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Hedging tanker freight rates with forward inter-crude spreads

Tamvakis, M. ORCID: 0000-0002-5056-0159 (2001). Hedging tanker freight rates with forward inter-crude spreads. Cass Business School, City, University of London.

Abstract

The market for tanker freight rates has been notoriously volatile since the inception of this industry sector near the beginning of this century. Since the latest tanker market recession in the mid-1980s, there have been increasing attempts to decrease freight rate risk. One obvious method of avoiding spot market freight risk is the use of time charters. However, long-term time charters have been few and far between and charterers may be more reluctant than before to enter such binding agreements. An alternative way of managing freight risk, however, has been the use of forward and futures markets. One such example is the market for futures contracts on the Baltic Freight Index, which are traded in London. This type of contract, however, is rather geared towards dry bulk market participants. Tanker market participants, on the other hand, have very limited choice, and sometimes use crude oil futures to hedge some of their freight risk.

This paper examines the possibility of using inter-crude forward spreads – as opposed to outright forward crude oil contracts – to cover freight rate exposure. To do this, a time series of weekly data for one-month and twomonth WTI-Brent spreads is compared against a time series of weekly data for freight rates for crude carriers operating on the U.S.Atlantic Coast-UK route, in order to determine whether a linkage can be established between the two series. Both series are found to be approximately difference stationary – i.e. integrated of order one – and tests show that the two series are cointegrated. Although cointegration per se is not a proof of linkage, the results can be interpreted as evidence that the two markets move in parallel.

In conclusion, the results seem to indicate that there is scope for the use of inter-crude forward spreads to hedge freight rate risk in a few selected sea routes. Although spreads and freight rates do not always move in concordance, spreads could still be an attractive hedging solution, because they represent by construction a smaller absolute price volatility, and are more relevant to freight rates that the absolute price of crude oil itself.

Publication Type: Monograph (Working Paper)
Subjects: H Social Sciences > HD Industries. Land use. Labor
H Social Sciences > HE Transportation and Communications
Departments: Cass Business School > Finance
URI: http://openaccess.city.ac.uk/id/eprint/20901
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