Could the BCI index fall to zero?
類別: Dry Bulk / Container / RoRo & Others
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The Brazilian dam collapse has received widespread market attention, and it was widely expected that Brazilian iron ore output will be significantly reduced. This led to a sharp rise in iron ore prices and an irrational decline in the Baltic Capesize Index (BCI), which fell to record-low 92 points on April 2, a significant decrease of 95% since the beginning of the year. As the Brazilian court agreed to restore operations of the Brucutu mine with a production capacity of 30 million tons, the threat of production cuts in the largest mining area imposed by the accident will be gradually eliminated, and the capacity of Vale shut down is nearly halved. As the accident handling progressed later on, the actual impact on iron ore supplies will become clearer, and BCI will recover from the excessive panic in the early stage, and the freight rate is expected to gradually recover.

1. Both the Brucutu mine and the Guaíba port received notice of restoring operations

On March 19, Vale announced that it had received documents from the Minas Gerais State Inspection Office and had approved the restoration of operations of its Brucutu mine and Laranjeiras tailings dam. On March 21, the environmental protection authority granted an operation certificate to the Laranjeiras tailings dam. The annual production capacity of The Brucutu mine is about 30 million tons, accounting for about 8% of Vale. At present, the Brazilian government is still stepping up efforts to deal with the tailings dam. The resumption of production in the Brucutu mining area may still face uncertainties. However, after the court lifts the mining area ban, the resumption of production will be significantly accelerated, and the mine is expected to gradually resume operations in the near future.

2. The expansion of the S11D project in the north will partly offset the actual impact of production capacity being shut down

Bolstered by the S11D project, the increased capacity in the north is likely to compensate for the production cut in the dam collapse area. In 2018, the S11D project recorded an export of 59.4 million tons of iron ore. Earlier, Vale officially stated that the output of S11D project will reach its capacity limit in 2019, and is expected to increase production by 30 million tons to cancel out the loss caused by the accident. According to data from the Brazilian foreign trade department, in the first two months of this year, the iron ore export volume recorded in the S11D project is 12.1 million tons, a substantial year-on-year increase of 68%, indicating a largely expedited output. In addition, Vale currently has a total production capacity of 450 million tons and provides an output of about 380 million tons. With strong internal ability of self-regulation, the company is fully capable of reducing the actual impact of shutting down capacity in the south through internal reallocation of resources.

3. Anglo American’s Minas-rio project resumed production; Brazil's total output continues to grow

The operation of Minas-rio mine under Anglo American was halted in March 2018 due to conveyor belt damage. That year, the mine only produced 3.16 million tons of iron ore. In 2019, it resumed production with a production target of 18-20 million tons and an increase of about 15 million tons in production. Driven by sufficient stocks and the resumption of production of the Minas-rio mine, Brazil's iron ore exports continue to grow. According to data from the Brazilian Ministry of Foreign Trade, Brazil exported a total of 62.1 million tons of iron ore in the previous two months, which is 14.5% higher than the year-ago export volume. In February alone, Brazil's iron ore exports reached 28.9 million tons, a year-on-year increase of 21.6%.

4. The market continues to maintain a weak balance; BCI will gradually recover from the irrational low

From the perspective of the China-Brazil route alone, considering the production reduction as a result of the dam collapse, S11D expansion and Anglo American’s resumption of production, Brazilian iron ore exports set to remain stable with the potential of a rise in 2019. The annual increase is expected to reach 15 million tons. Vale will add 11 ships to its 400,000-ton VLOC fleet this year. Considering the operation time, the annual iron ore cargo will be about 10 million tons. Therefore, the spot volume that has a direct impact on the freight rate will increase slightly by about 5 million tons compared with that in 2018, and will continue to improve moderately.
From the perspective of the entire dry bulk market, the supply and demand landscape will continue to improve in 2019. Looking back at the trend of the dry bulk market since 2002, the average annual growth rate of dry bulk shipping demand from 2002 to 2007 was 1.8 percentage points higher than the growth rate of transport capacity, so the market rose substantially; from 2008 to 2015, the average growth rate of demand was 5% lower than that of the transport capacity, during which period the market fell sharply and continued to maintain a low level. Since 2016, the growth rate of shipping demand and capacity supply has remained basically the same, both at around 3%. The market has recovered from a low level to somewhere near the break-even level.
According to the order data, by the end of 2019, the global dry bulk cargo transport capacity will reach 865 million tons, a year-on-year 3% rise, and will continue to remain at a low level, basically on a par with the demand growth. Moreover, the IMO2020 rules may lead to reduced transport efficiency this year. Some institutions expect that about 1% of the transport capacity will withdraw from the market because of tank cleaning, and 0.6% from the market for installation of desulfurization towers. Hence, the supply and demand landscape of the market will improve accordingly.

In summary, the Brucutu mining area and the Guaíba port have resumed operations. The capacity shut down is close to half of the level recorded in earlier stages. The threat of a sharp reduction in Brazilian iron ore production is partially removed, and Brazil’s production as a whole is expected to continue to grow in 2019. The Capesize shipping market has fallen sharply due to the expected production cuts in the early stage. The current BCI has fallen to a record low, and the rental level has been unable to cover the basic operating costs of shipowners. Is it true that BCI would slump to zero and shipowners would bear all costs and serve cargo owners for free? A rational market certainly would never be like that. As recently the biggest black swan event in the market is likely to ease off, the dry bulk market will gradually return to a reasonable level determined by the market supply and demand fundamentals. Coupled with Australia will speed up shipments after the hurricane, BCI is expected to gradually recover from the irrational low level caused by panic.