Avoid falling foul of price escalation

BP Marine offers a range of price risk management tools to help ship owners manage exposure to changes in oil prices

Fuel prices are at the core of shipping cost structures, representing between 40-60% of voyage expenses, so correct budgeting can have a dramatic effect on cash flow and overall financial performance. Bunker prices are related to the global oil market but, while market demand and supply may be a key determinant of price, other geo-political factors and non-oil industry speculators will also bring significant uncertainty to the market.

Strategy selection in relation to managing fuel procurement and the extent to which a shipping operator should hedge or manage its risk are the key issues. A useful starting point is an internal appraisal that profiles the company?s exposure to bunker fuel price changes and how these may affect the performance of the company. This will provide some measurement of the risk.

However, senior management needs to set objectives and be clear about what it expects the strategy to deliver. The fundamentals of this strategy would typically include a limit on total volume authorised to be hedged by the procurement team and agreed target bunker prices.

So what are these price risk management tools and how can they support a balanced fuel procurement strategy? Clearly, the objective of the strategy will determine the selection of tools and broadly these may be categorised as a complete or partial elimination of bunker price risk, an insurance against disaster which could jeopardise company viability, or a need to secure a competitive advantage. It may be that a company wants to fix and protect all or part of a fuel budget, which in turn will help to maintain a manageable cost base and help determine sales prices, protecting operating profit and securing cash flows.

Then there is also a competitive advantage to be gained from intelligent managing price risk by offering a ?no bunker price escalation? clause in freight contracts. This represents an attractive deal-winner.

BP Marine has developed a web resource to direct information to its price risk management and fuels customers. www.bpriskmanager.com, was created by BP?s derivatives specialists to support customers and allow them to manage fuels? price exposure on 24-7, user-friendly basis.

It began with relatively simple, straight forward tools such as the cap (also known as a call option) which fixes a maximum bunker price but still benefits from a decrease in bunker prices, to more sophisticated arrangements such as three-way options. These allow customers to accept some limited price variation up to a maximum, but still benefit after prices fall below a set level.

100% price risk elimination is possible, but effective management of exposure to oil prices can be a huge challenge. It is not about speculation, but managing energy costs and trying to meet budgets and targets, hopefully resulting in sustained profitability and business

stability.