Capitalising on freight derivatives

Transport capacity often lacks availability and alternatives are rare.

Buying a commodity is not enough.

Commodity traders, such as energy companies, as well as their commodity purchase, need to book transport capacity (which involves buying, hiring or leasing).

Frequently vessels are not available, pipelines overbooked and power grid capacity not provided to third parties.

Double-hulled tankers will be compulsory in the near future. Next, pipeline capacity is sometimes not present, or when it is, it is not always being used optimally.

In the power sector in North-West Europe energy companies are sometimes forced to provide third parties access to the capacity they bought with long term agreements (via so called 'use it or lose it' principles).

Commodity traders do not only buy the commodity but also transport capacity. Otherwise they would buy the commodity on a forward basis only to find that when they want to transport the material transport capacity is no loner available.

Even if it is available the chance still exists that the price has gone up significantly (price risk). Besides power and livestock I think that financial instruments based on transport show the highest price volatility. The fact that all of their underlying values are hard to store provides low flexibility. Lack of backup facilities, as well as fleet age, affect prices enormously.

The existing price risk can however be hedged in two ways: When commodities are traded you arrange (book) transport physically, or you choose to trade in financial instruments that give you a financial hedge. The latter opportunity is provide by Imarex, an exchange where transport routes can be traded.

Total trading volumes of freight derivatives at Imarex rose 94% in September compared to the same period last year. The notional value of the contracts rose 65% to over $2.1bn, while the number of transactions increased by 111% to more than 2,000.

Dry bulker FFA transactions numbers hit all time highs of 613. And freight option transaction volumes rose 21% compared to the same period last year, while nominal value were up 20%.

So, excellent developments in the exchange traded financial products with respect to freight. This is not strange because the number of clearing and trading members has gone up to 210 and is still increasing.