The longer-term trend of declining rates stems almost certainly from the increased capacity of the dry bulk fleet - the supply of ocean freight. Before 2003, the net-growth in the dry bulk fleet was always less than 5% per year and some years barely positive. Since 2003, it has been more than 5% and is probably now about 7%. This increase was achieved by a very immediate cut back in scrapping old vessels and a more gradual increase in new vessels. There was a slight delay owing to the time it takes to build vessels (Graph 2).

While 7% growth appears ambitious, considering the capacity of the dry bulk before the expansion, it is probably justified. However, it is less certain whether the investment will pay in terms of additional capacity, profitable operating returns and higher vessel values. As noted above, freight rates have declined, albeit erratically, for more than two years. Second-hand values of vessels, which doubled between 2003 and 2005, have also more recently eased being below replacement costs for much of 2006.

Two further elements that may yet play a critical role in investment decisions, or more accurately in disinvestment decisions, to scrap vessels are operating costs and scrap values. The most noticeable is perhaps the increase in the cost of the heavy fuel oils, called bunkers, used to power ocean vessels. While bunkers are the least expensive among the fuels, bunker prices have risen with the general increase in petroleum products. Although bunker prices have been increasing for several years, they did not appear to be a major cause in the very dramatic increase in ocean freight rates in 2003 and 2004. Bunker prices at that time appeared to be no higher than they were 15 to 20 years earlier.

Since 2004, ocean freight rates have been falling, but bunker costs have been rising. They are now about twice what they were in spring 2004 when ocean freight rates were at their peak. The Cockett Bunker Price Index has risen by about a third in the last 12 months. While ocean freight rates are set in the context of supply and demand for cargoes or shipping in specific situations, operating cost undoubtedly are parts of the consideration when deciding whether to scrap ageing vessels. The other element, of course, is the value of the vessel as scrap.

The growth in the dry bulk fleet is a function of both reduced scrapping and increased building, with the former occurring before the latter when the rate of expansion began to accelerate. As such, increased scrapping will lead to reduced building when the rate of growth begins to slow. R.S. Platou Economic Research information indicates 2.4Mt were scrapped in the 12 months before July 2006 but only 0.8M and 1.2Mt in calendar years 2004 and 2005 respectively.

While these losses from the fleet are dwarfed by new tonnage currently running at about 25Mt on an annual basis, it may be indicative of increased caution over investment. In all likelihood when the growth in the dry bulk vessel fleet returns to more sustainable levels in the context of probable long-term growth in cargoes, the longer-term downward trend in rates will level off. But the downward trend almost certainly has a year or two to go, as additional tonnage already on the books makes its way into the working fleet.

The expectation must be that ocean freight rates for grain will be higher and more volatile than they were prior to 2003. But they are likely to be lower and more stable than they have been over the last 30 months.

David Walker 001 780 434 7615