Tracking indexes, a new freight futures market may give insight into potential rate movement
If you sell goods, understanding supply and demand is a must. When there is more supply, prices tend to drop, and vice versa. The same holds true in the trucking spot rate market – when there is more capacity, rates tend to drop and when there is more volume, rates go up.
It’s basic economics really. Except there are other factors at play that affect rates and margins for brokers, and some of those dynamics can be found by tracking rate indexes, such as what DAT offers.
One factor is how quickly carriers respond to shifts in freight volume, explains John Engstrom, associate analyst with transportation and logistics equity research firm Stifel. Engstrom recently made a presentation to attendees at the DAT Executive Symposium entitled, “How supply and demand dynamics play into freight rate volatility and gross margins.”
Engstrom explains to FreightWaves how the spot market takes about 1 ¼ to 1 ½ years to transition from a supply-based market to a demand-based market. However, carriers tend to purchase more equipment when capacity is tight, and because the average fleet will hold those trucks for 3-5 years before they hit the secondary market, it can depress rates when the market shifts.
For instance, Engstrom’s presentation noted that in the first quarter of 2014, there were five times as many loads posted to DAT’s boards as trucks. Conversely, the number of loads searched by carriers in that period was six times higher than the number of searches for trucks.
Both those trends have been traveling upward since 2010, but they really began accelerating in 2013 when loads posted by shippers jumped from under two times the number of trucks posted in the first quarter of 2013 to the five times rate one year later. The same held true for loads searched vs. trucks searched on DAT’s boards.
The result was increased spot rates during this time, pushing up public truckload carriers’ revenue per loaded mile and negatively impacting the gross margins of brokers.
This drove two separate industry shifts. First, flush with freight and revenue, carriers began purchasing equipment. The industry purchased 220,405 Class 8 tractor units in 2014, according to data compiled by Ward’s Auto. It was the highest total for Class 8 sales since 2006.
But, Engstrom notes, adding capacity is easier than taking it out of the market, which can take years to correct itself. When combined with the shale oil boom collapse in 2014 and a colder-than-usual winter in Chicago that seriously depressed volumes out of the Windy City, there was a sudden over-capacity problem heading into 2015.
That led to a freight recession, where DAT data shows that loads posted by shippers dropped from the highs of early 2014 to fewer than twice as many loads as trucks posted. With fewer available loads in 2015, that led to a spike in the number of loads being searched on the boards – 6.2 times as many, in fact - by the third quarter of 2015. This led to a drop in dry van spot pricing (overcapacity), but a spike in gross margins for brokers.
Part of the reason for this seems to be the fact that many larger third-party logistics providers (3PLs) contract for freight, but then purchase capacity on the spot market. Consequently, when spot rates rise, margins are compressed, like what happened in 2013. But, when the spot market drops, as happened in 2015, margins increase.
In essence, the tracking of the ratio of truck searches to loads provides an indication of the direction of the spot rate market. That, in turn, provides guidance on where the contract market is heading during bid season since shippers don’t want to contract for freight at a rate lower than what they will pay on the spot market.
It also provides a correlation to margins – for both brokers and carriers. As the DAT spot rate indexes trend down, broker margins, at least those that are publicly traded and are required to report financials, tend to rise. Conversely, as DAT spot rates climb, so do the margins of public truckload carriers.
When outside factors such electronic logging devices (ELD) are added to the mix, the fundamentals change again. If, as many expect, ELDs drag down capacity by 6-10%, that presumably will drive up rates and drive down brokerage margins.
Solving this margin conundrum is complicated for 3PLs, who have few current options to manage this risk. But, a new company is hoping to provide tools that will provide some answers. TransFX is developing a trucking rate futures market.
TransFX explains that a futures market allows participants to purchase financial contracts based on major shipping lanes in the U.S. These contracts, which are separate from physical capacity on trucks – in fact, they offer no actual capacity – can provide more transparency during the bidding process and a means to minimize some of that rate exposure.
Futures markets in general tend to project out pricing in physical markets. As such, 3PLs could monitor TransFX’s futures contracts and potentially have a clearer picture of where rates are heading, thereby improving the bidding process. The company is hoping that these futures contracts will provide more transparency and forecasting capabilities, giving carriers and brokers even more data points to bring to the negotiating table.
The contracts can also be used as a way to hedge against changes in physical markets. While the contracted rate may be, for instance, $2 per mile, the 3PL could enter the futures market and purchase a futures contract for that lane, if it is offered, for the current futures price, which might be $2.20 per mile. When it’s time to purchase the physical capacity to satisfy the contract, even if the spot price is now above the $2 per mile contracted rate, the futures contract, when settled, will offset some, or all, of that loss on the physical contract.
This kind of rate management can help prevent a broker’s margins from becoming significantly compressed during times of rising spot rates, TransFX explains. In the case of outside factors such as the uncertain impact of ELDs, political uncertainty, or even weather on capacity and rates, the futures market provides yet another option to try and minimize exposure to rate uncertainty.