Will freight rates continue to rise? It all depends on China

International Herald Tribune -- The prices of wheat, soybeans and iron ore have surged in the last two years, but that is nothing next to the surging cost of shipping goods like these.

Since mid-2006, a confluence of powerful forces - from a shortage of ships to the seemingly unquenchable thirst by China for raw materials - has sent the global benchmark for shipping rates soaring 365 percent.

The meteoric, and at times volatile, course of shipping costs has grabbed the interest of Wall Street and focused attention on the tiny Baltic Exchange in London, where ship brokers set the price for ferrying goods each day. As the exchange's Baltic Dry Index of rates hovers near record highs, investment banks and hedge funds are entering the fast-growing market for financial instruments linked to the index.

The market for ships has heated up, too. For the first time, prices of vessels designed to carry dry goods like iron ore and grain have eclipsed those for some oil tankers. Some owners are converting tankers to dry-cargo ships. Others have begun trading slots in shipyards where new vessels are built. And prices of second-hand merchant vessels are leaping.

''It's absolutely out of the ordinary,'' said Nikos Nomikos, a professor of shipping risk management at Cass Business School in London and a former Baltic Exchange analyst. ''Five years ago, nobody would have predicted that the market would go up by that much.''

The booming economy of China has transformed the once sleepy exchange. Because most of the dry goods transported by sea are somehow linked to the steel industry, and China is the biggest producer of steel, the Baltic index has become a proxy for the state of the Chinese economy.

But China is not the only reason freight rates are soaring. As global demand for raw materials rises, many goods must be shipped further than in the past, keeping ships at sea longer. Recent strikes at ports and infrastructure problems have delayed loading. The credit squeeze and the reluctance of banks to lend will make it more difficult to raise the $350 billion needed to finance an estimated 10,000 ships on order.

Shipowners have ordered ships in record numbers. But many shipyards are already working at capacity. Some of the Chinese shipyards that have agreed to build vessels have not even been constructed. Most of the ships on order will not be delivered until 2010. The backlog is raising concern about a possible oversupply of ships in the future.

''There's no doubt that 2010 is a risk point,'' said John Luke, head of shipping at KPMG in London. ''The big question is, will China keep buying bulk?''

For some in the industry, the large order books are bringing back memories of the 1980s, when a recession and an oversupply in vessels kept thousands of ships in port.

''Shipping has a very bad record when it comes to boom and bust, and that's because shipowners always get too excited when there is a shortage of ships,'' said one broker.

Shipping rates may come down if growth in China slows, too many ships flood the market, or the United States economy sinks into a deeper downturn.