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Risk management in shipping industry

Theory and Practice

Abdulaziz Ashurov

on 6 December 2014

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Transcript of Risk management in shipping industry

(cc) photo by Metro Centric on Flickr
(cc) photo by Franco Folini on Flickr
(cc) photo by Metro Centric on Flickr
Risk Management in the Shipping Industry:
Theory and Practice


Risks come from fluctuatuations in freight rates, bunker prices, vessel prices, interest and exchange rates
Managing voyage costs risk
Add text
Abdulaziz Ashurov





Freight Rate Risk Management
Managing Voyage Costs Risk
Summary and Conclusion

The world bunker market
Bunker price fluctuations using futures contracts
Singapore Exchange - fuel oil futures contaracts. - 1988-2002
The International Petroleum Exchange - 1999
In choosing a petroleum futures contract to cross hedge fluctuations in bunker prices, one needs to consider the futures contract which is the highest correlation. The higher correlation between the bunker prices and futures contract, the more effective hedging exercise.

Alizadeh (2000)
indicate that the IPE gas oil futures miht be best hedging effectiveness (25%) and the hedging performance better in Rotterdam market than Singapore and Houston.
Hedging using OTC products
Role of Risk management has become increasingly
The aim
was to review and discuss types of RM tools to control shipping market risks
Two major risks are changes in freight rates and voyage costs
Non effective BIFFEX led to increase OTC market for FFA and options
Nikos Nomikos & Amir Alizadeh
Focus is to introduce and analyse different derivative instruments related to shipping market to control its risks.
Risk techniques in shipping sector:
a) period time charter contracts and Contracts of Affreighment (COA);
b) Hedging using forward, futures options

Liner shipping sector
Tramp shipping sector
The continuous interaction of demand and supply for shipping services in a nearly competitive market

Less volatile
Freight tariffs in an imperfect market periodically

More volatile
is to review the different RM tools to control the risks associated with operating vessels internationally

Freight Rate Risk Management
Historical development of shipping derivatives markets
Freight Futures market
Forward freight agreement
Options on freight rates
Price discovery role
Edwards and Ma (1992):
Risk management function
Hedging voyage freight risk
Hedging time-charter freight rate risk
Empirical evidence on FFA market
Kavussanos (2001), Batchelor (2002):
Characteristics of FFA contracts
FFA is principal to principal contract
About options
Call option
is a contract which gives its buyer the right, but not obligation, to buy an freight rate from writer of the call option at certain price (strike) at a certain point in time (maturity time)
Hedging example using options
Chicago Board of Trade (1860)
The growth of futures is the reflection of economic
that futures market provide to market agents.
Price discovery and Risk Management
The process of revealing information about current and expected spot prices through futures market
Using hedging to control the spot price risk.
Baltic Freight Index (1985)
A settlement mechanism for the newly established BIFFEX futures contract
Dry cargo freight:
Time charter route, Handysize route, Capesize route
Baltic Panamax Index (BPI) since 1999
BPI is weighted average index of voyage and trip time charter freight rates of seven component shipping routes for
Panamax type vessels
The current expectation of the market about the level of spot prices at those points in the future.
Cost of carry relationship
The price of the futures contract = the current price + total costs
Storable: oil, metal, and other commodities
Non storable: shipping freight
Literature review
Kavussanos and Nomikos (1999)
: Investigate the unbiasedness of hypothesis of BiFFEX prices 1/2/3 months from maturity
Result: 1/2 months - unbiased; 3 month - biased estimates
Kavussanos and Nomikos (1999)
: Investigate the forecasting accurancy of future prices and realised spot prices
Kavussanos and Nomikos (1999)
: Investigate the information about the current spot prices --- future prices tend to discover new information more rapidly than contemporaneous spot prices.
Finally, the information related to futures prices produces more accurate forecasts of the spot prices than competing models.
BIFFEX market contributes to the discovery of new information on current and expected BPI prices
Short / selling
hedge involves selleing futures contract as a protection against an expected decline in freight rates ---
Long / buying
hedge involves selleing futures contract as a protection against an expected decline in freight rates ---
54000 tons of heavy grains from US Gulf to South Japan
Kavussanos and Nomikos (1999):
For establishing a hedged position, a trader has to determine an appropriate hedge ratio -- future market
Ederington (1979):
Minimum variance hedge ratio
Hedge ratio = Ratio of the covariance between spot and future price changes / Unconditional variance of futures price changes
Kavussanos and Nomikos (2000):
a) Estimation of time varying hedge ratios for the underlining shipping routes of the BPI;
b) Evaluation of the effectiveness of these ratios using "historical" and "new " hedging strategies
Effectiveness increased 19.2% for BIFFEX contract;
57.06% for Canadian Interest rate futures;
69,61% for corn futures;
85,69% for soyban futures;
97,91% for SP500;
77,47% for Canadian Stock Index futures
Even the hedgers use BIFFEX contracts, they got minuscule gains .
Low performance of BIFFEX
The poor hedging performance of contract --> Low trading activity in 1996~2000 (146 contracts)
Reduction of using BIFFEX
---> Increase of using
Forward Freight Agreement (FFA)
FFA - a contract between two conterparties to settle a freight rate for a specified quantity of cargo or type of vessel, for one of the major shipping routes in the dry -bulk or tanker markets at a certain date in the future
Australia - Far East trip time-charter
The price discovery in FFA is same: short period is unbiased; long period is biased.
FFAs are to some extent predictable and it seems that multivariate models of spot and forward returns outperform univariate models in short term forecasts (1-10 days ahead) while univariate models perform better for longer horizons (10-20 days ahead)
FFA provide risk reduction against specific shipping routes
FFA position has to be carried over to the maturity of the contract and cannot be closed prior to it
--> Each counterparter is exposed to some element of credit risk in case the other party defaults.
Even so, FFA contracts are supported by shipping industry primarily because of their ability to track fluctuations o individual routes.
Put option
is a contract which gives its buyer the right, but not obligation, to sell an freight rate from writer of the put option at certain price (strike) at a certain point in time (maturity time)
Fuel costs, port chargers, pilotage and canal dues
Bunker fuel - 50% of of total voyage costs
Political and economical events around the world
The aim
- to discuss different techniques methods instruments to shipowners, operators and other agents involved in the bunker market; to ontrol their bunker risks
1. Bunker prices related to the world oil prices as bunker fuel is a low derivative of petroleum.
2. Historical prices indicate large fluctuations and high volatility in bunker prices.
3. The volatility of world oil and bunker markets leaves shipowners, and ship operators in very difficult position
Forward contract
Swap contract
Swap involves no transfer of physical commodity and are settled in cash at the maturity date.
Broker (facilitator) helps to the two counterparties identify each other and to settle swap contract
Option contracts
Methods for managing bunker cost
Futures of bunker is not effective intruments compared to OTC products
There is no studies in the literature on costs and benefits; the hedging effectiveness on different derivative contracts in the bunker market.
Thank you
Prof. Lee, Ki-Hwan
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