Trans-Pacific service contract rate levels reflect need for stability

Trans-Pacific service contract rate levels reflect need for stability

All-inclusive freight rates from Asia are $1,300 to $1,400 per FEU to the West Coast and about $2,300 to $2,400 per FEU to the East Coast. Photo credit: Shutterstock.com.

Container carriers and their customers say they are within two to three weeks of wrapping up their eastbound trans-Pacific service contracts at rates that are approximately equal to 2019-20 levels as imports from Asia continue to decline amid the COVID-19 pandemic.

That means both parties appear to have successfully navigated potentially contentious issues involving uncertainties in cargo forecasting, freight rates, and volatile oil prices. More broadly, the consolidation of major carriers and cargo owners’ gradual prioritization of service commitments over price in recent years has provided the backdrop for more constructive service contract talks. 

“Shippers are looking for stability in the current environment,” Uffe Ostergaard, president of Hapag-Lloyd America, told JOC.com. “They don’t want to see too many things shuffle around in their supply chain, and with the high level of uncertainty and volatility, most rely on established partnerships.” 

The COVID-19 crisis probably added a sense of urgency to this year’s negotiations, Ostergaard acknowledged. “There is a little more of a ‘get on with it’ attitude,” he said. “I think more freight procurement people see that the market is much more stable now. There are fewer players [carriers] than before...and drawn-out negotiations don’t pay off like they used to four or five years ago.”   

And despite unprecedented travel disruptions caused by the coronavirus disease 2019 (COVID-19), which made face-to-face carrier-shipper negotiations close to impossible, the process this year was mostly trouble-free.

“In some ways, it’s business as usual,” a carrier executive told JOC.com.

Among the executives from six ocean carriers, seven non-vessel operating common carriers (NVOs), seven beneficial cargo owners (BCOs), and four consultants that spoke to JOC.com for this story, the general consensus was that all-inclusive freight rates from Asia are $1,300 to $1,400 per FEU to the West Coast and about $2,300 to $2,400 per FEU to the East Coast. However, as happens in most contract years, there are some outliers. An executive from one carrier, for example, told JOC.com its rates are $100 to $200 per FEU higher than those quoted by most sources. As in previous years, typical annual container contracts will run from May 1 through April 30, 2021.

By comparison, the freight rates in the 2019-20 contracts that expired last week were about $1,400 to $1,550 per FEU to the West Coast and $2,400 to $2,550 to the East Coast. The 2019-20 rates were about $200 to $300 higher than those in the 2018-19 service contracts.

In comparing this year’s contract rates with last year’s, the administrator of a shippers’ association said the base rate “hasn’t changed much from last year.” When it comes to the bunker fuel component, each carrier is handling it slightly differently, he added.

Bunker rates will continue to float

The all-inclusive contract rate includes a fixed cost for ocean transportation that lasts the life of the contract. The all-in rate also includes a floating bunker fuel component that currently represents about 25 percent of the all-in rate to the West Coast and close to 30 percent of the total rate to the East Coast. Most carriers are floating bunker costs on a quarterly basis. 

Fuel prices have collapsed roughly 70 percent at major bunkering hubs since early January. Prices began to slide within weeks of the IMO 2020 mandate, once early logistical woes and supply issues were sorted. The declines accelerated in early March after OPEC and Russia initially failed to reach a deal to curb crude production, and then went into freefall as crude prices plummeted when energy demand vanished amid the global COVID-19 lockdown.

Due primarily to COVID-19, this season’s contract negotiations were marked by uncertainty about the volume of imports from Asia through the end of the year, which includes the all-important peak season that runs from August through October. Volume commitments from BCOs, known as MQCs (minimum quantity commitments), form the basis of the freight rate. The largest retailers commit the largest volumes, and their rates are therefore lower than mid-to-small size BCOs and NVOs.

With unemployment claims in the US exceeding 30 million, and even those consumers who are fully employed purchasing primarily essential goods, retailers have already cut way back on orders for summer and fall merchandise. “Retailers are canceling fall orders,” said Dean Tracy, managing director of the consulting firm Global Integrated Solutions.

As a result, some retailers and direct importers fell short of the volume commitments that were in the 2019-20 service contracts. But it appears that most carriers refrained from charging penalties for the unshipped containers.

“There is a lot of forgiveness of MQCs,” a carrier executive told JOC.com.

As carriers and retailers sign 2020-21 contracts for the shipment of holiday merchandise beginning in August, carriers are telling customers to give them their best estimates of import volumes on an annual basis, “and alert us if your forecast shifts,” said another carrier executive.

