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), as well as 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 participated in but also managed 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.
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 JL’s Board of Directors and managed by JL’s treasury department. Hedging transactions are made to minimize risks and only apply to the underlying commercial risks.
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 not covered by BAF (Bunker Adjustment Factor).
A proportion of estimated bunker oil consumption not covered by BAF and relating to JL vessels may also be hedged. Decisions on whether to hedge fully or partially are made periodically depending on future oil price trend forecasts.
Most 2006 JL trades were based on the spot market, where pricing reflects the current price of fuel, and on contracts covered by BAF.
At year-end 2006 around 16% of estimated total bunkers consumption for 2007 had been hedged, cf. Note 23.
Liquidity risk
During the past years, highly positive cash flows have made it possible to self finance the expansion of the fleet, thus building up considerable borrowing potential in debt-free vessels. Cash flow in 2007 is expected to continue supporting the financing of growth, although certain limited external financing will become necessary to continue the expansion of the fleet.
At year-end 2006, credit and overdraft facilities from banks were in place to cover the expected net cash flow for the next couple of years and the sufficient minimum cash requirement defined by the Board of Directors.
Figure 18: USD/DKK development
Figure 19: USD/JPY development
At year-end 2006, total cash, securities and similar bond-related products amounted to USD 157.8m (USD 316.9m at year-end 2005). Surplus funds are managed in accordance with the investment policy approved by the Board of Directors.
Currency risk
It is JL’s policy to use financial instruments to hedge the currency risk relating to non-USD costs and non-USD investments. Our hedging strategy for operating costs is based on a 12-month rolling cash flow base.
JL’s income is almost exclusively in USD (95%) with 4% in EUR and costs are also mainly in USD (74%). The most important non-USD cost currencies are DKK 17% and EUR 7%.
In order to reduce currency exposure, JL aims to further increase the already significant natural currency hedge between income and costs.
In 2006 total non-USD costs amounted to USD 109.7m. At the end of 2006, forward contracts were in place covering three months forward compared to six months of cover at the end of 2005, cf. Note 23.
Some investments in newbuildings are denominated in JPY. Around 45% of the total JPY instalments under the new-building programme were hedged at the target rate or better. The remaining, unhedged proportion of the JPY instalments is exclusively due in 2009-11.
The development in USD vis-a-vis DKK and JPY since January 2005 is shown in Figure 18 and 19.
Interest risk
JL’s interest bearing debt amounted to USD 49.9m at year-end 2006 compared to USD 77.2m at year-end 2005, cf. Note 21. Current interest bearing bank debt amounted to USD 109.3m cf. Note 22.
Debt of USD 49.1m relating to the sale and sub-lease of reefer vessels is set off against other receivables with identical instalment and interest profiless.
At year-end 2006, the average interest rate on JL’s loan portfolio including margins was 5.35% excluding lease debt. The corresponding figure for 2005 was 4.38%.
Trends in the six-month money market and 10-year swap interest rates are shown in Table 5.
Table 5: Interest rates
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 the return on surplus funds and reduce total interest risk by creating natural hedges between assets and liabilities.
A low risk financial strategy is applied and surplus funds are either placed on short term deposits or in short term bonds, making it possible to keep the investment until maturity, if necessary. Repo lines are in place to ensure that short term liquidity can always be raised.
At year-end 2006 financial assets valued at USD 83.9m were held in USD bonds and similar products.
In 2006, the rate of return on the average placement of total surplus funds was 3.14% compared with the average rate on the daily USD money market of 4.95%.
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 2006.
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 prepayments.
Investment capacity
In order to meet business related and financial risks, JL prepares semi-annual long-term projections based on updated freight rate expectations and comprising all commitments (newbuildings, time charters and other sale and purchase agreements). Based on the projection and including a defined minimum level of cash availability (USD 50-150m) and a defined minimum solvency ratio (35%), JL’s additional medium term investment capacity is calculated to be about USD 1bn.