Ship Broking : Tuesday 3rd October

13.30 - 14.00 John Banaszkiewicz - Simpson, Spence & Young

The Role of Futures

Why do we need Risk Management?

1999

• Kosovo Crisis
• Opec Production
• Japanese Govt. spending
• Euro Community problems
• Changing Coal trade
• Y2K

2000

• Global Economic Growth
• Crude Prices 25 Year High
• Weather Patterns
• Turn Around of Asian Economies
• Deregulation in Energy Markets

2000 has been characterized by short-term market movements.

Charterers in all of the dry bulk sectors have changed their operating style by moving away from long term contracts towards ‘spot’ fixing.

MARKET FORCES

ELEMENTS BEYOND CONTROL

INCREASING

MARKET VOLATILITY

Need for Risk Management

Eliminate Risk Exposure

COMPETETIVE EDGE

OPTION : A

Do Nothing

& Fix Spot

High Risk / Unpredictable

OPTION : B

Time Charter,

CoA’s

Inflexible

OPTION : C

Hedge Risk with Derivatives -- Flexible Option

Shipping Derivatives

Shipping derivatives are based around the Baltic Freight Indices

• Baltic Panamax Index (BPI)
• Baltic Handy Index (BHI)
• Baltic Cape Index (BCI)

Baltic International Tanker Routes (BITR)

Forward Freight Agreements

Swaps traded against the individual routes of the Baltic Freight Indices.

"An agreement made between a buyer and seller today for the future price of moving a product from one location to another, or for the future price of hiring a ship over a period of time"

What is an FFA?

• Principal to Principal contract

• Cash Settled on the difference between the contract price and the settlement price

• Extensively used by the dry cargo, financial and commodity markets

Characteristics of FFA trade

• Counterparties can be anonymous until trade price concluded

• Variable settlement Options to suit specific requirement

• Standardized trade details

• Trades can be bought or sold prior to settlement or expiry

Why an FFA?

• Certainty of freight rate

Lock in your rate, thereby guaranteeing margins

• Ability to react to spot market developments

Exploit favourable freight rate movements

• No restrictions to physical operations

Free to choose ship, ports etc. according to spot requirements

Shipowners Risk

• Concerned about falling rates leading to decreased vessel income.
• He would sell FFA’s as a hedge.

Charterers Risk

• Concerned with rising costs of moving commodities.
• Would buy FFA’s as a hedge.

Time-Charter FFA’s

In the BPI there are 4 T/C Routes:

• 1A-Trans Atlantic r/v
• 2A-Cont / Far East (Trip out)
• 3A-Trans Pacific r/v
• 4-Far East / Cont ( Trip back)

For owners needing a broad market exposure that does not restrict their flexibility, a hedge using the average of the 4 t/c routes fulfills their needs.

Example: Shipowners T/C Hedge

September - current BPI T/C Avg is $11500

An owner knows he has vessels coming open early next year and is worried about securing employment at attractive rates especially over the Christmas & early new year period

He therefore decides to hedge this exposure from Jan to March 2001 by selling the t/c average for this period.

He calls FFA broker, the current market is $11750 bid, $12000 offered. He decides to sell at $11750.

FFA Time Charter Contract:

Buyer: TUV Operator

Seller: XYZ Shipping Corporation

Route: Avg of 4 BPI T/C routes

Price: $11750

Duration: Jan/Feb/March 2001 ‘00- 91 days

Settlement: Average of all index days with monthly settlement.

Results of Hedge

January Average: $11000

Trade Price: $11750

Difference: $750 x 31days = $23250

February Average: $11500

Trade Price: $11750

Difference: $250 x 29 days = $7250

March Average: $12250

Trade Price: $11750

Difference: $500 x 31days = ($15500)

Net Result = $23250 + $7250 - ($15500) $15000 profit

Advantages of FFAs

• Use of FFA’s ‘offsets’ physical fixing levels
• Does not interfere or restrict physical operations.
• Ship owners retain vessel control, allowing them to react to spot market developments.
• Charterers can run more flexible trading strategies.
• Operators can maintain market visibility.
• All parties can be ‘buyers’ and ‘sellers’ depending on their position and market conditions.
• Flexibility
• Security of income.

Disadvantages of FFA’s

• Increased work load- ship still has to be run.
• Terms are unchangeable once an agreement is made.
• Exposure to a company who you do not normally do business with.
• Opportunity cost if price moves against you.
• Basis risk- hedge may not be a perfect fit (e.g. age of vessel hedged, laycans etc).

Shipping derivative products have been created to help the modern day freight company control its shipping risk exposure. The need for control, stable cash-flow and predictability all promote more structured and strategic planning in a rapidly changing world

Freight Derivatives

• Hedging with derivative products provides an additional set of forward rates to those provided by traditional approaches alone.
• Derivative products allow forward price cover to be taken before one knows what exact physical/geographical business requirements your company may have.

Conclusion

• Hedging is not a magic solution.
• Effective hedging decreases market exposure and price volatility.
• To leave an exposure unhedged is to speculate.
• To manage an exposure with an understanding of the derivative tools available will differentiate you and your company from the competition.
• Allows more effective financial planning by creating a flatter landscape.
• Rapid adoption amongst shipping community.