NVOs are picking up business amid uncertainties

This uncertainty has resulted in carriers signing contracts with NVOs earlier in the negotiating process than in past years. Carriers normally sign contracts with the top few retailers first, then with mid-sized BCOs, and then with small BCOs and NVOs.

Some carriers negotiated with NVOs and signed the contracts earlier than usual because “they seem to have a better read on the market,” said a carrier executive. Because NVOs have contracts with a number of BCOs across different product lines, they have a broader view of the trans-Pacific than BCOs with limited product lines may have. 

Also, some BCOs are increasing the portion of their annual volume that they normally reserve for NVOs. That often occurs in times of uncertainty because NVOs generally have a broad range of contracts that include most of the major carriers in each trade lane, so they are usually able to provide capacity even when one or more carriers blank sailings in a particular week. “We do well in mayhem,” an NVO executive told JOC.com.

Another uncertainty that carriers, BCOs, and NVOs are dealing with given current times is that imports today must be analyzed on a product-by-product and shipper-by-shipper basis, said Christian Sur, executive vice president, sales and marketing, at Unique Logistics International. Large retail chains and online retailers that sell essential and non-essential merchandise, such as Walmart and Amazon, are consistently shipping large volumes, he said.

However, cargo volumes destined for furniture retailers, clothing stores and other retailers that handle “nice-to-have” but not “gotta-have” imports are struggling in the COVID-19 environment, a former logistics director at a national retailer said.

The logistics director at a furniture importer said the retailer has enough inventory to carry it into the third quarter, so its import volumes this year will be down 40 percent from last year.

Carriers are definitely feeling the impact of reduced orders for furniture, home furnishings, apparel, and toys that have been sidelined by stay-at-home mandates in a number of states. “Those are the things that fill containers,” Sur said.

With the cancellation of professional and college sports seasons beginning in March and possibly continuing through the summer, caps, jerseys, and numerous memorabilia that account for a decent amount of volume moving to all regions of the country have also been cut off, an NVO said.

Blank sailings have propped up spot rates

Carriers have responded to the ups and downs of the marketplace by canceling more than 200 sailings so far this year. An NVO noted that these blank sailings have kept spot rates in the eastbound trans-Pacific from plummeting as they did during the 2008-09 recession. 

Spot rates to the West Coast in 2009 plummeted as low as $800 per FEU, the source noted, whereas so far this year the spot rate has been consistently above $1,500. The spot rate from Shanghai to Los Angeles last week was $1,724, which was 12.8 percent higher than the previous week and 9.9 percent higher than May 1, 2019, according to the Shanghai Containerized Freight Index (SCFI), which is published under the JOC.com Shipping & Logistics Pricing Hub.

“If it weren’t for the blanks, the carriers would be operating at 50 percent utilization,” the NVO said.

BCOs and NVOs often note that carriers’ blank sailings play havoc with their ability to accurately plan shipments in the short term because capacity they assumed would be present in a particular trade lane is reduced. 

A home furnishings importer told JOC.com he is likely to sign at least one contract this year through NYSHEX, which holds carriers to their space commitments and BCOs to their volume commitments, and includes penalties if either misses the mark. The BCO said he is doing this to add some degree of certainty to the shipments. Carriers and their steady customers generally don’t like to charge each other large penalties, and the home furnishings importer said he does not want large penalties included in his contracts, but he is experimenting to see if modest penalties can lead to greater certainty that his shipments will get on the vessel.

A carrier executive told JOC.com he is seeing some customers attempting to protect themselves in this uncertain environment by asking for force majeure clauses in the contract that would protect them in case they are unable to meet volume commitments due to COVID-19, due to reasons such as stay-at-home orders in some states. He said such clauses are “pretty one-sided.”

Changes in service contracting going forward

Generally, both carriers and shippers say COVID-19 has resulted in some changes in the service contracting process that will likely become entrenched going forward. For example, even when the stay-at-home orders go away and commerce returns to normal, carrier executives say face-to-face carrier-shipper meetings and courtesy calls will probably be reduced.

This process had already been evolving over the past decade. A former carrier sales executive recounted how when he started in the industry in the early 1980s, he was given an annual travel and entertainment budget of $200,000 and was expected to spend it all. Senior carrier sales executives had even larger budgets, he said. That used to result in four or five face-to-face meetings or courtesy calls each year with steady customers. Although the number of meetings has been reduced over the years, a good deal of money is still spent on entertaining BCOs, he said.

An existing carrier executive said that for some carriers, the collective savings achieved by reducing the sales calls will total millions of dollars a year.

Another carrier executive added: “A new era will definitely dawn. Lines are taking a hard look at costs.”

Contact Bill Mongelluzzo at bill.mongelluzzo@ihsmarkit.com and follow him on Twitter: @billmongelluzzo.