News / Arguments for the use of index-linked contracts and hedging in sea freight

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With container freight volatility increasing, participants at a hedging workshop organised by FIS heard that many forwarders and carriers have seen operating margins under increasing competitive strain in the marketplace, while the potential to use index-linked contracts or hedging is a possible antidote.

Rate volatility continues to be a problem for shippers, with carriers announcing almost monthly general rate increases (GRIs), a situation that has worsened in recent years resulting in an unmanageable situation and an inability to effectively plan future business, according to ED&F Man chartering broker Sebastian Smith.

Volatility was cited as the main driver in the take-up of alternative contract types as well as hedging. However the trend towards index-linked contracting does not remove the problem of rate volatility, with the index simply moving up or down with the market. Hedging such contracts however does provide stability and certainty that many in the market are searching for.

DSV Air & Sea sales director Richard Lawford told the seminar that benchmarking to a neutral freight rate index such as the World Container Index (WCI) or Shanghai Containerised Freight Index (SCFI) reduces the burden of refreshing quotes, and the use of such index-linked contracting has increased.

“We have implemented such deals to enable us to move in line with the market, so our customers can track rates in a timely and efficient manner. We have seen requests for this type of contract increase over the past year as customers search for alternatives,” he said.

Denholm Global Logistics commercial director John Keary described volatility as ”about the only market certainty”, and said that trying to offer his customers some stability and retain a competitive edge was the prime reason for his interest in index-linked contracts.

The next question was whether shippers and carriers were prepared to move to another level and embrace hedging alongside more flexible contracting.

John Good Shipping Far East trade manager Paul Ferguson said his company had recognised the potential of forward freight agreements (FFAs) as a tool to provide certainty for its customers.

“We see this as a potentially important tool, which is already working well in other commodity-specific industries, as well as in other areas of shipping. It seems a natural progression for the principles to be applied to containers particularly in the volatile Far East market where we see a growing desire from importers to have some stability and move away from massive fluctuations in costs.”

The FIS view is that the added benefit of being able to hedge is that it has no impact on rates agreed between shipper and carrier as the shipper simply agrees to pay spot. Because the carrier receives a fair market rate the relationship between both parties is preserved.

Seko Logistics commercial director Keith Gaskin said his company had already experienced the benefits that this approach can provide.  By using FFAs his customers had been able to achieve price stability regardless of changes to freight rates, whilst the ability to pay spot in the physical market brought its own benefits. “This provides us with the opportunity to do what we do best, which is focusing on the supply chain.”

With rate volatility increasing outside the Asia-North Europe trade, hedging is growing in the US market, with TSC Container Freight using container FFAs to fix costs for clients on US trades while also limiting its freight risk.

Despite the vocal interest from freight buyers, carriers have so far been less interested, which Paul Ferguson observed has slowed the development of the market.

The strategy of carriers has been to look for answers to volatility in the physical market by incorporating caps and floors into index linked contracts. However, such arrangements do not remove volatility entirely, leaving residual uncertainty for both shipper and carrier. Moreover, once these pre-agreed boundaries are breached, the contract has a tendency to come under unnecessary stress.

As such, FFAs not only provide rate stability to both shipper and carrier but also the opportunity to arrange more harmonious physical contracts. Despite their lack of support for hedging, freight rate stability is vital for carriers in a market where volatile cash flows do not lend themselves well to debt repayments associated to their large asset portfolios.

For HSH Nordbank head of commodity and freight solutions Jean-Marie Lamay, some carriers still need to overcome this initial educational hurdle, however many already see that a credible and sound price and risk management strategy can be developed by combining an index-linked contract with FFAs

“What was clear from the workshop was that the issue is one of balance,” said Webster Robertson’s Alan Robertson. “It is possible for a container line to hedge at least some of their revenue risk exposure, which would otherwise be completely random. For sure this may not result in grasping all of the revenue in a market upturn but it does provide protection and stability, in a market where they seek consistent revenue.

“In that sense, the question should be why would one not work with FFAs?”

DISCLAIMER: This is a guest post from Richard Ward, a derivatives broker at Freight Investor Services (FIS), reporting on a recent workshop the company held, promoting the use of container freight rate derivatives in the deep sea freight markets, and attended by forwarders and other ocean carriers customers. Opinions are those of the author and not The Loadstar.