Fixed Forward price (FFP) & Hedging in Bunkering (Bunker prices)

What is Fixed Forward Price (FFP) in Bunkering

Fixed Forward price (FFP) gives the tools to lock in one fixed price for bunker requirements in certain specific regions in the future months. It is simple process that allows the flexibility to fix any percentage of total requirements without the need to deal with complex financial instruments. FFP lock in forward bunker prices avoiding price volatility and assisting budget control and provide an opportunity to lock in profits.

Fixed Forward price (FFP) has advantages such as protection from spot bunker price changes, guaranteed future bunker supply with guaranteed price and settlement through normal invoicing after each delivery at normal credit terms. The only disadvantge with FFP is when the market prices are decreasing as one has to pay according to the lock deal.

Fixed Forward price FFP-Exit refers to Fixed Forward Price including an exit agreement. FFP agreement allows the bunker fuel buyers / customers to lock in the price they pay for bunkers in a specific time frame. This FFP agreement also includes an exit clause in which the customer can opt to exit the agreement and pay the difference between the fixed price and the spot price. There are few advantages of FFP-Exit such as protection from spot price increase, guaranteed fuel supply for future needs, guaranteed price, and settlement through normal invoicing after each delivery and the exit feature in the agreement to take advantage of the spot price downward movements. The only drawback of FFP-Exit is if the spot price increase after a person calls exit, than in this case there is no protection. Forward Fixed price agreement provides buyer fixed price bunker fuel at the decided port during the agreed period and agreed quantity. FFP is a much simpler process providing risk management for any percentage of bunker requirements. FFP avoids the requirements of complex financial instruments.

Fixed Forward price FFP-Limit refers to the agreements that allow customer or bunker buyers to lock in the price they pay for bunker in a specific time frame at a discount to normal FFP. This allows customers to take advantage of the lower forward prices and the current high premiums in the options market. FFP-Limit has advantages such as it provides a chance to obtain a discount on the fixed price compared to the normal FFP, It gives some protection against rising trend of market, and the last if the prices increase one will always save money in comparision to the spot price. The drawbacks of FFP-Limit includes opportunity costs if market price falls and FFP-Limit does not give guaranteed 100% protection against rising markets.

CFP - Capped Forward Price refers to the agreements which allow customer or a bunker buyer to cap the price they pay for bunkers in a specific time frame. To gain this benefit, it requires a non refundable upfront premium to be paid when a customer enter the agreement. In this case if the spot price is below the maximum price, one has to pay the spot price over the period of the agreement and if the spot price is above the maximum price, one has to only pay the maximum price over the period of the agreement. Capped Forward Price (CFP) has advantages such as Protection from spot price increase, Full benefit from falling spot prices, guaranteed future fuel supply, guaranteed certainty that price will be lower or equal to the agreed price level and settlement through the normal invoicing process. The only disadvantage of CFP is the upfront premium which is non refundable and has to be paid while one enters the agreement.

Fixed Forward Price FFP-Collar - Capped Forward Price with limited downside opportunity refers to the Capped Forward Price with limited downside opportunity. This agreement allows the bunker buyers / customer to lock in the price they pay for bunkers in a specific time but leave the opportunity open to achieve some limited cost savings should price decline. If the spot prices is between the maximum and minimum price, you pay the spot price. If the spot price is above the maximum price, you only pay the agreed maximum price (cap). If the spot price is below the minimum price, you pay the agreed minimum price (floor). The advantages of FFP-Collar includes Protection from spot price increase, Benefit from falling spot prices until the minimum price, Guaranteed future fuel supply, Guaranteed certainty that price will be lower or equal the agreed price level, Settlement through normal invoicing after each delivery at normal credit terms and No upfront premium as this agreement structure is calculated at zero-cost.

Spot Market and Future Market

The spot market for a commodity is the market where goods are sold for cash and delivered immediately. The contracts on spot markets are immediately effective. The spot market is also known as cash market or physical market as the prices are settled in cash on the spot at the current market price of the comodity. So the spot price of goods is the price for immediate delivery. The future market is a market that provides buyers to exchange contracts for future delivery of commodities or the financial instruments. The future price is the price for the delivery at a specified future date.

