The Shanghai Containerized Freight Index (SCFI) launched in October 2009 has led to the creation of a new tool for exporters and carriers/freight forwarders to use as a hedge against fluctuating freight rates . While many freight service investors may be familiar with the workings of a derivatives trading platform, this may be a new and useful tool for logistics managers.
Shanghai Containerized Freight Index
There are fifteen routes indexed weekly by the SCFI with four of them accounting for 57.5% of the export traffic from Shanghai according to figures published by the Shanghai Shipping Exchange on 20 August 2010. The rates are all published in US dollars with the four highest volume routes as follows:
Route Index as of:
10/08/20
Europe USD/TEU 1847 (Northern Europe) (20′ Containers)
Mediterranean USD/TEU 1819 (Mediterranean) (20′ Containers)
USWC USD/FEU 2752 (US West Coast) (40′ Containers)
USEC USD/FEU 4139 (US East Coast) (40′ Containers)
Container swap contracts can be bought and sold on these four routes currently, and it is anticipated that more routes will be added as the container swap market develops.
What is a Container Swap Derivatives Market?
Most logistics managers are familiar with the freight forward agreements (FFAs) as a means to stabilise shipping rates through long term future contracts for an agreed number of containers. Some of the advantages of these agreements may be lost or minimised for small to mid-size shippers lacking the leverage of larger operations to lock in favorable rates. A derivatives market in container swaps can aid the managers for small and mid-size operations to lock in rates and reduce the volatility they are currently experiencing.
Container swap agreements provide carriers and shippers alike, the opportunity to hedge against actual spot pricing by purchasing or selling containers at an agreed price for a future time period. The agreed price is negotiated between a buyer and seller with the aid of a broking house. Settlement of the contract is based on an average of the weekly SCFI rates during the contract period for the route being purchased.
It is not necessary to be a securities expert to participate in this market and one of its primary intended uses is by line managers in the shipping industry. Keep in mind that this is a paper transaction only and does not involve the physical containers. Also, understand that for a container swap market to exist, suppositions as to future pricing of containers must differ.
How Do Container Swaps Work?
A shipper needs 100 containers shipped to Europe during the fourth quarter of 2010. He fears prices are going to increase and would like to lock in his pricing now so that the company will be able to allocate their resources for the remainder of the year with greater confidence.
The shipper contacts a broking house with a request to purchase 100 containers at today’s price of 1847 to be used during the fourth quarter. The broking house finds someone, it could be a carrier or an investor, willing to sell the containers at a price of 1800 and an agreement is brokered at 1825.
The shipper conducts business as usual by contracting with a carrier to ship the 100 containers during the fourth quarter based on the spot prices at the time each container is shipped. The containers are shipped and the spot prices are paid.
During the fourth quarter the SCFI weekly index for the Europe route progressively increases 2100 and the ends the quarter at 2000. The weekly index for the thirteen weeks of the quarter ends up averaging 1925. The actual cost the shipper would pay the carrier is $192,500 or 100 containers times 1925.
The settlement of the container swap contract would have credited the shipper with a profit of $100 per container or $10,000 for a net shipping cost of $182,500. The seller would have been obligated to make up the difference between the sell price and the SCFI index price.
Had the shipper guessed wrong and the price actually gone down, he would have been obligated to pay the seller the difference between the average index price and the contract. This would have still provided the shipper with price stability at 1825 as opposed to being subject to the vagaries of the market place with all of the uncertainty therein. In addition, with a market place of buyers and sellers, the shipper may have been able to sell his position and minimize the downside impact.
The intent of this illustration is to show the advantage to shippers and carriers of being able to minimise price fluctuations through offsetting container swap contracts. This example does not take into consideration many of the variables that are particular to each scenario such as monthly cash settlements and/or actual container spot pricing at the time of each shipment.
Short of being able to predict the future with absolute certainty, hedging against unforeseen changes in the marketplace through container swap contracts can provide a new level of stability for shippers and carriers while providing a new investment vehicle for freight services investors.