Managing vessel value risk

By Philippe van den Abeele, Clarkson Securities Limited, and Dr. Roar Adland, Clarkson Research Studies

Rightly or wrongly, the shipping industry is still known as a conservative industry that does not lead the way in terms of developing and adopting new and sophisticated tools and technologies. That may not always be a bad thing in light of the recent boom and bust of the dot.com bubble. Certainly, these days, old-industry shipping appears to be one of the few global industry sectors that make decent profits. However, it also means that innovators in shipping may face a long battle to get the industry to use new products and markets. The slow growth of the freight derivatives market is a good example. It took more than 15 years from the inception of the Biffex to get to today’s thriving OTC freight derivatives market, with an estimated annual turnover of $4.0 Billion notional value of freight. Although the plain vanilla swap (FFA) contract accounts for the majority of the volume, more sophisticated option structures are also being traded. While liquidity is still a concern, the market is fairly active for short-maturity contracts. Consequently users of the freight market today have a mature financial tool for managing the risk they are exposed to, and many companies are quickly catching up to the opportunities in the derivatives market. Recently, one listed Scandinavian shipowner even hired a Ph.D. mathematician to supervise the company’s freight exposure in the physical and paper markets. That must surely be a world first in the bulk shipping industry.

With well-developed derivatives markets for freight, currency, interest rates, and bunkers, only one major risk factor cannot currently be managed, namely vessel value risk. In terms of dollar exposure, this is perhaps the most important risk factor to an owner. Highly volatile vessel values, combined with a lengthy S&P process and relatively low liquidity in the physical market, can make market timing difficult and have adverse effects on the return on equity. Some listed shipping companies have even stopped reporting asset values in their quarterly reports. Still, the Net Asset Value remains the primary benchmark for the value of a shipping company. The significant variation in the second-hand value of ships is highlighted in the figure below, which shows the historical values of a five-year- old VLCC and Capesize vessel, respectively, for the period January 1988 to March 2003.

Introducing the FOSVA In order to facilitate the management of asset value risk in shipping, Clarkson Securities Limited (CSL), a pioneer of the original FFA contract, has recently developed the concept of Forward Ship Value Agreements (FOSVAs). Similar in structure to the standard FFA derivative, this is a cash-settled forward contract (contract for difference) on the second-hand value of a generic vessel. In order to establish a truly neutral price index that can be used for settlement purposes, Clarkson Securities has pulled together a panel of eight shipbroking companies from around the world that independently submit their price assessments every two weeks. The task of collecting and processing the brokers’ assessments of the vessel values is expected to be handed to the Baltic Exchange in April 2003. The use of a broad panel of experts and the publication of the indices by an independent third party mimic the well-established procedure in the freight derivatives market. CSL believes that this approach will largely eliminate the possibility of market manipulation and, moreover, that the use of a familiar and proven system will lead to increased confidence in the market and a quicker adoption by users.

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