Direct Hedge and Cross Hedge

A hedge can be either a direct hedge or a cross hedge. A direct hedge is a hedge in which the hedger uses the same commodity that he has in a physical position to hedge againts such commodity's spot price change. In other words in a direct hedge, the underlying commodities in the spot and future market are similar. For example, a ship owner uses the future price of bunker to hedge against the fluctuation of the spot price of bunker on the spot market. Usually a direct hedge is more effective than a cross-hedge. A cross hedge can prove higher effectiveness if such a hedge uses the prices of several closely-related commodities.

Hedge Ratio

To obtain the effectiveness of hedging, the hedger has to define a hedge ratio or an optimal hedge ratio that could minimize the price risk. A hedge ratio can be described as a ratio of the asset needed to hedged in the future to the asset the hedger has in physical position. In other words, hedge ratio is the number of future contracts that the hedger has to buy/sell.

FFP Process includes following basic steps:

• Provide minimum monthly bunker requirements in selected ports
• Agree a fixed price
• Agree delivery nomination terms
• Agree a suitable method for any monthly overlift
• Confirm agreement
• Upon nomination normal procedures apply

Fixed Forward Price FFP is also known as Hedging. Hedging refers to making investment to reduce the risk of adverse price movements in bunker prices. Bunker Price Hedging is a tool to minimize the risk. Risk management professionals are involved in the bunker price hedging process. Hedging may also be defined as "the taking of a future position to reduce price risk" - this futures position is opposite to the one that the hedger has had on the spot market.

The hedge is effective only when the price risks are offset. Around the mid 1980's, ship owners and ship operators, who are always confronted with much risk in the industry, realized that succesfully applied instruments like futures, options, forward and swap contracts in the commodity and financial market could be also applied to reduce risk in the shipping industry. As a result, in 1988 the first bunker futures contract was launched at Singapore Future Exchange. 11 years later in 1999, a similar contract was introduced at the London based International Petroleum Exchange.

Bunker Hedging Instruments

Without an exchange based future contract, in order to reduce losses arising from the fluctuation of bunker price, ship owners, ship operators and other related parties could use a cross hedge with energy future contract, a bunker forward contract, a bunker swaps agreement or a bunker options agreement to hedge against the bunker price fluctuations.

Hedging Bunker price using a cross hedge with energy future contract.

A future contract can be defined as a highly standardized instrument agreed between a contract seller and a contract buyer to deliver a certain quantity of the underlying asset at an agreed price and at a certain time in the future. All future contract must be traded on an exchange based market place with strict rules and regulations under the management of clearing house. The size of a future contract is standardized by a number of units such as lots. In future contract a range of delivery date is usually specified and the settlement is excerised on a daily basis and is usually closed out prior to the contract maturity.

Hedging with a Bunker forward contract

In the absence of a future contract for hedging bunker and the low effectiveness of hedging bunker through a cross hedge with energy future contract, a bunker risk management could also be carried out with a tailor made over the counter (OTC) bunker agreement. A forward bunker agreement is defined as an OTC agreement between a bunker seller and a bunker buyer to exchange a specified quantity of bunker of certain quantity, at an agreed price and at certain place and delivery in the future.

Hedging with a bunker swaps agreement

Bunker swap is an OTC agreement between two bunker supplier or bunker purchasers to exchange their cash flows arising from the fluctuation of future bunker prices by locking in an agreed fixed bunker price. In this agreement the parties agree the date when the cash flows are to be paid as well as the wau use to calculated such a cash flows. The calculation thus considers the future value of an interest rate, an exchange rate, or other market variables. A simple bunker swap is an agreement in which a floating price for a bunker is exchanged for a fixed price for bunker over one period and for a certain volume of bunker per period.

Hedging with a bunker options agreement

Basically, there are two kinds of option. A call option gives the holder the right to buy (or not to buy) an asset by a specific date at an agreed price. A put option gives the holder the right to sell (or not to sell) an asset by a specific date at an agreed price. The specific date in an option is the expiration date or maturity date. The agreed price is the exercise price or a strike price. So a bunker option contract gives a holer the right to buy (or not to buy) or the right to sell (or not to sell) a certain amount bunker, by a specific date and at a strike price. A option can be traded either on an exchange based market or on over the counter market. Options have two styles: The American option - the option that can be excercised at any time up to the maturity date and the European option - the option that can only be excercised on the maturity date.

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