Bangalore: Shipowners have welcomed Reserve Bank of India’s decision to allow shipping companies to hedge freight risks; they expect to benefit from this in less than two years.
The move, notified on 4 February, allows shipowners to hedge against falling freight rates and oil refiners to hedge against rising prices. Dry bulk shipping rates have collapsed by at least 90% in the past few months.
“The global economy is very bearish and we believe 2009 is going to be a tough year for shipping,” says Nikhil Jain, a senior research analyst at Drewry Maritime Services Pvt. Ltd, the Indian unit of London-based independent maritime adviser Drewry Shipping Consultants Ltd.
“If a shipowner feels that the current market is still high and there is a downside potential, he can enter into a contract and hedge against falling rates,” Jain says. “If the market goes down, he can reap the benefits of prevailing rates. This will definitely help mitigate volatility in earnings of shipping firms.”
Secure deal: An oil tanker off the coast of Mombasa, Kenya. The conditions imposed by the Reserve Bank of India will permit shipping lines to hedge freight risks and also ensure there is no speculation. Tony Karumba / AFP
Ship earnings in the December quarter have been hit hard by global financial turmoil, shattered Western economies and slowing demand for global trade.
Analysts expect the downturn to have a severe impact on their financial performance for the fiscal year ending March.
“This is obviously a welcome move,” said Anjali Kumar, spokeswoman for Great Eastern Shipping Co. Ltd, India’s biggest private ocean carrier.
Oil refiners can start taking advantage of the decision immediately. Freight rates for shipping crude oil into India have seen wild swings from as high as 200 Worldscale points to as low as 40 in the past few months, said an official at state-owned Indian Oil Corp. Ltd (IOC), the country’s largest refiner.
Worldscale points are a percentage of a nominal or flat rate for a specific route. Flat rates, quoted in dollars per tonne, are revised annually by the London-based Worldscale Association to reflect changing fuel costs, port tariffs and exchange rates.
“Any hedging activity we undertake within the regulatory framework would help reduce volatility in freight rates, which have seen extreme swings over the past six to eight months,” the IOC official said. He declined being named because of company policy.
India’s ocean freight market is estimated at $20 billion a year, according to the Indian National Shipowners Association, a shipping industry body. IOC alone runs up a freight bill of about Rs1,300 crore a year to ship crude into India.
Shipowners and oil refiners have also sounded a note of caution.
“The permission to hedge will help shipping companies if done in a proper manner,” says Great Eastern’s Kumar. The company’s Sharjah subsidiary has been hedging its freight risk and this experience has been “very satisfactory”, she said.
“It will help provided firms undertake hedging discreetly,” said an executive at a private oil firm on condition of anonymity. “The market is generally bad now. There is not enough depth in the hedging market internationally.”
Firms getting into hedging contracts will have to take responsibility of risks associated with it after taking position on a future for which a certain down payment has to be made, he said. “It’s a double edged sword. You have to use it carefully.”
“In a volatile shipping market, when you enter into a contract with a counterparty, and if that counterparty is not able to honour the contractual obligations, then hedging can be tricky. The counterparty has to be strong,” said B.K. Mandal, finance director at state-run Shipping Corp. of India Ltd.
To guard against such possibilities, the central bank has set terms to ensure that Indian shipping and oil firms do not speculate by allowing them to hedge freight risks only on the basis of an underlying exposure.
The regulator has also capped the maximum forward period for hedging at one year. Globally, hedging of freight risk is done on paper for speculative reasons, as well as physically.
For oil companies, freight hedging will be on the basis of underlying contracts—import and export orders for crude oil and petroleum products. For shipping companies, hedging will be on the basis of ships owned or controlled by them that have no committed employment.
“It is good that RBI is not allowing speculative hedging,” said Mandal. In addition to these, the regulator has capped the volumes that can be hedged for freight risks.
Oil companies can hedge freight risks up to 50% of the volume of actual crude imports in the previous year or 50% of the average volume of imports in the previous three financial years, whichever is higher.
Contracts booked by past performance will have to be regularized by producing underlying documents during the tenure of the hedge.
For shipping companies, the quantum of hedge will be determined by the number and capacity of ships.
Contracts booked will have to be regularized by producing underlying documents—employment of ships—during the tenure of the hedge. “This should be strictly monitored,” Kumar said.
“The conditions imposed by RBI while granting permission to hedge freight risks are very good. Otherwise, it will lead to speculative trading, resulting in overexposure of shipowners and financial institutions,” said T.V. Shanbhag, group adviser at Trans Ocean Agency Pvt. Ltd, India’s biggest ship broking firm.
Shanbhag said shipowners, mainly dry bulk ones, have lost millions of dollars in the past few months due to failed derivative transactions such as forward freight agreements.
In the absence of a market for hedging freight risks in India, local shipping and oil firms would have to deal with international banks, brokers or exchanges such as the London Clearing House, Singapore Exchange and NOS Clearing ASA for their requirements.