Transcript No Slide Title

Developments in Freight
Derivatives and Shipping
Risk Management
Nikos Nomikos
Cass Business School
Current Developments in Shipping Markets
• Freight as a new commodity
• High volatility in the shipping markets
•
Sharp fluctuations and sudden changes in the market
• Emergence and growth of a paper market on
Shipping Freight
•
More extensive use of risk management techniques
and instruments
• Entrance of new players in the shipping markets
•
trading houses and energy companies as well as
investment banks and hedge funds
Fundamentals of the Bulk Shipping
Markets
• Freight rates reflect the cost of transporting
bulk commodities by sea across different parts
of the world
• Market Segmentation
•
Across Type of Commodity
•
•
•
Wet Market: Transportation of Crude Oil and Oil products
Dry Market: Dry Bulk Commodities – Grains and agricultural,
Coal, Iron Ore etc.
Across Sizes
•
Commodities are transported in different sizes according to
their Parcel Size Distribution Function
Dirty Tanker Index
Clean Tanker Index
04/01/2006
04/11/2005
04/09/2005
04/07/2005
04/05/2005
04/03/2005
04/01/2005
04/11/2004
04/09/2004
04/07/2004
04/05/2004
04/03/2004
04/01/2004
04/11/2003
04/09/2003
04/07/2003
04/05/2003
04/03/2003
04/01/2003
04/11/2002
04/09/2002
04/07/2002
04/05/2002
04/03/2002
04/01/2002
04/11/2001
04/09/2001
04/07/2001
04/05/2001
04/03/2001
04/01/2001
04/11/2000
04/09/2000
04/07/2000
04/05/2000
04/03/2000
04/01/2000
Index points
Freight Market Volatility - Baltic Tanker Indices
3500
3000
2500
2000
1500
1000
500
0
Panamax (70k dwt)
Capesizes (150k dwt)
Supramax (52k+ dwt)
04/01/2006
04/11/2005
04/09/2005
04/07/2005
04/05/2005
04/03/2005
04/01/2005
04/11/2004
04/09/2004
04/07/2004
04/05/2004
04/03/2004
04/01/2004
04/11/2003
04/09/2003
04/07/2003
04/05/2003
04/03/2003
04/01/2003
04/11/2002
04/09/2002
04/07/2002
04/05/2002
04/03/2002
04/01/2002
04/11/2001
04/09/2001
04/07/2001
04/05/2001
04/03/2001
04/01/2001
04/11/2000
04/09/2000
Index points
Freight Market Volatility - Baltic Dry Indices
10,000.00
9,000.00
8,000.00
7,000.00
6,000.00
5,000.00
4,000.00
3,000.00
2,000.00
1,000.00
0.00
Freight Rate Formation in the Physical Market
Demand
Spot freight rates are determined through the interaction of supply and
demand for shipping services at any point in time
•
The demand for sea transportation is a derived demand,
which depends on world economic activity and
international trade



Supply
•
The world economic activity
Seaborne commodity trade
Average haul


Political events
Transportation cost
The supply of shipping services is the amount (ton-miles) of
transportation service offered by shipowners’ fleet based on
the optimisation of their revenue
 Stock of the fleet
 Shipbuilding production
 Scrapping and losses


Fleet productivity
Freight rates
Freight Rate Formation
Spot freight rate determination through interaction between supply and demand
curves for shipping services
FR
demand
new demand
supply
ton-miles
150k mt Coal RichardsBay to Rotterdam
150k mt Coal Bolivar to Rotterdam
06/01/2006
28/10/2005
26/08/2005
27/06/2005
15.3 $/ton
decrease (51%)
over 3 months
22/04/2005
17/02/2005
09/12/2004
5
08/10/2004
06/08/2004
30
07/06/2004
31/03/2004
29/01/2004
20/11/2003
19/09/2003
18/07/2003
16/05/2003
12/03/2003
09/01/2003
20
31/10/2002
30/08/2002
28/06/2002
24/04/2002
19/02/2002
12/12/2001
11/10/2001
09/08/2001
08/06/2001
03/04/2001
31/01/2001
27/11/2000
26/09/2000
25/07/2000
23/05/2000
17/03/2000
17/01/2000
