2. Shipping
2.4 Key Risks in Shipping
This thesis will focus on key risks in shipping, with special focus on risks related to freight and bunker prices, as these are regarded as the most important factors in the shipping industry.
Moreover, the existence of derivatives for these prices on Imarex makes it interesting to study how well they work for hedging these risks.
However, although freight and bunker risks are the most prevalent risks in shipping, they are not the only ones by far. In addition to several others, important ones to mention are interest rate risks, currency (exchange rate) risks and vessel value risks. Table 5 summarizes the different risks that might be considered as the most important ones, as well as the different derivatives available for hedging these risks.
Table 5 Key Risks in Shipping with Respective Risk Management Tools
Table 5 shows the different derivatives available for the different underlying risks as of April 2010.
The table is a summary of the derivatives mentioned available for the risks as mentioned in Kavussanos & Visvikis (2006b).
Vessel value risks are the risks related to new ship prices, sales and purchase (second hand prices for ships) as well as scrapping-prices (demolition). As mentioned earlier in Section 2.1.2, Stopford (2008, p. 110) argues that the market for new ships and second hand ships are highly synchronized, whereas the price for scrapping is correlated with steel prices.
Kavussanos & Visvikis (2006b, p. 308) report that “It is argued that because vessels are the main asset which shipowners hold in order to provide their freight service to the market, and since the sums involved in holding these assets are the largest item in the shipowner‟s cash-flow, changes in their values can make all the difference in terms of ending up with a profit or loss from their investments in the shipping sector.” This illustrates the importance of the prices of both new and old ships, as well as scrapping prices, for a shipowner. There are no derivatives available today for hedging new ship prices, although purchasing contracts for new ships often include real options for additional ships. For hedging second hand prices for vessels however, one derivative is available through the Baltic Exchange, namely the Sales &
Purchase Forward Agreement. This is an OTC forward contract which covers both the dry-bulk and the tanker markets, and is settled against the Baltic Sale and Purchase Assessment (BSPA). The BSPA is an assessment made by ten panelists on five-year old vessels.
The Baltic Exchange also offers a Baltic Demolition Assessment, which may be used for hedging exposure to scrap prices. This is an assessment on the demolition values of bulk carriers and tankers. For interested readers, please see Kavussanos & Visvikis (2006b) chapter 5 for more information.
The shipping industry is a global industry, meaning that an agent in the industry will probably have to face different currencies in his day-to-day operations, i.e. he is exposed to currency risks. An example could be a ship owner who has to pay management costs in Norwegian kroner, but has revenues fixed in U.S. dollars. This means that the ship owner is exposed to fluctuations in the USD/NOK exchange rate. Table 6 shows a selection of exchange rates, and how they have fluctuated in the past. Notice the great variation in exchange rates in the NOK/USD and the EUR/USD, with respectively 15% and 12% annual standard deviations.
Also note that the price for one dollar, measured in Euros, has varied from 0.827 to 1.601 since 2000. These numbers illustrate the potential currency risks an unhedged agent would be exposed to.
Table 6 Statistics on Currencies
NOK/USD EUR/USD RMD/USD GBP/USD
Average 6.99 1.19 7.86 1.70
Minimum 4.94 0.82 6.78 1.37
Maximum 9.58 1.60 8.28 2.11
Annual std.dev 0.15 0.12 0.023 0.12
Table 6 shows exchange rates from January 3rd 2000 to April 16th 2010 (from July 22nd 2005 for RMD/USD). Averages, minimums and maximum values are calculated from level form, while the standard deviations are based on simple returns. Source: federalreserve.gov.
The shipping industry is by far not the only industry subject to currency risks, and it is therefore not surprising that a wide range of derivatives is available for hedging them. Swaps, options, forwards, futures and hedging through the money markets are some of the derivatives available to agents in the shipping industry. Interested readers should explore Kavussanos &
Visvikis (2006b) chapter 6 for further reading on currency risks and hedging in shipping. An excellent non shipping approach on hedging currency risk may be found in Kolb & Overdahl (2010).
Ships are very capital intensive, and it is therefore not uncommon that the leverage of a vessel is 80-90% of its total value24. Shipowners are therefore highly sensitive to changes in the interest rates on these loans. Changes in the interest rates on any loans will therefore tend to have a significant effect on the cash flows of a shipping company. As with currency risks, there exists a wide variety of derivatives, available through different sources (financial institutions and exchanges), which may be used for hedging purposes. Kavussanos &
24 See Kavussanos & Visvikis (2006b, p. 339)
Visvikis (2006b) cover this risk parameter in chapter 7. For a non-shipping approach, please see Kolb & Overdahl (2010) chapter 10.
The risks mentioned above are not a complete list of the risks involved in shipping. Political events, such as wars or trade barriers, or natural crises, such as tsunamis or hurricanes, are just some of the many factors which affect an agent in the shipping industry, bringing even more uncertainty to perhaps the most volatile industry in the world
This thesis will not explore these risks any further, but any agent in the shipping industry looking to hedge exposures would do well to look into these, as well as the risks on which the thesis focuses.