Securing competitive ocean freight rates has always been critical for grain traders and ship owners, because of their relative stability, but they have had little impact on producers and consumers at the two ends of the grain marketing chain.

During 2003 and early 2004 ocean freights rates for grain increased by a factor of up to four times, approaching, and exceeding where longer ocean voyages were involved, half the value of cargoes. While rates have declined from their peak levels in March, they are still well above levels of two years ago and if sustained could have an impact on longer term grain market prospects.

There are three principal classes of ocean freight - tankers used mainly for transporting crude oil, container vessels used for transporting containers of finished goods and the more general dry bulk vessels used for raw commodities. Grains and oilseeds generally compete for ocean vessels in the dry bulk market. The major dry bulk commodities are iron ore, coal, grain, fertilizer, steel and forestry products.

Of total annual dry bulk shipments, now more than 2,000 million tonnes, grain and oilseeds and their products are less than 15 percent. The dry bulk freight market is divided into a spectrum of vessels sizes. Cape size vessels, carrying cargoes of 120,000 to 140,000 tonnes, are generally chartered for regular year round shipment of such commodities as iron ore and coal, where special port facilities have been developed to handle them. Panamax vessels carrying cargoes of 60,000 to 70,000 tonnes and designed to be accommodated by most shipping facilities including the Panama Canal. Handimax vessels carry cargoes of 40,000 to 55,000 tonnes, and Handisized vessels are smaller, 25,000 to 35,000 tonnes, and can use smaller ports. And finally Coasters carrying 5,000 tonnes, which do not generally participate in longer haul business.

While the increase in demand for ocean freight has been mainly for the largest Cape sized vessels, there is a degree of substitution among all sectors. Freight rates for the various sizes, therefore, tend to move in concert in the longer term.

Grains and oilseeds are carried mainly in Panamax and Handimax vessels. Further, because of the season nature of the grain market, most grain freight rates are set on a spot market for specific voyages, rather than forward contracted or through time chartering for multi-voyage use.

Freight rates, of course, vary with the length of the voyage, but also with the availability of suitable vessels close to the port of loading and of cargoes requiring shipment close to destination. Further congestion at the ports themselves and ease of loading and unloading can materially influence ship owners' costs and rates.

Why feight rates rose

The ocean freight market is very competitive with prices determined by supply and demand conditions. There is little doubt that the 2003 run up in freight rates resulted in the main from an unanticipated and unprecedented increase in demand for shipping of Chinese imports, particularly iron ore. Seaborn trade in iron ore generally increased by more than 11 percent in 2003, with Chinese imports up 33 percent. Congestion at Chinese ports then effectively reduced the supply of shipping also contributing to the very bouyant market conditions.

The temporary closing down of nuclear power stations in Japan and France resulted in a 9 percent growth in steam coal trade. Trade in finished and partly finished steel rose by 8 percent. In aggregate the grain and oilseeds business was unchanged.

The dry bulk sector appears traditionally to run at between 80 and 90 percent capacity but this excess capacity was quickly absorbed by the market. This left shippers competing for a very limited supply of vessels, particularly in the fourth quarter of 2003 and the first quarter of 2004.

In many respects the current situation is not unlike the 1970's when Soviet centrally-planned decisions dictated the importation of record quantities of grain with little reference to market conditions. Chinese plans for economic development, expectations for their capital investment and hence their demand for steel and in turn iron ore imports have created the same kind of uncertainty. The ability of the Chinese to resolve their on land transportation problems which resulted in the port congestion also adds to uncertainty.

Outlook

Although freight rates have slipped from their peak levels in March, they have in recent weeks shown evidence of stabilizing at, and even increasing again from levels between two and three times what the industry has been accustomed to paying.

The increase in the value of ships themselves is owner confidence that enough of the increase in freight rates is likely to be sustained to cover their increased costs. In the longer term this will, of course, result in an increase in the supply ocean freight and lower freight rates.

It will discourage scrapping of older vessels and encourage investment in new ones. But this is a process that does not occur overnight. It takes three years or more to get a new vessel in service. In recent years, without an incentive to invest, the dry bulk fleet has increased by about three percent per year, with new tonnage of about five percent being offset by tonnage retired.

But shipyards around the world are already unusually busy, working on the replacement of single hull with double hull tankers amongst other things. Scrap values are unusually high reflecting demand for steel which encourages vessel replacements. Further marine fuel costs have risen by about 60 percent from levels prevailing five years ago and are currently [a major ocean freight cost]. Marine fuels are generally not taxed and changes in crude oil prices are reflected very directly in their price.

And finally without appropriate port investment any new vessel tonnage will not be effective. Ports are a challenge for vessel owners, both in terms of congestion and increasing environmental restrictions.

In the context of all this it seems probable that the ocean freight market will remain tight for some years, with rates significantly higher and more volatile than the grain industry has been used to.

Implications

Implication of an extra freight cost of $10 to $20 per tonne and more per tonne depending on length of voyage will be felt at both ends of the grain transportation chain. To date and in the short term discounting at the source has been the more evident. The industry will almost certainly attempt to minimize ocean freight seeking imports from closer to home and to use domestically produced grains.

The UK wheat market may be a case in point. The cost of imported milling wheat can be expected to increase because of added freight costs. Conversely, the value of feed wheat exported is likely to decline for the same reason.

David Walker
'phone: 01603 705153