19th February 2010 - Tanker FFAs - A Question Of Liquidity

After seeing double-digit growth in volumes between 2006 and 2008, in 2009 volumes of traded Freight Forward Agreements (FFAs) fell by 26%. In 2009, 31,500 FFA lots (each of 1,000 tonnes of cargo) were traded - which equates to 315 million tonnes of crude and refined products. This drop-off in paper trading was a reflection of the generally flat trading conditions and low earnings seen in the physical freight market last year, which did little to attract speculative or hedging demand in the paper market.

January 2010, though, saw a spike in spot rates in the VLCC and Suezmax segments, which rippled out across the tanker market. Earnings on the benchmark TD3 route, carrying crude by VLCC from the Middle East to Japan, soared from $34,000 to $101,000/day during January, a near threefold increase. A consequence of this volatility has been an increase in the trading of FFAs.  In January, 40 million tonnes of crude and clean products were traded in FFA contracts, a rise from December of 55%, and the highest level seen since monthly records began to be kept in May 2009; clearly volatility is a key driver to activity.

Whilst FFA volumes did rise in January, as is typical, trading was concentrated in the near-month contracts of the main clean (TC2) and dirty (TD3) routes, with trading in other routes and more forward positions far more patchy. This issue of liquidity has always been the most important issue facing the tanker paper market. Simply put, market participants need the assurance that there is sufficient liquidity to allow them to enter and exit contracts at will.

Throughout the evolution of the tanker paper market from BIFFEX through to today's FFAs, efforts have been made to grow the liquidity of the market and make it more accessible to non-tanker market players. The results of these efforts though, is a market fragmented across a diverse range of platforms, clearing houses and exchanges - with a plethora of contracts and routes available. In contrast, the oil industry is much bigger than the tanker market, but has only two main exchanges dealing in five contracts of outright price.

The latest reform on the FFA agenda is an attempt to switch from Worldscale to dollar-per-day contracts. Perhaps, this potential innovation will bring a degree of simplicity, as well as liquidity to the market, by attracting a wider range of market participant. Time will tell, though, if the current elevated volume levels remain, and if these market reforms help to bring fresh blood and liquidity into the FFA market.