Solutions
The sea may be calm but the freight rates are volatile
Blue Sea thinking
A new index on sea-freight derivatives helps investors tap into the China story
In the same week that UBS launched
its Blue Sea index on freight derivatives,
the 203,512-tonne bulk carrier China
Steel Team was booked to carry iron ore
from Brazil to China. At a record-break-
ing $303,000 per day, the freight rate
was more than three times higher than
the ship’s last fixture, just one month pre-
viously. China Steel Team is one of fewer
than 600 Capesize bulk carriers in the
world. And as the name of this particu-
lar one suggests, China’s prodigious appe-
tite for raw materials is keeping all of them
busy. That’s not surprising, when you con-
sider that Baosteel, China’s leading steel
producer, needs 150 ship-loads of ore
every year to feed its blast furnaces.
Statistics like these explain why sea
freight rates are rocketing, particularly for
dry bulk cargoes such as iron ore or coal.
According to Simpson Spence & Young, a
consultancy, average dry bulk freight rates
reached almost $220,000 per day in May,
up from $80,000 or below in January
and a previous long-term average of
$15,000 – $20,000. Capacity shortage is
responsible for part of this squeeze but
a lack of tonnage is not the whole story.
Even if the 185 or so Capesizers on order
could be delivered tomorrow, ports and
cargo terminals are too choked with ship-
ping to allow them to load and unload
on time. The upshot is a rising trend in
freight rates, coupled with spectacular vol-
atility; the benchmark Baltic Exchange sea
freight index for dry commodities sagged
by more than a third between November
last year and mid-January 2008 on fears
of a US recession, although it has since
bounced back.
That volatility, of course, has already
attracted banks, hedge funds, and other
financial institutions. So far, would-be
investors have looked to the existing mar-
kets for sea-freight derivatives, which are
based mainly on futures and forwards on
the principal reference indices. What was
lacking, however, was a packaged instru-
ment that offered a balanced exposure to
a representative spectrum of the dry-bulk
freight market. It was this gap that UBS
sought to fill when it launched its Blue Sea
Index on May 22.
Congestion factor
UBS Blue Sea is the first fully integrated in-
dex to be benchmarked on the most ac-
tively traded dry-bulk forward freight
agreements. FFAs are non-standardized
over-the-counter forward contracts based
on one of several underlying freight indi-
ces. They are agreed between two parties
for a specific route, for a specific delivery
rate and a specific vessel type. The index
also incorporates a “Port Congestion Fac-
tor” that takes into account the effect on
freight derivative prices of loading or un-
loading delays in more than 60 iron ore
and coal ports worldwide.
The index is aimed primarily at investors
who are interested in freight as a generic
asset class. In addition, shipowners and
charterers could use the index to hedge
their total exposure to freight rates. For
this purpose, sub-indices are also available.
These are based on the three categories of
bulk carriers that comprise the main index,
namely the Capesize giants and the hand-
ier-sized Panamax and Supramax types.
It’s too early to say which types of
investor will make the most intensive use
of the new index. But Blue Sea has cer-
tainly captured the attention of industry
experts. Lloyds List, the longest-standing
daily newspaper for the maritime industry,
commented as follows: “This new UBS
initiative deserves to be watched as it may
introduce a new level of sophistication to
the freight derivatives market by opening
it up to investors who are not necessarily
freight professionals. The Blue Sea Index is
indeed blue sky thinking.”
Ilija Murisic
UBS Investment Bank, Hybrid Derivatives Trading
ilija.murisic@ubs.com
UBS News for Banks / Autumn 2008 15