Freight transportation is a huge component in the costs of goods that everyone consumes, and like energy and raw commodities, freight cost are extremely volatile. Between January 2016 and January 2018, U.S. trucking rates were up more than 25 percent and have since fallen to 2016 levels..
In North America, trucking is the largest mode of freight transportation, representing more than 73 percent of all freight transportation services. The reason that trucking rates are so volatile is as simple as Economics 101 – supply and demand. On a given day, there are a finite number of trucks in the market and there are a finite number of loads in the market. Truckers adjust their rates based on current market conditions and competition for capacity.
In markets that are volatile, participants have significant exposure to their cash-flows as prices move up or down. If the market is big enough, futures contracts are established to help participants de-risk their exposure to volatility by creating hedging instruments that they can use to have more predictable cash-flow streams.
Trucking is certainly big enough – the $726 billion dollar U.S. trucking market is 30 percent bigger than oil, natural gas and coal – combined. It is also about twice the size of the agriculture, forestry and fishery industries, all of which enjoy vibrant futures markets.
The freight market operates similarly to the electric power industry; it is capacity-constrained, priced on geography, and not easy to store. The electricity market has had a robust futures market for nearly two decades. The underlying electricity market is approximately $320 billion, so it less than half the size of the U.S. trucking market.
In addition to providing a risk management option through hedging, Trucking Freight Futures contracts will help bring transparency to the industry by giving market participants a sense for where rates are headed in the near- and long-term. Since Trucking Freight Futures contracts began trading on March 29, 2019, daily Forward Curves are being produced for each of the 11 Trucking Freight Futures Contracts which help participants understand the market’s expectation of spot freight rates for 16 months into the future. These Forward Curves help them plan their operations, make better capital expenditure decisions (should they buy trucks now or not) and price freight more accurately to the market.
A participant is concerned (or expects) that rates in the physical market are going to move in an unfavorable direction (up or down).
Depending on which directional move (rates rising or falling) they want to protect against, the participant will BUY or SELL financially settled Trucking Freight Futures contracts to hedge against rate changes in the physical market.
As an example, if the market participant is concerned about the impact of rising spot freight rates on its cost of securing capacity, the market participant would BUY a Trucking Freight Futures Contract as a Financial Hedge. If rates do rise, the financial gain in the value of the Futures contract would offset the increased cost of purchasing capacity in the spot market.
As a freight market participant, a company is exposed to the volatility of rates in the trucking market. Unstable prices create cash flow management issues. By trading Trucking Freight Futures, a participant can mitigate some of its exposure to the volatility of trucking spot-rates and therefore more accurately forecast its forward cash flows.
FreightWaves is responsible for educating the freight market about futures and educating the financial market about freight. FreightWaves will not trade in the market and will not have access to any participant trading activity.
DAT Solutions is the leading authority for spot market freight rates in the trucking market, and is responsible for publishing daily spot dry van long haul price assessments which will be used for the final monthly settlement of the Trucking Freight Futures contracts. DAT will not have access to any participant trading activity.
Nodal Exchange and Nodal Clear are the regulated exchange and clearing house respectively for the Trucking Freight Futures market. Nodal’s role is to provide the trading platform and risk management for Trucking Freight Futures trading. The system is fully electronic; there will be no physical trading floor. Nodal also provides the regulatory compliance for the market, exchange activities and clearing house.
In order to trade Trucking Freight Futures, a prospective participant must do two things:
- A prospective participant MUST execute the Nodal Trading Participant Agreement http://www.nodalexchange.com/wp-content/uploads/Nodal-Exchange-Participant-Agreement-03212019.pdf
- Establish a Futures Clearing Account with at least one of the twelve Clearing Banks (FCM’s) that are approved by and are members of Nodal Clear http://www.nodalexchange.com/nodal-clear/clearing-membership/clearing-members/
A comprehensive due diligence process validated that DAT’s freight rate data was reflective of actual market conditions and the defacto industry benchmark. Moreover, their rigorous process met the principles required of a regulated market. Established in 1978, DAT is the largest freight marketplace in the world, handling over 268 million loads worth more than $60 billion in 2018. Their size, longevity and reputation made them an attractive partner.
Most carriers have at least two types of freight rates (contract and spot).
Compared to spot rates, contract rates are far more stable in the market. Spot rates can fluctuate throughout the day, week and year. In fact, on a given lane, a rate may increase or decrease 10-15 percent within a given week. Contract rates are not subject to this sort of volatility. Contract rates normally stay in place for a year.
