Logistics in Commodities - The BDI and Panama Canal

When I started in the commodity business in the early 1980s, my first job was in the traffic department. A traffic clerk works together with a trader to settle deals. Commodity production around the world is localized. Raw material output depends on geology when it comes to metals and minerals. These building blocks of infrastructure only occur in certain areas of the world, For example, a majority of the world’s copper comes from the South American nation of Chile.

The largest producer of nickel in the world is Russia as the ores are present in the geology of the Siberian region of the country. More than half of the world’s crude oil reserves reside in the Middle East.

Agricultural commodities rely on weather and climate. The fertile plains of the United States make the nation the world’s largest producer and exporter of corn and soybeans. Wheat grows around the world, but production of the main ingredient in bread depends on fertile soil and the availability of water. Soft or tropical commodities can only grow in certain weather conditions. That is why the world’s largest producer of cocoa beans is the West African nations of Ghana and the Ivory Coast. Sugar cane only thrives in hot and tropical climates, and so does coffee. As you can see, commodity production only occurs in areas of the world that provide the proper conditions. At the same time, every person around the world is a consumer of all of these important staples of everyday life.

Therefore, commodities must move from production sites to areas around the world for ultimate consumption.

The job of traffic professionals is to arrange the logistics of transporting goods from producer to consumer. A trader arranges and negotiates the terms of the deal, but it is the traffic person that executes the provisions of the contract and arranges for the transit of the commodity from point A to point B.

Commodities travel by various modes of transportation. Precious metals, due to their high value, often travel by air and by armored carrier. Other bulkier goods travel by pipeline, truck, rail, barge, and ocean vessels. The logistics of the trip from production to storage areas of consumption areas is an important function in the world of commodities. The expense of transporting goods can be very high at times. It depends on supply and demand for the mode of transportation. That is why during a bull market in commodities, when raw materials are traveling around the world the price of transportation tends to rise. Conversely, during bear market periods, the price of transportation tends to fall as demand for raw materials falls.

The Baltic Dry Index

One of the best tools to measure the current state of demand for commodity transportation is the Baltic Dry Index. The index is an economic measure of issued daily by the Baltic Exchange, which is London-based. The index measures the price of transportation on 23 different shipping routes around the world on a time-charter basis. Time-charter is the cost of booking or renting an ocean vessel in order the transport a commodity from point A to point B.

The Baltic Dry Index (BDI) includes ships of various sizes including Handysize, Supramax, Panamax and Capesize dry bulk ocean carriers that transport a range of commodities including iron ore, coal, grains and other raw materials. The vessels represented in the BDI have different capacities as follows:

Capesize: 100,000+ dead weight tons

Panamax: 60,000-80,000 dead weight tons

Supramax:  45,000-59,000 dead weight tons

Handysize:  15,000-35,000 dead weight tons

Fuel is the major component of travel cost, and the BDI can move significantly during periods of volatility in energy prices. The BDI is a benchmark index that measures the time-charter hire rates in “U.S. dollar hire per day”. In February 2016, the BDI fell to all-time lows of 290 as the bear market in commodities reached its nadir. Crude oil dropped to $26.05 per barrel at the same time, the lowest level since 2003.

By April, the BDI had recovered to 715, more than double the level just three months before. Many commodity prices reached significant lows in early 2016 and recovered, and the increase in the BDI was a sign that demand for raw materials at low prices and shipping activity around the world increased dramatically over a short period.

The Baltic Dry Index is a useful tool for those who wish to measure commodity demand. You can find the daily on Bloomberg, which publishes the BDI each business day. The BDI is an excellent metric for monitoring economic activity. It rises with booms in the global economy and falls during periods of bust.

Developments in Logistics

Ocean travel is often the only method of transporting dry bulk commodities around the world. That presents particular problems and logistics is essentially a science where professionals arrange to move raw materials to areas of the world where required in a timely fashion. Technology has improved the transportation function over the years, but ocean travel can be very time-consuming. Over 100 years ago, the Panama Canal transformed global trade as it reduced the time and costs of transit on many important shipping routes. The Panama Canal brought the Atlantic and Pacific Oceans together as it afforded vessels the opportunity of a shortcut negating the need for travel to points south around the bottom of South America to move east or west.

A nine-year construction project has equipped the canal with a third set of locks and deeper navigation channels at a cost of over $5 billion to double the capacity for transporting cargo between the two oceans.

The new lock opened to ocean traffic in late June 2016 and will affect sea traffic and all deep water ports around the world.  A wider and deeper canal comes at a time when enormous tankers are now carrying liquefied natural gas from the United States to Asia. This new passage will reduce shipping costs by about a third as well as transportation time for cargoes that can only travel on enormous ships that could not before pass through the narrow canal before the expansion. Commodity and container transport will become faster, cheaper and easier due to the upgrade project at the Panama Canal. The wider and deeper canal has triggered a multibillion-dollar dredging and improvement binge at ports around the world to accommodate the new massive ships that can now pass through the canal. Both the Panama Canal and ships are becoming bigger and more efficient.

The changes to the canal will improve logistics as it will cut down shipping costs for energy, dry bulk, and agricultural commodities. While some supertankers will still not fit through the passage, traffic and tonnages passing through will increase dramatically as a result of the change. The Panama Canal continues to be a logistical wonder of the world, and it will have a profound impact on the commodities business and the ability to move cargo around the world expeditiously.

The logistical change comes at a critical time for commodity markets. Demographic changes when it comes to global population and wealth means that people all over the world are consuming more raw materials each day. In 1959, when I was born, there were less than three billion people on planet earth. In June 2016, world population stood at over 7.3 billion. Exponential population growth combined with increasing wealth around the world has led to more demand for commodity staples. In the years to come it is possible that the Panama Canal will again undergo an expansion project as commodities will always have to travel from production sites to consumers around the world. Increasing demand for raw materials will lead to growing demand for ocean vessels to carry them.

Logistics can make or break a commodity transaction

There are so many important aspects when it comes to logistics in the world of commodities. When a trader buys products from producers and sells those raw materials to consumers, it is the traffic aspect of the transaction that can either save money increasing the profit or in some cases turn a profit into a loss. The longer it takes to transport a commodity from producer to consumer the more it costs. When booking a vessel for ocean transport, the traffic professional will be able to gauge the normal and average time for the carriage and then rents the transporting vessel from an owner for the required time. However, sometimes things can go wrong, and it can take a lot longer than originally anticipated. For example, a weather issue can slow a ship down, or a strike at a port could make loading or unloading impossible. Ports in various nations around the world require different types of documentation to accompany shipments and if those documents are not in perfect order that can slow delivery down to a snail’s pace increasing costs.

When a traffic professional negotiates the price for booking an ocean vessel, the parties will agree on rates for dispatch and demurrage. Dispatch is a credit that the party renting the ship will receive if loading, transit time and unloading occur in under the agreed upon time. Demurrage is a penalty for delays when the voyage takes longer than expected. Since ship owners always keep their ships moving and an extended period of delay can have a domino effect on other shipments waiting for a particular vessel. Additionally, the longer a voyage takes, the more it costs for fuel and compensation of the ship’s captain and crew.

Physical commodity traders must be experts at estimating the logistical costs associated with all of their transactions. If the costs wind up being more than the estimate the profit of the trade declines and can even become a loss at times. There are so many factors to consider in the world of physical commodities trading. A knowledgeable and experienced traffic professional is an invaluable resource for traders and can save money and add to profitability. The logistics of shipping goods around the world is a complicated science, and it is a critical part of the commodities business. The prices that consumers ultimately pay for goods reflect the costs of all related logistics.