How to Find Certainty in a Climate of Uncertainty

25th July 2017

We watch the ebb and flow of the oil market all day every day and, contrary to what some people think, we can’t possibly predict which way the oil price is going to go today, this month or this year. A vast number of political, economic and environmental events constantly unfolding around the world drive the oil market up or down, and commodity traders buy and sell in a hurried attempt to predict and outsmart the next fluctuation.

 

But in a climate of permanent uncertainty, we can at least be certain that the price of your marine gas oil is either going to rise or fall on a daily basis. Bunker fuel represents a significant proportion of the cost of running a vessel, and a rising market can impact heavily on operational costs.

 

We therefore offer a price risk management service: We help our clients to develop a hedging strategy, with the aim of minimising the risk of financial exposure whilst maximising profit and maintaining flexibility. A hedging strategy replaces a risk-laden unknown future with a certain outcome, stabilises fuel costs and assists in budgetary planning. The most commonly used hedging tools available are:

 

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.