Heartland Shippers Conference - Richard Heath

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The Heartland Shippers Conference is presented by Cargo Business News and the Midwest Global Trade Association, and supported by several other U.S. Midwest trade/shipper organizations.
The U.S. Midwest is home to major manufacturing, agriculture, and a significant consumer market of over 66 million. Conversely, getting cargo in and out of the nation's heartland is challenging for a variety of reasons, and the Heartland Shippers' Conference will address these themes among others pertinent to the global supply chain's vital connection to the region and its developing infrastructure.

Says Richard Heath, Head of Products at the Cleartrade: "The panel on freight rate risk management was well received. As many of the organisations present conduct their core business in the agricultural space they are used to using derivatives to manage underlying price risk. Due to this there was a general understanding and appreciation of how effective these tools could be if correctly applied to the container freight market."

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Heartland Shippers Conference - Richard Heath

  1. 1. Container Freight Indices,Index Linked Contracts andRisk ManagementRichard Heath – Heartland Shippers Conference – April 2013
  2. 2. • The World Container Index• Freight Rate Volatility– Trends observed by the WCI– Freight Rate Risk• Freight Rate Risk Management– Risk Management Options– Derivatives - The Basics• Index Linked Container Contracts– Types & Uses– Industry Adoption• Indices, Index Linked Contracts and Risk Management –Implications & ConclusionsAgendaHeartland Shippers Conference – April 2013
  3. 3. Heartland Shippers Conference – April 2013The World Container Index (WCI)The World Container Index is a joint venture between:Drewry Maritime Advisors and Cleartrade Exchange• Weekly freight rate levels on 11 majorport to port routes – Trans-Pacific, Asia-Europe & Trans-Atlantic• Weighted average Composite Index• Highly granular data providing an average,lowest and highest rates• Sourced from an international panel ofNVO / NVOCC’s providing over 300 priceseach weekThe index is designed for:• Benchmarking freight rates and trends• Index Linked Contracting• Settlement of freight derivatives
  4. 4. Heartland Shippers Conference – April 2013Trends Observed by the WCI25002700290031003300350037003900410043001200140016001800200022002400260028003000Jan-10Mar-10May-10Jul-10Sep-10Nov-10Jan-11Mar-11May-11Jul-11Sep-11Nov-11Jan-12Mar-12May-12Jul-12Sep-12Nov-12Jan-13Mar-13USECUSD/FEUUSWCUSD/FEUTrans-Pac Head HaulChina - USWC China - USECContainer freight rate volatility hasincreased for three primaryreasons:– Macroeconomic & geopoliticaluncertainty– Step change in vessel size– Carrier market behaviourFreight rate volatility is not a shortterm phenomenon:– Defining feature of the decade– Industry adaption critical– Impact on shipper-carrier relations 75080085090095010001050Jun-11Jul-11Aug-11Sep-11Oct-11Nov-11Dec-11Jan-12Feb-12Mar-12Apr-12May-12Jun-12Jul-12Aug-12Sep-12Oct-12Nov-12Dec-12Jan-13Feb-13Mar-13Apr-13USD/FEUTrans-Pac Back HaulUSWC - China
  5. 5. Heartland Shippers Conference – April 2013Freight Rate Risk-6-5-4-3-2-1012345Jun-11Jul-11Aug-11Sep-11Oct-11Nov-11Dec-11Jan-12Feb-12Mar-12Apr-12May-12Jun-12Jul-12Aug-12Sep-12Oct-12Nov-12Dec-12Jan-13Feb-13Mar-13Apr-13USD/TonneTrans-Pac Back Haul QuarterlyVolatilityDecrease IncreaseUnpredictability of freight rates constitutes real risk:– Rate volatility and shortvalidity contracts makeforward pricing impossible– Offering derived forwardprices exposes the exporter tolarge risks– Although backhaul rates lookto be more stable margins aresmaller
  6. 6. Heartland Shippers Conference – April 2013Freight Rate Risk ManagementRisk Management Options1. Removal of Risk / No Risk Management –Buy Spot2. Pass Risk Downstream – Pass to client3. Fixed Rate Long Term Contract – Suited toBCO/Intra-Firm trade4. Flexible Index Linked Contract5. Freight Derivatives
