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Thoughts on Hedging of Freight Exposure September 22, 2008. Kevin Holme Head of Financial Products – BP Oil Americas Dick Gearhart Senior Marketer Risk Management – BP. Agenda. I. BP’s Role in Fuel Hedging. Risk Management . II. Current Market Dynamics. III.

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thoughts on hedging of freight exposure september 22 2008
Thoughts on Hedging of Freight Exposure

September 22, 2008

Kevin Holme

Head of Financial Products – BP Oil Americas

Dick Gearhart

Senior Marketer Risk Management – BP

agenda
Agenda

I

BP’s Role in Fuel Hedging

Risk Management

II

Current Market Dynamics

III

Considerations/Implementations

IV

why trade

Crude

Purchases

0.4 mbd

Product

Purchases

5.4 mbd

Production (oil)

3.8 mbd

Refining

2.3 mbd

Marketing Sales

5.6 mbd

3rd Party

Product Sales

2.1 mbd

Crude Sales

1.9 mbd

Trading to balance and optimise system

Why Trade?
slide4
One of the largest oil trading organisations in the industry

Over 4,000 people worldwide

Hub of bp, dealing, 100 Business Units

Trading expertise and infrastructure

Activities:

Market and trade crude and refinery products to maximise margin

Supply and trade oil products, natural gas and power

Managing price exposure in bp’s asset portfolio including forex

Provision of third party risk management

  • BP’s Trading Activity: Size and Scope

One face to the energy market

In excess of 100,000 Transactions per annum

slide5

BP Supply and Trading

  • Tailored risk management
    • Security, quality and variety for physical delivery
    • Financial risk management
    • Combination of both
  • Aa1/AA credit rating
  • 24/7 Global market coverage and asset base
  • Insight provided by one of the largest derivates teams devoted solely to oil and products with almost 100 professionals worldwide
  • Strong relationships built on a tradition of trust, integrity, and discretion
slide6

bpriskmanager’s Offer

  • With more than 15 years of experience in risk management for third parties, bpriskmanager can offer a range of structures from swaps and plain vanilla options to more structured derivatives
  • Combination of its financial trading and physical market expertise
  • Client base made up of:
    • Airlines
    • Transport companies
    • Mining
    • Shipping companies
    • State and Independent Producers
    • Refiners
    • Power Producers
    • Petrochemicals
    • Other industrial companies (steel, paper…)

Over 175 million barrels hedged in 2007

slide7

Winner of House of the Year – Oil and Products award 2008

(elected by Energy Risk Magazine)

Winner of the Energy Risk Manager of the year award 2004

(elected by Commodities Now)

Winner of the Energy Risk Manager of the year award 2005

(elected by Energy Risk Magazine)

  • bpriskmanager– The Team
  • Top 5 global risk management player
  • Executed over 5,700 transactions directly with clients worldwide over the past two years
  • In 2007 we completed deals with more than 290 counterparties in over 40 countries
  • Traded with 9 of the top 10 Fortune 500 companies in the U.S.

Disclaimer: the awards are for past performance and are not a guarantee of future performance

physical and financial expertise
Physical and Financial Expertise

Strategic Evolution of Business

Broad Capability

Narrow Capability

Tailored

Structures

Origination Capabilities

Asset backed Structures

Credit

Structures

Pre-Pays

Swaptions

Correlation Structures

Asian

Options

Physical Institutions

Financial Institutions

Financial Trading Expertise

BP

Pipe Swaps

Pipe Options

Cross Commodity

Gas Daily Options

Gas Daily Swaps

Basis

Swaps

Options

Liquidity Provider

Natural Gas

Crude Oil Products

Crude Oil

NGLs

Power

Physical Asset Base

Physical Equity Production

Physical Purchases

Producer Services

Physical Sales

basic erm instruments
Basic ERM Instruments

Different instruments provide different ways to manage risk. The choice instrument depends upon the business’s requirements and the prevailing oil market environment.

risk mitigation decisions
Risk Mitigation Decisions
  • What risks am I really exposed to?
  • OK, I know what I am exposed to. What strategies are available to me? Is my current strategy the best choice?
  • What do I need to consider prior to implementing my chosen strategy?
  • How do I implement a strategy?
  • Who do I implement it with?
infamous titles in the risk management library
Infamous Titles in the Risk Management Library

