Hedging IMO2020 compliant fuel price exposure using futures contracts

Abstract

The IMO 2020 sulphur cap regulation, requiring shipping companies to reduce air pollution of their vessels, poses significant challenges for these companies in terms of bunker risk management. This paper examines for the first time the cross-hedging performance of several petroleum futures contracts which may be used to manage the new low sulphur bunker spot price exposure in the three major bunker hub ports of the world supplying such fuels. Using copula-GARCH models, among others we show that the most effective hedge for the price risk of the low sulphur marine gasoil, through the use of the corresponding futures contracts, is achieved in the port of Singapore in comparison to that achieved in the ports of Rotterdam and Houston. Petroleum futures in the middle distillates family (ultra-low sulphur diesel, and low sulphur gasoil) are shown to be more effective than other petroleum products in reducing return variability. The copula-based strategy performs only marginally better out-of-sample than the rest of the methods employed. The findings provide significant implications and can guide shipping companies' bunker risk management regarding the hedging decisions on bunkering port, the hedging instrument, and the optimal hedging strategy.