Is nothing safe from being made into a financial instrument? Well it seems not in the business world. An Economist article reports that Clarksons, the world’s biggest ship broker, who pioneered derivatives for dry-bulk cargoes like iron ore and coal in the early 1990s, made its first container-derivative trade in January of this year. Since then, two other London-based brokers, ICAP and Freight Investor Services, have also started to offer derivatives products. Although tiny at the moment, Alex Gray of Clarksons believes, container derivatives may be worth 5-10% of the physical market by the end of 2011.
Some 140 million containers now carry around half the world’s seaborne trade as the graph shows, and it should be said the dry-bulk market was also tiny ten years ago before Chinese demand made rates take off. That prompted shippers and producers to use derivatives to hedge against rate volatility such that now forward freight agreements are worth 40% of the physical market.
Simply put, the new Container Freight Swap Agreement CFSA is a forward dated swap allowing users to hedge against volatility in freight rates by off-setting a physical position (a movement of goods by container) against a paper one (the swap agreement) and thereby lock in a guaranteed freight cost. The swap is priced in US$ per TEU/FEU and settled against a freight Index, the SCFI. The SCFI is published by the Shanghai Shipping Exchange and uses a panel system of Carriers and Non-Carriers (NVOCC’s/Forwarders/Shippers) to provide weekly spot assessments in US$ per TEU/FEU from Shanghai to eventually 15 major trade destinations – the four principle routes being to Northern Europe, the Mediterranean, US West Coast and US East Coast; as well as a number of other trade-lanes including the intra-Asia trades. To begin with, only the four principal routes will be used to set the swaps. The weekly spot assessments are based on a general cargo container and include surcharges related to the “Vessel” side of the transaction – BAF/CAF/PSS/WRS etc and exclude costs related to the “Shore” side – THC, South China Origin Surcharge etc.
So who is likely to use the new contract? Well there are three main user groups who may be interested. Ship owners or operators, who are “net long of space, shippers or freight forwarders, who are “net short of space and traders or investors who may seek to profit from playing the forward market, speculators if you like, who help provide the liquidity such that a buyer and seller can always be matched up on like terms.
As with just about every futures market that has ever been launched, there is initial reluctance from the “producers in this case the shipping lines, who see this as a dissolution of their power or control and a commoditization of the service. But in reality it needn’t be, a shipper can still choose to use a premium line for the physical shipment of their cargo in the interests of superior service, speed, sailing dates or any one of a host of reasons that can become key drivers for a particular sailing or product trade. To pretend that all shipping lines don’t move rates up or down in some form of unison is to ignore reality, all lines on specific routes are driven by the same fundamentals of demand, supply, availability, etc. For frequent shippers with regular requirements there is always the option of a long term contract with the shipping line to fix costs, providing the line is willing to do that. But that ties the shipper into using that line, whereas a financial swap allows the shipper to use any line as vessel availability or spot rate advantage dictates secure in the knowledge the financial swap will anchor rates to no more than the swap price. How closely the swaps mirror the actual market will be a deciding factor and in part will be a function of how quickly the market develops a sufficient level of liquidity to efficiently match buyers and sellers. It is certainly an interesting development for importers and exporters to hedge their shipping cost risks but may yet be a year or two away from offering a truly market reflecting price.
TEU Twenty Foot Equivalent Unit standard container
FEU Forty Foot Equivalent Unit double length standard container
NVOCC Non Vessel Operating Common Carrier an organization or company that sells container space but doesn’t own the vessels the containers are shipped on.
BAF Bunker Adjustment Factor added by the line to cover fluctuations in fuel costs
CAF Currency Adjustment Factor added by the line to cover Fluctuations between the USD and local costs
PSS Peak Season Surcharge added when demand for container space is seasonally high
WRS War Risk Surcharge self explanatory!
THC Terminal Handling Charge cost of loading the container onto or off the vessel.