Freight futures sizzle as banks, funds tap growth

LONDON (Reuters) - Freight futures more than doubled last year on record prices to ship commodities and could grow another 20 percent this year as more banks and hedge funds, stung by the credit crisis, fish for profits.

Major brokers say freight derivatives trade to transport raw materials jumped 113 percent to $117 billion in 2007 from $55 billion in 2006, outdoing the most optimistic forecasts.

Early last year leading players had estimated the market for oil and dry commodities growing to around $150 billion in the next three to five years.

"This is a massive drive for the Freight Forward Agreement (FFA) market," said Michael Gaylard, strategic director at Freight Investor Services in London.

"There's been a significant increase in the number of players actually looking at the market and also the variety of trades that are executed. We are very much breaking new ground here," he said.

Futures growth has been driven by physical freight prices to ship dry commodities like grains, iron ore and coal which struck a record in November on voracious demand from China and India.

The Baltic Exchange's chief sea freight index, which gauges the strength of 40 such trade routes, has had a roller-coaster ride over the last six months, plunging in January from a record, only to recover again.

Brokers say it is precisely that physical volatility that has drawn big financial players eager to cash in on the evolving futures market.

Banks and hedge funds now account for close to 40 percent of the global market compared with 15 percent last year, they say.

VOLATILITY KEY

"Volatility is absolutely massive: capesize-class (largest ships) volatility is about 70-75 percent -- it's huge. We've seen $20,000 intra-day swings on voyages," Gaylard said, adding that participation wasn't for the faint-hearted.

"The exceptional growth has been driven by financial players who want exposure to the shipping markets, exposure to China and India, and cashing in on that growth," said spokesman for London's Baltic Exchange, Bill Lines.

Only last year the former chairman of the U.S. Federal Reserve called the exchange's major trade routes an excellent indicator of global economic growth.

Major investment banks Goldman Sachs, Citigroup, Macquarie Bank, Morgan Stanley, Credit Suisse and Merrill Lynch have all set up or bolstered existing freight derivatives desks in the last year.

"It's certainly hit peoples' radars and what has happened recently on financial markets has only accentuated the look for another sector to get their teeth into," Gaylard said.

"There are a number of banks that have structured products internally for clients built around the FFA market...they want a market that is slightly different something fresh," he added.

Hedge funds too have been eager to get a slice of the action, drawn by the volatility and growth in physical markets as international trade expands.

"There are probably eight in the market, and I'm speaking to another 25 others that are looking. They are doing modeling, looking at historical prices to see if market suits them and to see if it fits in with their ethos," Gaylard said.

Financial brokers say hedge funds really began to take an interest in a major way over the last year with respect to having proprietary desks and treating as a separate market, instead of building it around their commodity books.

UK brokers like Duncan Dunn at Simpson, Spence & Young (SSY) Futures, believe the global freight derivatives market still has enormous potential. He estimates the market growing at least another 20 percent in terms of volume of lots traded.

Others are betting on the market growing to more than the underlying physical value of freight estimate at $150 billion.

Dunn says the global credit crunch that has rocked financial markets could also work in the maturing market's favor.

"It will give people more reason to trade this market, whether that's because of a need to seek diversity from exposure in other markets or whether it's because they need to cover their positions in volatile freight markets remains to be seen."

(Editing by James Jukwey)