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

• Main Author: Chng, Wen Xin
• 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/10356/67140
• Institution: Nanyang Technological University

This report investigates if the volatility of tanker spot rates are able to compensate shipowners for their cost obligations, justifying the need for a hedging tool. Subsequently, the accuracy of the paper hedging tool, Forward Freight Agreement (FFA), through its predictive mechanism is explored. This set forth the effectiveness of using FFA for hedging for the subsequent volumes of this research. The time period of the data employed in this paper is from the period of 2005 to 2014. With the use of a generic new-build VLCC coupled with the varying weightages of Weighted Average Cost of Capital (WACC), the Break Even Spot Rates (BESR) was derived. The BESRs were compared against the historical spot rates to ascertain if shipowners were able to meet their cost obligations by merely operating in the physical spot market. The results revealed that at WACC 5% and 10%, spot rates were able to compensate the shipowners adequately from year 2005 to 2008. However, for the remaining results, shipowners were unable to be compensated for their cost obligations or marginally compensated. The fluctuations of this result emanate from the volatility in spot rates which are affected by myriad factors. Therefore, the need for a hedging tool for shipowners to manage their risk of not being able to break even by operating in the spot market is justified. Prior to engaging a hedging tool, its accuracy must be explored, lest exposing the shipowners to additional risk from employing it. The effectiveness of FFA was investigated through its predictive mechanism. Correlation and Regression analysis was used to determine the relationship between the forward prices and settlement prices. It was discovered that forward contracts with shorter maturity dates garnered higher accuracy based on their predictive ability. Following, it was concluded that the Balance Month, Balance Quarter and +1Year contracts were the most accurate within Monthly, Quarterly and Yearly contract durations. Overall, the paper seeks to provide a fuller understanding of how the volatility of the tanker market affects a ship-owner in a quantitative manner. In addition, the paper investigates the accuracy of a hedging tool prior to engaging it. The results were conclusive and the hypotheses were proven, thus, serve as a stepping stone for further research to add value to the maritime landscape.