Long-term contracts in the spotlight
Industry discussion about the concept of long-term rate agreements within ocean freight service contracts is heating up.
In the last month, speakers at two of the world's biggest liner shipping conferences have suggested that carriers and their shipper customers engage in long-term contracts to even out the inherent volatility in ocean freight rates.
At the Journal of Commerce-organized TPM conference in Long Beach last month, Eric Brandt, manager of global ocean transportation for Kraft Foods, described how his company is looking to contracts as long as five years to bring stability to its ocean procurement costs while also enhancing loyalty and service levels.
Brandt talked about Kraft's strategy in the January issue of American Shipper.
Then last week at Containerisation International's Global Liner Shipping conference in London, CMA CGM Senior Vice President Nicolas Sartini said his line is looking to build long-term rate mechanisms into its service contracts with large-volume shippers to minimize rate volatility.
Sartini dubbed the concept a 'market adjustment factor,' though acknowledged the negative connotations that term might have. Philip Damas, division director of Drewry Supply Chain Advisors later offered up his own term, Stable Market Adjusted Rate Terms, which he described in the February issue of American Shipper.
'It's a mechanism that's part of a larger contract,' Sartini said. 'The price is fixed for a longer period and does not change as long as it remains within a (band marked by a ceiling and basement of indexed rates).'
He explained the indexed rate would be based on whatever the carrier and shipper decide is applicable. It could be an average of the shipper's price and carrier's price. It could be based on an independent rate index, or a combination of all three. For instance, if the two parties agreed to a $2,400 average rate, the shipper would pay that rate for the duration of the contract unless the previously decided index or combination of indices dips below $2,000 or above $2,800.
'This concept has been well received by customers,' he said. 'They see the benefits of stability over time. If this can be generalized, some large part of the market can anchor volumes.'
Sartini was cognizant that the whole industry won't be interested, and that it won't happen quickly.
'You're not going to change shipping overnight,' he said. 'But you can try to address the needs of the largest shippers, so these long-term contracts can bring that much more volume into a more stable pricing environment. There will still be shippers who look for the opportunistic aspects. And it won't change the fact that forwarders will play the short-term market.'
Earlier, Sartini said the nascent container shipping derivatives market held little interest for CMA CGM because it relied on an index, the Shanghai Containerized Freight Index (SCFI), that doesn't capture all the nuances of the market.
'These (derivatives) products are created by financial institutions that are looking for new markets and for commissions,' Sartini said of derivative contracts for ocean freight services. 'The Shanghai Containerized Freight Index is not done in a transparent way. Rates are given by a group of small Chinese forwarders, and it only accounts for the most volatile segment of the sector. Shipping contracts are more complex than carrying goods from one location to another.'
Sartini pointed to the oil futures markets as evidence that derivatives wouldn't curtail price volatility.
'There are 30 paper transactions for every one physical transaction in the (oil) derivatives market,' he said. 'In peak season, CIF prices go up because space is tight and forwarders suffer. In the slack season, there's plenty of space and forwarders' rates decline. The index shows the exacerbated volatility.'
Another speaker at the conference, Jean-Louis Cambon, head of the ocean management committee for tire manufacturer Michelin, agreed. Cambon, who also chairs the Maritime Transport Council for the European Shippers' Council and is a former liner executive, said he believes derivatives have the potential to 'accelerate volatility.'
'Michelin won't pursue derivatives,' he said. 'The SCFI is not relevant for the flows of 20-foot containers (which Michelin predominantly uses). The index is based on CIF spot rates, so it's not representative of the full market.'
During a question-and-answer session at the conference, Sartini was asked how a market-adjusted rate contract with a single customer is different from shippers and carriers using derivative vehicles, which can ostensibly be used to hedge against peaks and troughs in freight rates.
'You don't have to pay a commission on a (market-adjusted rate contract), and you can design it customer by customer,' he responded. 'We're looking after our customers' individual requirements and we don't believe derivatives reflect that.'
American Shipper examined the issue of the viability of long-term contracts more than a year ago, and found little traction for the idea. But with keynote discussions at two of the industry's major gatherings focusing on the idea, perhaps things are changing. ' Eric Johnson