Shipping Prices Sink as Mining Companies Rack Up Record Profits

As big mining companies are set to book record profits the shipping companies that deliver the precious raw materials are plagued with the lowest freight rates since 2002.

Average leasing costs for capesizes, the 1,000-foot-long ships hauling iron ore and coal, will drop 34% to $22,000 a day this year, according to a Bloomberg News survey of eight fund managers and analysts.

When prices last plummeted that low, China's economy, the biggest consumer of the minerals used in steel and power, was 75% smaller and the benchmark Standard & Poor's GSCI commodity index stood 67% lower, Bloomberg reported.

This time, the problem isn't a potential economic meltdown, which caused shipping prices to tank in 2008-2009, but a glut of new capacity coming to the world's shipping lanes.

About 200 capesizes, spanning some 35 miles end-to-end, will leave shipyards this year, expanding the fleet by 18%, the Bloomberg survey showed.

"The market was able to take a punch in the face in the form of 200 capesizes and loads of smaller vessels last year but I doubt it will manage another punch without having to hit the deck," Erik Nikolai Stavseth, an analyst at Arctic Securities ASA in Oslo who correctly forecast in July that rental costs would more than triple by the fourth quarter told Bloomberg.

Rates jumped 33% in fourth quarter of 2010, reaching an average of $34,913 a day. But rates have dropped precipitously in the New Year, plunging 7.7% yesterday (Monday) to $11,900 - the lowest rate since Jan. 8, 2009.

Record numbers of new ships are sailing from yards in China, Japan, the Philippines and South Korea, according to data from the London-based Baltic Exchange, which publishes assessments for more than 50 shipping routes.

About 90% of global trade moves by sea, according to the Round Table of International Shipping Associations. And the cost of shipping goods tends to be more volatile than stocks and bonds, with rates gyrating by more than 10% or more in 32 weeks last year, according to data compiled by Bloomberg.

Bearer of Bad News

Shipping prices are established every working day in the form of the Baltic Dry Index (BDI).

Because BDI provides "an assessment of the price of moving the major raw materials by sea... it provides both a rare window into the highly opaque and diffuse shipping market and an accurate barometer of the volume of global trade -- devoid of political and other agenda concerns," according to the Exchange.

The BDI flashed serious warning signals ahead of the 2008 financial crisis, according to Money Morning Contributing Writer Jack Barnes.

The index dropped by more than 90% in six months beginning in May 2008 - a time when global investors still expected economic growth to continue.

"Had you been watching - and heeded its warning - this index would have saved you from the fallout of the biggest financial crisis since the Great Depression," Barnes wrote in a column in July of last year.

But this time the slump in rates is being caused by a vessel surplus, not a contracting world economy.

The current surplus of shipping capacity was caused by orders placed in 2007 and 2008, when daily prices averaged about $111,000. Rates touched a record $233,988 before plunging over 99% during the last six months of 2008 to $2,316 as economies shrank during the first global recession since World War II. Rates roared back more than four-fold in 2009, as the economic recovery took hold.

The wild swings in shipping prices are mainly due to the generally tight supply of cargo ships. It takes two years to build a new ship, and ships are too expensive to take out of circulation the way big airlines park unneeded jets in the deserts of California and Arizona.

That means small increases in demand and small fleet changes can push the prices up quickly, and marginal demand decreases and arcane logistical matters can cause the prices to fall rapidly.

The slump in prices plaguing the shipping lines comes even as the suppliers of the iron ore and coal tap into surging demand to post record profits.

Vale SA (NYSE ADR: VALE), Rio Tinto Group PLC (NYSE ADR: RIO) and BHP Billiton Ltd. (NYSE: BHP) the world's three largest mine operators, will report the highest profits ever this year, according to the median of analyst estimates compiled by Bloomberg.

A Bloomberg survey of more than 100 analysts, traders, and investors last month projected every one of 15 basic raw materials is expected to advance this year. A S&P gauge of 24 prices for commodities rose 20% in 2010, after jumping 50% in 2009.

However, the 200 or so new capesizes joining the existing fleet of about 1,100 vessels will have trouble garnering enough orders to justify higher rates.

"The big problem for 2011 is continued deliveries of new ships," Scott Burk, an analyst at Oppenheimer & Co. in New York told Bloomberg. "It puts a damper on any upside that would occur through an increase in demand."

But even at the low current rates, ship owners should be able to make money, with average daily expenses last year of about $15,000 for costs including crew and depreciation, Clarkson estimates. While the figure doesn't include debt payments, borrowing costs have dropped since the U.S. Federal Reserve cut its benchmark interest rate to near zero in December 2008.

Furthermore, some companies have insulated their fortunes against volatile shipping rates by signing long-term contracts with suppliers. As recently as two months ago, ship owners were signing one-year charters at $33,000 a day, more than double today's spot rate, according to data from Clarkson.

Athens-based Diana Shipping Inc. (NYSE: DSX) and Navios Maritime Holdings Inc. (NYSE: NM) have vessels on longer-term contracts, leaving them less-exposed to spot rates, Natasha Boyden, a shipping analyst at Cantor Fitzgerald LP in New York told Bloomberg.

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