How I Made A Fortune Hedging

Market Timing Strategies for Hedgers

The Orange County Guide to Appropriate Hedging Products

The Market Has to Go Down, companion volume to It Is Too Late to Do Anything

My Banker Tells Me All I Need to Know

common freight risks
Common Freight Risks
  • Before determining the actual risk trigger, determine the business risk
  • Am I trying to ensure that I do not exceed a pre-determined budget for freight or fuel in order to manage my response to inflation being driven through my system?
  • Does my margin contract as energy prices increase, I want to maintain my margin
  • Am I asking my carriers/suppliers to hold the line on prices without offering them solutions to manage these risks?
determine the risk exposure
Determine the Risk Exposure
  • Knowing what I am trying to accomplish, now what is my actual risk trigger? NYMEX HO, Wholesale Fuel, DOE, Bunker Fuel????
  • It is a pretty solid bet that this group is not buying and taking delivery of NYMEX HO, but most certainly your exposure is influenced by movements in the NYMEX contract.
  • Actual fuel and freight escalators really driven by the wholesale and retail market dynamics in the physical markets.
  • Do I understand the relationships and the risks of my program? Am I happy taking those risks? One size does not fit all
considering a program
Considering a Program
  • A very important decision, in addition to what underlying exposure are you going to hedge, is the decision on hedging either financially or physically. This decision is not always yours to make…What do my auditors say?
  • Financial hedging is done through the futures or Over-The-Counter market. Remember to consider which risk exposure you want to take and which you don’t
  • Physical hedging is done in conjunction with your physical fuel supplier or your common carrier. Changing relationships mean that the possibilities are changing as well
considerations program decision
FINANCIAL

Carried out with the exchange or a vetted financial counterparty

Chosen counterparties must pass credit muster

Advice on product mix may be driven by trading ability

Aggregation of risk

PHYSICAL

A transaction between shipper and carrier for a fixed amount of freight

Carriers must pass credit muster

Chosen carriers must be able and willing to offer program

Dis-aggregation of risk

Considerations - Program Decision
implementation financial
Implementation-Financial
  • First consideration is to determine who you will be trading your financial positions with.
  • Very often this is driven by current banking relationships with little consideration to limitations posed by this.
  • Key factors-credit comfort with counterparties, ability to trade and make markets in those products you are exposed to, and ability of counterparty to assist you in understanding the dynamics of the markets
implementation financial1
Implementation-Financial
  • Once counterparties are chosen then a trading relationship needs to be established
  • Commonly this requires an ISDA agreement to be negotiated outlining the credit and contractual terms of the trades
  • A program must be implemented and documented internally with proper trading authorities, trading policy, accounting decisions, and trading processes established-often a Treasury function to trade financially
implementation physical
Implementation-Physical
  • Determine which carriers are willing to work with you, who is the leader in bringing this to market?
  • Will I work with my current carriers to establish the program or will it be a combination of current carriers who are willing to adapt and new carriers?
  • What carriers meet my credit and business performance requirements
  • Realize that shipper is making a commitment as well
current state of market
Current State of Market
  • Market has been forcing hedging decision onto shippers
  • Hedging has been done financially, with mixed results. Advice is not always sound
  • Shipper community is beginning to “push back” to find collaborative solutions and there are a few forward thinking carriers willing to seek solutions
  • More of the risk management is migrating toward carriers who will collaborate. Still in the infancy, but gaining steam rapidly
traits of hedgers
SUCCESSFUL

Well developed understanding of Risk

Program executed according to thorough risk management program

Slow to change-predetermined events

Have a developed list of products

UNSUCCESSFUL

Hedging with inadequate review

Program executed in a reactionary manner, not clearly defined and judged in hindsight

Making decisions to change the program on the fly

Limited hedging strategies to a single product

Traits of Hedgers
what is bp s role in all this
What is BP’s role in all this?
  • BP is a major participant in the over-the-counter financial markets and is active in most major trading markets both physically and financially-we would be happy to investigate a financial trading relationship
  • BP has been very active for quite some time working with carriers to create and move to market a vigorous fixed price freight program that will serve the needs of all parties involved and create a new dynamic in the marketplace
disclaimer
Disclaimer

Thispresentation and any services described in it are intended only for Market Counterparties or Intermediate Customers as those terms are defined by the UK Financial Services & Markets Act 2000 and the FSA Handbook, or only for Eligible Contract Participants as that term is defined in the U.S. Commodity Exchange Act.

This presentation and its contents have been provided to you for informational purposes only. This information is not advice on or a recommendation of any of the matters described herein, whether they consist of financing structures (including, but not limited to senior debt, subordinated debt and equity, production payments and producer loans), investments, financial instruments, hedging strategies or any combination of such matters and no information contained herein constitutes an offer or solicitation by or on behalf of BP p.l.c. or any of its subsidiaries (collectively "BP") to enter into any contractual arrangement relating to such matters. BP makes no representations or warranties, express or implied, regarding the accuracy, adequacy, reasonableness or completeness of the information, assumptions or analysis contained herein or in any supplemental materials, and BP accepts no liability in connection therewith. The actual terms and conditions of any contract or specific arrangement that may be entered into between you and BP may differ from the arrangements described in this presentation. BP deals and trades in energy related products and may have positions consistent with or different from those discussed herein.

There is no assurance that the structure described herein will hedge risks the recipient may incur in the operation of its business. Prior to dealing in any investment or financial instrument or entering into any risk management product arrangement, you should obtain your own tax, legal and other advice as they may expose you to inappropriate financial risk.