It’s been a rollercoaster, highly volatile year for the container market. Shippers, forwarders and carriers alike have been facing significant levels of financial risk as the cost of moving containers around the world by sea has yo-yoed. 

 Within the space of just a few months we saw China go into lockdown, only to re-open as COVID-19 spread across the rest of the world. Consumer demand has waxed and waned. The spring of 2020 saw sharp demand drops with European container imports declining by 20%, Indian exports down 31% and North American imports falling by 15%. By the autumn we saw ports busy again as consumers resumed spending.

 Over the course of the year carriers have cut or redeployed their capacity in an effort to retain pricing discipline. But whilst the carriers have been able to adjust capacity quickly, this is not true of all the supply chain. Boxes are simply not positioned where they need to be. We are currently seeing severe shortages of empty containers where they are needed which is having a knock-on impact on freight rates. 

 The price of bunker fuel, a key cost component for the shipping lines and one which is ultimately passed on to the customer, fluctuated significantly over the course of the year hitting highs in January as the impact of the lack of low-sulphur fuels was felt, dropping sharply in April, with further volatility in September. 

 These fluctuations in vessel and cargo supply & demand as well as costs, have made themselves felt in the prices shippers are paying for ocean transport. At the time of writing (20 Nov), rebounding trade has driven rates from North Asia to the US West Coast to twice their levels at the start of the year.

 In February, just as the impact of COVID-19 was making itself felt in China, the Baltic Exchange announced the launch of a new daily index and set of container assessments in partnership with digital freight platform Freightos. 

 Covering the spot price of moving 40-foot containers (FEUs), the Freightos Baltic Container Index (FBX) is based on live pricing data from hundreds of global logistics providers. The rates are rolling short term Freight All Kinds (FAK) spot tariffs and related surcharges between carriers, freight forwarders and high-volume shippers. The headline FBX Index is a weighted average of its underlying regional route indices. Each individual trade lane index is represented by five to seven of the major ports of each region. 

 What makes the FBX set of indices so interesting, is the potential that offers the container market to limit price volatility through index linked contracts. For an index linked contract to work, there needs to be trust in the publisher of the data, a transparent methodology as well as checks and balances through a robust governance structure.  

 The role played by the Baltic Exchange in this process is that of an overseeing body or “Benchmark Administrator.” The Baltic Exchange has the responsibility for determining the benchmark in accordance with the methodology. The Baltic Exchange itself is a regulated entity and through its governance structure ensures that FBX complies with the Principles for Financial Benchmarks set by the International Organization of Securities Commissions (IOSCO). These rules are designed to ensure benchmark quality, integrity, continuity and reliability. 

 The Baltic Exchange is an independent, trusted body with deep experience of managing complex benchmarks for the shipping industry. The move to bring the Freightos index product under the Baltic Exchange’s governance followed a 20-month monitoring process to ensure that it meets the Baltic’s strict criteria.

 So how might a company manage its freight risk using the index? Traditionally rates for the bigger shippers could be locked in advance through an annual tender. In return for a guaranteed cargo volume, both shipper and carrier are guaranteed stability. But when the market moves down, beneficial cargo owners have been known to cancel contracts. Conversely upward movements can see carriers prioritise more lucrative spot cargoes.  A simple index linked contract is one way around this. Shippers and carriers are guaranteed a rate which moves in line with the index.

 Taken a step further the FBX easily allows for a freight forwarder and their customer to enter into a natural “collar” in which the forwarder commits to a maximum price, whilst the customer can commit to a minimum floor. A contract between two parties linked to the index could be established.

A simple format to execute this would be: 

• Freight forwarder agrees a maximum price the customer will pay. This commits them to sell to the customer at that price, if the customer wishes to buy. 

• Customer agrees a minimum floor price. This commits the customer to buy from the freight forwarder at this price at a minimum. If prices fall, the freight forwarder will continue to receive a minimum income

 For each FEU a small premium price is paid to the side who is taking on the risk. Crucially, if the index is in-between the minimum and maximum prices, then this will simply behave as an index linked contract. This can be easily modified to distribute the risk. It can, for example be structured so that if the index is below the floor, the gains are shared, but in exchange the freight forwarder receives a greater total up-front payment.

 There will always be a differential (also known as “basis risk”) between the index or trade-lane used, and the actual price paid by the seller. This points to a particular advantage of using more complex methods of hedging, as the premium payments can be used to offset or smooth out the differential of index linking.

Box items

FBX01 China/East Asia to North America West Coast

FBX02 North America West Coast to China/East Asia

FBX03 China/East Asia to North America East Coast

FBX04 North America East Coast to China/East Asia

FBX11 China/East Asia to North Europe

FBX12 North Europe to China/East Asia

FBX13 China/East Asia to Mediterranean

FBX14 Mediterranean to China/East Asia

FBX21 North America East Coast to Europe

FBX22 Europe to North America East Coast

FBX24 Europe to South America East Coast

FBX26 Europe to South America West Coast

 Underpinning the Baltic Exchange’s data services is a robust, independent governance structure to ensure the integrity of its benchmarking.

 Responsibility lies with the board of Baltic Exchange Information Services, Baltic Exchange’s data services arm. This is supported by the Baltic Index Council, which is made up of market representatives and Baltic Exchange officials. An Oversight Function provides an additional layer and ensures that Baltic Exchange Information Services control framework is performing. The Baltic Exchange is authorised and regulated by the UK’s Financial Conduct Authority (FCA) as a benchmark administrator under EU Benchmark Regulation.

 The Baltic Exchange has been providing daily assessments for the dry bulk markets since 1985 and expanded its coverage to tankers in the 1990s. But since its acquisition by the Singapore Exchange (SGX) in 2016, the Baltic has been expanding the range of its data services. These not only include container market assessments, but also tools for shipping investors to calculate the residual value of their assets as well as a move into the air freight market in collaboration with TAC, a Hong Kong based information provider. 

www.balticexchange.com