News / 'Volatile few years' for shipping could prompt new contracting approach

ID 4783925 © David Omar

Stakeholders looking to hedge cost-associated risks in anticipation of heightened market volatility could consider a new type of agreement, but there is one major hurdle for SMEs. 

Judah Levine, head of research at Freightos, said: “It’s been a very volatile year, maybe a volatile few years,” pointing to the Red Sea crisis, mounting trade wars and rapid fleet growth as examples. 

“There’ve been several key drivers that have made the year volatile for the container market in terms of volume timing, volume levels, and certainly in terms of spot rate behaviour. 

“These factors could impact the near term, and possibly the longer term as well,” Mr Levine warned.  

He added that shippers with long-term contracts during times of volatility would often find they became “unreliable” if the spot market and contract market diverged significantly. 

“When spot rates go up, we start to see contracted containers possibly rolled and, often, contracted shippers will start to pay premiums in order to get those shipments moved.  

“But then when the spot market comes back down, BCOs are incentivised to try and renegotiate rates, shift to other carriers, move to the spot market, or no-show… We start seeing contracts become a challenge,” he said. 

According to Mr Levine, this creates inefficiency for shippers and carriers, meaning “effort, headaches, unpredictability, time and price changes”. 

Currently, mitigating volatility generally entails signing short-term contracts, spreading inventory across service providers, or sticking to the spot market.

“But ultimately, none of those is able to be terribly effective in terms of changing these dynamics or changing the outcomes… there’s plenty of recent examples of how shippers and carriers are not satisfied with the status quo of what goes on with ocean contracts, and the impacts they have,” said Mr Levine.  

He recommended that, to protect against price fluctuations and to hedge risks, shippers could consider container derivatives or forward freight agreements (FFAs). 

In an FFA, two parties settle on a future freight rate for a specific route and an allocated volume. On settlement date, the agreed rate is compared with the actual market rate and the difference must be paid. The FFA will either go up or down in value, thus affording shippers more certainty of pricing, as the FFA fluctuation offsets their operational costs.  

For example, if a shipper buys an FFA at a locked-in price of $1,000 per teu for next month, but on settlement date the actual rate is $1,500, the shipper/forwarder must pay an extra $500 to the forwarder/carrier, but will gain that $500 as the FFA has become more valuable. 

Peter Stallion, commodity and freight futures broker at Clarksons, explained: “If freight price goes down, you’re paying less on the physical market, but you are also paying on the futures contract. So, one calculation offsets the other.

“We’re keen to demystify how this works and avoid some of the jargon finance people tend to get into,” he added. “It is simply a contract between a buyer and a seller for freight rates at a certain price, for a specific time, on an agreed route.”

FFAs are cash settled, and you would not deliver a physical container under a futures contract –” very important” added Mr Stallion, “because it essentially separates your activities on the physical market, which can be very complicated, with how you manage your risk on container futures.”

However, he warned that for SMEs, the hurdle is getting the clearing account open, and “having the means to do so”. 

To open a clearing cap for FFA trading, the minimum capital required is some $10m across total business equity, and often there are minimum yearly transaction values. 

“We’re in the process of trying to pull smaller players together to get this side of the market covered, but you have to go through the process of setup whether you’re an SME or a large player,” Mr Stallion concluded.