Minimising Risk Through Bunker Hedging explains how companies in the shipping and maritime industries can hedge their exposure to volatile fuel prices.

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HISTORICALLY, many in 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.

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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.
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THE VAST MAJORITY OF HEDGING
MISTAKES ARE THE RESULT OF A
POOR OR NONEXISTENT BUNKER
FUEL HEDGING POLICY