The Baltic Dry Index, 1985-2020

The Baltic Dry Index, 1985-2020

Source: Bloomberg; BDIY:IND. Value as of the last business day of the month.

The Baltic Dry Index (BDI) is an assessment of the average price to ship raw materials (such as coal, iron ore, cement, and grains) on a number of shipping routes (about 50) and by ship size. Thus, it is an indicator of the cost paid to ship raw materials on global markets and an important component of input costs. The index is considered a leading indicator (forward-looking) of economic activity since it involves events taking place at the earlier stages of global commodity chains (the procurement and transformation of raw materials). A high BDI index indicates a tight shipping supply due to high demand and is likely to create inflationary pressures along the supply chain. A sudden and sharp decline of the BDI is likely to foretell a recession since producers have substantially curtailed their demand leaving shippers to substantially reduce their rates in an attempt to attract cargo. Like all market indexes, the BDI is constantly changing, reflecting its price discovery mechanism. The major factors impacting the BDI are:

  • Commodity Demand. This is mainly a volume impact that could be irrespective of commodity prices. An increase in the demand, particularly if sudden, will likely result in a surge in shipping rates since additional capacity takes time to be brought online (either as new ships or reassignment of existing ones). If expectations about future demand change and producers reduce their raw materials demand accordingly, then the BDI will drop.
  • Ship Supply. Represents the availability of ships in terms of their capacity and their function. Many bulk carriers, such as tankers, cannot be readily converted to other uses, so the bulk market is quite segmented and fairly inflexible. The average ship age can also play since the useful life of a ship is about 25 years. If the average age becomes too high, there are expectations that significant capacity may be reduced and that this would imply a rise of the BDI. Inversely, the addition of new capacity in terms of ship orders may trigger a decline of the BDI, particularly if demand is not expected to change significantly in light of this new supply.
  • Seasonality. The demand for raw materials, such as grain and coal, has a significant seasonality, which will create fluctuations in the BDI when transporting these commodities is in high or low demand.
  • Bunker Oil Prices. Bunker fuel accounts for about 40% of vessel operating costs with limited opportunities to mitigate them. Thus, a surge in oil prices is directly reflected in shipping rates. The opposite also holds as if energy prices drop, the BDI can also drop accordingly.
  • Port Congestion and Canal Capacity. Some ports, particularly in the context of seasonality, can become congested and can tie up ships for longer periods than usual. This results in higher shipping rates as port supply is reconciled with shipping demand. Additionally, the Panama and Suez canals, important bottlenecks in global freight circulation, have a fixed capacity and can impose additional delays.
  • Geopolitics. Depending on the geopolitical context, there may be a risk of calling some locations, which is reflected in insurance rates and, consequently, shipping rates. Some chokepoints, such as the straits of Hormuz, Aden, and Malacca, may involve the risks of political instability and piracy, and capacity constraints to maritime circulation.

The above graph underlines that the BDI has been very volatile in recent years, particularly between 2005 and 2009 when it behaved as a bubble. The main driver of this surge was linked to commodity prices, particularly oil. The index then plummeted back to historical levels and remained weak despite a recovery in global trade. A factor is that many ships were ordered during the “bubble years” and have entered the market, providing capacity growth above demand growth. In recent years the BDI remains low, underlining a situation of excess capacity in the shipping industry.