Today, we are bringing you an overview of the development in the shipping industry, and answering a fundamental question: are the dynamics we are seeing in the industry an indicator of a coming recession, the true beginning of deglobalization, something else entirely, or a combination of it all?
For the last couple of months, the shipping industry has been on a downward trajectory. There is a myriad of reasons for this, but the main ones can be attributed to the gradual stabilization of the supply chains in the world, driven by the decrease in most commodity prices, the reduction in demand due to the macroeconomic conditions, the complete reopening of the world’s economy after COVID-19 (with the main contribution in the last few months coming from China after the end of its zero COVID-19 policy). In today’s blog, we’ll focus on the dry bulk shipping industry only, as this industry can be used as a direct indicator of future economic activity and is less influenced by the supply/demand fluctuations present in for example, the tanker industry. The reason why this industry is a good indicator of future economic activity is that these ships are used to transport vast quantities of dry bulk cargo, such as coal, fertilizer, various metals, and food commodities. As such, they are only used when there is actual demand for these commodities, as is the case of industrial production, which again, is highly correlated to future economic growth. If you would like to read a more comprehensive overview of the shipping industry including the tanker industry, click here.
With that out of the way, we can focus on the fundamental question in this blog – what is going on with the shipping indices, and what could this be an indication of? Starting off with the Baltic Dry Index (BDI), an index that tracks daily shipping costs of dry bulk carriers, we can see that it has declined significantly in the recent period.
Baltic Dry Index (2019 – 2023 YTD, points)
Source: Bloomberg, InterCapital Research
As we can see in the graph above, this decline has been significant. In fact, the index by itself has been on a declining trend since the beginning of 2022, with several periods of growth. Recently, however, it declined to its lowest point since the beginning of March 2020. In fact, it currently stands at 538 points, a reduction of 75% compared to the average since March 2020, a reduction of 72% compared to its average in 2022, and an 82% reduction in comparison to its average in 2021. Furthermore, compared to the peak in October 2021 of 5,650 points, this represents a decline of 90%. Having all of this in mind, what could be driving this decline? To better understand this, it’s worthwhile to look at the commodities that are most transported by these ships, that being coal, iron ore, fertilizer, as well as food commodities such as corn, wheat, and soybean.
Select dry bulk commodities price change (December 2020 – 2023 YTD, %)
Source: Bloomberg, InterCapital Research
Since the beginning of December 2020, the BDI itself declined by 56.4%. The commodities which are most transported by the ships that this index tracks, however, are telling us a quite varying story. For example, the price of fertilizer has gone up by 217% in the same period. This makes sense considering the increased demand for fertilizer after the reopening of the economies following the end of the pandemic. Furthermore, the war in Ukraine caused constraints both in the supply of fertilizer, as Russia is one of the largest exports in the world, but also in terms of food commodities such as wheat, which was also under the negative influence of the war. In fact, during this period, prices of coal and wheat have gone up by 105.4% and 27.9%, respectively. Both of these commodities are still experiencing high demand even in 2023, especially in the developing world (in terms of wheat) and coal (in terms of a strong resurgence in demand from China, but also European economies due to the lower supply of other energy commodities from Russia). On the other hand, one of the main commodities needed for the construction, and manufacturing of many products, iron ore, experienced a decline of 16.9% since December 2020. However, none of these numbers nor the differences they record are surprising, if we take into account the size of the world’s economy and just the sheer volume of trade that transpires in it.
The next data point that’s worth looking at is the so-called Freightos Baltic Index, an index that measures the real-time costs of global container freight rates, of the standard 40-foot (12.2m) containers, on 12 global shipping lanes.
Freightos Baltic Index price change (2019 – 2023 YTD, USD)
Source: Bloomberg, InterCapital Research
The index experienced strong growth from the end of 2020 until 2022, with a single container costing as much as USD 11.1k per unit, before a drop to app. USD 2k today, a decline of 82%. It should be noted that looking at the longer-term trend, the decline experienced by the index, even though it seems large, is more of a return to normality than anything else, at least when compared to the levels the index was at before 2020. So having all of this data in mind, we can try answering the question – is this a return to normalcy, a sign of an impending recession, a sign of deglobalization, or a combination of it all?
The reduction in the BDI index, as well as the Freigthos Baltic Index, can be linked to the normalization of trade across the world. As the world came out of the pandemic, there were a lot of supply constraints in 2021, and some of them continued in 2022. The main issue with this was the fact that China, a large export/import market, was closed for most of this period due to its pandemic policy. As such, the demand for shipping from that side of the globe was reduced, while supply chains that are also strongly tied to China were affected by the lockdown, irrespective of demand from China itself.
