BEIJING, March 6 (Xinhua) -- The volatile shipping market in 2022 saw a strong demand for shipping freight risk management, thus a rise of interest in relevant risk management products and services such as the Forward Freight Agreements (FFAs), according to the Baltic Exchange in an analysis as follows:
2022 opened with the largest percentage drop in decades for the widely used Baltic Dry Index (BDI), a measure of the health of the dry bulk shipping markets. Rates for chartering dry bulk vessels, used to haul iron ore, grains, coal and steels, plummeted in the first week of January, with the BDI seeing 17.5 percent drop on just one day. It has been a similar story of volatility for the tanker sector, with rates moving fast, but in a more positive direction for shipowners. The past months have seen rates soar, driven by high tanker demand and ship shortages, compounded by poor weather and Russian sanctions.
Volatility in the shipping markets looks set to stay for 2023. For charterers, traders and shipowners who are seeking to manage this volatility and risk, the trading of freight derivatives is delivering a degree of certainty. In a strongly cyclical sector, having an FFA strategy offers advantages to market participants.
2022 was a breakout year for tanker derivative trading with a record 734,972 lots traded (one lot equaling 1000 tonnes of ocean transport or one day of vessel hire). The most heavily traded tanker route was the Baltic Exchange’s benchmark for the movement of crude oil on Very Large Crude Carriers (VLCCs) between the Middle East Gulf and China (TD3C).
On the dry bulk side, FFA volumes once again broke the 2 million mark, hitting 2,218,249 lots. A surge in trading in the handysize (38,000 dwt) sector helped make 2022 another very strong year for FFA volumes.
It is not just the bulk markets which are using derivatives to manage their exposure to volatile freight rates, but also the container shipping and gas sectors. The introduction of a credible benchmark for the container markets in the form of the Freightos Baltic Index (BFX) has added momentum to the use of index linked floating contracts and growing interest in the concept of Container FFAs as an alternative to the often-protracted annual rate negotiations between carriers and shippers.
FFAs are commodity derivatives which derive from the underlying physical shipping markets. In a volatile market, FFAs give companies the ability to manage their freight rate exposure as well as the ability to speculate on future rate movements without the need to purchase or trade a ship. They also provide a mechanism for companies to take on price risk through an exposure to global trade and are an extremely important element of the shipping markets. Many shipping companies, trading houses and charterers have developed strategies which allow them to cope with the sharp upward and downward movements in the freight markets.
FFAs are either traded as futures or options across different expiries on the forward curve starting from the first month and up to six calendar years.
Freight futures are financial contracts with standardised features such as specific expiry dates, cleared on a regulated financial exchanged and with standardised lot sizes – normally one day or 1000 metric tonnes is the minimum trade clip.
Freight options have the same standardised features such as expiries and lot size, but are traded as either calls or puts.
FFAs are cleared through exchanges and their respective clearing members. This reduces counterparty risk and automates netting of long and short positions.
FFAs are traded in the over-the-counter (OTC) market on the terms and conditions of the Forward Freight Agreement Broker Association (FFABA) standard contracts.These are contracts negotiated between a broker and two counterparties (shipowner and charterer).
(Source: The Baltic Exchange, edited by Niu Huizhe with Xinhua Silk Road, niuhuizhe@xinhua.org)
The information presented here is from the Baltic Exchange and do not necessarily represent the views of Xinhua Silk Road and Xinhua Silk Road website.
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