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Expert Column Risk Management Strategies of Shipping Companies

Registration dateAUG 24, 2022

Risk Management Strategies of Shipping Companies

#Case 1: In January 2020, COVID-19 Pandemic caused the collapse of the global supply chain of major global products due to the blockade of Wuhan, China. Since then, the global shipping chaos has occurred due to the port blockade caused by the COVID-19 infection of port workers.

#Case 2 In March 2021, Taiwan's Ever Given, which was passing through the Suez Canal, ran aground and blocked the world's largest maritime trade route for six days.

#Case 3 : In February 2022, Russia's invasion of Ukraine disrupted the global supply chain of energy, food, and semiconductor materials, putting countries around the world in a state of emergency.

The above are examples of the recent collapse of the global supply chain. Since countries are in a global economic system, supply chain risk management is becoming an essential capability for companies as well as the national economy.

The global business industry has been in turmoil as unexpected supply chain disruptions often occur across the entire industry, including pharmaceuticals, semiconductors and automobiles. Most of the causes of the supply chain crisis are due to the lack of a process to identify risks in advance and an efficient risk management plan. The process for managing supply chain risk consists of risk identification, risk evaluation, risk response, and risk monitoring steps.

Risk identification is the step of identifying potential events that may affect the company and determining whether they are threats or opportunities, through which the types of risks inside and outside the company should be distinguished and understood.

Risk evaluation can be defined as the step of determining how many future events will affect management for a company. The risk matrix evaluated from two perspectives are utilized: 'risk likelihood' and 'impact' of events. This is because a lot of investment is required in risk management and overall management is not easy, so it is necessary to prioritize risks. Risk response is a step of using five strategies: acceptance, avoidance, reduction, retention, and transfer for individual risks evaluated based on the risk matrix. For example, predictable risks such as a supplier’s bankruptcy, although the impact of it is small, can be avoided through 'dual sourcing strategies' such as selecting new sources.

Risks that have great effect but are difficult to predict, such as natural disasters, terrorism, and cyber-attacks, are called black swans. To avoid such risks, you can strengthen the crisis management capabilities through regular scenario planning, or transfer the risks through insurances. Small and predictable risks such as labor disputes and changes in consumer preferences should be avoided through education and training for employees and IT systems. Relatively predictable yet high-impact risks like the U.S.-China trade dispute should be mitigated by reviewing the sourcing and inventory strategies to establish a new supply chain. That is, the systematic classification of risks and the development of response strategies are a must to improve supply chain resilience. Monitoring is conducting a series of activities such as reviewing, supervising, observing and implementing on a given basis to derive anomalies for the risk under control.
[Process of risk management] Process of risk management (Copyright © POSCO Management Research Institute,『 Understanding risk management from an enterprise perspective 』, 2011)
The Reason Why Risk Management in the Shipping Industry is Important The shipping industry, which is responsible for 85% of the world's trade volume transportation, is fundamentally international, so risk management is more important than any other industry. This is because it is necessary to cope with regulatory and policy pressures from around the world as it runs its business it runs its business globally globally.

In addition, since the shipping industry is inelastic in demand and supply, it is greatly affected by market fluctuations, so professional management skills are required to respond to this. For example, from 2003 to 2008, maritime freight rates more than tripled due to the "China effect," but plunged 95% in the second half of 2008. This extreme change in market conditions puts companies facing enormous risks leading to a sharp drop in shipping companies' freight income, operating funds, and ship asset values. The bankruptcy of Hanjin Shipping in 2016 is another example of how important the management of market risks for shipping companies is. This is why the shipping industry is traditionally called a risk and reward industry.

