Risk Management
The global shipping industry is highly sensitive to any fluctuations in world industrial and economic activities. The risks relating to this are primarily commercial risks (fluctuations in freight and charter rates as well as oil prices and vessel values), financial risks (liquidity, currency and interest rates), and finally operational risks (incidents and off-hire).
Charter rate levels and freight rates vary with world market changes and influence the ratio between supply and demand in the various shipping sectors.
JL manages commercial risks through a balanced portfolio of owned vessels, chartered tonnage and contract coverage supplemented with oil hedging and to some extent Forward Freight Agreements (FFAs), cf. Note 23.
Over the years, JL has not only managed but also participated in partnerships in order to increase market access and reduce some of the general market risks.
Each business area is responsible for monitoring and controlling its own business risks associated with supply and demand issues and for including their findings in routine reporting.
The operational risk regarding incidents and off-hire are managed through focused, high quality fleet management. For more information on fleet management services please seep. 24-25.
Fleet and cargo are insured by first class international insurance companies. Vessels are always insured above their market values.
The overall limits for financial risks and oil risks are defined by the Board of Directors and managed by the central treasury department. Hedging transactions are made to minimize risks but only apply to the underlying commercial risk.
Oil risk
Bunker oil is a significant cost element, and JL’s policy is to hedge projected consumption of bunker oil needed for contracted cargo volumes. Decisions on whether to hedge fully or partially are taken periodically depending on future oil price trend forecasts.
Most 2005 trades were based on the spot market where pricing reflects the current price of fuel, and on contracts covered by BAF (Bunker Adjustment Factor).
At year-end only limited bunkers consumption for 2006 had been hedged, cf. Note 23.
Liquidity risk
During the past years, highly positive cash flows have supported a build-up of significant cash reserves, whilst also financing expansion of the fleet. As a result, JL has built up considerable borrowing potential in debt free vessels. Cash flow in 2006 is expected to support continuing expansion of the fleet through JL’s own resources, thus limiting liquidity risk.
At year-end 2005, total cash, securities and similar bond related products amounted to USD 316.9m (USD 121.5 in 2004). Surplus funds are managed in accordance with the investment policy approved by the Board of Directors.
Currency risk
JL’s primary currency risk relates to non-USD costs.
JL’s income is almost exclusively in USD (98%) with 2% in EUR and costs are also mainly in USD (80%). The most important non-USD cost currencies are DKK (14%) and EUR (5%).
In order to reduce currency exposure, JL aims to further increase the already significant natural currency hedge between income and costs.
In 2005 total non-USD costs amounted to USD 152m, up from USD 110m in 2004 primarily due to tax payable in DKK and a large number of dockings carried out in Europe. At the end of 2005, forward contracts were in place covering six months forward compared to one month of cover at the end of 2004, cf. Note 23.
Some investments are denominated in JPY and were all hedged at year-end 2005.
Interest risk
Due to the strong cash position, JL has been able to reduce debt, thus also reducing interest risk.
JL’s interest bearing debt amounted to USD 77.2m at year-end 2005, down from USD 101.2 at year-end 2004, cf. Note 21. Current interest bearing bank debt amounted to USD 50.0m, cf. note 27.
Debt relating to the sale and sub-lease of reefer vessels amounting to USD 57.3m is set off by other receivables with identical instalment and interest profiles and consequently at the end of 2005, debt relating to JL’s own activities amounted to USD 19.9m.
At year-end 2005, the average interest rate of JL’s loan portfolio including margins was 4.375%. The corresponding figures for 2004 were 6.48% and 3.90% excluding lease debt.
Trends in the six-month money market and 10-year swap interest rates are illustrated below:
There are two facets to the interest risk relating to liabilities and assets. Interest changes have reverse effects depending on the type of asset and type of debt interest fixture.
JL endeavours to optimize its return on surplus capital and reduce total interest risk by creating natural hedges between assets and liabilities. However due to the considerable build up of surplus funds, creating natural hedges has become increasingly difficult.
A low risk financial strategy is applied, and thus a significant part of the surplus funds are placed in short matu-rity bonds, making it possible to hold the investment to maturity, if necessary. Repo lines are in place to ensure that short term liquidity can always be raised.
At year-end 2005 financial assets valued at USD 190.5m were held in USD bonds and similar products, and USD 112.2m was held on short term deposit.
In 2005, the rate of return on the average placement of total surplus funds was 2.84% compared with the average rate on the daily USD money market of 3.19%.
Credit and counterparty risk
JL’s credit risks mainly consist of freight receivables and prepaid charter fees and are not regarded as exceptional. In previous years, there has only been minimal loss on debtors. The same applied in 2005.
The risks relating to JL’s trading in financial instruments, securities and in placing cash funds are minimised by trading only with financial institutions with a high international credit rating.
Other counterparty risks are limited through agreements and adequate pre-payments.
Figure 16: USD/DKK exchange rate 2004-05
Source: Nordea Bank
Figure 17: USD/JPY exchange rate 2004-05
Source: Nordea Bank