  7. 7. Heartland Shippers Conference – April 2013Freight Derivatives – The BasicsThe “Physical” and “Paper” Markets• Physical Market– Agreement to move XX TEU at XX USD/TEU between POL and POD– Between, carrier and shipper, carrier and NVO, NVO and shipper etc.– Physically settled, e.g. boxes shipped• Paper Market– Agreement for XX TEU at XX USD/TEU on route XX in XX month/quarter/year– Between, party A and party B– Cash settled, e.g. party A pays party B or v.v.
  8. 8. Heartland Shippers Conference – April 2013Freight Derivatives – How do they Work?• Freight derivatives are used to manage risk by securing a fixed rate• A fixed rate is achieved by creating a position in the paper market which is equaland opposite to a position in the physical marketShipper Example• Physical Market Position = pay more if freight rates go up (Short Position)• Paper Market Position = get paid if freight rates go up (Long Position)• Physical Position + Paper Position = Fixed Freight Rate-6-5-4-3-2-1012345Jun-11Jul-11Aug-11Sep-11Oct-11Nov-11Dec-11Jan-12Feb-12Mar-12Apr-12May-12Jun-12Jul-12Aug-12Sep-12Oct-12Nov-12Dec-12Jan-13Feb-13Mar-13Apr-13FreightRateUSD/TonnePaper P&LLoss Profit-6-5-4-3-2-1012345Jun-11Jul-11Aug-11Sep-11Oct-11Nov-11Dec-11Jan-12Feb-12Mar-12Apr-12May-12Jun-12Jul-12Aug-12Sep-12Oct-12Nov-12Dec-12Jan-13Feb-13Mar-13Apr-13FreightRateUSD/TonnePhysical P&LProfit Loss
  9. 9. Heartland Shippers Conference – April 2013Index Linked Container Contracts (ILCC’s)ILCC’s are used to create flexible long term agreements whichmove with the market reducing the drivers for contract default• Ensure contract rates move relative to themarket• Removes drivers for contract default• Eases shipper – carrier tensions• A “BAF” clause for your freight
  10. 10. Heartland Shippers Conference – April 2013ILCC Types – Time Lag vs. Real Time100015002000250030003500JanAprJulOctJanAprJulOctJanAprJulOctJanAprJulOctJanAprJulOctJanAprUSD/FEUTime Lag ILCCSpot Contract100015002000250030003500JanAprJulOctJanAprJulOctJanAprJulOctJanAprJulOctJanAprJulOctJanAprUSD/FEUReal Time ILCCSpot Contract• Time lag contracts measure a changein the market over time• This change is then applied to theagreed contract rate• The example uses the average changein the index over 1 quarter• Time lag contracts decrease disparitybetween market and contract rates• Real time contracts are synchronisedwith the market• The difference between the contractand the index is a fixed differential• Differential is either numeric or advalorem• E.g. Index – 200 USD/FEU or Index x0.7
  11. 11. Heartland Shippers Conference – April 2013Industry Adoption of Index Linked ContractsEarly Adoption• To date mostly used on Asia exporttrades to North America and NorthEurope• Trans-Pacific was first to see ILCC’safter 2009-10 contracting seasonNumber of ILCC’s in 2012-13• North America Trades – 61 (FMC)• North Europe/Other Trades – 100 +(Drewry estimate)Early adopters• BCO’s (Retail/FMCG)• European Lines• NVO/NOVCC’s/Freight ForwardersApproach & Tactics• Experiments focused on small numberof key lanes• Agreed within existing strongrelationships• Mutual trust essentialCommon Contract Methodologies• Time lag• In frequent changes (replace tender)• 1 – 3 year durationBarriers to Uptake• Knowledge and expertise• Step change in contracting behaviour
  12. 12. Heartland Shippers Conference – April 2013Implications and Conclusions• Freight indices create tools with lots of potential• Derivatives and ILCC’s can have the advantage of moving pricing out of theshipper-carrier relationship• To date uptake of these tools has been relatively slow• More transparency, more experience and adopters are required• Derivatives and ILCC’s will bring evolution not revolution to the container market• The WCI will continue to work with the market to help develop new index basedtools• In the future these could form part of every organisation’s freight tool box to beused as and when they deliver best advantage
  13. 13. World Container Index15-17 Christopher StreetLondonEC2A 2BSUnited Kingdom+ 44 20 7759 2146info@worldcontainerindex.comwww.worldcontainerindex.com

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