Before the Memorial day weekend, the dry market participants were not particularly upbeatabout the recent rise in the Capesize...

In the physical Bocimar, the dry bulk arm of Compagnie Maritime Belge (CMB) has been "capsized bytheir Capesizes", reporting a near ten-fold increase in Q1 losses.[1]

Jean-Paul Dezutter is drybulk shipbroker at Aegir , Botra & Partners in Belgium, an active broker,market participant and member of The Baltic Exchange.

Dezutter who also confirmed be an attendee at the Lugano Commodity & Shipping Forum (8th – 9thJune, 2015) said the recent activity in the Capesize FFA rather portrays a certain sentiment, "which isnot always factual". So if this increase is hinged on a couple of major orders the question remains onhow representative this indication of Q4 2016 is of the physical market ?

A flagship consultancy in New York observes that the daily break-even (finance cost-plus operatingtechnical costs) on a "modern" Capesize will be somewhere around $15K to $18K, depending on howattractively it was purchased. Barry Parker, head of BDP1, also concedes that Capesize brokers areaccurately describing the recent rise.

The market sentiment is unequivocally skeptical. Both brokers and market watchers think that the risewill be short-lived, it might be a good idea to get a closer look into this curve... (particularly inside theend-part of the curve).

What's in the Cape "Expectations" Market ?

The FFA market might only be one side of the market, yes it is true, but this trade is not crowded bysmall traders. Regular Big hands are Trading cos such Vitol but also Banks such Morgan StanleyGroup, Macquarie.

First, Banks maintain economic growth models, policy outlooks for countries and industries.

Like much of the demand outlook for Aluminium will depend on upon government spending in areassuch as infrastructure and the electrical grid, the Chinese demand for steel and iron ore depends ongovernment infrastructure programs.

Because Capesize were purposely geared for the Brazil and South Africa to East trade and to satisfyChina’s prodigious requirements for iron ore, Capes are hugely relevant for a macro research desks:they serve both as inputs and proxies for China's economic machine.

credit: BHP Billiton

Secondly, Banks are lenders to shipping, commodities and industrial projects. They might not own acrystal ball yet but their daily role as lenders and deal brokers give them a privileged access now topotentialities in the forward curve later.

Recent volume in the Cape FFA seems more concentrated in Q4, 2016... where banks can also usually(through their intermediation between end-users & owners) get a different picture of the market.

For a FORWARD FREIGHT AGREEMENT ( FFAs) (the freight swap), the contractsettlement is independent of any physical deliveries, that's a noteworthy differencecompared to other commodity derivatives markets.

Q4 and so forth are now very active. When rates were high hedgers (owners) would be active in thispart of the curve to lock rates (it is obviously not the case, rates are very low).

I theorize that in these conditions, the hands in this part of the curve are Banks and Managed Money(closing their shorts and initiating longs) while Charterers, end-users (short freight), can also hedgetheir position by taking a long Q4 or CAL 16 until they charter physical vessels.

The Demolition Factor

Could it be a bottoming factor for Capesize that big hands are having in their head ? The number of scrapped unit is inversely related to freight rates. see [2]

BIMCO, a shipowner minded association, said May 7 that 2015 could soon become arecord year for scrapping dry Capesize vessels. With 52 sold for demolition in its first fourmonths, 2015 is getting close to breaking the record of 70 Capesizes demolished in 2012.[3]

A Fudge Factor

The tanker community seems particularly concerned about the potential capesize tanker conversionSwitch given the recent strength in their sector.

In one of its very insightful tanker opinion, Poten & Partners, the world leading tanker brokerage firm,has put the candidates list for a conversion at 50 units.

[slideshare id=48235068&doc=tankeropinion20150123-150516234854-lva1-app6892&type=d]

This could be another bottoming factor for Capes that big hands are seeing in the curve, butunfortunately my recent research has determined that the conversion option of a Cape to a Suezmax orLR2 Tanker strictly based on a transactional approach* is not-in-the-money.

Suezmax, the Lazarus of the shipping market !

Broker Gibsons has noted the near disappearance of TD5, key Suezmax trade from West Africa to theUS. (due to unfavorable Brent/WTI Spread Economics for USAC Refiners).

For this reason, Suezmax supply has remained largely flat last year, with the average fleet size

expanding by just 2 units according to the estimate of the London broker[4]

Recently, firmer Suezmax earnings were aided by rising WAF to Europe crude trade (currentlybuoyed by very odd above the 5 yr average seasonal NWE Distillation Crack-Margins at around$15/bbl).**

Still with the current economics, a Capesize Owner can achieve $5-6/MT on a Tubarao-ARA spotvoyage while in the Suezmax, TD20 Bonny-Rotterdam is traded at $22.53/MT, that's 4 times moreearnings which is in line with Fig 1 in Poten's Tanker note.

Although Cape owners are not able to achieve this Dry-to-Wet spot earnings conversion potential in thephysical market, it will give serious food for thought for FFA Traders given that NWE refiners (theend-users of Suezmaxes) with their low-complexity are the 1st at Risk on the list in the verycompetitive world of refining.

Notes

* not operating the tanker but locking it under the term T/C or selling it)

** The crack margin also influences prices that you pay to get a bunker delivery at this hub which in turn will affect a component of the spot earnings for the owner/time-charterer.

[1] Bocimar results deteriorate - TradeWinds, paid subscription.

[2] Niton’s Scrap Fund, Hot Pancakes Amidst Irrational Exuberance, http://wp.me/p3k7lL-2Lx

[3] Analysis: Ship launches still outpace scrapping, Platts

[4] A vote of confidence for suezmaxes, Gibsons, 8th May 2015.

Commodity Merchant Trading and Shipping Advisory Services

The author is an Economist and a Commodity Transportation Specialist. He consults full-time with hedge, traffic and logistics desks in commodity trading and end-user firms.

© 2015 Navigating the commodity markets with Freight and Spreads