08/11/1999
07/09/1999
06/07/1999
04/05/1999
Date
US$/ton
Freight Market Volatility – Coal Routes
35
Apr-05: 24$/ton
25
16.13 $/ton
increase
(135%) over
1.5 months
15
10
Aug-05: 9.2$/ton
0
Risk management options in shipping
Option A:
Do nothing & fix spot
High risk /
Unpredictable
Option B:
Timecharter, COA or long
term management
Inflexible /
inefficient pricing
Option C:
Hedge with FFA and
use profit / loss to
pay for spot physical
deal
Opportunities to
cover requirements,
quickly fixed and
flexible to allow you
to alter your position
should it change
Forward Freight Agreements (FFAs)
“An agreement made between a buyer and seller to settle the
difference between a freight rate agreed today and the future
price of the freight rate on a specific voyage”
•
Cash settled
•
Standardised contracts and lot sizes – opportunity to close out
positions quickly & easily
•
Suitable for hedgers– ability to take significant cover quickly
and simply
•
Flexible periods
•
Tradable on different routes and vessels
•
Over The Counter and Cleared markets
•
Cleared market is “OTC Cleared” i.e. not exchange listed
•
Anonymous, rapid and cost effective execution
Forward Freight Agreements – Underlying
Routes
• Dry Market
•
•
•
Baltic Capesize Index (BCI) (150,000+ dwt)
Baltic Panamax Index (BPI) (70,000+ dwt)
Baltic Supramax Index (BSI) (52,000+dwt)
• Wet Market
•
•
•
•
Baltic Tanker Index (Dirty and Clean)
Baltic LPG Index (44,000cbm)
Platts Assessments
Arithmetic average taken of worldwide shipping panel &
published at 1300pm GMT
Baltic Capesize Index (BCI)
Route
Number
C2
C3
C4
C5
C7
C8
C9
C10
C11
C12
•
•
Description
160,000lt Iron Ore
150,000mt Iron Ore
150,000mt Coal
150,000mt Iron Ore
150,000mt Coal
Trip-charter
Trip-charter
Trip-charter
Trip-charter
150,000mt DWT Coal
Tubarao to Rotterdam
Tubarao to Beilun & Boashun
Richards Bay to Rotterdam
W Australia to Beilun - Baoshan
Bolivar to Rotterdam
Trans-Atlantic Round Voyage (Cont-US-Cont)
Europe to Far East
Trans-Pacific Round Voyage (China-Aus-China)
Far East to Europe
Gladstone / Rotterdam
Routes 8 to 11 are based on a standard 172,000 mt dwt “Baltic
Capesize” vessel with certain clearly defined performance measures
FFAs can be traded against any of these individual routes or against
the averages of Routes 8 to 11
•
Most trades concentrate on C4, C7 and the average of C8-C11
Baltic Dirty Tanker Index (BDTI)
Route
TD1
TD2
TD3
TD4
TD5
TD6
TD7
TD8
TD9
TD10D
TD11
TD12
TD14
TD15
TD16
•
280,000mt
260,000mt
260,000mt
260,000mt
130,000mt
130,000mt
80,000mt
80,000mt
70,000mt
50,000mt
80,000mt
55,000mt
80,000mt
260,000mt
30,000mt
Route description
PG to US Gulf
PG to Singapore
PG to Japan
West Africa to US Gulf
West Africa to USAC
Black Sea / Mediterranean
North Sea to Continent
Kuwait to Singapore
Caribbean to US Gulf
Caribbean to USAC (DH)
Cross Mediterranean
ARA to US Gulf
SE Asia to EC Australia
West Africa to China
Black Sea to Med
Indicative Route
Ras Tanura to LOOP
Ras Tanura to Singapore
Ras Tanura to Chiba
Bonny to LOOP
Bonny to Philadelphia
Novorossiysk to Augusta
Sullom Voe to Wilhelmshaven
Mena al Ahmadi to Singapore
Puerto la Cruz to Corpus Christi
Aruba to New York
Banias to Lavera
Antwerp to Houston
Seria to Sydney
Bonny to Ninqbo
Odessa to Augusta
Most trades concentrate on TD3, TD4, TD5, TD7 and TD8
FFA Trading in the OTC market - Practicalities
Broker establishes trading interest and obtains a firm ‘Bid’
and ‘Offer’
Full trade confirmation agreed verbally with both
counterparts.
