Effectiveness of forward freight agreements in mitigating VLCC shipowners' business risks between 2005 and 2014

• Main Author: Chia, Wei Min
• Other Authors: Soh Woei Liang
• Format: Final Year Project
• Language: English
• Published: 2016
• Subjects: DRNTU::Engineering::Maritime studies::Maritime management and business
• Online Access: http://hdl.handle.net/10356/67138
• Institution: Nanyang Technological University

Shipowners operating in the tanker market are exposed to the volatile freight market which influences the business risk faced by shipowners since freight is directly pegged to the revenue received by shipowners. This ultimately determines the ability of shipowners to fulfill their cost obligations in operating a shipping business. Hence, FFAs were introduced to manage the freight volatility to mitigate VLCC shipowners’ business risk. This paper aims to evaluate the effectiveness of FFA in mitigating a VLCC shipowners’ business risk from the period of 2005 to 2014. The risk faced by VLCC shipowners was first discussed. Due to the lack of past literature in quantifying FFA’s effectiveness, a risk-return measure was adopted to evaluate FFA’s hedging performance in a quantitative model. A model was developed to simulate the cost obligations as well as revenue earned by a practical VLCC shipowner. Consequently, a hedging strategy was also developed to simulate the hedging by a shipowner. Therefore, this allows the comparison of risk and return of a hedged and unhedged profile. The study found that hedging with FFA produced better returns and lesser risk as compared to operating solely in the spot market. However, the performance of hedge was not consistent throughout the period tested and there exist years which FFA eroded the high earnings brought by the bullish market. This paper provides a structured process for shipowners to identify their risk and the usage of FFA as a risk management tool. The objective nature of this study allows for comparisons against other risk management tools and can be replicable under different variables for practical applications to the maritime landscape.