What will happen next year, next month, next week? Rarely has the future direction of markets been as unknowable as it is today, so why take all the risk if you don’t have to?
Players in commodity and securities markets have long used derivatives to curb downside risk and hedge multimillion-dollar positions. But in container shipping, it’s been over a half-decade since participants have had the ability to use cleared, cash-settled futures to offset their risk.
That changed on Monday when futures contracts for six routes debuted: China-West Coast, West Coast-China, China-East Coast, China-North Europe, North Europe-China and China-Med.
The contracts — now available through 2024 — are listed on and cleared by CME, settled against spot rate assessments of the Freightos Baltic Daily Index (FBX), and have a minimum contract size of 10 forty-foot equivalent units.
If at first you don’t succeed …
Cleared container futures have been tried before. The first attempt failed. In 2010, Clarksons Securities debuted container freight swap agreements that settled against the then-nascent Shanghai Container Freight Index (SCFI). Clarksons threw in the towel in late 2013 due to a lack of interest.
During a 2013 interview, Clarkson Securities’ then-CEO Alex Gray told American Shipper, “The volume just isn’t there.” He said at the time that “the industry has to reach a point for itself where the major buyers and sellers on the physical side of the container freight market recognize that there is a need for this kind of product and push it forward.”
That tipping point has now been reached, believe those behind the new futures product.
“I feel pretty confident,” Zvi Schreiber, CEO of Freightos, told American Shipper. When the initial push for container futures was made in 2010-13, “the index [SCFI] wasn’t mature and the bankers were under a very short timeline to show volumes, and when they didn’t get it, they gave up fairly quickly.
“We’re in a different situation,” Schreiber said. “Our index is tried and tested, and we’re in this for the long haul. Our main business is being a transactional booking platform, but it is very important that there is an index and that people can hedge their risk. We’re playing the long game. If it takes four years to build the volume, we’re OK with that.”
Sell-side interest: Liners and tonnage providers
The buyers and sellers of a container freight futures contract agree on a settlement price and a time period for the settlement. If the FBX ends up below the settlement price, the seller gets the difference from the buyer; if it’s higher, the buyer gets the difference from the seller.
Thus, in the case of hedging not speculating, the futures contract seller is protecting against a market fall (offsetting the physical rate decline with a paper gain), and the buyer is protecting against a market rise (offsetting the physical cost increase with a paper gain).
Liner companies would theoretically be the largest group of container freight futures sellers. There were not enough liners on the sell side in 2010-13. But in 2022, with freight rates near historical highs, liners should be motivated to sell futures to offset the risk of a rate plunge in the months or years ahead.
“There was a lack of support from the sell side in the old swaps market. We don’t see that anymore,” said Peter Stallion, head of the container and airfreight desk at FIS, the brokerage that has pioneered the new contracts and traded them over the counter since early 2021.
“It’s critical to get buy-in from the asset owners in any of these markets and with rates being so high, the case for futures is really, really strong,” he told American Shipper.
Another tailwind for futures sales by liners: Ocean carriers are pushing customers toward multiyear contracts, which now account for a higher share of cargo volume than ever before.
Stallion explained, “The old swaps market would only price out for the first six months or the first year, whereas we’re able to clear out three years forward, the current year plus two years. That puts it right in line with the sweet spot that the carriers want [by mirroring long-term contract durations]. If we didn’t provide that liquidity, we would have very little interest in trades in this market.
“A lot of the interest will land in cal-23 [futures covering the calendar year of 2023] and we’ve got selling interest out to cal-24 already. This is really, really important to bringing in the asset owners, to make this actually valuable to them, rather than just having a tool that only works for the next six months or a year.”
Another potential source of sell-side volume: container-ship tonnage providers, the companies that lease the ships to liners. These shipowners have locked in a large portion of their fleets to liners on multiyear charters to liners but still have significant lease maturity risk in 2023-24, coinciding with a large wave of newbuild deliveries that’s a clear threat to lease renewals.
