Minimising Risk Through Bunker Hedging
- 1. !! """#$%&'()"*)+,#-*. HISTORICALLY, manyin the industry have argued that a bunker adjustment factor (fuel surcharge) is the ideal way to mitigate one’s exposure to bunker fuel prices. However, in recent years, industry best practices have evolved and a new consensus is forming which says that shipping companies must take their own proactive steps to manage their exposure to volatile bunker fuel prices, as bunker adjustments rarely eliminate a company’s entire exposure to bunker prices. There’s no question that management teams and investors alike detest the idea of having to commit staff and capital to managing fuel price risk, which is understandable. AS THE GLOBAL OIL MARKETS CONTINUE TO EVOLVE, THE QUESTION OF WHETHER OR NOT TO HEDGE CONTINUES TO CHALLENGE COMPANIES THROUGHOUT THE SHIPPING INDUSTRY.
- 2. !"!"#$%&'!"((%)*#©istockphoto.com/Pgiam & OlivierLantzendörffer !""#$%&"'()*&+"$,"-.&"/(012&)"312" 4)&,$2&1-"(/"#&)53-0,"61&)7+"829$,(),:" 31"&1&)7+".&27$17"312")$,%";3137&;&1-" <<<=;&)53-0,&1&)7+=5(; However, given that bunker prices account for such a large percentage of most companies’ operational costs, not managing this risk is simply no longer an option. The key to developing, implementing and managing a successful bunker- hedging programme is utilising strategies that perform well in high, moderate and low-price environments. This typically means making use of a combination of instruments, including swaps, call options and collars, among others. In our firm’s daily discussions with companies across the globe, there are several key aspects of bunker fuel hedging that we tend to emphasise because they are often overlooked or misunderstood by many in the industry: hedging strategies are crucial. There are significant differences in the various hedging instruments available to bunker fuel prices, differences that are often overlooked by many companies, especially as these relate to basis, credit and operational risk. the industry term for complex hedging strategies, often involve the sale of options, either direct or indirect, which can lead to a disaster if the structures are not completely understood by the management team. must “stress test” their hedge portfolio on a regular basis so that the performance of their individual hedge positions, as well as the entire portfolio, are well understood in all potential price environments. These tests should not only include price (market) risk, but basis, credit and operational risk as well. Shipping companies should not solely depend on their bunker suppliers, banks or trading counterparts to provide them with potential hedging strategies. Bunker suppliers, banks and trading companies who provide their customers with hedging instruments most often take the opposite side of their customer’s hedges, which means that the parties’ best interests is their own, not that of their customer. Simply accepting the exact hedging structure suggested by these parties’ is often not in the shipping company’s best interest. When a company makes the decision to develop a bunker fuel hedging programme, one of the main challenges is identifying the potential hedging strategies that will allow the company to meet its business objectives. The first step in developing a sound bunker fuel-hedging programme should be to determine the company’s risk tolerance as well as its hedging goals and objectives. More specifically, what is the company seeking to accomplish by implementing a hedging programme? Is it to reduce cash flow volatility? To ensure that bunker fuel expenses do not exceed budget? To potentially obtain an advantage over competitors who do net hedge their exposure to bunker fuel prices? Only after answering these questions, as well as many related questions, should a company begin to discuss what hedging strategies might be appropriate for the company. In addition, there are a number of common hedging mistakes that companies should seek to avoid at all costs. First, it is crucial to remember that hedging should not be intended as a potential source of revenue. A well-designed hedging programme should provide cash flow certainty, budget certainty, and the ability to lock in profit margins and/ or protection against potentially rising bunker fuel prices. If a company initiates a hedging programme with the primary goal of generating revenue, it is no longer hedging or managing risk, it is speculating on bunker fuel prices. The vast majority of hedging mistakes are the result of a poor or nonexistent bunker fuel hedging policy or failing to abide to the policy. Most hedging mistakes can be avoided if the company takes the time and effort to create a proper hedging policy and to develop and implement strategies that will allow it to meet its hedging goals and objectives. The shipping industry has always been a volatile and cyclical industry and the future is likely to present the industry with even more challenges. While many of these challenges are still unknown at this time, we can be almost certain that bunker fuel prices will remain volatile for the foreseeable future. In this light, shipping companies will be well served to develop and implement bunker fuel hedging programmes to ensure they are doing everything possible to mitigate their exposure to volatile bunker fuel prices. Clearly,developing,implementing and managing an effective bunker fuel-hedging programme requires a significant amount of time and expertise. Implementing bunker fuel hedging without the required expertise can quickly turn into a nightmare of epic proportions, as evidenced by the failed hedging initiatives of numerous companies. If your company does not have the in-house resources to properly carry out all required functions, it is highly recommended that you engage experts, who do have the necessary expertise, to assist you. guestfeature THE VAST MAJORITY OF HEDGING MISTAKES ARE THE RESULT OF A POOR OR NONEXISTENT BUNKER FUEL HEDGING POLICY