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What's the Best-Case Scenario for Dry Bulk?

With the iron-ore trade facing a sea change, we ask readers of TheStreet: What's the best-case scenario for the dry-bulk shipping sector?
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NEW YORK (TheStreet) -- The world's most formidable steel industry and the world's biggest miners of iron ore are once again embroiled in their yearly pricing negotiations.

This time around, the outcome could bring a sea change to

the iron-ore business

. At issue is the very nature of the trade, with the big three iron ore miners angling to do away with the annual-pricing regime that has structured the business for the last 40 years.

Within the last year or so, more and more of the world's iron ore trade has moved from the annual-contract system to the spot market, a more lucrative model for miners. Steelmakers, on the other hand, despise the spot market's volatility. In the end, the most likely outcome would appear to be a compromise quarterly-contract system.

Some might even suggest that as pricing talks have dragged on between the miners and their iron-ore customers in China, both sides have been trying to influence the iron-ore spot market to gain leverage -- or, at least, the evidence, plus a cynical worldview, suggests that this might be so. "In any negotiation, there's gamesmanship that goes on on both sides," said one stock analyst. "So why would that


be happening right now?"

Perhaps miners are hesitating to put iron ore onto the market in an attempt to drive spot prices higher. Perhaps China is purposefully hesitating to book iron-ore cargoes out of places such as Australia and Brazil in a bid to weaken prices on the spot market.

Indeed, a pattern has developed: During the period of price-negotiation tension between miners and Chinese steelmakers, China goes to India for more of its ore. This increases the supply of available ships on the market, since the India-to-China route is far shorter than the Brazil-to-China route.

It also increases the supply of available capesize ships relative to smaller vessels, since India's ports are generally too small to handle capesizes -- the largest bulk carriers on the seas, and thus the world's iron-ore transporter of choice.

Since last week, the going rate for a cargo on a capesize ship was less than that of a much smaller panamax-size vessel. According to the Baltic Exchange, the London ship broker, capesize day rates were about $28,500 on Monday, compared with $30,600 for a panamax. This marks the first time since late 2008 -- when the global financial system and the maritime freight market both collapsed -- that capesize day rates have been cheaper than those for a panamax.

Ultimately, there are a range of impacts on the companies that haul iron ore from mining-nation exporter to manufacturing-nation importer. Every big name in the sector has a stake in the iron-ore talks:


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Still, in the long run, what matters most for shippers is whether the iron-ore pricing status quo remains in place, or whether some kind of variable system supplants it.

Shipping experts appear to be divided on this. Certainly a pure spot-pricing model would render dry-bulk shipping rates much more volatile. The Baltic Dry Index, a measure of spot rates across vessels sizes, would be much more closely linked to iron ore prices.

Some observers -- including Omar Nokta, the shipping analyst at Dahlman Rose -- believe shippers would benefit far more from a fixed pricing model as opposed to a spot-market one.

The thesis runs thusly: If steel demand is strong and prices are rising, as they have been recently, steelmakers want their ore, not matter the cost, and this pushes freight rates higher. If all iron ore was bought and sold on the spot market, miners could hike their prices for the raw material almost instantly, adjusting for customer demand and squeezing out the gains just made by the shipping companies.

"We believe the shift towards a spot-priced iron ore system will continue to benefit miners at the expense of shipowners," Nokta wrote in a note to clients earlier this year. "And we look for the outcome of the 2010 iron ore negotiations to be the most important factor in determining the potential for freight rates this year."

With all this in mind, we ask readers of


: As a shareholder in the dry-bulk shipping sector, which of the following iron-ore pricing scenarios would you prefer?

-- Written by Scott Eden in New York

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Scott Eden has covered business -- both large and small -- for more than a decade. Prior to joining, he worked as a features reporter for Dealmaker and Trader Monthly magazines. Before that, he wrote for the Chicago Reader, that city's weekly paper. Early in his career, he was a staff reporter at the Dow Jones News Service. His reporting has appeared in The Wall Street Journal, Men's Journal, the St. Petersburg (Fla.) Times, and the Believer magazine, among other publications. He's also the author of Touchdown Jesus (Simon & Schuster, 2005), a nonfiction book about Notre Dame football fans and the business and politics of big-time college sports. He has degrees from Notre Dame and Washington University in St. Louis.