World Bunkering > News > Autumn 2009 > Time to get sophisticated

The risk management market has seen some dramatic changes over the last year. According to Jan Knudsen, Executive Sales Director at Global Risk Management, business grew rapidly up until the middle of 2008. It had doubled in size from 2007, and that in turn had doubled since 2006. “Unfortunately, that growth rate of over 100% died on the day the world markets started to decline,” says Knudsen. “Companies went from looking at risk management to looking at core survival. People were being met with huge demands for margin calls, and at the same time, liquidity was very hard to secure, as banks cut back drastically on their lending. This scared a lot of customers away.” In addition, reports about falling oil prices encouraged some buyers not to hedge in the expectation that prices would fall still further.

However, rising oil prices and the prospect of economic recovery are taking effect. “From February this year, people have been coming back to the idea of hedging,” says Knudsen. We’re now back almost to pre-crisis volumes, but we certainly won’t be seeing 100% growth this year. There are still some customers that do not seem to have been affected too much by the financial crisis, in particular ferry lines and cruise lines, where business continued as normal. On the whole, though, people are starting to believe that the market will recover, and to look to the future.”

While many firms did continue with hedging strategies during the last year, Morten Dehn, general manager risk management at OW Bunker, says that many of them altered their strategies – and not necessarily in a way that was helpful: “Risk management strategies have changed significantly over the past year. For a start, many companies are hedging on a month-to-month basis, which really defeats the whole point of hedging, as to be truly effective it should be conducted on at least a medium term basis of more than six months.” “This has led to many companies actually speculating rather than hedging, where they are not taking an opposite position as a means of off-setting their risk exposure, and in reality are guessing at where the market is heading.”

“The uncertainly in the market is clearly driving this trend of short-termism where there is a real fear that the customers of the shipping companies might default. However, longer term hedging will come back as the markets improve.”

The approach that shipowners take will change, he predicts: “[OW Bunkers] believe that for the foreseeable future, companies engaged in hedging will have a clear interest in showing conservatism rather than using it as speculative process. For this reason we believe that we will see a revival of physical hedging, where you actually buy your product on a forward basis.” However, he also points out that a range of strategies are needed to ensure a successful result.

More sophistication needed

Simply ensuring that policies are focussed on hedging rather than speculation is not enough to ensure a successful policy, however. Simplistic or short-term solutions can create more problems than they solve, says Knudsen: “Shipowners are not aware of the full range of opportunities that are available to them. They might know about some, or even most of the tools available, but they often like to keep things as simple as possible, and as a result, their hedging strategies may not be customised enough. They may well end up locked into a certain price contract, whereas there are a lot of tools that let you keep flexibility. Most of the obvious tools tend to lock you in pretty tight. If you compare the situation with that in the airline industry, airlines are much more sophisticated about managing risk, and much more focussed on maintaining that flexibility.

“The problem is that shipowners try to beat the bunker price, but they need to take a step back and look at the commercial and operational risks as well. Often, they are looking to achieve security by opting for a fixed bunker price, but this is not always the right option if their income is not fixed. You have to take the income side into consideration.”

Counterparty risks

Fluctuating income, in particular as a result of defaulting customers, is an increasing problem for those in charge of risk management strategies. “I feel very sad when I hear about companies losing money where they have locked in their costs on a certain freight contract, and then they run into a contract default. They’ve done exactly the right thing, but you cannot build a hedging strategy on contract defaults. You should, however, always ensure that there is sufficient collateral,” says Knudsen, “Counterparty risk is a huge issue, and it is absolutely vital to secure yourself against this as far as possible.”

To a large extent, payment volatility has now overtaken price volatility as the major concern of fuel buyers. This applies as much to shipowners as it does to bunker suppliers. “Counterparty risk is without question one of the most significant factors and catalysts of the recent global downturn. It is vital that there is a level of financial transparency within the industry, where companies have regular access to counterparty information to mitigate their risk as much as possible,” says Dehn.

Adam Dupre, ceo Ocean Intelligence, advises that there are a number of tools players can use to reduce or manage counterparty risk: “Typical tools used for credit management are credit insurance, detailed credit reports, and up-to-date pricing and market information. All of these have different costs and cover different levels of risk. While it is unlikely that a risk manager would use all of these tools all of the time, together they should give a comprehensive range of risk management possibilities.” When looking at payment records, he says: “Ideally, you need a buyer who is consistent, transparent, and whose reputation is backed up by the credit agencies.”

Hedging, not speculating

There have been a number of articles in the press recently citing companies that have lost money due to forward buying on the bunker fuel market. Both Knudsen and Dehn point out that this is due to a misunderstanding of the nature of the deals involved.

“You cannot avoid losing money on hedging, but to concentrate on the losses is a very unprofessional way of looking at it,” says Knudsen. “If you’re losing money on hedging, it just means that you are buying cheaper on the spot market, so you are saving money in that way. You have to consider both sides of the equation.”

Similarly, Dehn says: “It’s almost a contradiction in terms to make losses through hedging. While some might have set up an incorrect hedging strategy or even done speculation and been unable to control the process, they should still have made gains through lower fuel prices. If companies end up losing money it is most likely because the income side was not fixed, or that some of their customers defaulted reducing their need for bunkers, thereby ending up in stituations where they ‘over hedged.”

In order to avoid these situations, companies have to realise that it is not advisable to hedge just the bunker risk, says Knudsen. “Instead you have to look at all of the operational and commercial issues surrounding your business. This means choosing your counterparties right, and it means that your advisers need to have an in-depth knowledge of shipping, finance and oil trading.”

Looking forward

As companies look at the cost of mismanaged – or missing – risk management strategies and start to plan for the future, there are obviously considerable opportunities for growth for companies providing services in this area. Global Risk Management has been doing well, having opened offices in Singapore and Copenhagen over the last year, in addition to its head office in Middelfart. However, says Knudsen, the most significant development has been agreements which are being put in place with bunker suppliers to provide fuel at fixed prices. Offering guaranteed stability of this kind is likely to be a very popular option in the future.

OW Bunker believes that there is likely to be growth in particular at the lower end of the market: “The larger organizations utilize hedging on a more consistent basis, and believe in the importance of implementing a coherent strategy, which the smaller operators have not fully embraced yet. However, this will change, because often survival depends on it,” says Dehn.

An increased interest in risk management is also apparent in other areas of the business. Software provider Aspect Enterprise, for example, which provides a suite of applications for information and risk management in the oil industry, amongst others, says that interest from bunker suppliers has gone up rapidly, particularly in the last nine months. “ It is particularly interesting that we have received significant numbers of unsolicited enquiries – I think interest has been fuelled by massive volatility in the oil and fuel markets,” says Steve Hughes, ceo of Aspect Enterprise. “Even some of the established players, including some who have been in the market for as much as 25 to 30 years, are now realising that managing things through paper and spreadsheets doesn’t allow them to optimise their business.

“To a certain extent, the attitude is ‘We’ve survived that, lets get our house in order for the next time’.” And it is this attitude which will drive the risk management business into the future.