The impact of container freight derivatives and index-linked contracts has yet to be fully felt on U.S. export trades, and for good reason.
There aren’t really any indexes for export shippers to base such contracts or derivatives on quite yet, according to two experts who spoke Friday at the Agriculture Transportation Coalition’s annual meeting Friday.
“There’s still today a lack of relevant index for export shippers,” said Benjamin Gibson, a freight derivatives broker for Clarkson Securities. “All the tools available today, you can’t use. But there are products being developed that you will be able to use.”
Derivatives are gradually gaining traction in global container markets, providing shippers and carriers a way to hedge against volatile freight rate movements on tempestuous east-west trades. But the bulk of existing indexes allow shippers to benchmark rates on major headhaul trades, with precious little information available on, for instance, the westbound transpacific. At least it's currently not enough to place well-educated guesses to underlie long-term hedging strategies.
Yet the potential benefit of freight rate hedging could be even more significant for low-margin ag shippers than for their import counterparts, given that even slight rate volatility impacts export shippers greatly.
“There’s clearly a need for it,” Gibson said. “Shippers want service levels and equipment availability. Carriers are struggling with a difficult market and intense instability.”
“Existing contracts with carriers are suboptimal,” Michael Rainsford, a freight trader for Morgan Stanley, said. “The contract is signed at a certain level, and one party always believes they are getting a raw deal. By hedging exposure 12 to 18 months out, you can extend your business for a longer period than you may confidence in the market.”
Rainsford gave a specific example of how a hedge might impact a shipper whose cargo is in jeopardy of moving on a particular sailing due to tight capacity. If there’s one slot left on a ship, a shipper can use an index-linked contract to say to the carrier that they’ll pay the higher end of the agreed-on range to ensure its cargo gets the last slot on the ship.
Then that shipper would use its hedged derivative contract as a backup, paying the shipper back the difference between the rate it thought it would get, and the rate it actually had to pay to get on the ship. The hedge allows the shipper to offer its carrier a more attractive rate without losing the money by doing so.
Carriers have been somewhat slow to accept derivatives as a valid tool, primarily due to the belief that such instruments debase their services into simple rate-space commodity agreements.
But Rainsford argued the industry is headed that way, with or without widespread acceptance of hedging mechanisms. He noted many shippers already hedge their fuel costs, which account for close to two-third of sailing costs these days.
“It’s no surprise that carriers are actively hedging their bunker consumption,” he said. “The G6 Alliance (a partnership of two alliances and six ocean carriers that jointly operates services on the Asia-Europe trade) formed overnight,” he said. “They almost signed away overnight their competitive edge. The only way they can compete is on price. In my view, that’s a clear sign that the market has become commoditized.”
Gibson admitted that getting carriers on board has been difficult.
“One of our biggest challenges is to get more carriers involved,” he said. “We’ve seen carriers try out hedging tools. Investors are saying to carriers, if you want to keep getting our money, if you want to keep making investments, we need to see that you’re operating responsibly. But we’re dealing with big, people-heavy companies, so it will take some time.”
Both spoke of the need for ag shippers to support the U.S. Federal Maritime Commission’s efforts to develop a commodity based rate index
for U.S. exports. The comment period
on that effort ends July 8. The idea, they said, is the more indexes that are out there, the better, as it gives shippers and carriers more transparency into rate levels, and thus a better idea of how to structure derivative contracts.
Both Gibson and Rainsford argued that such forward deals inevitably give both service providers and users a chance to minimize the huge fluctuations in rates seen the past three years.
“Whether you’re 50-50 on whether you’d want to use an index, I think you should be supporting the FMC in establishing an index,” Rainsford said. “Having the option for more indices in the market is incredibly important.”
More indexes also allow shippers to better benchmark their rates, even without the use of derivatives, Gibson said.
“The container market hasn’t been a transparent place to do business,” he said. “It’s difficult for you to figure what an acceptable market rate is. When we do have data available, there’s been some trust issues. There’s no way of validating information provided by a carrier in an independent way.” - Eric Johnson