How can bunker oil price risk be reduced using fuel oil futures?

Abstract

The primary objective of this thesis is to study fuel oil futures contacts to find possible ways to reduce bunker oil price risk. Specified, by examining the hedge performance of fuel oil futures to find out “how can bunker oil price risk be reduced using fuel oil futures?”. The thesis also has a second objective, to examine the relationship between freight rates and bunker oil to find if there is a natural hedge possibility. It begins by introducing the objectives, providing background and reviewing previous literature on the subject. Further, the data and methodology are presented, followed by analysis and discussion on the performance. Monthly freight, bunker and fuel oil price data from 2008 to 2017 are used. Bunker and fuel oil prices are based on the Rotterdam and Singapore port. Futures contract prices are spliced and extracted 3, 6 and 12 months before settlement. The analysis of this data show variance reduction ranging from 0.635 to 0.835 for hedging bunker price changes. The results varied with increased results in the period from 2008-2012, and reduced results in the period from 2013-2016. This indicated that some periods are more applicable for hedging, which corresponds well with previous literature. In total, it seems to indicate that fuel oil futures could work well to hedge bunker oil price risk. The study finds no support for the secondary objective of locating a potential natural hedge in the freight/bunker oil relationship. Analysis was also performed on the spread between freight rates and bunker oil prices to examine if fuel oil futures could be used to hedge it. Low correlation and poor results show that there is limited possibility of any link between bunker oil and freight rates – and that the changes in variance are unrelated.