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| Risk management The international shipping industry is highly sensitive to any fluctuations in world industrial and economic activities. Charter rate levels and freight costs vary as a consequence of world market changes and influence the supply and demand ratio in the relevant shipping sector. JL manages these risks through a balanced portfolio of owned vessels, charter tonnage and cargo coverage supplemented with currency and oil hedging and to some extent Forward Freight Agreements (FFAs). Over the years, JL has not only developed but also participated in pools 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 in the transport market and for including their findings in routine reporting. During 2004, Lauritzen Bulkers developed an Economic Risk Assessment and Forecasting Model based on Value at Risk methodologies. The model utilizes the know-how expressed through trading and time charter results experienced since 1994, and additionally employs market rates for spot, 6-month T/C, 12-month T/C, and 36-month T/C. The model will be used in 2005 in parallel to the proven systems used in the past years. The overall limits for financial risks and oil risks are defined by the Board of Directors and managed by the central treasury department. Hedging transactions are made to minimize risks and hedging only applies to the underlying commercial risk. Oil risk Bunker oil is a significant element of expenditure for JL. The figure shows crude oil price trends since 1994. Oil prices rose significantly during 2004 from USD 30 per barrel at the beginning of 2004 to more than USD 50 per barrel before falling back to towards the end of 2004 to USD 40. These significant oil price increases were caused by a general increase in global demand due to an increase in Chinese oil consumption, and a lack of spare capacity making the oil market vulnerable to supply fluctuations.  OPEC appears to have increased its price target to USD 30-40 motivated by the impact of the falling USD. Geopolitical events in countries like Iraq, Nigeria and Venezuela disrupted the global supply situation several times during 2004. In 2005, oil prices are expected to stay at the present high level of around USD 40 caused by a continuing tight supply/demand situation and reluctance by OPEC to tolerate oil prices falling below USD 40 as long as the USD is weak. JL’s policy is, to hedge projected consumption of bunker oil needed for contracted cargo volumes. The policy of whether to hedge fully or partially is determined periodically depending on forecasts for future oil price trends. Total consumption of bunker oil amounts to approximately 770,000 tons a year. Almost 80% relates to spot market contracts for which the pricing is based on the current price on fuel, and to BAF (Bunkers Adjustment Factor) cargo contracts. Approximately 21% of 2004 total oil consumption of 770,000 tons was hedged using financial instruments, saving USD 0.5 million on oil costs. At year-end 2004 14% of total 2005 forecast oil consumption had been hedged. Liquidity risk Liquidity is managed via the JL cash pool, which contains the surplus cash funds held by the business areas. At the end of 2004, cash funds amounted to USD 160.4 million, made up of cash and bonds. Surplus funds are placed on money market deposits and in bonds. The risk related to these USD placements is managed via limits for the duration on the total portfolio of deposits and bonds In 2004 the rate of return on the average placement in USD bonds and deposits was 0.47% and 1.31% respectively. The bond portfolio is short term and is expected to be held to maturity. Currency risk JL’s primary currency risk relates to non-USD costs. JL’s income is almost exclusively in USD, and 86% of costs are also in USD, and consequently JL has a significant natural currency hedge. The most important non-USD cost currencies are EUR 6%, DKK 5%, and SEK 1%. Other non-USD cost currencies amount to 2%. JL aims to further increase the already significant natural currency hedge between income and costs in order to reduce the company’s total currency exposure. Some purchase options and newbuilding contracts are in JPY. It is JL’s policy also to hedge these investments. The USD continued its long-term decline, falling sharply during the last months of 2004 to levels not seen since the middle of the 1990s. After a break in the long-term downward trend, USD was fairly stable for most of 2004. However, late in 2004 the market again focused on the financing of the twin US deficits - the external current account deficit and the budget deficit. Toward the end of 2004, USD weakened against JPY as Bank of Japan had not intervened to stop the appreciation of JPY. China has been under pressure to abolish the long standing policy of maintaining a fixed exchange rate between Yuan and USD. No changes in this policy are expected in 2005. If the policy is changed, some of the pressure on the EUR will be relieved. There seems to be room for more USD depreciation in 2005 against EUR and JPY but the market is expected to periodically change focus towards interest and growth differentials. This would benefit USD. The USD is expected to remain volatile during 2005 but the long-term downward trend is expected to continue.  JL’s total non-USD payments in 2004 amounted to the equivalent of USD 110 million of which USD 10 million was allotted to repayment of debt. Currency hedging reduced costs by a total of USD 2.3 million. At the end of 2004, USD 8 million had been sold forward, corresponding to a period of about one month. The market value of this hedging transaction was USD 1.2 million. Some of the future purchases of vessels denominated in JPY have been hedged amounting to USD equivalent of 12.1 million. The market value of this transaction at year-end was USD 0.8 million. If the USD exchange rate were to change by 1% for all cost currencies, it would change 2005 earnings by USD 1.1 million. Interest risk JL’s interest-bearing debt amounted to USD 101.2 million at year-end 2004, down from USD 196.8 million at year-end 2003. During 2004, a significant part of JL’s total debt was redeemed, made possible by JL’s positive cash flow position. A summary of the instalment profile is provided in Note 21. At year-end, investment in USD bonds totalled USD 75.3 million. There are two sides to interest risk for assets. A rise in the general level of interest would have a negative impact on bond holdings but a positive effect on cash held on short term money market deposit. Taking the year-end holdings of bonds and cash into account, an interest rate rise would have a negative impact on assets. However, interest risk also affects liabilities. A rise in the general level of interest would increase interest charges on variable debt. On the other hand, if interest rates were to fall there would be a loss on debt fixed at a higher rate than the prevailing market rate. JL aims to optimize returns on surplus capital and to reduce interest risk by creating natural hedges: - short maturity dates on the bond portfolio. If necessary the bonds can be held to maturity and supporting funds raised through repo lines. - a bond portfolio lower than or equal to total fixed rate debt - and finally cash placed on money market deposit and other short term liquidity must be equal to or exceed total variable interest debt.  At the end of 2004, 90% was fixed rate debt and 10% variable interest rate debt (including the effect of interest rate swaps). During 2004, debt amounting to USD 75.2 million was repaid and the corresponding interest and currency swaps were closed, resulting in a profit of about USD 0.5 million. The market value of the Company’s remaining interest rate swaps at year-end 2004 was USD 0.3 million. During 2004 USD 5.3 million was raised in new loans and USD 26.7 million was paid in instalments. The Federal Reserve tightened monetary policy during 2004 and raised the Fed Funds interest rate five times from 1.00% to 2.25%. The ECB held EUR interest rates unchanged at 2.00% making USD short-term interest rates higher than EUR short term interest rates. Interest rates are still at historically low levels and the Federal Reserve is expected to continue tightening monetary policy raising the Fed Funds interest rate even more during 2005. It is less clear whether EUR interest rates will rise but with low growth rates in some large EUR countries and a strong EUR, short term EUR interest rates are expected to stay at the present level.  During 2004, long-term interest rates fell in Europe due to disappointing growth forecasts, whereas USD interest rates remained almost unchanged. USD long-term rates rose significantly in the middle of 2004 but fell back due to somewhat disappointing growth and employment figures. In Japan, short-tem interest levels were still very close to zero while long-term rates were also very low (at year-end 2004 1.48%). Trends in six-month money market and 10-year swap interest rates are illustrated below:
At year-end 2004, the average interest rate of JL’s USD loan portfolio
was 6.48%, including margins. Excluding the three family class reefer
vessels financed on long-term leasing contracts, the interest rate on the
remaining loan portfolio was 3.90%, including margins. |