extricate themselves from any false sense of security the last seven years has brought. In short, freight must not be taken for granted anymore.

yGV8

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Posted by on October 11, 2013 in Investments

 

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