Rogue waves come out of nowhere, and have been known to swallow massive ships in the blink of an eye. For mariners and investors alike, it pays to keep a vigilant watch even when conditions appear favorable.

In the wake of a perfect storm, that vigilance must intensify further; and the recent bear-market rally among the dry bulk shippers provides the ultimate cautionary tale. Understandably eager to climb aboard the first available life raft within a sea of uncertainty, buying interest returned to the shipping sector in December when a sudden reversal in the Baltic Dry Index (BDI) set the blogosphere ablaze with bullish sentiment.

Now that a series of dramatic developments have bashed the group like a rogue wave, and fourth-quarter results are beginning to emerge, let's step back and take a comprehensive look at the sector.

Credit running dry
Placing an exclamation mark after the company's epic deterioration from last year's glory, DryShips (NASDAQ:DRYS) doused investors last month by slashing its dividend and later revealing that the company had breached debt covenants. I believe that contravention of debt covenants presents a wholly unacceptable level of risk for Fools in this environment, so I held no punches in cautioning Fools to leave this one alone. Hopefully, Fools heeded my caution, since a momentary recovery after two lenders renegotiated debt terms lasted only a matter of days.

How rogue waves are formed
South Korean shipper Samsun Logix has run aground, filing for court receivership and splashing some competitors in the process. With close ties to struggling steelmaker POSCO (NYSE:PKX), Samsun Logix provides a timely reminder that a global downturn of this magnitude will not reverse as easily as the sudden spike in the BDI might have suggested. Consequences will continue to reveal themselves, and Fools are encouraged to proceed cautiously with their precious investment capital.

This development has far-reaching implications for the industry. The failure was precipitated by the cancellation of charter contracts by shippers that themselves became insolvent. Like an airborne virus, the malaise travels through Samsun Logix to the publicly traded shippers. As an integrated ship owner and operator, Samsun Logix inked charter contracts with vessel owners like DryShips and Navios Maritime (NYSE:NM) to maintain a more elastic fleet. DryShips was in the process of selling a vessel to Samsun Logix, while Genco Shipping & Trading (NYSE:GNK) had only one vessel chartered to Samsun Logix.

Mounting bankruptcies within the sector give charter clients additional bargaining power when it comes to renegotiating long-term charter contracts … many of which were priced at rates substantially higher than present charter rates.

First to report a rogue wave
The ability to rely upon contracts as binding instruments is central to the normal functioning of global commerce, so the news that two charter clients of Excel Maritime Carriers (NYSE:EXM) suddenly decided to pay only half the contracted rate caught the industry off guard. Excel Maritime promptly halted its dividend, citing a $107 million hit, and warned that the company "cannot assure that charterers will continue to pay hire at agreed rates, reduced rates, or at all." 

That chilling statement, I believe, speaks to a systemic threat affecting all dry bulk shippers. Because legal means of enforcing contracts are costly and time consuming, cash-strapped commodity players around the world may feel emboldened by this development to force shippers back to the negotiating table for major reductions in charter rates.

With substantial debt-related concerns, a looming writedown, and the resignation of the CEO announced Monday, Excel Maritime leaps to second place behind DryShips on this Fool's list of scariest shipping stocks. Frankly, however, the news places the entire sector within a cloud of risk and uncertainty.

Is anyone still making money?
Both Navios Maritime and Diana Shipping (NYSE:DSX) carried earnings into port late last week. Navios lost $5.6 million on an array of charges and a 30% reduction in revenue from the prior year. While I am decidedly less bullish on the company than I was in November, Navios still appears better-positioned than several competitors.

Diana Shipping recorded income of $54.2 million with a 43% increase in revenues, and solidified its position -- in my view -- as the best competitor in the sector. With high-profile clients like BHP Billiton (NYSE:BHP), a 25% increase in average charter rates, and one of the cleanest balance sheet in the sector, Diana appears best-equipped to absorb the impact of any further rogue waves. Although poised to pounce upon opportunities as they arise, Diana remains uninterested in its publicly held competitors. If Diana has no interest in the other dry bulk shippers, then perhaps Fools would do well to leave them alone as well. I expect Diana Shipping to survive, and that's about all I can say with any conviction at the moment.

Further Foolishness:

The "dry bulk shipping" tag within Motley Fool CAPS lists 16 companies. Join our online community today and share your views on the offerings in this sector, or any other. CAPS is free and fun!

Fool contributor Christopher Barker captains yachts and writes about stocks. He can be found blogging actively and acting Foolishly within the CAPS community under the username TMFSinchiruna. He owns shares of BHP Billiton and Diana Shipping. POSCO is a Motley Fool Income Investor pick. The Motley Fool's disclosure policy is designed to roll 360 degrees if impacted by a rogue wave.