For-hire trucking in the United States is a truly massive industry: the spot market alone accounts for about $115B of business annually. It’s also a massively inefficient marketplace: price discovery is difficult, service commitments are less than firm, seasonality is unpredictable in its timing and magnitude, and spot rate volatility negatively affects both shippers and carriers.
There isn’t a good way to hedge against price volatility in trucking: in periods of low demand, shippers move their freight inexpensively and carriers take losses; in periods of high demand and tight capacity, like the current environment, trucks fetch high rates and shippers’ margins shrink. There’s very little either party can do to limit its exposure to trucking rates, short of building a dedicated fleet with drivers paid by the hour, because even ‘contract freight’ agreements become moot once the market moves enough. Instead, everyone is at the mercy of a boom-and-bust cycle.
Other industries have hedged their exposure against price volatility through futures contracts, which are essentially standardized agreements to buy or sell something at a predetermined price in the future.
What makes a successful futures exchange? In the July 2018 issue of Energy Risk magazine, recently retired Icap Energy founder Paul Newman discussed his five tests for a successful derivatives market: “there must be a range of different reasons why firms come to the market; there must be a sufficient underlying spot market; there must be enough volatility; there must be a credible index; and it must be big enough.”
We believe that truckload transportation passes all five of Newman’s tests. There is certainly a range of different reasons why participants would come to the market: for every truckload mile driven in the United States, there’s at least one party who wishes the rate was higher and one who wishes the rate was lower. As stated above, the spot market is large: the industry is full of hundreds of thousands of owner-operators who move spot freight and drive the rates that shippers and large carriers are exposed to. And as readers of FreightWaves know, the truckload spot market is extremely volatile.
As an example, according to DAT’s Rateview tool, trucks driving from Los Angeles to Dallas brought $2.38 per mile in December 2017, but only $1.69 in February, a drop of 28.9%. DAT, in fact, helps trucking pass Newman’s fourth test, which is a credible index: DAT uses actual transactions to assess the physical market and it has a sound, published methodology for quoting prices. Finally, trucking is ‘big enough’, whether in terms of notional value, the total amount of the commodity to be hedged (we estimate 40B miles annually are exposed to the spot market), and the number of participants.
How would futures work for trucking? The simplest analogy is in college football: imagine that your alma mater is playing in the Rose Bowl and you want badly for your team to win. If you bet on your team to win, you’re doubling down, and you’re emotionally and financially exposed to the same outcome. If they end up losing, you’re sad and you’re out some money. But if you bet the opposite of what you want to happen, if you bet that your alma mater will lose, you’re not doubling down but hedging. You’ll be okay no matter what happens. That’s exactly how futures trading would work for exchange participants who have a commercial interest in trucking rates: they bet the opposite of what they want to happen. Truckload carriers would be short, so if rates collapse, they’ve protected themselves; shippers would be long the rates, so if they go up, they’ve still got some miles at a favorable price.
FreightWaves is building a trucking futures contract with Nodal Exchange and DAT that will launch later this year. A crucial point of distinction between freight futures and some traditional futures contracts is that freight futures will be financially settled, not settled by physical delivery. Financially settled futures are actually quite common: Brent crude oil futures are financially settled; so are electricity futures. In other words, if a shipper wants to buy 4,000 miles from Atlanta to Chicago at $2 per mile over a three month period and holds the contract until expiration, a truck isn’t going to bump the dock. Instead, the exchange will settle the contract against the spot rate index for that lane on that day. If the rate has gone up to $2.50, the exchange will deposit $2,000 (4,000 * 50 cts) in the shipper’s account. If the rate falls to $1.50, the shipper will pay the exchange $2,000.
“DAT and Nodal Exchange are ideal FreightWaves partners to launch the first futures contracts for the trucking industry. DAT is considered the de facto industry standard, well established for its benchmark supply, demand and rate data for the truckload freight market,” said Craig Fuller, CEO of FreightWaves. “Nodal Exchange grew from a cold-start exchange a decade ago to quickly become one of the largest players in the power markets. This entrepreneurial achievement is a testament to the quality of the exchange, clearinghouse, and culture of the firm.”
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Future of Supply Chain
JUNE 21-22, 2023 • CLEVELAND, OH • IN-PERSON EVENT
The greatest minds in the transportation, logistics and supply chain industries will share insights, predict future trends and showcase emerging technology the FreightWaves way–with engaging discussions, rapid-fire demos, interactive sponsor kiosks and more.