IMO2020: Illiquid Markets and Group Buying Power

Paul Hardy, NSI

I have been analyzing this week what lessons we can learn from the past about the specific market opportunities which might arise from IMO2020.

The main opportunity in the bunker trading world over the last 15 years has been the matching of illiquid markets with more liquid ones. A couple of examples:

1. Fixing contracts in South Africa buying against average of the month Singapore cargoes and selling spot.
2. Fixing contracts in China buying against average of the month Singapore cargoes and selling spot.

The question is why were they so profitable? The answer is simple: you have a very liquid futures market and an illiquid local market. Over time natural arbitrages appear e.g. if you have a refinery maintenance programme then there is a shortage of product and the spot price rises. Your buying price is not affected by this as the markets dynamics are not connected. You simply buy swaps at opportune times to lock the buying price.

So why is it attractive for suppliers as well as traders? Again is straightforward; the supplier can sell swaps to lock their selling price in advance and guarantee profit. The trader and the supplier can lock their margin independently of each other. The downside is for the owner who buys against the illiquid and potentially much more expensive spot market.

So why have traders done it and not ship owners?

1. Most do not know how to structure the contracts
2. The traders aggregate volume

So how does this relate to IMO2020 market? At the moment you have no real market for 0.50% product. This, though, is set to change. The liquidity in that market will first appear in the main hubs i.e. Singapore, Rotterdam, Houston cargo markets. The knock on effect is the futures liquidity will also be in those main hubs. So if a refiner is sitting outside of the main hubs and wants to lock profit it would make sense to price the product against the nearest main hub.

This mirrors the situation described above i.e. an illiquid local market and a liquid contract market. As a result there will be natural arbitrages especially in the first 6 months after the legislation.

So what can I do as a broker?

1. Point out to our owners where the natural arbitrages exist
2. Aggregate volume to enable owners to take advantage of the market and allow suppliers to price their product out independently

Essentially, with correct management we can create a win win scenario. The supplier has direct contracts with first class owners and all parties can take advantage of the new market dynamics pricing product independently.

The crux is finding owners that are prepared to work together for the common good. It is not a new phenomenon and can be seen in the many pooling companies operating today looking after chartering and operations.

The key question for me is why are we are waiting on the bunker side and giving away unnecessary profit to others who simply aggregate the owners buying power and place the contracts in the market?