The shipping industry is a capital-intensive industry that requires huge funds to secure ships because it has to provide maritime transport services globally. This acts as an entry barrier to new companies. However, it implies that it is difficult to be competitive if the economic effects of scale are not secured. Therefore, for shipping companies, financing to secure ships and appropriate ship sales strategies due to changes in ship prices are important to secure profits. Various risks exist in the shipping industry Shipping risk can be classified into four categories: strategic risk, financial risk, operation (industrial) risk, and traditional risk. Strategic risks arise from geo - economic risks and technological advances. Representative examples are the Russia-Ukrainian War, the U.S.-China trade dispute, and the digital transformation following the 4th Industrial Revolution. Financial risks are caused by changes in freight rates, oil prices, interest rates, exchange rates, credit, and liquidity. In particular, changes in sea freight rates are the most important factor in determining the size of imports of shipping companies. Oil price fluctuations account for about 30% of the ship's operating expenses, which accounts for the largest portion of the shipping company's cost expenditure.

In addition, low-cost financing for securing ships and abundant cash funds for operating expenses are directly related to the survival of shipping companies. Operational (industrial) risks include macroeconomic environmental changes affecting changes in the shipping industry (market), IT systems, terrorism and piracy, securing skilled sailors, and environmental regulations on international ships.

Finally, traditional risks in the shipping industry include natural disasters, technical defects, and human errors that account for most of the causes of maritime accidents.
[The Type of Shipping Risk] The Type of Shipping Risk Copyright © Written by the Author
The most important risks for shipping companies are freight and oil price fluctuations In order to effectively manage these various shipping risks, risks must be prioritized individually based on the possibility of risk occurrence and the impact on corporate management. The best countermeasures should be prepared in consideration of the costs and effects of many risks.

According to a study by Frederick & Vitalijs (2017), which surveyed Danish shipping companies, freight fluctuations and oil price fluctuations were cited as the most threatening risks to shipping companies. Followed by, ship environmental regulations, macroeconomic fluctuations, ship price fluctuations, IT system stability, and ship accidents In addition, interest rate and exchange rate fluctuations, technological development and securing skilled sailors and geo-economic risks were ranked as median risks.
[Shipping Industry Risk Matrix] Shipping Industry Risk Matrix (Copyright © Frederik Holm, Vitalijs Kalinovs, Risk and Risk Management in the Shipping Industry, Copenhagen Business School, 2017)
What are the ways to effectively manage shipping risks?

As mentioned earlier, the most important factor for shipping companies, the risk of freight fluctuations (aka market risk), is due to the industrial characteristics that demand and supply for shipping services are inelastic. In other words, in terms of demand, it is difficult for shippers to secure alternative transportation no matter how high sea freight rates rise. In addition, in terms of supply, it takes an average of two to three years to build a new ship, making it difficult to immediately respond to changes in fares.

In addition, the changes in ship value according to the shipping situation also means the changes in the asset value of the shipping company, so it is one of the essential management targets. Financial institutions lend to shipping companies with ships as collateral, so if the ship price falls, they may face bankruptcy in the worst case if they are not prepared for financial institutions' demand for repayment. Therefore, for accurate risk management, it is necessary to actively utilize market-related information provided by specialized institutions. From the perspective of companies, it is necessary to prepare for future freight changes by using the Freight Forward Agreement (FFA)[1] or signing a Contract of Affreightment(COA) to hedge the freight rate.

