The Bubble You May Not Have Heard Pop

Many things have recovered since the Great Recession's lows of 2009: The S&P 500 (SNPINDEX: ^GSPC  ) passed its record high of 1565 earlier this year, the unemployment rate sits at 7.6% after slowly having floated down from its recessionary high of 10%, and even the housing market in Phoenix posted a 22% gain year over year.

But one industry continues to languish according to its own index: dry shipping. This industry just can't find its footing in the new post-recession world, with its Baltic Dry Index sitting at just a tenth of its boom-time high.

Just what is the Baltic Dry Index? Does its fall mean investors have a chance to grab a piece of a future recovery for cheap? To find out, let's look at why it bubbled up in the first place.

Built in 2012, the Los Angeles is owned by Diana Shipping. Photo courtesy of Diana Shipping.

Seasick
The Baltic Dry Index measures the average price to ship raw materials around the world by sea. From 2005 to 2008, the index jumped from under 2,000 to over 11,000. And now, it sits at just 1,150:

Source: Capital Link

How can such an integral part of the global supply chain be so erratic? There are a few reasons. One, fuel makes up roughly 40% of operating costs, so when oil prices spiked in 2007, both the cost of shipping and the index jumped.

Two, commodity demand can affect the index, as a greater volume takes more ship capacity. Conversely, less demand means ships might look for capacity, and even help pay to ship commodities instead of running empty. Bloomberg quotes one shipper who paid $2,000 a day to cover part of a shipment's fuel: "Our other option was to stay in the Pacific and earn poor revenues or ballast to the Atlantic and pay the fuel ourselves."

And three, the index can be so erratic because supply in the dry shipping industry is relatively inelastic. This means that it takes a few years to build new ships, and if shipping demand increases or decreases, prices to ship goods will increase or decrease rapidly as well.

For example, when prices were high and companies, such as Diana Shipping  (NYSE: DSX  ) and DryShips (NASDAQ: DRYS  ) , ordered more ships, these ships were finally completed a few years later when shipping prices had already cratered. Now, Diana's fleet is on average only 6.4 years old, while DryShips' fleet is on average 7.4 years old, when the typical life of a ship is 25 years. While these young fleets might be good as an investment in the future if global trade picks up, today's troubled eurozone and slowing China will leave these newer ships wanting for higher demand.

Red sky at night, sailor's delight, red sky at dawn...
The questions that any investor in dry shipping must ask is whether trade will pick back up ahead of expectations if shipping capacity won't overrun future trade demand, and if these companies can survive in the near term. Unfortunately, the current data shows that shipping capacity is still growing at a little above 6%, while the World Trade Organization predicts global trade will only grow about 3.3% in 2013.

Even five years removed from the Baltic Dry Index's crash, bankruptcy risk is alive and well in 2013. Excel Maritime Carriers, once worth over a billion dollars, filed for bankruptcy just in the past month. Profits are hard to grab industrywide: DryShips losing $116 million this past quarter and Diana losing $3.2 million.

Remember there is no physics in the stock market. Just because the Baltic Dry Index once topped 11,000 doesn't mean it will ever return. But also know that once a dry shipper proves that it will be able to survive through one of the worst periods in industry history, its stock will be in high demand.

You may be wary of these listing shipping companies, even though you believe in a strong global resurgence. Take a look at a recent Motley Fool report, "3 Strong Buys for a Global Economic Recovery," which outlines three companies that could take off when the global economy gains steam. Click here to read the full report!


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  • Report this Comment On July 17, 2013, at 10:19 AM, PEStudent wrote:

    "One, fuel makes up roughly 40% of operating costs, so when oil prices spiked in 2007, both the cost of shipping and the index jumped."

    This doesn't explain why the price of oil is higher than the 2007 price, yet the index is 10% of what it was in 2007.

    And both oil and demand are much higher than in 2009 yet the index is 1/2 to 1/3 as much now.

    Am I missing something?

  • Report this Comment On July 17, 2013, at 12:54 PM, TMFHelloNewman wrote:

    @PEStudent

    As I understand it, it's a complex relationship: these companies want to run near 100% utilization of their fleets no matter the cost of fuel. If shipping demand is high, then they can pass more of these fuel costs on even when they're high and the index increases. If demand is low, the companies have to stomach more of these fuel costs themselves (like the case of paying $2,000 worth of fuel a day above), but the index stays low.

    Does that make sense?

  • Report this Comment On July 17, 2013, at 6:25 PM, imacg5 wrote:

    The vast majority of the Dry Bulk ships that are chartered out, are on time charter, and the charterer pays the fuel bill.

    The ships that are on spot charter, which are the ones reflected in the BDI, have their fuel payed by the owner of the ship.

    Time charter rates have not been as volatile as the BDI, they had a steady slow decline, right through 2012.

    As for demand, there was a very slight drop in the seaborne transport of dry bulk products in 2009.

    By 2010, there was again record amounts of dry bulk product shipped, and the records keep falling every year since.

    Bunker fuel also regained it's 2008 high of around $600 per ton, by 2011. And is holding in that range.

    If you are hoping for a resurgence in trade to rescue the dry bulk companies, the demand is already here. And the rate of demand is slowing.

    The entire reason for the dismal charter rates is the huge growth of the fleet.

    And 2013 will once again have a net fleet growth, (minus scrapping of older ships), that surpasses the increase in the rate of demand.

    It's all about the overcapacity.

    And the owners are still ordering more ships.

  • Report this Comment On July 17, 2013, at 7:26 PM, imacg5 wrote:

    Both DSX and DRYS will survive this period. But for different reasons. DSX because of their low debt, and huge cash position. And DRYS, because they will continue to sell off it's ORIG stock in order to pay the bills.

    But, DRYS will continue to struggle when charter rates are at $12,000 per day for Panamax. While for DSX, that charter rate will be slightly profitable.

    DRYS pays a ridiculous amount of interest and financing expense. And George has so many fees he charges, so expect the losses to continue.

    DSX continues to buy ships at very low prices. And DRYS continues to pay someone to take ships off it's hands.

    DSX has all it's fleet on time charters, however, many of the lucrative charters have, and will continue to expire, so their losses will increase.

    DRYS has 18 ships on time charter, and 18 ships on spot. Most of the spot charters are on Panamax, and those rates are expected to remain dismal, as more of those ships get delivered.

    And then there is the matter of the worst CEO in shipping, George Economou of DRYS.

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