Index-linked contracts open the door for container freight derivatives
Hedging through the use of forward-freight agreements is common in other shipping sectors, but the contract-led nature of box shipping has meant it has never taken off for carriers and shippers. But changing from fixed price contracts could lead to an overhaul
Carriers and shippers should look to index-linked contracts to reduce volatility and avoid contract breaches
AS CARRIERS and beneficial cargo owners begin their negotiations for this year’s contracts, container freight rate booking platform Freightos is suggesting that annual tenders have become a waste of time.
“Companies are spending a lot of time and energy on annual tenders,” Freightos chief executive Zvi Schreiber told Lloyd’s List on the sidelines at the Journal of Commerce’s TPM conference in Long Beach. “But they don’t work very well.”
Annual tenders, which lock in prices for guaranteed minimum volumes of cargoes, are designed to bring stability to both shippers and carriers. But the volatile nature of container freight spot rates due to the seasonality of demand and the flexibility of supply, mean that contract and spot rates can vary widely during the year.
“When you lock in a fixed price and then the price moves, someone is going to feel silly,” Mr Schreiber said. “Last year, it was the carriers, because they locked in low prices at the start of the year but then managed to get the spot price higher. In 2016, however, the spot prices crashed after contracts had been signed.”
In that event, many beneficial cargo owners simply ripped up their contracts and moved to the spot market. In cases where the spot market moves higher than contract rates, carriers will roll contracted cargo in favour of more remunerative spot cargoes.
“Contracts are not fully honoured in either direction,” Mr Schreiber said.
In an effort to get around this, Freightos, in conjunction with the Baltic Exchange, last year began developing the Freightos Baltic Index, which it hopes will become the de facto standard on which index-linked contracts can be formed.
These would guarantee shippers and carriers a rate that was linked to the index and would move in line with the index.
“That way they are always paying the right price,” Mr Schreiber said. “The contract will be close to spot so the carrier has no incentive to roll contract cargoes, and the shipper has no incentive to go off contract as they are always close to spot rates already.”
The system, if widely adopted, also opens the door for derivative trading for container freight.
“Our plan, in conjunction with the Baltic, is to enable the carriers, forwarders and BCOs to move to index-linked tenders,” Mr Schreiber said. “They can then hedge the risk using derivatives. This year, we will start to see some index-linking and next year we will start to see derivatives. Every other industry has derivatives, except for us.”