With shipping markets presenting another risk, freight derivatives have become a viable method for shipowners and operators, oil companies, commercial companies and grain companies to manage freight rate risk. The London Baltic Exchange publishes the Baltic Dry Index daily as a market barometer and leading indicator of the shipping industry. It provides investors with an overview of the shipping price of key commodities, but also helps with the pricing of freight derivatives. The index includes 20 sea routes measured on a seasonal map basis and covers various bulk carriers of different sizes, including Handysize, Supramax, Panamax and Capesize. FFE, the most common freight derivative, is traded outside the terms of the Forward Freight Agreement Broker Association`s (FFABA) standard contracts. The main terms of an agreement include the agreed route, the time of settlement, the size of the contract, and the rate at which differences are settled. As we know, shipping is a very risky and volatile industry. In the past, the dry bulk market and the tanker market have fallen sharply or increased in a matter of days, and forecasts are very difficult (short-term), if not impossible (long-term). To manage their market risks, market participants can use a variety of instruments. Fixing a ship on the bareboat period/charter is a traditional solution used to secure your income (shipowners) or transport costs (charterers) for a certain period of time. However, this measure is not at all flexible, as the vessel is detained over a long period of time and withdrawing a period contract can be costly. Fleet diversification is another traditional tool used by shipowners.
By diversifying the fleet, a shipowner participates in several markets where market risks are shared. To overcome the disadvantages of traditional market risk management strategies, a more advanced tool has recently been developed: freight derivatives. Let`s see what freight derivatives are, their history and use in the shipping industry, and how they operate. The instruments are settled using various freight rate indices published by the Baltic Exchange and the Shanghai Shipping Exchange. On the other hand, customs-cleared contracts are bordered daily by the designated clearing house. .