Unfortunately, for carriers or shippers with any exposure to trucking spot rates, there is no way to manage the volatility. That volatility wreaks havoc on cash flows, even if exposure is limited. By settling the futures contracts against spot rates, Trucking Freight Futures participants can enjoy more predictability.
DAT collects rates on over $60 billion in truckload transactions per year from over 700 sources. These are confirmed loads that brokers, carriers and shippers participated in and reported to DAT electronically. Most of the transactions that are reported come directly from the contributors’ TMS systems. The DAT Freight Rate Indices are price assessments developed specifically for the futures market and are derived from a subset of DAT data. DAT’s methodology limits the impact any one participant can have on the price assessments.
FreightWaves and DAT staff worked together over the course of two years to determine which lanes are most representative of the trucking market. The companies wanted to make sure that the lanes had enough density (i.e., high levels of freight transported on them) and were representative of the overall market. The 7 lanes were chosen specifically because they represented the entire National market or 3 Regions in the National market.
The 7 chosen lanes represent approximately 24 percent of the truckload spot volume that is reported to DAT from the entire country. Additionally, when modelled based on historical patterns, the rate movement in the chosen lanes is predictive of the movement in the broader market.
Moreover, those buying Trucking Freight Futures can choose among futures on 7 directional lanes, 3 regional corridors and the national market.
Los Angeles to Seattle Long Haul Van
Seattle to Los Angeles Long Haul Van
Los Angeles to Dallas Long Haul Van
Dallas to Los Angeles Long Haul Van
Chicago to Atlanta Long Haul Van
Atlanta to Philadelphia Long Haul Van
Philadelphia to Chicago Long Haul Van
West US Long Haul Van (Los Angeles to Seattle Long Haul Van + Seattle to Los Angeles Long Haul Van)/2
South US Long Haul Van (Los Angeles to Dallas Long Haul Van + Dallas to Los Angeles Long Haul Van)/2
East US Long Haul Van (Chicago to Atlanta Long Haul Van + Atlanta to Philadelphia Long Haul Van + Philadelphia to Chicago VLong Haul an)/3
National US Long Haul Van (West US Long Haul Van + South US Long Haul Van + East US Long Haul Van)/3
Trucking Freight Futures contracts are traded in calendar month increments for 16 consecutive months forward.
Futures markets participants have two primary reasons for trading – hedging and speculating.
Hedgers are protecting a degree of exposure against an unfavorable price move that will impact the value of future cash flows.
In the physical market, there are two sides – buyers and sellers. Buyers naturally want prices to decline (they want to pay the least possible), while sellers naturally want prices to go up (they want to achieve the highest price possible). In trucking, shippers are naturally short capacity in the physical market (their profits reduce as prices rise), and trucking carriers are naturally long physical capacity (their profits increase as prices rise). In general, shippers will want to BUY futures contracts and carriers will want to SELL futures contracts to offset their natural risks. (Carriers want the price for trucking services to go up, while shippers want the price for trucking services to go down.)
All markets have supply/demand fluctuations that impact price. This is exacerbated in markets like trucking where the product cannot be stored for future use. The price fluctuations make companies’ cash flows difficult to predict, so they look for opportunities to manage these risks. This is the definition of hedging.
Futures markets are tools to do exactly this in an efficient manner – they are established to help participants offset their risk by trading opposite of their natural position (hedging). No matter what a futures market participant expects or wants the market to do, a participant that hedges executes the contracts to ensure that it is less exposed if the market goes against them. The moment the participant trades in the same direction as its natural exposure, it is speculating.
Trucking Freight Futures will be cash-settled only (there will be no actual trucks involved in the trading of a Futures contract) and participants will be trading against an index (an average of prices), which means its hedges are unlikely to be perfectly aligned to the actual physical market price.
Speculators are often portrayed negatively. However, speculators add depth and liquidity to a market. Put simply, a speculators primary motivation is to profit on the direction of a price move in the market. They may or may not be in the physical market. Speculators use information and instincts about the market to predict direction and make their trades accordingly. If they are right and the market goes in the direction they traded, they profit. If not, their futures contracts will lose value and they will suffer a loss.
A participant can hedge and speculate in the market at the same time. A participant could have a position in the futures market that is hedged and speculate on an entirely different futures contact at the same time.
Example: Executives at a trucking company that operates only on the East Coast are concerned that rates may drop after the holidays. They decide to hedge their exposure to a rate drop by shorting the trucking futures market on the East Coast lanes. At the same time, they believe that rates on West Coast lanes will increase. They trade futures contracts on the West Coast lanes by going long. They are hedging on East Coast contracts and speculating using West Coast contracts.