From TPM: Index-Linked Contracts Still Slow to Catch On

From TPM: Index-Linked Contracts Still Slow to Catch On

LONG BEACH, Calif. — Beneficial cargo owners still have too many concerns about long-term index-linked contracts to abandon the long-established model of negotiating annual freight contracts with ocean carriers, a panel on the new instruments was told at the TPM Conference in Long Beach on Monday.

ILCs, as the panel’s participants dubbed them, have been slow to catch on in the three years since they were approved by the Federal Maritime Commission, said panel moderator Ed Sands, global practice leader, logistics, for Procurian.

Of the 45,000 total contracts on file with the FMC, only 61 were index-linked service contracts in 2012, up from 50 in 2011,

“While some beneficial cargo owners do indexed contracts, the majority of us don’t,” said Brian Bernarding, global practice leader, logistics, for Dick’s Sporting Goods. He talked with a number of shippers in preparation for the panel to ask why they were or were not using ILCs. “ILCs are new. We need to be certain the results we achieve match what we would do in the annual business cycle.”

Bernarding said shippers are seeking a better return on their investment for the time and effort they expend on their annual contract negotiations. “We should see a benefit in the amount of time we spend on these annual contracts.”

But the time and effort needed are going up as carriers announce ever-more general rate increases during the contract year. “A few years ago, whenever a GRI was announced, we had time to talk about it. But now they are occurring monthly,” he said. “If a carrier doesn’t send out a GRI announcement I would think they had gone out of business.”

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In his talks with shippers, Bernarding discovered that they shared several common concerns about ILCs, including:

  • The carriers control the index, which is not the same as the situation with fuel.
  • Carriers are not approaching them to do it. (This was a common theme.)
  • The carriers need to sell them the index and why they should use it.

“Some BCOs said everyone should do it, while others said no one should do it because it’s a mechanism for carriers to control pricing,” Bernarding said.

“The structure of annual contracts is fundamentally broken,” said Sheila Hewitt, vice president, international for Transplace, a third-party logistics provider. “We owe it to our customers to keep as much noise as possible out of their supply chain.” She said ILCs can do that.

Dave Briggs, senior manager, container freight derivatives, at TSC Container Freight, said his company, a non-vessel-operating common carrier, uses ILCs to hedge against price fluctuations on its annual freight contracts. “We want to transfer that risk,” he said. “The index link transfers the risk.”

He said ILCs are useful for NVOs in protecting their customers against price swings. “We have been fixing rates for our customers using the swap market since 2011. The product works as advertised,” he said. “GRIs come and rates go up. There are a lot of risks that way we do it today and ILCs remove those risks.”

Contact Peter Leach at pleach@joc.com and follow him at twitter.com/petertleach.