1.1 Introduction
Seaborne transport has been the most important form of transportation of goods for centuries.
In the last hundred years, ships have increased spectacularly in both size and efficiency.
Moreover, from being an entrepreneur industry where the captain often was the owner, and only had a few ships at the most, the industry today is characterized by large corporations with wide-ranging vessel fleets.
The shipping sector is one of the world’s most risky and cyclical industries. The freight rates are highly influenced by the overall world economy, as are the bunker prices. Moreover, shipping firms are exposed to foreign exchange and interest rate risks due to the globalization and capital structure of the industry. The latter two risks have had highly liquid derivative markets for a quite some years. In contrast, the freight and bunker risk have been harder to manage. To expand the risk management toolbox, Imarex, an Oslo Stock Exchange listed marketplace for freight and bunker futures, opened in November 2001. This thesis will examine the hedge performances of some of these futures contracts.
But should a firm hedge? This question is frequently debated in the financial risk management theory. Miller and Modigliani argue that a firm should not hedge risk exposure, given some modifying assumptions. They argue that as long as the investor can replicate the hedging strategy the firm cannot add value by managing risk. In practice we see that firms do focus on risk e.g. Grieg Shipping states in their 2008 annual report1: “The group uses various financial derivates to manage its financial market risk. This includes forward contracts, options, interest rate swaps and freight forward agreements (FFA)”. In other words, the assumptions underlying this theory do not hold in practice. However, the assumptions give a direction on where to look for value adding risk management. This thesis will briefly discuss the Miller-Modigliani Theorem and elaborate on how the shipping industry can reduce and manage their risks through Imarex’s futures for freight and bunker fuel.
The thesis investigates the optimal hedge performance for a numerous of freight and bunker oil futures contracts through various strategies for hedging. The findings are compared with results from other futures markets.
1 See http://www.grieg.no/kunder/grieg/griegmma.nsf/lupgraphics/GSG2008web.pdf/$file/GSG2008web.pdf
1.2 Objectives
The goal of this thesis is to investigate the hedge effectiveness of Imarex futures contracts for freight and bunker fuel. Freight and bunker prices are some of the greatest sources for risk to which an agent in the shipping industry is exposed, and therefore natural to consider for hedging. The thesis will look at the hedge performance of Imarex’s contracts on the freight routes PM4TC, P2A, P3A, C4, C7, TD3 and TC2 as well as the bunker contracts for NWE10FO, RMD380FO, SPO380FO, USG30FO and SPO180FO. The thesis will also try to explain why or why not the futures contracts provide good hedge instruments for their underlying prices.
The potential hedge effectiveness of the futures contracts on Imarex has been studied before, however little or no research has been done on the futures bunker contracts. One of the objectives of this thesis is therefore to contribute with empirical studies on the bunker contracts’ potential hedge performance, and provide a cross-hedge analysis to compare with previous studies.
1.3 Parties Involved
This part will present the various parties which are relevant to the thesis. These are: Imarex, NOS, the Baltic Exchange and Platts.
Imarex – The International Maritime Exchange
The International Maritime Exchange ASA (Imarex) is a regulated market for freight derivatives and bunker fuel oil derivatives. It opened for trading the 2nd of November 2001, is publicly listed on the Oslo Stock Exchange, and is regulated by Finanstilsynet (the Financial Supervisory Authority of Norway)2
NOS – Norsk Oppgjørssentral
NOS (Norsk Oppgjørssentral) is the leading clearing house for freight markets and a specialist clearing provider to the commodities market. It is the clearing house for all Imarex derivatives. NOS merged with Imarex on the 1st of September 2006. Since 2001, NOS has invested significant resources in building a cleared ship freight derivatives market. It has also expanded into clearing service in the emerging seafood market, as well as launched a clearing service for the combined Nordic and German power markets.
The Baltic Exchange
The Baltic Exchange is the only independent source of maritime market information for trading and settling physical and derivative contracts3. It provides underlying indices for Imarex’s futures contracts. Today, the Baltic Exchange focuses on providing freight market information, dispute resolution and a light regulatory framework for the shipping market4. Platts
Platts is a leading provider of energy and metals information5. They serve as a provider of the underlying indices for Imarex’s bunker fuel oil derivatives. The company is headquartered in New York, but has offices all over the world, such as in Singapore, London and Huston. Platts is a division of The McGraw-Hill Companies listed on the New York Stock Exchange (NYSE).
2 Source: http://www.exchange.imarex.com/about-us/
3 For a complete history and more information on The Baltic Exchange, please see www.balticexchange.com .
4 Source: http://www.balticexchange.com/default.asp?action=article&ID=395
5 See the company’s webpage for further information. http://www.platts.com/AboutPlattsHome.aspx.
1.4 Outline
Chapter two describes the shipping market in general and divides the market into four sub-markets; the freight market, sale and purchase market, newbuildings market and the
demolition market. The chapter also gives a brief description of the dry-bulk, tank and bunker markets in more detail. Finally the chapter introduces a supply and demand model for
shipping freight. Moreover, it discusses the key risks in shipping and gives a detailed description of the various futures contracts used in this thesis.
The third chapter gives a fundamental introduction to the theory of risk management. First, the question of why firms hedge is discussed in light of the shipping market. Second, the theory on price formation in the forward and futures markets is discussed in detail,
emphasizing the non-existence of the cost-of-carry relationship for freight rates. Third, the chapter explains how conventional and time-varying hedge ratios are calculated using OLS regression and Exponential Weighted Moving Average (EWMA) estimations. Finally, the chapter gives a literature review on research which has focused on the hedge efficiency in the freight and bunker markets.
The fourth chapter discusses the data series used in the thesis. First, descriptive statistics are presented to describe the nature of the sample. Second, discussions are made on how to splice the futures data series into a continuous series. Third, the consequence of choices of sampling intervals is analyzed and the seasonality in the data is discussed. Finally, the chapter discusses the choice of monthly, quarterly or yearly contracts and the arithmetic average properties of the futures contracts.
The fifth chapter presents the results from the study. The chapter is divided into A and B, analyzing the freight and bunker market respectively, starting with an analysis of the in-sample results followed by an out-of-in-sample comparison. The chapter also tries to answer why the hedge efficiency is lower for non-storable goods. The bunker analysis also provides a cross-hedge analysis using futures contracts traded out-side of Imarex.
Chapter six is the conclusion and seven presents a bibliography.