With spot rates chronically below annual contract rates, shippers are increasingly questioning whether they should continue to sign contracts with fixed annual rates.

 The annual carrier contract with rates fixed for the next 12 months has been for many years the main way in which large shippers have bought ocean transport services. But this contract type is looking less and less solid.

 For about 6 months, Drewry Supply Chain Advisors has been asked by major and medium-size beneficial cargo owners to advise them on moving away from annual contracts with fixed freight rates. Several objectives triggered this review: spot rates have been much lower than contract rates for some time (see chart) and following the shipping spot market price rather than trying to fix at the current level would have reduced costs.

 Furthermore, low spot rates have resulted in shippers having to or deciding to re-open and re-negotiate current contracts to avoid paying much more than “the going rate” and or paying more than some of their competitors. So what is the point of a fixed annual rate? Drewry operates a benchmarking club, which enables companies to benchmark their rates against their peers, giving them visibility into BCO rates by lane.

 Some carriers to whom Drewry has spoken see annual contracts as a better way of doing business with shippers because they provide regular, guaranteed capacity in return for volume commitments and the annual contracts include certain additional services which spot rate agreements do not offer.

 You can also argue that buying ocean transport on the spot market is more time consuming, makes invoice payments more complex and makes it harder to develop customer-provider relationships. And the fact that the rate is fixed protects shippers from the “US$1,000 GRI” shocks which smaller shippers and forwarders regularly have to pay to secure capacity in certain weeks, carriers say.

 So there is value in having capacity guarantees, less risk of price volatility and less complex management of numerous spot transactions under fixed-rate annual contracts. In fact, the argument that fixed-rate contracts protect shippers from sudden high rates is not so valid in the current market, because the highest spot rates do not even reach the year-long contract rates (and the lowest spot rates are way below).

- While annual contracts can make sense to many shippers, Drewry sees advantages for some shippers to connect to the spot rates without losing the main benefits of annual contracts. How?

 You can enter into an annual contract which is indexlinked, meaning that the service features are the same as for a standard contract, but the price is based on an external, variable index (like the Container Freight Rate Insight or the WCI indices).

- You can allocate say 80% of your volume to fixed-rate contracts and the remainder to spot-market carrier or forwarder agreements.

- You can have a rate review clause in the contract (same approach as fuel surcharge review clauses in some existing contracts). Should you consider a change in your ocean transport contract type?

(Source : Drewry Supply Chain Advisors)