Recap of trade issued detailing main terms.
Full contract issued for signing. Original kept by broker
On settlement day, the settlement price is calculated and a
settlement statement is issued.
Settlement funds paid no later than 5 London banking days
after each settlement date
FFA Trading in the OTC Market - Practicalities
•
OTC FFAs are traded through a network of specialist FFA brokers.
The brokers are members of the Forward Freight Agreement
Brokers Association (FFABA)
•
Contract used is either FFABA or ISDA® contract
•
Counterparties can be anonymous until just before trade terms are
concluded
•
Hedges can be offset prior to expiry
•
Settlement is between the counterparties in cash within five days
following the settlement date.
•
The broker, acting as an intermediary only, is not responsible for
the performance of the contract. Typically, brokers get commission
of 0.25% from each party on the fixed (or expected) freight rate but
that may differ between contracts
FFA Volume in the OTC Market
Number of lots traded in FFA market
1600000
Notional Market
wet
Value (dry) 05
1400000
dry
1200000
Cape: $8bn
1000000
Pmx: $15bn
Supra: $5bn
800000
600000
Coal: 500m tons
400000
200000
Wet: $8bn
0
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006e
Source: FIS
Spot
1-Month
2-Month
22/02/2006
08/02/2006
25/01/2006
11/01/2006
28/12/2005
14/12/2005
30/11/2005
16/11/2005
02/11/2005
19/10/2005
05/10/2005
21/09/2005
07/09/2005
24/08/2005
10/08/2005
27/07/2005
13/07/2005
29/06/2005
15/06/2005
01/06/2005
18/05/2005
04/05/2005
20/04/2005
06/04/2005
23/03/2005
09/03/2005
23/02/2005
09/02/2005
26/01/2005
12/01/2005
29/12/2004
15/12/2004
01/12/2004
17/11/2004
03/11/2004
20/10/2004
06/10/2004
22/09/2004
08/09/2004
$/ton
Spot, 1 and 2-Month BFA on BCI C4
35
30
25
20
15
10
5
Uses of FFAs
• Hedging
• Cargo owners (power utilities, oil companies) are
buyers of FFAs
• Market information
• Forward curves
• Speculation
• FFAs give the possibility to profit from falling freight
markets
• Enhanced trading opportunities
• Arbitrage trades (e.g. API2 vs API4)
• Spread trades (TD3 vs TD5, Cape vs Panamax)
• Collateral in ship finance transactions
Uses of FFAs: Tanker Hedging
•
It is early April 2001, and TD7 (80,000mt North Sea to Continent) is
trading at WS 125 for June.
•
An energy trading company is worried that freight rates will increase
over the following 12 weeks, and decides to use FFAs to cover this
risk. The company thus buys 80 TD7 June 2001 contracts @ WS
125 (each contract being for 1,000 tons)
•
At the end of June, the settlement price is WS 156.15 (calculated as
the average of TD7 freight rate assessments over June)
•
The charterer will incur higher freight rates in the physical market,
but, at the same time, he has made a profit in the FFA market:
•
Net WS = 156.15 – 125 = WS31.15
•
Settlement = Contracts x Lot Size x Flat Rate x net WS
= 80 x 1,000mt x $4.30/mt x 31.15% = $107,156
Uses of FFAs: Forward Curves
• Forward curve is a ’snapshot’ of current market
forward price expectations.
• An implied market forecast – based on all market
participants
• A method of comparing FFA opportunities against
physical options.
• Used for position and portfolio valuations.
