From Big Ships to Black Swans

Three Lessons in Risk Management from the Grounding of the Ever Given

The agency problem drives every company, thanks to the build-up of hidden risks, to maximal fragility.

After six days of being wedged in the Suez Canal, the MV Ever Given, a 200,000-ton cargo vessel the size of a skyscraper, was re-floated on Monday. Whilst this is a huge relief to shipping companies around the world, and to their customers whose supply chains rely on speedy and reliable transport networks, it is still not entirely clear how long it will take for global shipping operations to get back to normal. In any case, the disruption to the Suez Canal, which handles about 12% of world trade, has been an expensive mishap, pushing up prices in commodities such as oil and coffee beans and potentially reducing annual trade growth by close to half a percent, according to German insurer Allianz. From a risk management perspective, there are three important lessons we can take away from the grounding of the Ever Given:

1. ‘Rare’ events happen (and are usually not ‘Black Swans’!)

   Whenever rare events happen, from banking crises to global pandemics, there is a tendency to chalk them up as ‘Black Swans’, as if to say there is nothing that could have been done and any negative consequences are just ‘bad luck’. This is not the case – rare events are usually not ‘black swans’, which, as Nassim Taleb (author of ‘The Black Swan’) writes will ‘(lie) outside the realm of regular expectations, because nothing in the past can convincingly point to (their) possibility’.

   While the recent Suez blockage has been described as a ‘Black Swan’, groundings in the Suez Canal happen regularly; there have been 25 cases over the last decade. The Suez Canal freezing over could be considered a Black Swan event – the grounding of a ship in the Canal is not. If your business model is heavily dependent on a reliable supply chain, good risk management should involve considering the possibility that an event like the Ever Given grounding can (and will) occur and making sure the appropriate ‘hedges’ are in place.

   In our world (financial market risk), there are plenty of rare events which we can plan for, and hedge against. The onset of high inflation and / or the collapse of a currency, for example, may be low-probability events, but they are not ‘black swans’. Such events happen (with some regularity) and can be prepared for, whether through hedging or other means.

2. Over-optimization is dangerous

   One of the reasons that the Ever Given event was so disruptive was because the ship itself was so big. Its extremely large size helped cause the accident and made the resolution more complicated (and slower). Container-carrying capacity on ships has doubled in the past decade and increased by about 15 times over the past 50 years. This dramatic increase in ship size was in part a result of rising oil prices, which incentivized ship owners to maximize economies of scale. In addition, ultra-low interest rates ensured that the required capital investments were affordable.

   However, in this drive towards scale and optimization, other risks were created, including the increased probability and severity of accidents. In addition, the risk of industry overcapacity grew, leading the OECD to warn: ‘Shipping lines are building up overcapacity that will most likely to be fatal to at least some of them’.

   The dangers of such hyper-optimization are well known to financial risk managers. One of the most infamous hedging disasters, the Metallgesellschaft AG $1.5 billion energy hedging blow-up, was largely down to the German conglomerate’s push to optimize hedging costs by hedging long-dated risk with short tenor hedges. This is not to say optimization is a bad thing – we are always looking for ways to reduce hedging costs for our clients for example – but that care is needed not to push this optimization too far. Optimization requires a laser-like focus on a specific variable (e.g., shipping capacity, hedging costs) – however this can have secondary or tertiary effects on other (non-optimized) variables (e.g. accident risk, liquidity risk) that must be carefully considered.

3. Volatility is not Risk

   Volatility can be an important indicator of risk – we use this measure every day when quantifying risks for our clients. However, it can also be misleading. The Suez Canal has only been closed five times since it opened in 1869. As such the ‘volatility’ of the Suez Canal’s accessibility could be considered very low. Any risk model using ‘volatility’ as its primary input would have greatly under-estimated the risks of a blockage. However, shipping experts have been highlighting growing risks of exactly such an event, based on factors such as increases in ship sizes and traffic volumes, in addition to geopolitical risks.

   The danger of risks being masked by low volatility is often present in financial markets, with currency pegs or controls acting as an excellent example. Risk models failed to account for the risks of Swiss franc appreciation in 2015, as the Swiss National Bank (SNB) was selling Francs to cap its value against the euro, artificially compressing volatility. When the SNB unexpectedly changed its policy, the Franc surged by 30%, and damaged or destroyed several market participants.

   In both cases, a lack of ‘volatility’ was misinterpreted as an absence of risk - perhaps the most dangerous mistake a risk manager can make. When designing and evaluating hedging programs or risk management strategies, volatility can be a useful input but must be supplemented by a qualitative or quantitative analysis of other risk factors which could disrupt this volatility regime. Managing financial risk can be like piloting a 400-metre-long vessel through a narrow 120-mile waterway. It is a complex endeavour, where unforeseen events, whether a gust of wind or an unexpected central bank decision, can cause havoc if your strategy is not sufficiently robust. And the implications of failure can be costly (and embarrassing!). If things do go wrong, prompt remedial action is essential. As costly a mistake as the Ever Given accident was, it could have been worse – a fleet of ships was once stranded in the Suez Canal for more than eight years!