Baltic Dry Index Definition
The Baltic Dry Index (BDI) is an indicator of the price to ship various raw materials along major shipping routes across the globe. Demand to ship goods is seen as a proxy of economic activity; therefore the BDI is seen as an economic indicator.
How to Calculate the Baltic Dry Index
The Baltic Dry Index (BDI) is issued daily by the London-based Baltic Exchange. On each working day multiple international shipbrokers issue their current freight costs to the Baltic Exchange. Enough rates from enough shipbrokers are used so that the rates calculated are a proper sample of the overall market. The Baltic-Exchange weighs these numbers to come up with the Baltic Dry Index, which is actually an overall averaged reading for the three component ships of the Index: Capesizes, Panamaxes, and Handysize/Supramaxes. The BDI also issues individual averages for the component ships.
This is the formula used to calculate the Baltic Dry Index:
((Capesize5TCavg + PanamaxTCavg+ SupramaxTCavg + HandysizeTCavg)/ 4) * 0.110345333
TCavg = Time charter average
Baltic Dry Index Sub-Indexes
The Baltic Dry Index is actually made up of three component ships. It is useful to assess the overall BDI’s movement, and also the movement of the component ships as it can provide insight into what is driving the BDI’s prices. This is because each component ship transports its own mix of raw materials. Also, a phenomenon that is sometimes seen in weak economies is the splitting of large cargoes and using smaller ships because there is not enough demand to send the larger ships out to sea with enough frequency.
Capesize ships are the largest ships of the BDI with a 100,000 Deadweight tonnage (DWT). The average size of a Capesize ship is 156,000 DWT, although there are very large ships that are over 400,000 DWT. These huge ships are called Very Large Iron Ore Carries (VLOC) and, as the name suggests, are dedicated to iron ore transport. Capesizes are the most common ships, making up up over 60% of the world’s fleet. These ships are too large to transit the Suez canal or the Panama canal. To traverse between oceans they take either Cape Horn or the Cape of Good Hope. These ships primarily transport coal and iron ore on long-haul routes. They may occasionally transport grains.
Panamax ships have a capacity of 60,000-80,000 DWT, and they are the largest ships that can traverse the Panama Canal. They primarily transport coal, grains, and minor bulks including steel products, cement and fertilizers. Panamax ships require ports with specialized equipment for unloading, as the ships themselves do not contain the necessary equipment. This limits where they can port.
Handymax vessels have a carrying capacity of 40,000-59,999 DWT. Supramaxes normally offer the equipment necessary for cargo loading and unloading and also have a capacity that is near Panamaxes, making them the best alternative carrier to a Panamax when ports do not have the necessary equipment to load and unload.
Baltic Dry Index Price Determining Factors
Demand for the raw materials that the BDI component ships transport is a major influencing factor on price. Demand for shipment influences the price that shippers can charge, and in turn the overall value of the BDI. Demand for raw materials, overall, is dependent on the health of the global economy. When it comes to the steel and iron ore that BDI ships transport, China’s economy is paramount. Demand for thermal coal depends, to a degree, on weather, but lately emissions regulations have had more of an influence on thermal coal. Metallurgical coal demand is related to global economic health. Demand for grains is not as economically sensitive as the other goods that the BDI transports because people need to eat; therefore they cannot completely forgo the purchase of grains. The demand to transport grains has a major seasonal factor, a point we will come back to.
Ship supply is another factor that affects the BDI’s price. BDI ship supply is both tight and inelastic. It takes years to bring a ship online and ships are not readily convertible to other uses. This can have a major impact on BDI prices when we have short-term swings in demand because ships cannot easily be brought into services to account for increase demand, nor can they be converted for another use when demand sinks. The expense in building a ship often leads to ship-owners inflexibility in removing ships when BDI rates fall.
Another factor to consider is that the demand for raw materials has significant seasonality. While we already brought up the seasonality of the grain market, as it is the most obviously seasonal commodity with a definable harvest season, there is seasonality involved in almost every raw material the BDI transports. When it comes to iron ore, major consumer China tends to stockpile the steel-making ingredient in the late winter and early spring. There are other examples of seasonality, not as pronounced as the examples here, but the important part is to know that the BDI is influenced by seasonality that makes ship hiring rates more expensive at certain times of the year. To generalize, prices are usually higher in the spring and then by late fall and into early and mid-winter the BDI tends to retreat.
The cost of bunker oil accounts for about 40% of vessel operating costs; therefore an increase in oil prices is directly reflected in shipping rates.
The Baltic Dry Index as an Economic Indicator
A high BDI index is an indication of a tight shipping supply due to high demand for commodities. This is a sign that the global economy is strong as raw material demand generally means that economies are growing. Conversely, a steep drop in the BDI means that shippers have had to drop their rates due to a decrease in demand and this could foretell an economic slowdown.
It is important to note that as an economic indicator the BDI can be used as information, but its accuracy is not precise. For example, the BDI hit a record low in February 2016, and afterwards demand to ship many of the raw materials jumped. Investors who would have used the BDI as their sole source of information would have missed out on the opportunity to make some profits.
The major factor that influences the BDI’s shortfall as an economic indicator is the price inelasticity of ship supply. There is a lag time in terms of bringing new ships into supply or out of supply, and because of this lag time we can have periods of time where demand and supply are not necessarily perfect indicators of market fundamentals. In a counter-example, when supply can rapidly be decreased or increased, prices adjust accordingly. When there is a delay, such as the case in the BDI, it can exacerbate price swings. This can explain why prices fell to a record low in 2016. During the last economic expansion (before the Great Recession), ship builders started construction of a large number of new vessels. These vessels came online during a time when demand was far below what expectations were in the last economic expansion. Now, an oversupply of ships is underpinning the BDI prices. There is the theory that the only thing that will cause the BDI to rebound is the scrapping of ships, and that will take some time. For now, the supply and demand balance seems to be off-kilter.
January 1985: The first daily freight index was published by the Baltic Exchange
May 20 2008: Index reaches record high of 11,873 points
December 2008: As impact of Great Recession felt, index falls to 663 points
Feb. 3 2012: Index reaches multi-decade low of 647 points
Feb. 10 2016: Index falls to all-time low of 290 points