The FBX measures freight rates, not charter rates, yet both move in the same direction. If ship charterers sell freight futures, they can limit downside if freight rates, and consequently, charter renewal rates, decline in 2023-24.
“Owners are definitely looking to hedge on the sell side — 100%,” Stallion said. “In the past two and a half years, the underlying [freight] market has been correlating quite well with the time-charter market. There has even been the idea of linking the time charter against the underlying market so that it would be an FBX rather than a time-charter index.”
Buy-side interest: Cargo shippers
Perhaps the biggest question for container futures 2.0 is whether there will be enough interest on the buy side, given that contracts would lock in extremely high transport costs. On Friday, Asia-West Coast FBX rates topped $16,100 per FEU, its highest level since early November.
“If you’re a buyer, you don’t necessarily want to hedge at really high levels,” acknowledged Stallion. “It’s more about security and predictability in any kind of market situation, whether it’s high or low.”
A number of market developments have made freight futures more attractive to cargo interests than in 2010-13.
In the earlier era, there was skepticism toward buy-side demand because freight represented such a small percentage of the landed cost of containerized cargo, meaning that shippers could easily stomach the freight risk. In dry bulk, a shipping sector that embraced futures, freight represented a much higher share, at around 30% of the landed cost.
Fast-forward to 2022. This calculation has completely changed: In many cases freight costs now represent an exorbitant percentage of containerized cargo’s landed cost.
Asked whether this changes the dynamic for futures buyers, Stallion replied, “Across the board. Container shipping and supply chain has been front and center. Prices have reached levels that have completely evaporated margins, depending on the business. That really greases the wheels for us to prove the validity of the contract.”
In addition, more shippers are getting more of their volumes shut out of the long-term market and pushed into the spot market. “With the amount of spot going on in the market, and the volatility of the past two years, [buying] a futures contract is an instantly recognizable way to hedge that exposure,” noted Stallion.
Another big change in the container market since 2010-13: There are a lot less liners, due to consolidation.
In the past, when markets went sharply up or down, liners and shippers walked away from contract commitments, which are traditionally not legally binding. That obviated the need for hedging. Now, with so few liners left, shippers may face higher liner-relationship risk if they walk away from contracts. At the same time, more physical contracts are actually enforceable, due to innovations such as NYSHEX’s commitment contracts.
“There’s more of a focus on performance these days, which helps with the futures,” said Stallion. “Things like commitment contracts help with futures by giving a bit more security on the physical side.
“Back in 2010, the Asia-Europe trade was pretty much gentlemen’s agreements … that would be extremely flexible. You don’t really see that anymore. One of the liners is even looking for bank guarantees on long-term contracts, which is extremely stringent and implies it’s trying to protect itself.”
Forwarders in the middle
The traditional model would be for liners to sell futures contracts to hedge against lower rates and for liner counterparties such as retailers and freight forwarders to buy futures contracts to hedge against higher rates.
But more than ever, freight forwarders are potentially both buyers and sellers.
On one hand, smaller and midsized forwarders are getting forcibly pushed into the spot market, making them potential freight futures buyers seeking to protect against rising rates.
On the other hand, the larger freight forwarders are signing multiyear contracts for volumes they’ve yet to sell along to beneficial cargo owners, so they have huge downside risk if the market falls. That makes them potential freight futures sellers.
According to Stallion, “Some of the liners have been trying to do pretty stringent three-year deals, the liquidity of which can be helped by futures, because the buyers of these big three-year deals don’t know what’s going to happen in year two and year three and they need to be able to manage that risk, and that puts them on the sell side of futures.
“The big buyers of some of these three-year deals have been freight forwarders. These freight forwarders are essentially assuming the risk that the liners had. The liner is offloading its risk by a three-year deal to a freight forwarder, which then has to manage that risk moving forward, and the futures fit almost perfectly into that situation.
