Managing Risk in the New World Order
By Morten Dehn
General Manager, Risk Management
OW Bunker
The global recession, credit crisis, fluctuating oil prices and widespread consolidation have served to act as a ‘perfect storm’ for the shipping industry. As the financial markets and national economies begin the slow process of recovery, the pressure for ship owners and operators to maintain profitability while increasing efficiencies and reducing costs is central to remaining competitive. The process of controlling expenditure has never been more important. But as the industry landscape has changed, so too have the strategies for managing risk and the professionalism and consultative ability that are required in the partnership between ship owners and providers of risk management solutions.
The overarching principle of risk management has always been straightforward. With bunker fuel oil accounting for as much as 50% of a vessel’s operating costs, the importance of managing risk as a means of locking in fuel costs and controlling cash is a central part of maximising profits for ship owners and operators. However, implementing the right risk management strategy is a multifaceted process that has been made even more complex by the events of the past year.
Not only have oil prices remained volatile, the shipping industry has been directly effected by the impact of the lack of credit in the market, where the global recession has acted as a catalyst for the onset of new threats to manage, such as counterparty risk. Given the huge amount of credit required to cover the costs of just one stem of bunker fuel on a large container vessel, for example, the shipping industry has found itself more exposed than many other sectors. In responding to these new market conditions, many companies have confused themselves through the unwitting implementation of strategies that have been relatively ineffectual and do not embrace the founding principles of risk management.
For example, due to the unpredictability of the financial markets, many companies have chosen to hedge on a month-to-month basis. While it may seem sensible in terms of being flexible and responsive to the changing market dynamics, the reality is that it defeats the whole point of hedging, which, to be truly effective should be conducted over a medium term period of at least six months. This short-term approach has actually led many companies to ‘speculate’, rather than ‘hedge’. Essentially they have not taken an opposite position as a means of offsetting their risk exposure, and have ultimately been guessing which way the market is heading. When companies end up in a highly speculative position, it can have a real impact on the perspective and support of financing banks or auditors who find it extremely difficult to ascertain the real purpose or positive impact of hedging if it is done with swaps.
For the foreseeable future, the core message to those engaged in hedging is to exercise an appropriate level of conservatism, rather than using it as a speculative process. We are now operating in a new age of austerity, and companies should caution themselves against unnecessary risk taking, even if the appetite for risk returns at the onset of economic recovery. There should be no return to what came before; it is worth remembering that irresponsibility was the catalyst for the worst financial disaster for 100 years.
In conjunction with this prudent approach, there is a belief that there will be a revival of physical hedging in the market, where products are bought on a forward basis. The process of physical hedging allows customers to fix and lock in the price of bunker fuel in a specific port where the customer knows they will be purchasing products, while still allowing the customer to lift in any port in the world and still maintain the use of the contract. The benefits are clear. It is a definitive and easily auditable hedging tool that provides cost stability and at the same time allows the customer to use as a hedge for multiple ports and areas of the world.
One of the keys to the success of physical hedging is based on the continual management and attention to the changing dynamics of the market; a central and synonymous principle that must be adopted for the successful implementation of any risk management strategy. Achieving this requires a fundamental change in the relationship between the risk management provider and the customer, moving from being perceived as a ‘supplier’ to a ‘partner’ where communication and interaction is based on a complete understanding of the industry and its challenges, as well a total knowledge of the customer’s business and its objectives.
The foundation of the relationship must be consultancy-based, that is focused on maximising operational and financial performance. It changes the approach from being ‘told’ by the customer what they want, to discussing, debating and advising the customer on what they need and why they need it, substantiated by an understanding of the current market challenges, in line with their strategy for business growth and development. An effective risk management strategy is also driven from the basis of being integrated into the overall infrastructure of the customer’s business - its corporate and financial processes as well as the day-to-day operations.
Working from this basis provides companies with the ability to guard against the increasing risks that they now face, which have increased following the financial crisis. For example, counterparty risk is a direct catalyst of the lack of credit within the market. As credit lines are decreased, the potential risk of debtors defaulting is one of the single biggest issues within the industry. The generic lack of confidence in the financial strength and stability of organisations necessitates the importance of companies understanding their exposure to counterparty risk. The requirement for an understanding of the creditworthiness of counterparties, has led to a generic ‘call’ within the industry for increased and regular financial transparency, both from the perspective of ship owners and operators who need financing from banks, as well as bunker suppliers who are being forced to take on more counterparty credit.
Clearly effective risk management must encompass a thorough understanding of a company’s exposure, its appetite for risk as well as the motives for managing risk. And most importantly, in developing the right strategy, it must incorporate a variety of hedging tools, instruments and analytical processes that provide balance and stability against the increasing elements of risk that exist; from basis and time risk to volume and counterparty risk.
There is every reason to believe that 2010 will be a year of recovery for the global economy, but the rules have changed. The shipping industry is under huge pressure to increase efficiencies and reduce costs to remain competitive.
Despite this, shareholders will still be demanding value and a return on investment. The effective procurement of bunker fuel and the implementation of an integrated risk management strategy are central to driving these efficiencies and increasing profitability. Some ship owners have stated that they do not have the resource for external risk management solutions. The reality is that they can’t afford not to do it. Not only is it vital to commercial success, it is also fundamental to business continuity.
