Proposals to eject handysize vessels from the Baltic Exchange’s overall dry bulk shipping index have excited strong opposition, but the ships have historically gone in and out of the general reckoning, and even the critics want a rebalancing. So what is the problem?
In defending its plans to drop handysize ships from the Baltic Dry Index (BDI), the exchange says that over its 32-year history the broad reflection of dry bulk trading patterns has not represented all sectors of the shipping market all the time.
“The handy vessel contribution to the then Baltic Freight Index was lowered from an initial 20% [in 1985] and between 1986 and 1992 contributed 15%, then 7.5%, before being completely dropped in 1993. Handysize contributions were only included again after a 13-year absence in 2007,” it says.
The Baltic has proposed altering the composition of the BDI to a 40% capesize, 30% panamax and 30% supramax weighting from its current 25/25/25/25 make-up, which includes handysizes on an equal footing with the other types.
Angry owners and brokers
That has angered some brokers and owners, with major shipbroking group Howe Robinson leading the opposition. Critics argue that totally removing about 12% of the fleet damages the BDI’s ability to act as a "bellwether" of the shipping market.
The Baltic Exchange argues that regression analysis shows a good statistical correlation, with the measure coming in at 0.9876 between the current BDI weighting of 25/25/25/25 and a 40/25/25/10 ratio that would still include handysizes.
Regression analysis is a mathematical tool that helps understand how the typical value of a dependent variable changes when an independent variable is changed but others are held fixed. Figures range from 0 to 1.0, with 1.0 the closest fit.
As handysizes are the least liquidly traded vessels in forward freight agreements, the exchange looked at removing them. It found that a 40/30/30 composition for capesize, panamax and supramax ships gave a regression of 0.9886. “This means that the 40/30/30 split is actually slightly better than the 40/25/25/10 split,” the exchange claims.
But a low correlation is not necessarily a bad thing — depending on the statistical input and the desired outcome.
Howe Robinson says the correlation is distorted in a strong market when big discrepancies arise between the two models. “There is a marked upward bias in the new index whose mean is almost 12% higher, with differences reaching up to 1,400 index points in some cases and an average daily volatility that is over 30% higher,” the broker says.
Howe Robinson has campaigned for several years to rebalance the index so it better reflects the make-up of the global shipping business. Ironically, the levels it would like to see are not so far from the Baltic Exchange’s own research, which points to 40/25/25/10 being a better representation of today's market based on dwt composition, vessel utilisation and cargo carried.
But Baltic Exchange chief executive Mark Jackson argues that there is very little statistical difference between basing the BDI on a 40/25/25/10 or 40/30/30 ratio, as supramax ships are now the workhorses of the fleet, able to poach business from the handysizes when rates rise for the smaller vessels.
Handysize weightings were altered in the 1980s and 1990s as the vessels quickly upsized from about 20,000-dwt capacities to nearer 40,000 dwt, and as the newer, bigger ships pushed out smaller ones on many routes. With a tendency for the ships to take voyage rather than time charters, it was increasingly considered too difficult to price them accurately.
But Howe Robinson argues that the proportion of handy spot to total fixtures is almost certainly higher than for capesizes and estimates that the small ships transport annual cargo volumes 8.5 times their dwt capacity compared with 6.2 times for capesizes.
Howe Robinson managing partner Guy Hindley has told TradeWinds he believes the changes are being made to create a tradable index mainly for futures — and that is taking priority over the need to create an index that truly reflects the shipping business.
Jackson says the changes can be made easily because, at least as far as the exchange is aware, no companies are currently trading against the BDI. But the Baltic is clear that it does want to make that much more likely to happen.
“The proposed changes potentially allow companies to develop a range of products which will enable the BDI to be traded, whilst ensuring that the index’s ability to track the overall dry bulk market remains unaffected,” the exchange states.
The Baltic has stressed that its plans to modernise indices are designed to reflect vessel fixtures and cargo flows, as required by the International Organization of Securities Commissions, which demands that index providers “demonstrate that their indices are a true reflection of the underlying market”.
Jackson says this requirement applies to individual vessel routes that are traded on time charter rate levels, not to the BDI, which does not reflect actual prices but is a points-based mechanism.
“We did not start with the idea we must make the BDI more tradable, but that we should make it more relevant,” Jackson adds. However, that exercise revealed that there was an interest in trading the index, without the handies that do not have sufficient liquidity to trade into and out of, whether for physical movements or derivatives.
Howe Robinson responds: “If traders cannot use a properly constituted BDI, one designed for their purpose should be developed in addition to, and not as a replacement of, the BDI.”
Hindley says the Baltic claims the BDI is not a sufficiently volatile index to trade against, but Howe’s research shows it is more volatile than many other major traded indices.
