News / Ocean freight rates – is the future in the futures market?

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By: Dan March, logistics specialist

Increasingly volatile rates on the world’s major ocean freight lanes is an ongoing concern for shippers and freight forwarders.

Multinational forwarders like DHL are carefully considering the use of indexing tools, in conjunction with customers and carriers, to smooth out rate volatility and provide a more stable environment.

Yet, a small but growing number of companies are creating and offering a more structured paper-based, index-linked facility, including options for full hedging of future volumes and rates.

Questions remain, however. Can containerised freight really be classed as a commodity? And is the industry ready and willing to fundamentally change the way in which capacity and prices are secured?

Shippers repeatedly call for less volatile pricing. This is understandable, considering their margins can be decimated by the rollercoaster ride of spot rates. The carriers themselves seem incapable of controlling the rapid fluctuations in pricing. So, can financial tools from other ‘commodities’ help?

Well, why don’t shippers and freight forwarders arrange more traditional service contracts with carriers? Surely, this would give shippers security and carriers steady reliable volumes, enabling both to plan ahead and set a sustainable pricing structure. Set over a defined period with volume commitments and agreed service levels and parameters, plus a fixed freight rate, this is the traditional way of ensuring some stability for shippers.

The problem, however, seems to lie with the nature of the contracts. For a start, often the legal status of these contracts is questionable, as is how enforceable they are. Secondly, volume commitments are not widely enforced and ocean freight service levels barely register as they are insignificant compared to price. Finally, the rate agreed between the counterparties can severely harm relationships as one party inevitably loses out as rates climb or sink.

When spot rates move higher carriers seek to benefit and they come under pressure to increase surcharges in order to guarantee space. Conversely, if spot rates fall shippers become desperate to move volumes to rivals that offer cheaper rates.

This was clearly demonstrated in 2010 when a sudden shortage of capacity saw rates rise rapidly. Lloyd’s List reported the ‘tearing up of contracts’. There have also been many instances of shippers’ cargo being ‘delayed at the port’ coinciding with pressure from carriers to renegotiate the contracts. It appears that win-win deals do not really exist in competitive, ‘commoditised’ markets.

Linking a service contract with a carrier to an index is certainly a way of ensuring neither shipper nor carrier is a major loser or winner against the prevailing market conditions. Indices such as the Shanghai Containerised Freight Index (SCFI) are now pretty firmly established and respected and can provide a basis for index-linked contracts.

David Briggs, senior manager, container freight derivatives for TSC Container Freight is a keen advocate for extending the indexing of rates forward to the futures market, allowing shippers and/or forwarders to hedge rates well into the future. His company already offers a hedging facility, based on indices and he says that interest is growing rapidly.

“The container industry continues to struggle with massive rate swings, problematic contracting procedures and unreliable forecasting. Innovative products such as index-linked service contracts and hedging tools are now available that allow shippers and carriers to agree stronger commitments and fix their freight rates without placing undue stress on their commercial relationships,” he explains.

Briggs highlights that some 65% of dry bulk is now hedged and that containers have the potential to go the same way.

Using a clearing house inLondon, shippers would for the first time be using a paper market rather than a physical market. Briggs says this would help all shippers plan well in advance with security of rates for specific volumes.

“This is a risk management tool that benefits both carriers and shippers” he argues. “The rates available in the futures market are very competitive and shippers have the opportunity to ensure the rapidly changing spot market does not affect their margins. Carriers have the benefit of guaranteed volumes at guaranteed rates for a portion of their capacity, helping them to plan capacity more effectively.”

So if hedging is such a win-win solution, why are shippers and carriers not flocking to embrace the scheme?

The Loadstar asked a selection of medium-sized shippers and forwarders their views on hedging in a virtual ‘paper’ market and the response was mixed.

Although all agreed stabilisation of rates was highly desirable, many expressed a fear that involving financial institutions would not only lead to a drain of money away from the core industry to ‘financial gamblers’ but also would require expertise they just didn’t have in negotiating hedging contracts.

However, the biggest elephant in the room when considering hedging rates is the prospect of major penalties if the volumes are not fulfilled. Hedged contracts have no room for negotiation once the deal is done. If the shipper wishes to lower volumes or delay shipments as inventory demands change they would face hefty penalties for any hedged volumes that are not fulfilled.

Briggs accepts that hedging is not the way forward for all shippers, but he points out that hedging 100% of required volumes is not the idea anyway. He explains: “Shippers with steady container freight demand should look to hedge a proportion of their future requirements. This gives the flexibility to alter volumes as needed.”

Whether the industry will come to accept index-linked contracts and will then push one step forward to future hedging of rates is questionable. But at a time that shippers are increasingly exasperated with rate fluctuation, it may develop into a tool that could benefit the industry as a whole.