Sunday, July 20, 2008

The Baltic Dry Index

The Baltic Dry Index is an index compiled by the London Baltic Exchange which tracks the cost to book cargoes of raw materials (iron ore and other metals, coal, grain, cement, oil etc) by sea across the world.

It's important because it is a leading indicator - it doesn't deal with the shipping of finished goods, but with the shipping of raw materials from which those goods are made. It's also one of the few indexes that is free of speculators - people only book freight ships if they have stuff to ship. The supply of ships is inelastic as it takes up to two years to build a new ship, therefore the index tells very quickly whether there has been an increase or decrease in demand for ships.

In other words the Baltic dry index is the best indicator there is as to what is going on with world trade. And where world trade goes, oil demand goes too.

The graph above shows the Baltic Dry Index over the last year, and you will notice that it peaked first at 11033 on 29/10/2007, and then fell to 5615 on 29/01/2008. The index then made another surge to 11689 on 5/06/2008 but has fallen back to 9012 on 18/07/08. The oil price doesn't track it exactly, due to the speculative element, but it did hit $100 in early Nov 2007, and fell back to $87 in last January, before powering up to $147 on 4/07/2008. Nymex closed at $128.81 on 18th July.

If the Baltic Dry Index continues to fall, it indicates demand for raw materials is dropping, which means orders are slowing down. The oil price will be bound to follow.


Anonymous said...

In other words were having a global recession so what's the problem?

World trade grew massively in the 1990s but the oil price fell. So how does that work?

snowflake5 said...

Anonymous, the oil price isn't based on the absolute amount of trade at any point. Rather it's an interplay between supply and demand.

The more demand there is, the more suppliers like Russia, Norway and others try to explore more, drill more, pump more, to meet demand. OPEC of course try to regulate supply within their cartel, but most of them cheat and pump the max they can anyway.

As you say world trade grew massively during the 90's, but so did the supply of oil from players like the former Soviet Union. But by 2000, demand was growing more rapidly than supply and the price began to rise. Then the world had a sudden recession in 2001/3 with the dot-com bust and 9/11. Demand fell suddenly. And hence so did the price.

If we are having another global recession, and the travails in the USA are slowing down the Chinese economy, then demand for oil will drop again, and so will the oil price.

The point I'm trying to make is that the oil shock this time has been demand driven, but this demand can only be sustained in a boom. Take away the boom and you take away demand and the price falls.

Many in the press and conservative party talk about "stagflation", but that is a product of supply shocks - eg the OPEC price hike in the early 70's - where even as demand dropped due to a recession, supply was constrained even faster, so the oil price was maintained or ratcheted up. We are not in supply shock territory now. If there is a global slowdown, demand will drop, and hence so will the price of oil.