fighting rate declines - a carrier perspective
TRANSCRIPT
CARRIER’S RISK
Due to the volatile market there
remains huge uncertainty regarding
future income, whilst any declines in
rates can result in reduced earnings.
Furthermore it could be argued that
even fixed rate contracts do not offer
adequate protection from this volatility
given their non-binding nature.
However carriers can use Forward
Freight Agreements (FFA’s) to secure
a proportion of their future income,
thereby protecting themselves from
this uncertainty.
THE STORY SO FAR
With rate volatility showing no sign of
relenting, carriers are increasingly
looking at ways to protect their future
income.
Similarly demand is increasing from
shippers, who are looking to use tools
such as FFA’s to manage their own
risk outside of traditional agreements.
“Being able to hedge our
shipments provides us with added
certainty, which is otherwise not
always achievable in the physical
market” says Sebastian Smith,
Chartering & Container Freight
Broker at ED&F Man.
Its not just commodity traders looking
to use these tools. Freight forwarders
such John Good Shipping are also
participating in their use.
Commercial Manager, Paul
Ferguson says that “clearly there
is a need for tools to manage rate
volatility, particularly for carriers
given recent declines, whilst for
shippers it can provide us with
added certainty.”
Since the SCFI was launched in 2009
it has become an established industry
benchmark. As a result market
participants regularly refer to the
index or use it as part of a physical
index linked contract.
Naturally by combining FFA’s with
these indexed contracts carriers are
able to secure future income in
advance, regardless of rate volatility.
In such arrangements shippers
simply continue to pay their chosen
carrier spot or an index linked rate,
thereby ensuring the relationship
between both parties is maintained.
FFA’s can therefore almost be viewed
as a sort of insurance protecting the
holder from either rate increases or
rate declines.
This need for effective rate
management is highlighted by TSC
Container Freight. “We see FFA’s
as being an effective tool that all
market participants can use to
manage risk” says Senior
Manager, David Briggs.
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CONTAINER FREIGHT - MANAGING
RATE VOLATILITY
HOW DOES IT WORK?
FFA’s act almost like an insurance,
meaning that for sellers of these
contracts, such as carriers, as the
physical market declines the FFA
contract pays out. This cash flow can
then be used to offset the reduced
income received from the physical
market.
In a rising market the seller pays out
to the FFA counterparty. This cash
outflow is equally offset by the
increased income received from the
rising physical market.
With a hedge in place the carrier
therefore knows that its future net
income is secure regardless of
whether the market increases or
declines.
EXAMPLE: FALLING MARKET
A carrier decides to sell FFA’s for
next month at $1,025 TEU as they
are concerned the market will decline.
(Fig.1)
As feared the following month the
market declines and the carrier
receives less income per TEU in the
physical market.
Lets say on average the market
declined to $999 TEU and this is
reflected by the average of the SCFI.
This equals the carrier’s income for
the month from its physical business.
At the same time the carrier will, via
the FFA agreement, receive $26 per
TEU. This is equal to $1,025 (FFA
rate) - $999 (SCFI rate).
The carrier’s net income therefore
equals $999 + $26 = $1,025 (Fig.2)
By taking out a FFA contract, the
carrier was able to protect itself from
the declining market with no impact
on the rate it charged to its
customers.
EXAMPLE: RISING MARKET
In some cases the carrier may sell an
FFA contract in the belief the market
may decline, but in fact it could
increase. In these instances the
reverse of the previous example
holds true.
Lets say the carrier again sells FFA’s
at $1,025 but the market actually
increases to an average of $1,050. In
this instance the carrier pays out $25
to the FFA counterparty.
However despite the cash outflow its
net income remains the same as the
previous example. $1,050 (market
rate) - $25 (FFA cash flow) = $1,025.
In both examples the carrier was able
to secure its net income per TEU at
$1,025 regardless of whether the
market increased or declined.
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CONTAINER FREIGHT - MANAGING
RATE VOLATILITY
Fig.1.
Fig.2.
CARRIERS: WHY USE FFA’S?
For carriers there are many reason
why they may wish to utilise FFA’s.
For example physical contracts are
non-binding and therefore do not
always offer adequate protection from
the volatile spot market.
The market also remains highly
volatile due to continued oversupply.
FFA contracts are flexible. They can
be sold or bought depending on
requirements.
There is no impact on the physical
contract and therefore relationship
with shipper.
For carriers future income can be
secured in advance by using FFA’s.
There is a potential to lower the cost
of capital as the business is seen as
less risky to investors.
SHIPPERS: WHY USE FFA’S?
Similarly for shippers there are
benefits in using FFA’s compared to
traditional contracts.
Shippers are able to pay their chosen
carrier spot. Spot paying cargo
should ensure cargo is less likely to
be rolled.
For shippers future costs can be
secured in advance by using FFA’s,
whilst having no impact on the carrier
relationship.
Freight forwarders can focus their
attention on the customer’s supply
chain rather than rates.
In particular for freight forwarders
such as Seko Logistics this was a key
reason for entering the market.
“We have successfully used the
tool in the past, which enabled us
to focus our time on improving the
customers supply chain” says
Keith Gaskin, Group Commercial
Director
In addition FFA’s are legally binding,
providing users with adequate
protection from rate volatility.
THE FORWARD CURVE
The forward curve is available on
request and provides all participants
an indication as to what levels are
achievable in the FFA market. The
curve consists of buyers or “bids” and
sellers or “offers”.
Bids indicate where buyers are
prepared to pay for the FFA contract,
this could for example be a shipper or
freight forwarder.
The “offer” indicates at what levels
sellers are prepared to sell the FFA.
contract. This could be a carrier or
bank.
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in contact using the below details.
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CONTAINER FREIGHT - MANAGING
RATE VOLATILITY
For more information about the use
of Container FFA’s please contact us
at:
London: +44 (0) 207 090 1125
Twitter: freightinvestorservices
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