How Does the Baltic Dry Index (BDI) Impact Marine Finance Offerings?

The Baltic Dry Index, or BDI, measures the amount of business activity in the shipping industry by calculating daily shipping rates for specific global shipping routes. In this article we will explain what the BDI is and how it can impact a Marine Finance Offering. Before getting into BDI we recommend reading our intro article or video on Marine Finance.

The index helps measure demand for shipping capacity vs. the supply of available ships through daily freight market prices and shipping costs. It is calculated through the input of a panel of shipbrokers who submit their assessment of the freight cost of twenty international shipping routes on a daily basis. The index helps ship owners, raw goods producers, and traders on Wall Street gauge the level of business activity in the shipping industry.

Vessel Supply vs. Shipping Demand

There are two main factors that impact the BDI: the supply of available shipping vessels and the demand for shipping contracts. Freight rates in different markets are directly impacted by the supply of vessels available to transport goods and the demand for shipment. When the economy is strong and global trade is flourishing, there is greater demand to exchange goods, driving up shipping rates, and therefore the BDI. An oversupply of ships, on the other hand, would drive shipping costs, and thus the BDI, lower.

BDI as an Economic Indicator

Aside from the supply/demand dynamics of vessels and freight rates, the index is also used as a barometer for the global economy. Investors use the BDI as a leading indicator to gauge the direction and health of the economy; the BDI indirectly measures global supply and demand for commodities shipped aboard dry bulk carriers. YieldStreet will primarily be offering investment opportunities for vessels classified as dry bulk, which are those vessels that are designed to carry solid goods such as grains, coal, metal ores and forest products.

BDI’s Impact on Vessel Value

Not only is the BDI instrumental for planning chartered routes, but depending on its direction, the index can impact the actual value of a vessel. Have you ever heard that a new car depreciates by 10% the moment you drive it off the lot? This concept does not hold true for commercial vessels. A ship’s value appreciates when charter rates improve. This dynamic can work both ways – a newly constructed ship in pristine condition can depreciate in value when charter rates deteriorate, without having ever set sail. The value of a vessel is dependent on the earnings a vessel can generate. If the BDI points to higher future charter rates, a ship can earn more money, thereby increasing its worth for a future sale or expected earnings.

Importance of BDI to Marine Finance Offerings

Having said that, we do not concern ourselves with the daily fluctuations of the BDI. It is important to understand the factors that affect the BDI because they can expose Marine Finance offerings to external market factors. Small day to day fluctuations in the index would not necessarily impact the terms of a Marine Finance offering, however a sharp decline in the index could impact a ship’s resale value at the end of the offering lifetime. For Vessel Acquisition offerings, this is why Residual Value Insurance (RVI) is used as a risk mitigator for volatility in such a scenario. More on RVI below.

Risk Factors Affecting the BDI:

  • Tariffs and Trade Wars: Recent tariffs proposed by the U.S. and China could be a direct risk to the global economy, and therefore the BDI. An increase in the price of goods because of tariffs could negatively impact demand and thus drive down the BDI. This however, doesn’t necessarily mean shipping rates would decrease: if the economy holds up, the U.S. and China might seek new trading partners, opening up the market to new global shipping routes and contracts.
  • China and India: Because of their size, growth, and demand for raw materials, any slowdown in the Chinese or Indian economy would have an outsized impact on the demand for dry bulk charters.
  • Vessel Oversupply: An excessive ramp-up in ship building that exceeds demand could drive prices down while a shortfall of available vessels could drive prices up.

Downside Protection & Residual Value Insurance (RVI)

While BDI is an important factor in determining a ship’s value and the overall state of the industry, it is just one of many tools we use during our diligence process. We thoroughly vet offerings and require safeguards to protect against any major fluctuations in the index. To address some of the above risks, Marine Finance offerings involving vessel acquisition have the mitigating factor of Residual Value Insurance (RVI) which helps to protect your investment and principal. Typically used in the airline industry, we believe this is the first time ever that RVI will be used in a Marine transaction.

By adding RVI to vessel acquisition offerings, the lessor is protected against a loss if the sale proceeds of the ship at the end of the lease are less than the insured residual value determined in the original offering terms. If the BDI, and thus a ship’s value, were to dramatically decline, RVI helps bridge the gap between the original and final sale price. The insurer would be responsible for purchasing the ship if a reliable buyer could not be located. Read more about RVI in our article here.

Deconstruction Value: If freight rates decline and a ship owner finds it unprofitable to have the vessel on the market, he or she can choose to take it off the water and sell it for its parts. Downside is protected by the scrap value of the ship itself, or the value of the components (engines, turbines) and raw materials (steel, aluminum, iron). Although the value of those raw commodities fluctuates, they are generally uncorrelated to the shipping industry, providing a residual base value.

Cash Reserves: Depending on whether the vessel earning income is on the spot or time charter market, both require a significant amount of cash reserves from the lessee. Ultimately, cash reserves help manage the ebbs and flows of cash during periods of volatility.

Summary

While an important factor, we caution investors not to focus too much on the daily movements of the BDI. Our outlook on the industry is positive and we believe that our offerings are largely protected from normal fluctuations in the index.

To learn more about Marine finance check out the following links:

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