Counterparty risk and financial concerns in the COVID-19 age
To what extent has the COVID-19 pandemic affected the financial health of bunker suppliers and buyers and, consequently, counterparty risk and credit lines? We discussed these questions with IBIA members in late April and there is no doubt that these concerns weigh heavily on their minds. Unexpected bunker price volatility has caused additional complexity.
This year has been a violent rollercoaster. We started off with the transition to IMO 2020, which meant a sharp increase in bunker prices because fuel that complies with the 0.50% sulphur limit costs more. This is what the market was preparing for, and indeed suppliers and traders had been nervous of increased counterparty risk because of this, while also securing increased finance to be able to offer more credit to maintain sales volumes. Then the measures to control the coronavirus pandemic hit the global economy, causing significant pain for some shipping segments and grave concerns about prospects for demand as global trade slowed down.
We have seen oil demand destruction in a market that was already oversupplied due to the failure of OPEC+ to agree on a deal to limit supply. Oil prices plunged to their lowest level in over two decades in late April as storage has been filling up fast and supply looks set to outpace demand for a while yet. The latter, while cushioning shipping companies by reducing their operational costs, has led to other concerns.
The sudden collapse of Singapore-based bunker trading firm Hin Leong was, many believe, partially a result of the company having taken substantial forward positions betting that energy prices would remain high. This is seen as “another O.W. Bunker” type of event. The demise of O.W. Bunker, a global giant, was in large part due to the company holding long positions betting on high prices for marine gasoil in 2015. This turned out to be very wrong as oil prices staged an unexpected collapse in the second half of 2014. Its other mistake was bad debts by not being aware of large amounts of unsecured credit extended by one of its subsidiaries.
Some of IBIA’s members are certain that further “disastrous bankruptcies” are on the cards, both on the supply side and on the shipping side. On the shipping side some think we’re about to see dire consequences due to a huge drop-off in global trade, led by reduced exports of goods from countries like China and less demand for commodities. There is huge concern that shipowners will be losing income. On the other hand, shipyard delays have been helping to sustain shipping rates as it keeps supply of new ships down.
Counter party risk different between segments
“Counter party risk comes in many forms now,” observed one of the participants in IBIA’s COVID-19 discussions. Indeed, it does. There are different risks depending on which shipping segment you look at, which countries companies are affiliated with, and whether they may be propped up by state support.
Big container operators that have affinity with governments will probably be bailed out or given assistance, another participant suggested. There is big concern, meanwhile, about container lines that do not have state support. The memory of Hanjin, which many thought was too big to fail and expected to be bailed out by South Korea, also preys on the industry’s collective mind.
Segments that are really suffering right now are cruise and ferry operators relying on paying passengers, and the off-shore sector due to low oil prices.
“We monitor our credit lines much more frequently than we used to. We had driven credit lines up to cover high prices [associated with selling mostly IMO 2020 compliant fuel]. Now we’re driving it down as quickly as possible to make sure we do not have unused credit sitting with customers that may present a risk,” an IBIA member on the supply side commented.
Uncertainty and volatility mean counter party risk has to be much more closely monitored. Suppliers, although performing the same due diligence as before, are more cautious as general risk is perceived to be higher. Credit insurers are also reducing possible cover, we heard.
One member said credit lines have been shortened for some ship operators, some of which were also being hit by stinging cancellation fees. Other shipping companies, meanwhile, have no issues because of a good payment record.
Another said liquidity, or more precisely the lack of it, is “the number one issue the market is facing right now”. The squeeze on available cash resources has been the fundamental issue, both inside and outside our industry, he said.
Regarding hedging, the point was made that taking part in derivatives trade can be speculative, or part of a structured price risk management approach. For trading organisations holding physical inventory, derivatives are part of day to day work as part of their price risk management. The value of the inventory and the value of the hedges against it change as product prices change. The issue is the margin calls placed on those hedges, which is where it can go wrong. Forward hedging is a budgetary approach seen in bunker trading, shipping and the aviation industry and it can lead to unexpected losses or gains. Airlines are worse off now because they will have issues both with margin calls and future purchasers that will not be lifted now as airlines have had to ground much of their fleets.
Buyers also worried about counterparty risk
It isn’t just the supply side that is worried about counterparty risk, which for is both the ability of their customers to pay their bills and the financial health of other parties they deal with in the supply chain. Bunker buyers are also careful about which suppliers and traders they use, and concerned about their credit worthiness.
The recent example of Hin Leong and memories of O.W. Bunker’s demise means some are cautious about some of their suppliers/traders, especially if they have made huge losses on hedging due to the unexpected oil price fall se have seen. Moreover, they see a need to be extra careful with traders to clarify title issues before committing to a bunker transaction.
Buyers are therefore also taking care to “pick the right suppliers”.
Some also believe falling prices means margins for suppliers now are very thin, though opinions varied on to what extent that applies.
The bunker supply industry has been dominated by a high turnover/low margin business model for many years in an intensely competitive market. There have been some indications that the increased complexity of bunker fuel management and purchasing resulting from the new IMO 2020 sulphur regime would nudge the market toward appreciating that the lowest price isn’t always the best price, but it will take time.