The second installment of our series on bunker hedging will focus on two more compelling reasons why companies should manage their fuel price risk.
#3: Secure Competitive Advantage
One of the most important reasons to manage price volatility in fuel markets is to secure a company's competitive edge. If you ask an executive why his company performs better than the competition, it is highly unlikely that he would cite the ability to purchase fuel at lower prices than his peer group. He would list the quality of his management team, the additional services the company offers its customers, reliability and perhaps flexibility with regard to contractual terms.
The essence of bunker hedging is that it allows a company to remove the risk of price spikes from damaging profitability and focus on being a better operator and differentiating its services from the competition. Let us look at two examples:
A) A pool operator who has traditionally insisted on a fuel clause in charter contracts
The operator has traditionally included these contractual clauses to protect itself against sharp rises in bunker prices. Given the current oversupply of vessels, many of its clients are refusing to accept this fuel price risk and there are other operators willing to charter vessels without this clause. Therefore, to remain competitive, the company must decide whether to follow suit.
The fuel clause can be easily replicated with exchange-traded financial instruments
The fuel clause can be easily replicated with exchange-traded financial instruments; a company with a sophisticated hedging program would be able to price, retain on its books, and hedge this fuel risk. This would allow the operator to offer more flexible contractual terms to its clients: one price where the operator passes on the fuel risk, and a different price where the operator retains and manages that risk. Despite the different prices and terms, the hedging program would effectively render the financial performance of these contracts identical.
B) A regional fuel supplier or bunker trading house offering new products
Many small- and medium-sized suppliers have traditionally only offered fuel either at i) spot prices or at ii) a price agreed today for delivery at an agreed date in the future (physical fixed price forward). Although the fixed price forward is a useful hedging tool for some companies, it does little to help companies who may not know in advance how much fuel they require or those who wish to retain some ability to take advantage of potentially lower future prices.
Having a hedging program in place would allow the company to market a wider range of solutions
There are a number of hedging instruments that provide attractive optionality for fuel buyers (caps, collars, barrier physical fixed price, as well as more highly customized solutions). However, many of these solutions are only offered by a few large multi-national suppliers/traders. A smaller business with a hedging program would be able to offer similar products to its customers and retain and manage that price risk. Having a hedging program in place would allow the company to market a wider range of solutions and enable it to increase the volume of business it does with both existing and new customers.
#4: Improve Finance Terms
Bunker risk management can also play a significant role when negotiating terms with a financier. A hedging program (or lack thereof) can affect the availability and size of credit facilities, loans and the interest rates payable on them. Lenders will pay particular attention to the asset or trade that is being financed, but also to the credit risk posed by the company to whom they are lending.
lenders are well aware of the impact a fuel price spike can have on an operator's profitability
If we take, as an example, a pool operator purchasing a new ship, an operator hedging their exposure to fuel prices may receive more preferential loan terms than one who doesn't. Given how low day rates have been in recent years, lenders are well aware of the impact a fuel price spike can have on an operator's profitability.
Since the financial crisis, lenders in the maritime sector have had to deal with a significant number of non-performing loans. Underwriting standards are tightening and companies that want increased access to credit, or better credit terms, need to be aware of the effect unhedged risks will have.
Read part 1 of this series covering #1: Increase cash-flow certainty & #2: Eliminate risk of financial distress here.
Christopher Cheetham is the President and Co-founder of Soter Advisors Ltd