In early 1999 Anne Rodrigues, Treasurer of Malaysia International Shipping Corp., was preparing for a meeting with the Finance Committee on the following day. The meeting was to hear a presentation from a foreign bank on the possibility of MISC financing itself by issuing a structured note whose debt service would be tied to the level of world freight prices.

MISC's management was intrigued by the idea, if the instrument could at once raise needed funds and protect against the vagaries of the world shipping market. MISC has been particularly hurt in the late 1990s by the weak local market for bulk freight that resulted from the general economic downturn in Asia. At the same time, freight rates had fallen, as the BIFFEX chart below shows.

Bulk shippers can be squeezed by low freight prices, by high fuel costs, or sometimes by both. Experience had taught her that oil prices are extremely volatile, and it is this volatility combined with ever changing levels of supply and demand that lead to large fluctuations in bunker prices. As a result, ship owners find it difficult to control costs and can often see their profit margins disappear with untimely fuel price movements, as the attached charts demonstrate.

In oil, however, paper risk management products instruments such as swaps and options can be used to 'fix' (set absolute) or 'cap' (set maximum) bunker prices for agreed volumes and time periods. Paper transactions of this kind are tied to an index such as Platt's Bunkerwire and are settled by cash at the end of each pricing period. The paper based nature of the agreement leaves the ship owner free to choose his physical bunker supplier.

This leaves freight rates as the main risk. In principle, they could be hedged in the LIFFE where BIFFEX futures are traded. MISC, however, was reluctant to trade futures, and was concerned about the illiquidity of the BIFFEX futures contract. The CFO had heard that commodity linked bonds and notes could be designed to appeal to investors while at the same time offering the borrower a cost effective source of financing. He had asked Rodrigues to consider an oil-linked note issued by J.P. Morgan, the American bank, and perhaps model a MISC deal on a similar formula.


Appendix 1: Relationship between fuel costs and freight revenue (from LQM Petroleum Services)
Appendix 2: J.P Morgan commodity linked "Oil Range Note"
Appendix 3: Commodity Linked Investments, report from J.P.Morgan

Ian Giddy