In these increasingly uncertain times we are all assessing risks and, when possible, devising a means to minimise them – consciously or otherwise. Increasing access to information should permit better risk management but without systems and an appreciation of the level of exposure or damage that can result from poor management, the process of trying to alleviate risk can have a negative impact. Risk management is not gambling but must be an integral part of a company’s business processes.
This book is published at a very opportune time with the future seemingly less predictable now than at any time in the past decades. After many years of accepting that energy prices would continue to increase in real terms, they have faltered. At the time of writing, the majority of industry commentators are predicting that they will stay relatively low for some time but, with the rapid slowdown in capital exploration, they may shoot up again in the not too distant future. In the meantime, prices will be set by the market supply/demand balance rather than a cartel. Hence controlling exposure to price volatility has become even more complex and the approaches and concepts set out in this book provide both the seasoned trader and the newcomer with valuable insights.
The publication of this book coincides with one of the longest periods of poor freight income for the shipping industry, with perhaps the exception of tanker owners. This situation will lead to more shipowners becoming hostage to the banks, an amalgamation of the less fortunate owners and an acceleration of failures. The bunker suppliers, who globally are lending some $6 billion to the shipping industry on an unsecured basis, have an even greater need to assess their credit risks and manage them. At the same time, bunker buyers are under even greater pressure to minimise costs which can result in purchases at the lowest price but not always at the lowest cost. Cheap fuel is often poor fuel which can expose vessels to the inherent risk of engine damage and in extreme cases, the loss of a vessel. Again, accessing and balancing the risks against achieving lower costs requires knowledge and experience as well as techniques.
This book authored by Nigel Draffin will be a welcome and timely aid to many who have thought they could leave risks to others. Knowing how to identify risks and minimise them at a reasonable cost is now an essential management skill.
Contents
Foreword
Preface
About the author
Contents
List of Figures
Chapter 1 - What is risk?
The ALARP principle
Price risk
Credit risk
Counterparty risk
Operational risk
Failure to manage risk
Bunker price risk
Bunker price history
Identifying strategy
Business need
Price sensitivity
Appetite for risk
Currency risk
Unsecured credit
Product price
Risk reduction
Insurance risk
Link to physical contracts
Link to paper derivatives
Chapter 2 - The History of Derivatives
Differences between futures and forward contracts
Over the counter (OTC) trades
Futures exchanges
Chapter 3 - Hedging Basics
How a swap works
How an option works
Call option
Put option
Using cargo prices instead of bunker prices
Chapter 4 - More on Hedging
Forward curve – contango/backwardation
Volatility and option pricing
Historical volatility
Implied volatility
Black-Scholes
Market perception – Bull versus Bear
Basis risk
Arbitrage
Over the counter (OTC) products for buyers
Swaps
Options
Cap / collar
Chapter 5 - Credit risk
Managing credit lines (product buyer)
Managing credit lines (product seller)
Credit scoring
Credit insurance
Assignment of receivables
Factoring
Chapter 6 - Overall exposure
Exposure for derivative seller
Exposure for derivative buyer
Exchange exposure
Specific risks
Country risk
Currency risk
Chapter 7 - Supplier’s risks
Basis risk
Market risk
Credit risk
Operational risk
Liquidity risk
Chapter 8 - Assessing counterparty credit risk
Identifying counterparties
Business model
Market exposure of a ship operator
Market exposure of a trader
Use of credit reports
Resilience versus survival
Security
Credit troubles – the warning signs
Chapter 9 - Tools for sellers
What are you ‘protecting’?
Hedging stock – long position
Hedging an individual transaction – short position
Exposures
Pricing exposure
Physical exposure
Techniques
Product spread
Geographical spread
Crack spread
Calendar spread
Volatility trading
Interpreting historical data
Volatility
Relative strength index (RSI)
Chapter 10 - Margin calls and exposure
Impact on cash flow
Consequence of breach
Chapter 11 - Market prices
Published prices
Non-publishing days
Liquidity
Exchange prices
Chapter 12 - Liquidating positions
Planned
Unplanned
Reducing exposure
Liquidity risk
Chapter 13 - Managing portfolios
Rolling contracts
Multiple ports
Changes in trading pattern
Stress testing
Hedge effectiveness
Opportunity cost
Value at risk (VaR)
Chapter 14 – Regulations
Revenue treatment of derivatives
Fair value accounting
Taxation
US rules
UK rules
General principles
Financial services regulation
Chapter 15 - Authority
Understanding potential liabilities
Management controls and reporting
For ship operators
For sellers
Accounting requirements
Chapter 16 - Dealing with risk across management structures
Chapter 17 - Contracts
Identification of counterparties
Pricing basis
Settlement dates
Liquidation
Non-performance
Disputes
Chapter 18 - Business continuity
Incident resilience
Business impact analysis
Threat and risk analysis
Solution design
Plan testing, verification and maintenance
Disaster recovery
Testing your response
Some quick suggestions
Temporary office
HR issues
IT issues
Communication procedures
Chapter 19 - Cybercrime
Fraudulent emails
Fraudulent web links
IT policies, procedures and precautions
Chapter 20 - Where to go next
Risk assessment
Credit risk
Credit reports
Currency risk
Derivative trading
OTC products
Business continuity
Marine fuels – technical and legal information
Glossary
Index
List of Figures
Figure 1. 380 cSt fuel oil quarterly average
Figure 2. Rotterdam prices – historical spot level vs money of January 2015
Figure 3. Volatility as annualised % of standard deviation of prices
Figure 4. Example of daily volatility – Rotterdam 380 cSt January – June 2011
Figure 5. Liverpool Exchange in 1829
Figure 6. The beer hedge
Figure 7. Swap illustration – $340 – budget price $343
Figure 8. Call option illustration – $340 strike, $5 premium
Figure 9. Put option illustration – strike $340, premium $5
Figure 10. Forward curve – Rotterdam barge swap
Figure 11. CBQ15 – Brent crude oil – 120-minute candlestick chart
Figure 12. Multiple overlapping credits
Figure 13. Rotterdam relative strength index
Figure 14. Liquidity pyramid. Crude is the most liquid
Figure 15. Comparison of 12-month, rolling 1-month, rolling 12-month and cap hedges
Petrospot is a dynamic independent publishing, training and events organisation focused on the maritime, energy and transportation industries.
It delivers the highest quality strategic information in the most comprehensive and convenient formats – via magazines, websites and books, or face to face in conferences, exhibitions, seminars and training courses.
Based in Oxfordshire, England, Petrospot was established in May 2003 by Llewellyn Bankes-Hughes (Managing Director). He is supported by Lesley Bankes-Hughes (Director – Publishing), and Luci Llewellyn-Jones (Director – Events).
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