• In all, a key tool for freight market users
Forward curves: Dry
Spot prices vs forward curve
Cape T/C
50000
Cape FFA curve
45000
Pmx T/C
Pmx FFA curve
40000
Supra T/C Avg
Supra FFA curve
30000
25000
20000
15000
2008
2008
2008
2008
2008
2008
q34 07
q34 07
q12 07
q12 07
q12 07
q4 06
q4 06
q3 06
q3 06
q3 06
Jun-06
May-06
May-06
May-06
Apr-06
Apr-06
Source: FIS
Mar-06
Mar-06
Mar-06
10000
Mar-06
$ / day
35000
Forward curves: Tankers
Spot Prices vs Forward Curve
350
TD3: AG -East
300
TD7: North Sea to Continent
TD3 - FFA
250
TD7 - FFA
200
150
100
50
Ja
n03
M
ar
-0
M 3
ay
-0
3
Ju
l-0
3
Se
p03
N
ov
-0
3
Ja
n04
M
ar
-0
M 4
ay
-0
4
Ju
l-0
4
Se
p04
N
ov
-0
4
Ja
n05
M
ar
-0
M 5
ay
-0
5
Ju
l-0
5
Se
p05
N
ov
-0
5
Ja
n06
M
ar
-0
M 6
ay
-0
6
Ju
l-0
6
Se
p06
0
Source: IMAREX
20
03
20 07
03
20 08
03
20 09
03
20 10
03
20 11
03
20 12
04
20 01
04
20 02
04
20 03
04
20 04
04
20 05
04
20 06
04
20 07
04
20 08
04
20 09
04
20 10
04
20 11
04
20 12
05
20 01
05
20 02
05
20 03
05
20 04
05
20 05
05
20 06
05
20 07
05
20 08
05
20 09
05
20 10
05
20 11
05
20 12
06
-0
1
35
Forward Curves: RBay – Rdam Coal Route
30
25
20
15
10
5
0
BCI 4
Sep-04
Source: Baltic Exchange
Oct-04
Nov-04
Dec-04
Apr-05
May-05
Jun-05
Jul-05
Uses of FFAs: Trading Opportunities
• Good liquidity in FFAs – position tradability- ‘buy’
and ‘sell’
• High volatility – position taking opportunities
• Easier to trade than physical
• More trading players than physical
•
Investment banks, trading houses, hedge funds
• Physical Asset Swaps – Diversification
• Spread Trades
•
•
•
Inter route spread, e.g. C4 v C7, TD3 v TD5
Inter month spread, e.g. 3rd Q06 v 4th Q06
Inter-size spread, e.g. P-4TC v C-4TC
FFAs: What are the risks?
- Credit Risk (Netting Clause)
- Volatility of market
- Limited forward period
-
Usually up to 2-4 years
- Hedging and speculation are different approaches
- Basis risk
- Liquidity risk
- Overall, less risky than
physical market
Credit Risk in the Freight Derivatives Market
• Credit risk is particularly relevant for the shipping
derivatives market since most of the paper trades are
done on a principal to principal basis
• Trading cleared contracts
•
IMAREX with NOS in Oslo offer cleared FFAs and Options
•
London Clearing House, NYMEX and Singapore Exchange also
provide clearing services
• Cleared FFAs provide protection against counterparty
default, however
•
Margin requirement and initial deposits tie-up a lot of capital
•
Margining and marking to market may create a cash-flow
mismatch between the paper and physical markets
Imarex – Tanker Margin Curves
FFAs – Future Trends
• The market has grown sharply following deregulation and
liberalisation in the European Energy market as energy and
other traders seek to manage freight risk
• Recent high volatility in the market has also attracted interest
from investors outside shipping such as hedge funds
• Credit Risk and Clearing
•
Clearing will also attract new players in the markets as it also
facilitates and speeds up negotiations
• Electronic Trading
• Emergence of Freight Options
•
•
•
Asian Options on Freight Rate
Create opportunities for asset owners
Pricing and risk management issues
Conclusions
• Freight as a new commodity
• High volatility in the shipping markets
• Growth of a paper market on Shipping Freight
•
•
More extensive use of risk management techniques
and instruments
Concerns regarding credit risk
• Entrance of new players in the shipping markets
•
trading houses and energy companies as well as
investment banks and hedge funds