Risk Minimisation Service in Uncertain Times

12th December 2018

As the UK’s Brexit crisis continues to keep the world on tenterhooks, we are working closely with vessel owners and operators in the shipping and offshore industries, to help minimise the financial risks associated with fuel price fluctuations.

In these times of deep political and economic uncertainty, the company has seen an increase in enquiries about its price risk management service, which stabilises fuel costs and helps with budgetary planning.

Adam Russell, the company’s Trading and Hedging Manager, said: “As traders, physical suppliers and purchasers, we have become accustomed to volatile fuel prices over the last few years, so the uncertainty of the current situation is almost business as usual. We are helping more and more of our clients to develop a hedging strategy, which replaces a risk-laden and uncertain future with a more certain outcome. Our advice to ship owners and operators is: Don’t gamble on the markets at this time, make sure your hedges are in place, continue to trade responsibly and don’t take unnecessary risks. This becomes even more important when trading in sterling.”

The price of oil, and therefore the price of marine gas oil, rises and falls on a daily basis as a result of the large number of political, economic and environmental events unfolding around the world all the time. Bunker fuel represents a significant proportion of the cost of running a vessel, and a rising market can impact heavily on operational costs. There are several hedging tools offered by the Geos Group (Sea Bunkering) that can help to mitigate these risks, including:

THE SWAP

The swap contract, or ‘fixed price paper’, fixes the price of a volume of fuel to be delivered in the future. The buyer and seller agree an index price (which changes), usually based on figures from Platts – a provider of reliable benchmark price assessments in energy markets. When the index price moves above the agreed fixed price, the seller pays the buyer the difference; when the index price moves below the agreed fixed price, the buyer pays the seller the difference. This helps to flatten out price fluctuations over time.

THE CAP

The cap protects the buyer from rising prices, whilst enabling him/her to take advantage of falling prices. As with a swap, a fixed price and an index price are agreed upon. When the index price moves above the agreed fixed price, the seller pays the buyer the difference. However, if the index goes below the agreed fixed price, there is no payment due from buyer to seller. The fixed price therefore protects the buyer from rising prices, but allows him/her to benefit from price reductions. Buyers are required to pay an up-front premium for this service, which varies according to contract length, volume, price and market conditions.

THE COLLAR

The collar keeps the bunker costs within an agreed range. A maximum price (cap) and minimum price (floor) are agreed. When the index price moves above the cap, the seller pays the buyer the difference; when the index price is below the floor, the buyer pays the seller the difference; when the index price is in between the cap and floor, so within the collar, no payments are made. There is no up-front premium payment for this service, and the best part is that the buyer only pays for protection when he/she can best afford it (when prices are low and below the floor).

THE SWAP OPTION (SWAPTION)

Here, the buyer of a cap has an option, but not an obligation, to buy a swap. So, if the market ends up above the swap price level, the buyer will exercise the right to enter the swap contract. There is an up-front premium to be paid for this service, which acts as a kind of insurance policy to the buyer.

Although there is still some risk involved, and possibly an additional cost, a hedging strategy that is carefully structured to suit a ship owner or operator’s requirements can significantly protect them against the financial risks presented by a highly volatile fuel market.