By Ulf Bergman
“Lagom” is a Swedish word that can be translated as "just right" in the context of "not too little, not too much". Beyond its literal translation, it is a quintessential Swedish word and is often seen as a key to understanding the Swedish culture. Typically, the use of the word implies that one actually should know what the right amount/level should be, notwithstanding one’s personal preferences. Shipping’s relationship with commodity prices could perhaps also be described in this fashion, with high, but not too high, prices typically being good news for shipping. While rising commodity prices often signifies strong demand and a greater need for seaborne transportation, if the prices are rising too much there is always the risk that volumes will eventually suffer, as demand softens with declining profit margins in the manufacturing sector. Low prices could on the other hand signify a lack of demand with the corresponding lack of need for transportation across the oceans, despite the relative attractiveness of cheap raw materials.
The relationship between commodity prices and shipping volumes are undoubtedly more complex than this, which is highlighted by the current state of the crude oil market where the healthy price levels are a function of strict supply control by OPEC+ rather than strong consumer demand. A surge in commodity prices may also give producers an incentive to increase output, which would both increase seaborne volumes and temper continued price increases. However, the supply situation for many major dry bulk commodities remains tight, without much immediate additional supply available. While it is expected that Brazilian iron ore exports will recover much of the volumes lost to the pandemic and dam accidents, any major increase in quantities shipped is several years into the future when new African projects are expected to be operational. Likewise, additional volumes of coal are currently off-limits for Chinese buyers, the world’s largest consumer of the commodity, due to the political tensions between China and Australia.
The high commodity prices and their expected effect on inflationary pressures have recently raised the alarm among leaders and central bankers on both sides of the Pacific. Factory gate prices have surged in China, leading the country’s leadership to fear that it will feed through to the consumer sector and threaten the fragile recovery in retail spending. The Chinese leadership has initiated measures aiming at bringing commodity prices under control and limiting any further upside, by releasing strategic reserves and imposing trading restrictions among other things. The Chinese steel production has also been targeted with environmental restrictions aiming at reducing the output. Beijing has additionally been vocal in critiizing the extensive stimulus spending in the US, which it argues is excessive and has contributed to the surging commodity prices. Hence, the Chinese leadership perceives much of the inflation as an imported problem, which could threaten the continued recovery of the domestic economy. Nevertheless, it is the prices and not the imported volumes that are targeted, as the demand for commodities will remain strong as the nation seek to meet the growth targets of the current five-year plan.
Following a sharp increase in US inflation rates, the Federal Reserve has changed to a more hawkish stance with interest rate hikes now on the distant horizon. While much of the continued inflationary pressures are expected to come from the US economy recovering faster and more forcefully than previously expected, the Fed’s chairman, Jerome Powell, has also singled out supply chain bottlenecks and rising prices for commodities, such as oil, as contributing factors. While the Fed sees the effects as transitory with the inflation rate returning to its longer-term target, other observers are less convinced and see the elevated inflation rates remaining in place. Such a scenario could force the Fed to adopt a more aggressive stance, but if such a development would materialise it is likely to be some way off into the future.
Economists often like to use the concept of utility when exploring optimal outcomes. Shipping’s utility function in regards to commodity prices is likely to be somewhat dissimilar to the commodity producers’, as volumes shipped rather than prices paid are likely to be the deciding factor for the sectors’ profits. Hence, the shipping sector’s interests may in this case be more aligned with those of the central bankers and national leaders looking to limit further upside on commodity prices, than with the commodity producers. A continued strong recovery for the global economy, without excessive inflationary pressure from ever-increasing commodity prices, would maintain a strong commodity demand and provide support for ocean freight rates. At the same time, commodity prices need to give producers the incentive to maintain high output levels and cater to demand. In other words, “Lagom” rules!