In an article a few weeks ago we discussed the massive dip in rates the container market has suffered in the past year. A combination of overcapacity and various (mostly EU) economic turmoil has caused the shipping rates for 20’ and 40’ containers to drop 52 % since May 2012.
World economic indicators are ‘mixed,” and the next year (barring unforeseen political or military circumstances) the world recovery will remain slow: while the American economy continues to improve, the EU and Japan continue to lag as China pumps out exports in order to keep people employed and their domestic miracle from faltering. Additionally, the carriers are proving to be their own worst enemies as an estimated 1.7 million TUE’s are scheduled to be delivered this year, an almost 30% increase over 2012.
The result of this over-capacity in a slow economy has been a collapse of freight rates; the Asia to Northern European market index for sea freight has seen a consistent downturn as the fall in rates was felt across several popular Asia – Europe trade lanes. On the Shanghai-Rotterdam trade route, for example, the price for moving a 20’ cntr dropped from US$ 1,600 on 1 Nov 2012 to current quotes in the US$ 950 level.
All fascinating, if perhaps academic – but it raises the question of how a shipper manages freight rates to his/her best advantage?
The Reason for Indexing
Freight rates are no longer a static part of Costs-of-Goods-Sold, but similar to raw materials can be considered a cost that needs to be managed. Imagine a corporate logistics manager or a 3PL who booked his 2013 20’ cntr freight in November 2012; within 6 months his rates are 25% higher than spot, his company’s products are now no longer competitive, and if he’s an NVOCC or a 3PL’s, his rates are now prohibitively high.
So big shippers need to protect themselves from these sorts of debacles; Sony’s expertise is electronics, Coca Cola’s is soft drinks, Ikea’s is knocked-down furniture…none are freight experts; how do they book freight in a manner that keeps enables them to ship reliably yet stay competitive?
By tying their long-term freight contracts to a freight index. If the freight market drops, their rates drop also; if the rates rise, their rates rise, but so does the rates for their competition.
What is a Freight Index?
Similar to a basket of currencies or a mutual fund for Fortune 50 stocks, a freight index is an independent listing of freight rates in a selected market over an extended time period. Xeneta tracks such major routes as Shanghai-Rotterdam, Singapore-Bremerhaven, as well as a global container index. In time we’ll be adding EU-US and US-Pacific rates, and are considering selected Latin American routes.
The rates are obtained independently, verified, and charted weekly. In this way anyone shipping cargo in a 20’ container on one of these routes can compare the market rate to what they paid.
Using a Freight Index:
The idea of using an index is to obtain competitive freight rates over an extended time period. The savvy 3PL or corporate logistics manager who needs to book an annual China-Rotterdam freight contract will want to book it based on the Xeneta Shanghai-Rotterdam Index, priced say for the monthly average for month-of-shipment. That means every container the 3PL ships in June 2013 is priced at the June 2013 monthly average. They’ve now got their annual container requirements covered with a carrier of their choice and at a price that’s never any worse than market price on that particular route.
Or they can tie it to the index +/- an agreed %! Bigger companies would not relate to the average – but surely the development (fluctuations). Hence using the movements in the index for their pricing.
They also have an option to book 50-75-90% of their requirements annually, and buy the remainder off the spot market. While that increases the spread in a falling market, it also runs the risk of finding sufficient availability in the peak seasons. While freight can be a profit center if managed by trading professionals, it can also be a loss center if misjudged; using an index ensures the rates are never worse than the competition while maintaining both the relationship and reliability of your chosen carrier.
Or even worse: not using an index might leave you explaining to your superior why your company is today paying US $ 1,600 per 20’ because of that November 2013 contract while your competition is paying US $ 950; your upcoming summer holiday might become a permanent one.
Thought for the week:
“Know the difference between a calculated risk and a foolish decision.” ///