Global iron ore demand continues to escalate, and is pulling production and shipments along in its wake. DryShips (NASDAQ: DRYS ) couldn't be more excited. Navios Maritime Partners (NYSE: NMM ) is so confident that it is getting ready to raise its dividend. Even the cautious and conservative Diana Shipping (NYSE: DSX ) is singing high praises. There is something, however, that the street seems to be missing that could cause shipping demand to skyrocket still even higher than you think.
Iron ore demand in China
Hedge fund manager and shipping expert Jay Goodgal thinks they're all nuts and are ignoring a credit bubble in China that could kill the party. He reasons that most of the demand has been artificial, stoked by easy credit and easy money similar to the bubble in the United States before 2008. It can't last forever, it will burst, and demand and shipping rates will come crashing down.
The number one driver of global dry bulk rates has been iron ore shipments to China, which accounts for 70% of the current worldwide market. Believe it or not, though, most of China's consumed iron ore has actually come from domestic sources and not from imports.
According to an interview with DryShips CEO George Economou, imports of iron ore accounted for roughly one-third of the consumption of iron ore in the country. This means that the demand for specifically imported iron ore is more important than just demand for iron ore in general. DryShips points out that domestic production is more pollutive, more expensive, and even some of it is financed by the very credit that Goodgal is worried about losing.
Rising import demand
A situation could arise in which overall demand and consumption of iron ore in China will decline, yet the import demand and volumes of shipments actually would rise. As weakness in global iron ore demand causes prices to fall, expensive domestically produced iron ore in China would become unable to compete with the cheaper, better quality imported ore because the cost of mining can be prohibitively too high.
Is it starting to happen already?
According to a report by Nikos Roussanoglou of the website Hellenic Shipping News Worldwide, we may already be starting to see this shift. Last year domestic production was up 14.5%, whereas so far this year it's only up 4.5%. Meanwhile, imports are up a staggering 21%. Dryships, Navios Maritime Partners, and Diana Shipping must love it.
Contributing to this shift is a 23% drop in year-over-year spot prices for iron ore. The actual iron content in imported ore tends to be two to three times greater than domestically mined ore, adding further to its competitive advantage as prices decline. According to Roussanoglou, iron prices have been under pressure this year, which has priced several small mining firms completely out of the market. Iron ore prices are expected to continue to fall.
Foolish final thoughts
Watch not only the macroeconomic picture out of China, but specifically the import environment and iron ore prices. One thing everybody seems to agree on is that China will indeed dictate where the dry shipping market is heading for the foreseeable future. Fools invested in DryShips, Navios Maritime Partners, and Diana Shipping should absorb everything they can about iron ore and China to stay ahead of the game.
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