The strategies of shipping companies to address the risk of oil price fluctuations, which is one of the carriers’ top interests, include Bunker Adjustment Factor (BAF) and slow streaming strategies. Recently, interest rates have been raised to curb inflation around the world, including the U.S. Federal Reserve, and shipping companies that ordered large amounts of new ships are suffering from increased financial burdens caused by high interest rates. The KMI data showed that raising the key interest rate to 2.5 percent would increase interest costs for domestic and foreign shipping companies by 828.7 billion won.[2] As private banks' loans to the shipping industry have declined significantly since the 2008 global financial crisis, unlisted small and medium-sized shipping companies are likely to face a shortage of operating funds as well as funds needed to secure new ships in the future. The need to preemptively respond in the carbon neutralization of the shipping industry
Cello Square Copyright © Clip Arts Korea
Among the operational (industrial) risks, environmental regulations on ships are expected to have the greatest impact on future shipping companies. The International Maritime Organization (IMO) has been considering various agreements to tighten air pollution regulations on ships to reduce greenhouse gases due to climate change. Starting with strengthening regulations on nitrogen oxides (NOx) in 2016, IMO regulated sulfur oxides (SOx) in 2020. In addition, It has set a goal to reduce annual GHG emissions of ships by more than 50% by 2050 (compared to 2008) by 2050. It plans to introduce Energy Efficiency Regulations (EEXI) and Carbon Aggregation Index (CII) regulations for existing ships.[3] Therefore, shipping companies should preemptively move to carbon neutralization of the shipping industry in the future by securing eco-friendly ships and securing alternative fuels, which can be used as an opportunity to secure competitiveness in the domestic shipping industry. Governments should also strengthen information provision and financial support by forming a consultative body consisting of shipping, shipyards, shipping and related agencies.[4] The shipping industry needs to be reborn Through digital innovation
digital innovation image Copyright © Clip Arts Korea
One of the prerequisites for successful shipping company operation is to prepare for cyber-attacks by securing a stable IT system. In particular, since digitalization and automation are becoming common, the possibility of cyber-attacks on shipping companies and ships is also increasing. In 2017, Maersk Line, the world's largest shipping company, suffered a loss of nearly 300 billion won due to a ransom ware Infection which paralyzed the logistics system. If smart shipping and logistics platforms or autonomous ships emerge in the future, the importance of cyber security will increase.

In case of Korea, although domestic shipping companies are aware of the need for digital transformation of the shipping industry in the future, the actual response status to this is significantly insufficient. Shipping companies also need to actively promote digital transformation using big data and artificial intelligence, away from the perspective of traditional business methods, and establish an enterprise-wide IT security system. The need to actively develop new business models British shipping economist M. Stopford has stressed that the success of Greek shipping was possible because it distributed risks by predicting and preparing for the low and high points of the shipping market. Greece generated profits by buying used ships at a bargain price during the downturn and selling ships at a high price during the boom. In other words, it was possible to become the world's largest ship owner through an economic retrograde ship investment strategy. Until now, Korean shipping companies have focused only on freight markets that provide maritime transport services, but now they have to utilize a new business model that distributes risks and generates profits through ship transactions. The Korean tonnage provider, which is being promoted by the Korea Maritime Promotion Agency, needs to be actively reviewed by the private sector.

In order to revitalize the ship finance market, which has shrunk since the global financial crisis, the government should introduce a tax lease that allows accelerated amortization of ship assets Additionally, it is recommended to establish a "sea shipping industry crisis response system" to identify and respond to shipping companies' signs of insolvency early by conducting market early warning systems, shipping companies' insolvency predictions, and stress tests by crisis situation. Prepare for an era of uncertainty With a dynamic and flexible risk management strategy The world is entering a new normal era of rapid environmental change and uncertainty. In this situation, in order for Korean shipping industry to develop into a global shipping powerhouse in the future, it should preemptively manage the aforementioned shipping risks instead of reacting to them like now. In particular, since the shipping industry is sensitive to changes in the external environment, dynamic and flexible risk management is required. Crises are often repeated. If we prepare for an era of uncertainty with appropriate risk management strategies, expect the next crisis to be clearly different from the past. References [1] Forward Freight Agreement (FFA) is defined as an over-the-counter derivative product by exchanging the current fare with a fixed price and a variable price, which is the future fare.
[2] Park Seonghwa, Kim Hanna, Choi Sooho from KMI Trend Analysis Vol.183, 2022.6
[3] EEXI(Energy Efficiency Existing Index) is defined as the amount of CO2 emitted to transport a ton of cargo for a mile is calculated and indexed in advance using the engine power, cargo weight tonnage, and ship's parameters.
[4] According to the Ministry of Maritime Affairs and Fisheries, 1,084 of the national ships are subject to EEXI regulation, of which 40 percent are lacking (2021.6)

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Cheolhwan Han Cheolhwan Han