Managing Freight Rate Volatility

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Introduction

Freight rates are shaped by various factors including wars, natural disasters, geographical bottlenecks, and regulatory changes. With the frequency and intensity of these events increasing, volatility in freight rates has become a critical concern for shipowners and charterers.
In addition to external impacts, the freight market is cyclical and runs in roughly seven-year cycles of freight rate highs and lows. Rates are driven by the availability of tonnage which is further affected by port delays and voyage duration. Although slow steaming can help to reduce fuel consumption and extend voyage times, the broader market dynamics and rate fluctuations often lie beyond the scope of individual control.

Freight Volatility

In 2024, several key factors significantly impacted available tonnage across different sectors. One major influence has been the limited growth of the global fleet, particularly in tankers and bulk carriers. This constrained growth stems from historically low levels of new vessels deliveries, exacerbated by supply chain delays in shipbuilding and uncertainties regarding technology requirements for impending environmental legislation.

Geopolitical issues have also had a significant impact. Conflicts in regions like the Red Sea have prompted many vessels to take longer, safer routes, increasing voyage times and reducing available tonnage. In addition, more stringent vetting requirements and environmental regulations, such as the International Maritime Organization’s (IMO) emissions rules, are pushing older vessels out of service faster than they can be replaced. Combined, these factors have led to a tightening in fleet capacity, driving up freight rates and limiting tonnage availability for global trade.

Ongoing Volatility Expected

We anticipate ongoing volatility in freight rates driven by two primary factors: the impact from the geopolitical climate and the other, uncertainty around decarbonisation and supporting infrastructure for new fuels. The long-term effects of greenhouse gas (GHG) regulations are likely to unfold over years rather than months, further adding to the market’s uncertainty.
The transition to greener fuels and carbon-neutral technologies will almost certainly increase costs. IMO2023 regulations and potential tightening of emissions standards impose operational constraints and raise costs for shipping companies. Limits on sulphur emissions and carbon reduction targets impact fleet capacity and further exacerbate pricing volatility.

What Shipowners Can Do to Manage Volatility

Shipowners have several strategies to counteract fluctuations in available tonnage, though most are effective over longer time horizons rather than in the shorter-term (six to twelve months).
To optimise their fleets, owners may scrap older, less efficient vessels or convert them to comply with new environmental regulations, thus managing supply and operational costs. However, this approach is risky due to uncertainties surrounding alternative fuels, requiring a bet on specific technologies.

Shipowners may also diversify their cargo types to mitigate risks associated with fluctuations in specific markets. However, many vessels are designed for specific cargo types, limiting flexibility.
Adjusting shipping routes in response to geopolitical risks or economic shifts, is another option, though this is often market driven. Rerouting ships through longer but safer routes, such as avoiding the Red Sea, helps to maintain operations but adds costs. Investments in technology, such as fuel-efficient or dual-fuel vessels, allow shipowners to reduce operating costs and align with evolving environmental regulations impacting freight demand and availability. However, for example, dual-fuel LNG address only sulphur particulates and not carbon emissions and are therefore, susceptible to future GHG limits and associated carbon offsetting schemes.

Limited Options for Immediate Management

To stabilise revenue, many shipowners opt for long-term time charters rather than spot market agreements, ensuring fixed income over extended periods. Some use financial instruments such as freight derivatives (e.g., Forward Freight Agreements or FFAs) to hedge against rate volatility. However, these instruments are complex, costly, and require expertise in trading and energy markets, leading to significant in-house costs for shipowners (e.g., hiring, financing, etc.) Many shipowners remain fully exposed!

The Need for Insurance – Food for Thought

Navigating this complexity requires addressing immediate risks and managing the business with sustained coverage. While capital availability (which only reduces the exposure on cashflow not revenue) or FFAs can mitigate some risks, these approaches bring further associated uncertainties and remain open to market fluctuations, leaving vessels subject to near-term market changes.

Considering that ships are floating assets worth between US$50–100 million and have lifespans of up to 15 years before their trade value begins to decline, maximising their revenue potential demands a more forward-thinking and strategic approach for optimising owners’ return on investment. Paratus insurance policies reduce the adverse impact of freight rates on margins and earnings, safeguarding the financial interests of shipowners and charterers.
Unlike the inherent risks and complexities associated with FFAs, Paratus policies are priced transparently, straight forward to understand, and easy to implement without requiring additional operational resources. They provide superior risk coverage without the burden of mark-to-market exposure.

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