Volume 3, issue #11 - 03-04-1998

Feb. 24, 1998 Paper trading has increased dramatically onto the freight market over recent years, as the shipping industry has started to recognise the potential for minimising risk and improving profit margins through the use of increasingly sophisticated financial mechanisms.
It is now the turn of the tanker freight market to try to emulate the dry cargo freight derivatives success which has reached an annual world-wide turnover of $ 1 bn.
In an attempt to make tanker freight rates more accessible and transparent, the Baltic Exchange will soon publish 5 tanker route assessments on a daily basis. However, the driving force behind the latest Baltic Exchange project came from London-based shipbrokers Simpson, Spence and Young.
John Banaszkiewicz, SSY Futures manager, was keen to realise months of research concerning the volatility, liquidity and profit instability of tanker freight rates into a transparent route assessment scheme which would help all aspects of the tanker industry make more informed decisions.
Five routes were initially chosen and several months of trials were undertaken to ensure the accuracy of panellists' contributions had taken place before the Baltic Exchange took over.
"The tanker industry is probably one of the last to adopt some sort of forward price discovery of forward oil freight rates. It was within the interests of the industry to create it. Not just from the derivative angle but also for the industry, which is a secretive business, to have a forward price as a reference," said Mr Banaszkiewicz.
However, SSY realised that they needed the Baltic Exchange to prove that the rates were provided independently by an approved panel from an impartial and already internationally respected mediator.
Now that the ground work has been laid, SSY hopes that not only will the industry use the rates as benchmarks but will also utilise the potentially vast paper related market.
Despite its eagerness to promote tanker freight derivatives and plenty of apparent interest, the SSY team is unsure of the real potential of this venture.
However, with the paper market for oil three times the size of the physical market, the brokers have looked at the 1.4 bn tonnes of crude oil transported via seaborne trade annually and commented that the five route assessments to be published by the Baltic Exchange represent 25 % of that business.
With this in mind, SSY director, Colin Cridland said: "If we are not able to be twice as big as the dry cargo market in half the time, I would be surprised."
Potential players have been identified as those in need of risk management such as refiners, owners, traders and those institutions who do not want a physical position exposure but want to trade paper, such as banks.
"We can capitalise on a lot of the dry cargo success where the buzz word is derivatives, but it's already an industry well versed in derivatives," said Mr Banaszkiewicz.
As it exploits the success of the dry cargo market, the team hopes that its ideas will be more readily received, and suggested that with oil prices falling, freight could become a more important factor in the oil world in the not too distant future.
"At present, oil freight prices constitute 5 % to 9 % of the overall commodity cost compared with grain at 15 % and coal at 25 %. Therefore exposure to a hedge is reduced. But we do have volatile price swings, with freight the catalyst," said Mr Banaszkiewicz.
"People who think that oil freight volatility is very low are wrong. We've seen, particularly in the Asian crisis, crude oil tanker freight rates drop from a peak of W110 in November '97, to today's average of W67," he added.
He explained that, in the space of two months, the freight price from the Persian Gulf to Far East had dropped from $ 3 mm gross income to $ 1.88 mm, with the income of a VLCC having dropped from $ 42,400 to $ 26,000 daily.
He believed that freight would become a more important factor of the overall cost of oil, alluding especially to the recent drop in the Brent crude oil prices which had made freight a bigger portion of the risk. This, he said, was particularly the case when margins were weak and the fact that oil prices were forecast to drop even further.
By late autumn the SSY team would not be surprised if Brent fell to $ 12 a barrel. This slump would have been precipitated by the hiatus in the east, significant increases in world-wide production, and a continuation of projects seen in the North Sea. Oil companies which have performed consistently well over several years have realised that oil is their only asset and will therefore continue to pump it to the surface.
As a result prices are expected to fall, stockpiling to occur, and more oil to be sold in order to maintain profit levels. However, one of the benefits of low oil prices would be a faster recovery in Southeast Asia.
This acknowledged, and with declining margins for some oil companies, more effective management of freight risk will be inevitable.
"The shipping market is becoming much more sophisticated. Investment managers and shareholders want greater security. They do not just want to see the ships their company own or manage merely playing the spot market. More sophisticated tools for better security are very important especially for public listed companies," said Mr Cridland.
But there is plenty more hard work in store before the success of tanker freight derivatives can even be discussed. The SSY team intends to work hard promoting the benefits of tanker rate derivatives in a language everyone can understand.
To this end, Andrew Elmslie has joined the workforce and his job is to reduce tanker owners' resistance into trying something new, to ensure they understand the benefits and value to their trading as a whole. Once this is accomplished, tanker freight derivative trading is expected to soar.
After forward freight agreement trading on the initial five tanker routes published by the Baltic Exchange becomes established, the SSY team envisages more routes being added to the assessment list.
In particular, it sees a huge potential for products tankers and trades, and has already earmarked the most important routes for the industry.
However, at present, the SSY team rules out the possibility of the generation of an index from these routes. This, it admits could prove a stumbling block towards complete transparency of forward markets, but so it said, could an index.
"With an index there is a danger of distorting the picture. You have to constantly reassess. The tanker market is constantly changing. Through market driven fluctuations the market is constantly restructuring," explained Mr Cridland.
Despite this, SSY feels confident that there is a need for shipping and oil companies to adopt these types of products in order to increase the liquidity and transparency of the industry.
Should the project bear fruit, success is expected to emerge a lot faster than the five years it took on the dry cargo freight paper. "At the early stages we can utilise more sophisticated products that have been used and seen elsewhere. Within this market we can take advantage of all other developments and products that exist in the market and apply them specifically to the shipping market," said Mr Cridland.
However, until widescale acceptance of this new market is achieved, the SSY team hopes that the first hurdle of the first tanker freight derivative trade based on the Baltic routes will take place soon.