Oil prices are set to rise again in light of the recent unrest in Libya and the Middle East. This has made fuel price risk management is a top priority within the cruise liner industry. Ross Davies examines how operators can offset potential losses through a successful bunker hedging strategy, rather than levying unpopular surplus charges on passengers.
The rise and fall of oil prices has always been a volatile business. During the nadir of the global recession, the price of Brent crude fell to $40 per barrel in November 2008, its lowest since 1983 - only in July 2008 it had been at $140 per barrel.
This had a knock-on effect on the cruise industry, where fuel costs always signify concern given they represent a major part of a ship's expenditure.
In order to successfully respond to such vicissitudes, there have been calls for cruise liners to hedge their oil purchases, effectively placing two-way bets to cover themselves during both high and low periods.
However, in some instances this hasn't been the case; as economies begin to emerge from the downturn, together with rising oil prices, some operators are again implementing fuel surcharges on passengers. Having first been introduced in 2007, they were dropped during the recession.
In January 2011, a host of UK-based operators, including Voyages of Discovery, Swan Hellenic and Cruise Maritime Voyages, announced their intent to increase the costs of cruises by £4 per passenger per day. This followed the lead of P&O and Cunard, who had already implemented a £4 charge in addition to a cap of £150 per person.
While these operators insist the surpluses are unavoidable due to rising oil prices - at the time of writing, Brent crude is at roughly $115 per barrel - others, such as Saga, have refrained from introducing supplements, questioning the effect it may have on consumer confidence.
"If you run a business properly, you should not have to resort to such measures," says Paul Green, head of communications at Saga, in response to the announcements. "Companies can hedge their fuel purchases and should be able to price their products accordingly. It is unfair on passengers, and doubly unfair if these companies have already hedged their fuel anyway."
Aside from the fluctuating base prices, the industry is also in the process of ratifying a series of environmental regulations giving operators further food for thought.
Due to be implemented in 2012, new rulings will demand that cruise liners use higher quality low-sulphur fuel, with the hope of cutting the level of sulphur from 4.5% to 0.1% by 2015. It has been estimated that the use of these fuels will cost vessels an extra £10,000 per day.
In order to cover these incremental costs without alienating consumers, fuel price risk management, or bunker hedging in a shipping context, has become prevalent in recent years.
One of the major issues still revolves around a company's ability to pay for bunkers in advance - known as forward purchasing - and the ramifications of defaulting on payments, as recently highlighted by Adam Dupré, managing director of marine credit analysis company, Ocean Intelligence, when commenting on his new book, An Introduction to Bunker Credit Risk.
"Anyone selling fuel to ships almost always does so on credit," he says. "The amounts of money involved can be substantial. There is no security of payment and margins can be thin, so customer default is always a danger and can be very serious for the supplier. For anyone involved in the business, it is essential to understand the dynamics of credit risk."
Cruise liners also need to ensure that bunkers are of a high quality. Poor quality fuel can lead to substantial engine damage or failure; hence pre-testing has become more commonplace in recent years.
Royal Caribbean Cruises is one such operator that is reaping the awards of a successful hedging programme. In April, it reported a net income of $91.6m in its first-quarter results, compared to $87.4m during the same period in 2010, aided by lower costs and gains from fuel-oil hedges.
Pre-empting rising fuel prices, it has roughly $2.5bn to $3bn available in currency hedges for planned expenditure for new ships and other factors.
Events in the Middle East and Libya, and March's earthquake in Japan have unsurprisingly sent oil prices soaring in recent months, which Royal Caribbean's chairman and chief executive Richard Fain admits "turned what was shaping up as a spectacular year into merely a very good one".
However, he is hopeful of offsetting potential loss of business by being 56% hedged for the remainder of the year at the equivalent of $75 a barrel of West Texas Intermediate and 55% hedged for next year at the equivalent of $86 a barrel.
Norwegian Cruise Line is another example of an operator benefitting from a prescient hedging structure - it has 60% of its fuel hedged for 2011, which CEO Kevin Sheehan hopes will make the rise of oil prices more manageable.
"In 2008, Norwegian had a very small percentage of its fuel hedged and had to levy fuel surcharges on its passengers," he told the Wall Street Journal in March. "The company began hedging after that experience and isn't currently considering fuel surcharges."
With the future uncertain, it appears that more responsibility could fall on external assistance from energy traders and bunker suppliers in offering risk management tools, and focusing on both the technical and financial aspects within the supply chain.
In recent years, counter parties have sometimes included banks, which offer trading services, and local suppliers, so as to ensure stability, and suppliers that provide the best possible value for money.
This was corroborated by Singapore-based bunker supplier Chemoil in a recent newsletter stating that supplying risk management services offers bilateral advantages; customers can control their risk, while the supplier itself benefits in managing risks on its physical inventory in storage.
Due to the precariousness of markets, it is difficult to cite what makes for a flawless hedging strategy. However, given the more than lukewarm reaction to fuel supplements over the past year, it would be unsurprising if more cruise operators didn't follow the likes of Royal Caribbean in developing a similar entrenched approach in meeting rising oil prices to ensure the ultimate goal: passenger satisfaction.