If container shipping today is a commodity, as many argue it is, then freight rate derivatives make intuitive sense. Because the market will always be volatile, shippers, carriers and 3PLs can significantly reduce price uncertainty by transferring risk to a third party through a hedge.
For shippers and carriers that want to focus on service, a hedge against an index-linked contract can effectively take price out of the equation. Hedging is what producers of hogs, wheat, soybeans, iron ore and dozens of other commodities do every day to lock in predictable cash flow. Last year, 25 billion derivatives contracts were traded worldwide, John Banaszkiewicz of Freight Investor Services told a conference last week in New York organized by the Container Freight Derivatives Association.
So why are container derivatives, now 2 years old, still struggling, as I see it, to gain traction? Investment firms see it differently, saying any new paper (versus physical) market takes time to develop — as others have — but that signs are positive.
“It is a new market with new participants, so it makes sense that it starts with low volumes,” said Kai Miller, head of the container desk at London-based ICAP, which produces forward-curve freight rates based on swap agreements settled against the Shanghai Containerized Freight Index.
Added Richard Heath, managing director of the World Container Index: “Our goal right now is to educate the market, increase transparency and help the products evolve.”
And Ben Gibson, freight derivatives broker at Clarkson Securities, said, “What we are seeing is a huge amount of willingness to understand that wasn’t there 12 months ago.”
That said, the market appears (to me, at least) to be encountering headwinds on several levels. One big one is that carriers have yet to embrace derivatives as a tool, and may never (although Miller said, “it’s totally wrong to say there is no interest on the liner side.”). Yet promoters seem to be growing blue in the face trying to convince carriers that hedging is in their best interest. “The concept is explained and explained again, and it makes sense. It totally makes sense. The concerns should be eliminated,” Miller said.
So why the reluctance from carriers? I’m reminded of a CNN interview a few years ago with a Hollywood studio executive trashing the idea of futures contracts based on opening-weekend box office receipts. “When everything we do is aimed at producing the best movie possible, why would I want to bet against myself?” he asked.
It’s the same with carriers. Despite evidence to the contrary, they don’t accept their business is commoditized and are always trying to increase rates, even if frequently in vain. Derivatives represent a potential transformation of the industry, and the always-conservative carriers don’t appear ready, despite mountainous losses last year.
As Maersk, often an industry pioneer, said in an e-mail: “Maersk Line does not participate in the derivative market, as they find that long-term contracts directly between a shipper and a shipping line are the best way for both parties to achieve stability and predictability. But, of course, Maersk Line follows the developments closely.”
Another angle promoters see with potential is banks lending on new ship construction demand a derivatives position to lock in cash flow.
But while some believe the market can take off without carrier support, others aren’t sure. Banaszkiewicz said successful derivatives markets, such as delivered prices on grain, had the support of major players, in that case Archers Daniel Midland, Louis-Dreyfus and Cargill. “The problem with the container industry is you haven’t got a sponsor,” he said.
It’s doubtful beneficial cargo owners or other shippers will drive the market. BCOs often just want to lock in a competitive price for a full year in return for guarantees of capacity. The ocean freight component of the delivered cost of a pair of Nike sneakers is pennies, so despite the tens of millions of dollars Nike may spend annually on ocean transport, it’s far more important to ensure capacity than to play the freight market if that puts the core business at risk.
Of the 45,000 total contracts on file with the Federal Maritime Commission, only 62 are index-linked service contracts (a basis for hedging, and up from 50 last year), according to FMC General Counsel Rebecca Fenneman.
“Movements in index-linked contracts can really help to smooth these relationships,” Heath said. “If your cargo is moving in sync with the spot rate, your counterpart will feel a lot better about it.”
Where derivatives may make more sense is for 3PLs that by their nature are always playing the market. Indeed, 3PLs are often on one side of the roughly 300-FEU derivatives trades that typically get executed, Miller said. Ultimately, derivatives are gaining supporters: As Ed Sands, global practice leader for logistics at Procurion and an influential former BCO, said: “The industry should embrace the idea of derivatives, hedging and index-linked contracts — or perhaps just suffer another decade of uncertainty.”