“That’s the sort of thing you see in every other market we deal with. If you’re in dry bulk, you take a ship for three years and have no idea what the market’s going to do, but it gives you a bit of guaranteed capacity.
“That fits with the question of: How do futures allow you to secure capacity? If you think about it in terms of a three-year index-linked deal [hedged with futures] you have more scope to get capacity without having to give up price security.”
Rise of the indexes
One of the big hurdles in the first era of container futures was how new the indexes themselves were. In contrast, there are now many indexes that have been around for years, and index-linked long-term contracts have become an accepted part of the market structure. In addition to FBX and SCFI there are spot-rate indexes from Xeneta, Drewry, S&P Global Platts and Container Trade Services.
“Everybody is used to using indexes, so that helps,” said Stallion.
“Remember, back in 2010, the SCFI was brand new and all of a sudden you’re using a brand new index to run your freight contracts that was basically mandated by the Chinese government. If you’re a big ocean liner and you’re being asked to run a freight contract against someone else’s index that you’ve been forced to use by the Chinese government, that’s not really a good setup.
“[By] now, we’ve had 13, 14 years’ worth of index linking. That has really expanded. There’s obviously demand for the index stuff. So you have demand for the futures because it’s a really easy, simple way to manage exposure to anything index-linked.”
“Anecdotally, we’ve heard that indexing is around 30-40% of the contract market. That’s huge. That’s enormous. These are contracted volumes but they’re fluctuating rates so you can use futures to make those fixed rates. It’s really as simple as that.”
FBX includes premiums, others don’t
No matter how accepted indexes are in general, container futures won’t work if market participants don’t trust the numbers in the underlying index. “That is the key question,” affirmed Schreiber, who expressed confidence that the FBX will be trusted.
One of the quirks of today’s crowded field of container indexes is that they all give different numbers for the same route. For example, Drewry’s current Asia-West Coast assessment is $11,000 per FEU, a whopping 32% below the FBX assessment.
Stallion countered: “If you’re looking at the indexes — FBX, SCFI, Xeneta, whatever — if you say the numbers are different, sure the numbers are different, but they’re pretty well correlated because they’re all coming from the same marketplace. [The differences] are more about the nitty-gritty and methodology.”
One key methodology difference is that the FBX includes premium surcharges in its rate assessments for Asia-West Coast and Asia-East Coast, and other indexes don’t. FBX made the change and added in the premiums on July 28, 2021. The FBX Asia-West Coast rate spiked 176% that day, and the Asia-East Coast rate jumped 85%.
According to Stallion, “The abrupt change in July was part of an expanded audit procedure looking for and actively seeking out any methodology faults. They did a full audit and as a result of the audit and feedback from us and some of the market participants, there was a change in the index.
“After that change, a lot of people had a lot of respect for what the Freightos numbers were showing, particularly the U.S. shippers that were paying a totally different rate, with premiums, than what they were seeing on, let’s say, the SCFI. The audit of the FBX 1 and FBX 3 [the eastbound trans-Pacific routes] has woken up a lot of interest from the U.S. side.”
Schreiber explained, “Last summer we said, ‘OK, the reality now is that you can’t get your container on a ship without paying this premium, which was in the thousands of dollars.’ It was absolutely the right thing to do to adjust the index and acknowledge that. It has kind of shocked us that some of the other indexes have not done so. Some indexes are showing $8,000 [per FEU, Asia-West Coast] and everyone in the industry knows you can’t get a container on a ship for less than $15,000, so their indexes aren’t reflecting any kind of reality.
“I have to admit, it took us a few weeks to realize that we formally had to change [the index] to reflect the brand new situation in the industry, but I’m proud we adjusted to that new reality instead of just denying it and continuing to publish a rate that doesn’t reflect the physical market. I think that has been key,” said Schreiber of the July index change. “It has helped us hugely.”
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