Risk Management in Commodity Markets: From Shipping to Agriculturals and Energy

11

Freight Derivatives and Risk Management: A Review

Manolis G. Kavussanos and Ilias D. Visvikis

11.1 INTRODUCTION

During the last two decades there has been a significant growth in financial instruments that can be used to address the need of “protection” in the volatile economic environment in which business operate. While financial derivatives products such as futures, forwards, options, and swaps, have a long history in the management of risk for various commodities, these instruments have started to be used consistently by the shipping industry only during the last decade.

Shipping markets can be characterized as being capital intensive, cyclical, volatile, and seasonal, while shipping companies are exposed to the international business environment. Shipping freight derivatives have the potential to offset (hedge) freight rate risk of the dry-bulk and wet-bulk (tanker) sectors of the shipping industry.¹ The volatility observed in freight rates constitutes a major source of business risk for both the shipowner and the charterer. For the charterer wishing to hire-in vessels for transportation requirements, increasing freight rates leads to higher costs. For the shipowner, lower freight rates involves less income from hiring out the vessels. For a detailed analysis of the business risks prevalent in the shipping industry, and the traditional and derivative strategies that may be used to tackle them see Kavussanos and Visvikis (2006a, 2007).

Freight derivatives can provide real ...