Forward Freight Agreement Explained

At this point, we look at an example of how this works: in February 2016, a trader buys three shipments of NOPAC grain in Japan, which will be transported when the grain season begins: one shipment in August, one in September and one in October. The distributor is concerned that the shipping market will rise in August and wants to secure its freight against such a potential increase. On the other hand, a Panamax shipowner, who fixed his ship when the charter opened in mid-July in the Far East, fears that the market will loosen again, and that is why he wants to sell an FFA. The owner and charterer negotiate and set in August 8,000 USD/day for a duration of 50 days (estimated duration of the trip) and the billing price based on BPI-Route 3a (the Trans-Pacific route for Panamax-Bulker s) as an average of the last 7 indices published in August 2016. We also encounter swaps, but also in other sectors of the maritime industry (finance, accounting) to manage the risk associated with interest rate fluctuations (interest rate swaps). Derivatives are used for hedging, in which Hedger enters into a futures/advance contract contrary to its position in the physical market, in order to counteract changes in the value of the spot position by offsetting changes in the value of the derivative. They are also used for cargo projections. If you look at derivatives trading, you can get an idea of the future movements of the physical market. Studies have shown that FFAs can be used to predict the direction of the spot market for about 2 months. Finally, derivatives are also used for speculative purposes, as transaction costs are much lower than in physical markets.

Speculators – who are not necessarily shipping professionals – help the derivatives market because they provide market liquidity. FFAs, the most common freight derivative, are traded under the terms and conditions of the Forward Freight Agreement Broker Association (FFABA). The main terms of an agreement include the agreed itinerary, the date of the billing, the size of the contract and the rate at which the differences are compensated. As marine markets are more at risk, freight derivatives have become a viable method for shipowners and operators, oil companies, commercial enterprises and grain companies to manage freight interest risk. The instruments are billed using various freight price indices published by the Baltic Exchange and the Shanghai Shipping Exchange. On the other hand, compensation contracts are awarded daily through the clearing house provided for this purpose.