Propeller Club Geneva, January 26th 2006

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Propeller ClubGeneva, January 26th 2006
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1.- Freight market characteristics 2.- Freight
economics 3.- Using freight derivatives 4.-
Market outlook oil shipping
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Freight specificities

• Freight is a commodity but all commodities are
  not born equal
• 1gt Oil, coal, ore, veg oil, chemicals, etc.
• These commodities can be stored, at a financial
  cost, defining cash carry
• 2gt Electricity, emissions, broadband, weather
  and freight
• No storage !
• 3gt The specificity of freight, beyond SD
  variables (new buildings and scrappings), is that
  offer can be increased with routing and speed,
  and can only be reduced by slowing the speed and
  staying at anchor.
• 4gt Hence a higher volatility than most commodities

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Market participants

• Over the last 3 years, the market has been
  through a concentration cycle, through mergers
  acquisitions and the creation of pools.
• 50 of apparent market is covered by 5 players,
  on all segments
• On the other side, oil majors have furthered
  their concentration But the oil market remains
  more fragmented than shipping.
• 5 years ago, charterers and owners were fighting
  over ½ WS point, whereas today the market can gap
  10 20 points.
• Another reason for record volatility

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Volatilities (30 days annualised)
TD3 Av. 65.16
WTI Av. 34.72
EUR/USD 9.8
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From Fixed Prices to Price Formula?
SHIPPING MARKET
OIL MARKET
1975/1985 Long Term Contracts OSP
1980s A Fixed Price per Spot Cargo
1987 Indexation to a Crude Oil Reference
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Oil Price Formula
1987 Indexation to a Crude Oil Reference
How does it work ?
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Oil Price Formula
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A Shipping Price Formula?
WAF / CHINA
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Oil Paper vs Physical ratio
Future contracts daily volumes in M bbl per day
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OIL DIFFERENT MARKET PARTICIPANTS TRADE
DIFFERENT TIME HORIZONS
Refiners
55
T R A D E R S
50
End-Users
45
40
USD/BBL
35
Producers
30
Utilities
25
20
15
2002
2003
2004
2005
2006
2007
2008
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FREIGHT WILL DIFFERENT MARKET PARTICIPANTS
TRADE DIFFERENT TIME HORIZONS ?
350
Ship owners Charterers Traders Bankers Refiners
300
250
200
WS
150
100
50
0
M
J
S
D
M
J
S
D
M
J
S
2003
2004
2005
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Market players
LONG FREIGHT
SHORT FREIGHT
SHIPOWNER
END USER
EP CO.
TRADER
TRADER/OWNER
REFINER
INTEGRATED OIL CO.
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1.- Freight market characteristics 2.- Freight
economics 3.- Using freight derivatives 4.-
Market outlook oil shipping
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What are our cash flows made of ? The DNR concept
X
minus
minus
Number of days
X
X
Flat rate function ( ,
)
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Factors influencing shipping profitability

• FACTOR HEDGING INSTRUMENT
• Ws rate FFAs
• Bunker consumption Fuel oil swaps
• Harbour dues Forex

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TD3 Term Structure
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Bunkers Term Structure
350
Barges FOB Rotterdam for fuel oil 3.5 S.
300
250
200
USD/MT
150
100
50
0
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
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1.- Freight market characteristics 2.- Freight
economics 3.- Using freight derivatives 4.-
Market outlook oil shipping
20
Back to basics whats hedging about after all ?
Expected Cash Flow
Probability
Cash Flow
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Tweaking the cash flows curve through hedging
tools
100 hedged
50 hedged
Probability
Unhedged
Cash Flow
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Other tools, other ways to transform our risk
profile
Probability
Unhedged
Cash Flow
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An example among many the floor option

• We may decide to purchase a Floor on the freight
  route so as to insure a minimum rate and get
• a full protection against a drop in market
  prices
• and the full benefit of market up movements (no
  opportunity cost)
• by paying the Option Premium required for such a
  price insurance policy.

• Floor

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Price (WS)
125
120
Floor 100 WS
We buy a 100 Floor
115
110
105

• Floor

100
95
90
85
Premium 5 WS
80
AUG
SEP
OCT
NOV
DEC
JAN
FEB
MAR
APR
Volume (KMT/Month) 10 10
10 10
25
Price (WS)
We do not have to pay

• Floor

We receive
Result (WS)
Volume (KMT/Month) 10
10 10 10
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HOW CAN WE USE FFA TO MAXIMISE REVENUE IN A BULL
MARKET
WS
Equivalent vessel sold _at_ Nov avg - ws25 170
Oct 24th
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Hedging to reduce volatility
Forward Market Valuation
10.0
9.0
8.0
7.0
67 HEDGE
6.0
5.0
4.0
33 HEDGE
3.0
2.0
NO HEDGE
1.0
0.0
70
80
90
100
110
120
130
140
14.1
16.7
19.4
22
24.6
27.3
29.9
For Bunker _at_ 210
11.5
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1.- Freight market characteristics 2.- Freight
economics 3.- Using freight derivatives 4.-
Market outlook oil shipping
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Shipping market summary

• Exxon Valdez / Erika / Prestige pollutions have
  led to single hull phase out
• 9/11 prompted the FED to lower interest rates
• Massive newbuilding program shipyards are
  saturated 3 years forward
• Economic growth (USA/China/India) boosted world
  oil demand and transportation demand
• In 2004 shipping markets have been strong with
  record values
• (WS) VLCC 330 / SUEZ 400 / AFRA 400
• Ships trading value (M) VLCC 125 / SUEZ 78
  / AFRA 62
• 2005 from a record high to a record low in the
  shortest time followed by range trading 60/100
  before present rally

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Growth in oil supply/demand
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Crude tankers fleet
CRUDE FLEET EVOLUTION
(DWT)