One of the main characteristics of the shipping market is the dynamic changes in trade flows which over time also lead to changes in shipping patterns and relative pricing among different routes. Lately, an interesting pattern has emerged which is having a profound impact on the Capesize freight market. Year to date, the Australia to China freight rates have outperformed the Brazil-China freight rates and now the spread stands at its widest level in many years. In fact, with the exception of a rather brief period earlier in the year, the benchmark Capesize Australia to China freight spot rate has consistently been above that of Brazil-China. Historically, the relative pricing of these two important routes for Capesizes tend to fluctuate but differences over time have been negligible most of the time. So far in 2021, there is a clear trend which could provide some important clues about the near term direction of average Capesize freight rates.
USD differential in freight rate, Brazil-China spot rate minus Australia-China spot rate
Now, a few months does not constitute a trend, but one can easily see how the Pacific market has again and again led any meaningful positive change in Capesize spot rates in the last several months. In fact, as most shipping analysts’ attention (including ours) is focused on Brazilian iron ore exports and the potential impact on the Capesize market, it is the relatively “sleepy” C5 route (C5 refers to the Australia to China route) that has been the most volatile and unexpectedly strong in terms of absolute rate moves. More importantly, such volatility is also coming in an environment of relatively stable oil prices, despite the fact that the C5 route has historically been influenced the most by changing oil prices.
Naturally, to explain such a trend, the mind of most dry bulk observers will go to stronger cargo flows. However, data does not clearly support that. Year-to-date, Australian iron ore exports have been relatively flat compared to last year, albeit with the expected month to month fluctuations.
Australia monthly iron ore exports
Additionally, given the Chinese ban on Australian coal imports and the related decline in trade activity from Australia to China, one would expect more Capesize tonnage open and available to chase iron ore cargoes and thus an overall weaker Capesize Pacific spot market, all else being equal. However, this is not the case. The key Capesize Australia to China route remains this year’s top performer, despite all the above headwinds.
So, what is then the driver behind such relative outperformance?
As always, the answers are not as straightforward as one would expect. To begin, there are significant inefficiencies and delays caused by increased crew inspections relating to COVID-19. Although the calculations for a standard Capesize roundtrip from West Australia to China call for roughly 35 days, in reality such a trip now might take longer, thus the earnings are divided by a longer period of time and the headline time-charter rate is not representative of the actual daily earnings of the vessel. Although this is not universal, it might be adding to the level owners are willing to accept given the actual and not theoretical duration of the voyage.
Then, there is the recent ban on coal cargoes from Australia to China. As available vessels see demand narrowing to only iron ore cargoes, there could be the case that some vessels positioned in China that were aiming in completing either iron ore or coal cargoes are now choosing to transport coal cargoes from East Australia to other regions ex-China, thus tightening the supply of available capes in the region (also evident by a relatively strong backhaul rate).
Finally, with iron ore prices and a backwardated iron ore futures curve, the closest to China origin for physical iron ore is Australia, so for physical traders that are trying to capture such a high iron ore price the willingness to pay up for relatively fast physical cargo delivery versus a cargo coming from Brazil is stronger.
All the above reasons by themselves would not be enough to move the needle on relative freight prices, but put it all together and the impact on Australia freight versus Brazil is becoming meaningful with the benchmark route currently pricing above 45,000 versus the Brazil-China roundtrip currently at below 35,000. The futures curve remains relatively flat to the spot index (as a reminder, the spot Capesize index is a weighted average of 5 different routes around the world) at roughly 35,000. A simple calculation reveals that the weak link remains the North Atlantic market which is priced at barely 30,000 and it is the one that is keeping the index from approaching the psychologically important 40,000 mark.
In summary, although such a discussion might seem small details to the naked eye, given the mechanics behind freight futures, index-linked charters and the ability of vessels to move where the returns seem higher, such details are becoming increasingly important for operators, investors and traders alike. As we slowly exit the slow summer months, one would expect more volatility and activity to gradually close such differences, and only time will tell if that would be the case or whether we will continue to experience such major divergences on regional freight rates for the rest of the year.