To enter the world of OW Risk Management - Just click here
General Manager, Risk Management
OW Bunker
The global recession, credit crisis, fluctuating oil prices and widespread consolidation have served to act as a ‘perfect storm’ for the shipping industry. As the financial markets and national economies begin the slow process of recovery, the pressure for ship owners and operators to maintain profitability while increasing efficiencies and reducing costs is central to remaining competitive. The process of controlling expenditure has never been more important. But as the industry landscape has changed, so too have the strategies for managing risk and the professionalism and consultative ability that are required in the partnership between ship owners and providers of risk management solutions.
The overarching principle of risk management has always been straightforward. With bunker fuel oil accounting for as much as 50% of a vessel’s operating costs, the importance of managing risk as a means of locking in fuel costs and controlling cash is a central part of maximising profits for ship owners and operators. However, implementing the right risk management strategy is a multifaceted process that has been made even more complex by the events of the past year.
Not only have oil prices remained volatile, the shipping industry has been directly effected by the impact of the lack of credit in the market, where the global recession has acted as a catalyst for the onset of new threats to manage, such as counterparty risk. Given the huge amount of credit required to cover the costs of just one stem of bunker fuel on a large container vessel, for example, the shipping industry has found itself more exposed than many other sectors. In responding to these new market conditions, many companies have confused themselves through the unwitting implementation of strategies that have been relatively ineffectual and do not embrace the founding principles of risk management.
For example, due to the unpredictability of the financial markets, many companies have chosen to hedge on a month-to-month basis. While it may seem sensible in terms of being flexible and responsive to the changing market dynamics, the reality is that it defeats the whole point of hedging, which, to be truly effective should be conducted over a medium term period of at least six months. This short-term approach has actually led many companies to ‘speculate’, rather than ‘hedge’. Essentially they have not taken an opposite position as a means of offsetting their risk exposure, and have ultimately been guessing which way the market is heading. When companies end up in a highly speculative position, it can have a real impact on the perspective and support of financing banks or auditors who find it extremely difficult to ascertain the real purpose or positive impact of hedging if it is done with swaps.
For the foreseeable future, the core message to those engaged in hedging is to exercise an appropriate level of conservatism, rather than using it as a speculative process. We are now operating in a new age of austerity, and companies should caution themselves against unnecessary risk taking, even if the appetite for risk returns at the onset of economic recovery. There should be no return to what came before; it is worth remembering that irresponsibility was the catalyst for the worst financial disaster for 100 years.
In conjunction with this prudent approach, there is a belief that there will be a revival of physical hedging in the market, where products are bought on a forward basis. The process of physical hedging allows customers to fix and lock in the price of bunker fuel in a specific port where the customer knows they will be purchasing products, while still allowing the customer to lift in any port in the world and still maintain the use of the contract. The benefits are clear. It is a definitive and easily auditable hedging tool that provides cost stability and at the same time allows the customer to use as a hedge for multiple ports and areas of the world.
One of the keys to the success of physical hedging is based on the continual management and attention to the changing dynamics of the market; a central and synonymous principle that must be adopted for the successful implementation of any risk management strategy. Achieving this requires a fundamental change in the relationship between the risk management provider and the customer, moving from being perceived as a ‘supplier’ to a ‘partner’ where communication and interaction is based on a complete understanding of the industry and its challenges, as well a total knowledge of the customer’s business and its objectives.
The foundation of the relationship must be consultancy-based, that is focused on maximising operational and financial performance. It changes the approach from being ‘told’ by the customer what they want, to discussing, debating and advising the customer on what they need and why they need it, substantiated by an understanding of the current market challenges, in line with their strategy for business growth and development. An effective risk management strategy is also driven from the basis of being integrated into the overall infrastructure of the customer’s business - its corporate and financial processes as well as the day-to-day operations.
Working from this basis provides companies with the ability to guard against the increasing risks that they now face, which have increased following the financial crisis. For example, counterparty risk is a direct catalyst of the lack of credit within the market. As credit lines are decreased, the potential risk of debtors defaulting is one of the single biggest issues within the industry. The generic lack of confidence in the financial strength and stability of organisations necessitates the importance of companies understanding their exposure to counterparty risk. The requirement for an understanding of the creditworthiness of counterparties, has led to a generic ‘call’ within the industry for increased and regular financial transparency, both from the perspective of ship owners and operators who need financing from banks, as well as bunker suppliers who are being forced to take on more counterparty credit.
Clearly effective risk management must encompass a thorough understanding of a company’s exposure, its appetite for risk as well as the motives for managing risk. And most importantly, in developing the right strategy, it must incorporate a variety of hedging tools, instruments and analytical processes that provide balance and stability against the increasing elements of risk that exist; from basis and time risk to volume and counterparty risk.
There is every reason to believe that 2010 will be a year of recovery for the global economy, but the rules have changed. The shipping industry is under huge pressure to increase efficiencies and reduce costs to remain competitive.
Despite this, shareholders will still be demanding value and a return on investment. The effective procurement of bunker fuel and the implementation of an integrated risk management strategy are central to driving these efficiencies and increasing profitability. Some ship owners have stated that they do not have the resource for external risk management solutions. The reality is that they can’t afford not to do it. Not only is it vital to commercial success, it is also fundamental to business continuity.
To enter the world of OW Risk Management - Just click here