Volumes in dry freight derivatives are set to double next year as end users, such as utilities and coal shippers, look to hedge out the rising cost of moving freight, according to market participants. Philippe van den Abeele, managing director at Clarksons Securities, a London-based shipping broker, estimated the total financial value of dry freight derivatives traded over the last year was around USD20 billion, a five-fold increase year-on-year.
Yet despite the market's prodigious size and price volatility, swaps and options have been slow to develop and instead forward agreements make up more than 99% of the market, said Christian Jakobsen, portfolio manager at The Torvald Klaveness Group, a shipping company in Oslo. "I hope that the option market expands so that we can begin to trade volatility," he said. Although forwards are widely used to express a view on the market's direction, options would be a better means of doing this, he added. Jakobsen blamed the absence of a liquid options market on the lack of OTC derivatives sophistication among freight companies.
Paradoxically, the conditions that make purchasing options such an attractive proposition for end users have frightened potential option sellers out of the nascent market, observed Espen Åbø, v.p. in commodities at Morgan Stanley in London. Prices and volatility need to stabilize before principals would be willing once again to start trading these instruments, he added. Stabilization of prices and volatility could happen within the next year, Åbø noted. Indeed, Deutsche Bank, which has been trading freight forwards since the third quarter, plans to start quoting options on dry freight by year end, said Eric Verhaar, director in commodity trading in London.
Market participants say two fundamental factors are driving activity in this market. First, demand from China for coal and iron ore is rapidly increasing as gross domestic product rises. Second, there is a severe shortage of dry freight shipping capacity that is unlikely to be alleviated before 2006. These pressures have led to a 300% increase in dry freight prices over the last 12 months, noted Andy Lucey, director of Freight Investor Services in London.
