TransFX works to create shipping price transparency through trucking lane futures contracts
How many times has a carrier sold capacity on its trailers at a future date only to learn that when the load is picked up, the going rate for that lane is now $1 more than it charged? Conversely, how many times do shippers get stuck in the same predicament, paying more to secure capacity only to realize they have overpaid based on current spot-market rates?
Smart carriers, shippers and brokers try to mitigate their exposure to price volatility whenever they can. Many have successfully done so through fuel hedging to combat diesel fuel price swings, but until now there has been no similar option when it comes to volatile shipping rates. That’s where a new Chattanooga, TN-based company, located in the center of Freight Alley, is hoping to carve out its niche.
TransFX, founded by CEO Craig Fuller, intends to offer “freight futures contracts” that allow brokers, carriers, shippers and speculators to hedge against rate movements. All of this is marketed under the TransRisk banner. The financially settled contracts, which will feature no physical delivery or service, are meant to be a risk-management tool that participants can use to normalize price fluctuations. They will be based on line-haul rates among major freight lanes in the U.S.
What is a futures market?
According to Investopedia, futures markets play an important role in the economic activity of a nation. One, they provide “price discovery,” which is where the futures market becomes “an important economic tool to determine prices based on today's and tomorrow's estimated amount of supply and demand.” Information that affects the price of the commodity, in this case trucking lane futures, alters the value of that contract on a daily basis and is referred to as price discovery.
Secondly, futures markets provide risk reduction. “Futures markets are also a place for people to reduce risk when making purchases,” Investopedia writes. “Risks are reduced because the price is pre-set, therefore letting participants know how much they will need to buy or sell. This helps reduce the ultimate cost to the retail buyer because with less risk there is less of a chance that manufacturers will jack up prices to make up for profit losses in the cash market.”
For more on futures markets, read: Futures Fundamentals: How the Market Works
How does this work?
Rate volatility is a function of supply and demand within a lane, which is driven by a number of factors including weather, fuel prices and even the political winds of change. The problem is that no one knows when those winds of rate change will blow. TransFX intends for its futures contracts to increase price transparency within a lane, giving participants the chance to settle financial contracts at a pre-determined price.
A carrier may participate in a freight futures contract because it believes rates in a certain lane are overpriced at that time, for instance. TransFX describes the following example of this situation.
“During February, a carrier is concerned that rates on a key lane will drop significantly by July. The carrier seeks to protect its rate exposure on the Los Angeles to Dallas lane because current rates are above historical average,” the company explains. “On Feb. 1, the carrier sells the trucking futures contracts on that lane with a July expiration. This sale locks in a current rate of $2.50 per mile. As the carrier predicted, rates begin to drop to $1.50 per mile for physical loads on that lane by July.”
In July, the carrier settles those futures contracts in a financial transaction for the $2.50 per mile rate. At the same time, the carrier is currently selling its physical capacity at the $1.50 per mile rate. The result is physical capacity being sold at market rate, but the futures contract is netting the carrier a profit on the financial market, offsetting that “lost” profit due to the softer rates.
Shippers would participate in the same manner, although they would be betting that rates in the physical space will rise. Brokers and third-party logistics providers (3PLs) as well as speculators could survey the physical market and buy in on either side of the transaction.
The futures contracts will be settled using TransFX price index data. That index will be created through a joint agreement between TransFX and DAT Solutions using DAT market data, which covers some 65,000 North American shipping lanes.
The current plan calls for the freight lanes to be based on 12 major freight routes, although contracts will likely be offered in both directions as well as for dry van, refrigerated and flatbed, giving participants dozens of opportunities. That might seem like a small number of the overall market - but miraculously these lanes are so heavily traveled that they represent over 24% of the spot volume of the entire country.
While the futures contracts do not affect the physical shipment of goods – or the rates agreed upon between parties – they do offer another tool to affect the bottom line, TransFX says. Spot prices face swings as high as 40% on some major lanes and these futures contracts offer the opportunity to protect against that volatility in the physical market.
The company is working through the regulatory process, it says, and hopes to have futures contracts to offer later this year. They will be listed on an as-yet unnamed commodities exchange.
Futures are the present
What TransFX is doing is unique to trucking freight markets, but not to other futures markets. In fact, maritime freight futures contracts have been traded for years and closer to home, participants can purchase futures contracts for everything from corn to natural gas and electricity.
Unlike stocks, which most Americans understand to some degree (buy low, sell high), futures contracts are more of an unknown, but not a foreign concept completely. TransFX, though, believes the time is right and that transportation participants can use its contracts to their advantage.
This includes the aforementioned price transparency, which can lead to a better understanding of where prices might be in the future. For instance, oil traders frequently trade crude oil futures, which provide market participants a market expectation of where oil prices will be at that point. Freight industry stakeholders may be able to use futures contracts in a similar manner.
This will be extremely important going forward, Fuller believes, as more freight brokerages transform into digital, “uber”-like operations, growing that aspect of the business from an estimated $8 billion today to more than $250 billion. In order to accomplish real-time price quotes it’s important to have a firm price for a future shipment, he explains. Currently freight brokers bare all the risk of the transaction and if pricing in the spot market surges, the broker is the loser. By having a firm transparent clearing price, the broker can protect themselves against an increase in spot rate before the load is covered.
TransFX is betting that the freight industry is ready for such a tool. Market speculators certainly will be, but trucking and shipping executives don’t need to be professional speculators to use freight futures contracts. They just need to be experts in what they do well – moving freight.