News / An ILA may be the best deal for liner clients mulling a spot rate gamble

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Shippers and forwarders currently tendering should consider index-linked contracts if they are caught between betting on a fixed deal or gambling with the spot market. 

President of Jon Monroe Consulting, Jon Monroe, told The Loadstar Podcast that, when signing agreements, it was important to understand the relationship between the contract rates and spot rates – as spot rates would determine the contract rate level at the time of signing. 

“If the spot rates are down to a low level, or a much lower rate than current contracts, nobody is going to sign a large commitment, they’re going to ride through the spot market,” he said. 

And CEO of Xeneta Patrik Berglund told The Loadstar: “There is still structural overcapacity in the market, so it is hard to see the current spot market remaining high for the full year – but it could take months before carriers successfully redistribute capacity and rates drop again.” 

However, amid the Red Sea crisis, fears that carriers are prioritising spot market shipments due to the high profit margins has sparked concern that long-term contracts won’t be honoured.  

Mr Berglund said: “Plenty of shippers made it through Covid and the current situation, so far, with suppliers honouring their agreements. But there are a significant number of contracts which have been thrown out of the window.  

“There are three scenarios at play – contracts being honoured, contracts being honoured on a minimum quantity commitment basis and contracts not being honoured.” 

Mr Monroe advised Loadstar Podcast listeners to split their business between carriers and NVOCCs. 

“The carriers under Covid walked away from some of their commitments on the contract, so you need to know you’ve got something in your back pocket, just to move things,” he said.  

Partner at Law Firm HFW Matthew Gore advised making sure contracts are agreed correctly and legally enforceable, to mitigate risk.  

“There is a need for agreements to be legally enforceable… They must be properly drafted to ensure obligations on rates agreed by carriers and volumes committed by shippers are enforceable,” he told The Loadstar. 

Index-linked agreements (ILAs) may be a good alternative, as they should guarantee the shipper space on a vessel, but also mitigate some financial risk for both shipper and carrier. This is because ILAs are longer-term contracts which include a periodic price adjustment based on the current market. 

Mr Gore explained that, because ILA rates track the market, albeit with a time lag, there was less potential for parties to breach the contract.  

“Often where you get large disconnects between the spot market and fixed rates in contract, there is a tension which will lead to one party or the other trying to renegotiate the rates – ie, to vary or breach the contract,” he said.  

Japanese carrier ONE told The Loadstar: “ILAs are used by a limited number of customers. These tend to be forwarders that can provide regular FAK volumes. The idea behind an ILA is that the customer provides a regular volume for which the carrier can reserve space. This is a key difference between using spot rates in the market where no space is guaranteed.” 

Mr Berglund told The Loadstar that, in the current volatile market, a mechanism that allowed shippers to revisit agreed rates could ensure competitive rates and stable supply, while limiting risk.  

“An index model that captures movements on both short-term and long-term markets is probably the most favourable and cleanest setup to achieve this,” he said.  

 “Shippers tendering now, or about to, could consider quarterly or six-month rates to avoid significant financial losses when the market stabilises either through ships returning to the Suez Canal, or carriers redistributing capacity to account for additional sailing time around Cape of Good Hope.”