However, it cannot all be attributed to normalization. Even though the prices of commodities can be tied to supply/demand across the world, one also has to take into account the massive impact of the war in Ukraine. The direct impact in terms of the supply of certain commodities, such as energy, food, metals, and fertilizer), but also the indirect impact. In this case, the indirect impact demonstrated to the entire world, a very important point – the importance of stable and diverse commodity sources. Europe paid a high price in 2022, and will surely pay one in 2023, due to its dependence on Russia for oil, and especially gas. After the beginning of the war and its subsequent development, the EU as a whole attempted to find as many different sources of commodities it depended on Russia for as possible. Furthermore, the sanctions demonstrated what can happen when commodities outside of a country’s control, commodities which they require to function, are suddenly not available or are available at exorbitant prices. The effect of the sanctions on the foreign reserves of Russia (over EUR 300bn), is also demonstrating to many countries that their foreign currency reserves (mostly held in dollars, followed by euros, pounds, etc.) can be frozen at any time if any of these countries decide to follow a path which will justify the freezing of such assets by other countries. Both of these factors can pose a significant security risk to countries, especially developing countries which often do not have many options on their path of growth.
All of this leads to the aforementioned deglobalization, a term which you could read more and more about in the news lately. What this refers to is the importance of security, diversity of supply, and proximity of supply/production to countries, as opposed to a global system in which every country specializes in the things it is most productive in. Of course, as globalization was a process that basically started after the end of WW2, and needed decades to grow, the beginning of deglobalization will not mean that global trade will suddenly end, it just means that there will be a larger focus on regional groups of countries working more closely together. This will mean that countries with similar cultures, ideologies, political and economic systems, shared histories, and alliances, will work more closely together in the regions there are all present. In such a world, the more correct term for deglobalization would be “regionalization”. If such a development happens, that’s exactly what could be on the horizon – several strong regional blocks of countries with a lot of cooperation, trade, and everything in between. As the situation currently stands, the most prominent of these regional blocks would be North America led by the US, and European Union by itself but also in cooperation with North America, making an even larger block, and South and East Asia centered around China, Japan, South Korea, India, among many others. As such, the decline in the shipping indices can be attributed partially to this trend. More regional focus on trade, even though it reduces efficiency and increases costs of production, also reduces the cost of transport, as either smaller vessels are required, or larger vessels are used for shorter periods of time, thus increasing their availability, and reducing the costs. We have already seen some signs of this. For example, companies leaving Russia after the invasion of Ukraine, companies (especially US companies) realigning their supply chains to be less dependent on China, and choosing to invest more in the US, Mexico, or any other country with a similarly skilled workforce, but friendlier governments in Southeast Asia.
And even though this entire process might be painful for the developed world due to higher costs and reduced efficiency, the largest fallout will be felt by the developing world. The reason why is that even though the developed world benefitted greatly from globalization, one could say that the developing world benefitted even more. One only has to look at China, Japan, South Korea, or a myriad of other examples of countries that experienced strong growth exactly due to increased trade that was facilitated by globalization.
The last argument that could be made as the reason for the decline is the expectation of a recession in the near future. We have already seen several European economies, and the US having either slow growth or even negative growth (albeit only slightly negative) in 2022. Through the aforementioned decline in the indices then, we can say that there is going to be a decline in economic activity as well. Furthermore, as these indices track both dry bulk cargo transportation and container prices, we can say that both the demand for commodities, but also for manufactured goods (which are usually transported by containers) has declined significantly thus far. Of course, the shipping indices are only one part of the story. There are many other indicators, such as industrial production and industrial producer prices, consumer prices, unemployment, exports, and imports, that have to be taken into account, on individual country levels but also in terms of how the specific countries are performing in comparison to other countries.
So having all of this in mind, what can be said about the current decline? In my opinion, the decline in the shipping rates is under the influence of many factors, many more than described in this blog. However, the few mentioned factors really do have an influence on the shipping industry, and as such, it could be said that all of these things are happening at once – trade between countries is normalizing, trade is becoming more regionalized and diversified, and countries and companies are bracing for a possible recession. How can all of this be possible? It can be, as we are describing the entire world with all of its intricacies. This would mean that at the same time, some countries are dealing very well with the current situation, increasing their trade, other countries are on the brink of an economic collapse, while yet others are doing their best to diversify and improve the resilience of their supply chains. As such, it could be said that we are living in thought-provoking times indeed, and it will be interesting to see how the situation will develop.