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NEW MARKET DYNAMICS DRIVING DEMAND

FOR FREIGHT FUTURES

Two new ocean freight futures products underpinned by well-known industry indices that have emerged over the last two weeks seek to
succeed where past efforts to provide hedging tools to shippers, forwarders, and carriers have failed.

The indices enter the fray in a market turned upside down by ocean freight capacity shortages driven by a demand surge and equipment
dislocation that has sucked away as much as 20 percent of effective vessel capacity.

Both the new indices are based on freight rate data from companies — Freightos and Xeneta — that didn’t exist the last time there was
an effort to drive usage of ocean freight derivatives. That initiative, pushed primarily by Morgan Stanley and futures broker Freight
Investor Services (FIS) in the wake of the global economic crisis in 2010, fell flat due to a lack of interest from both container lines and
shippers. FIS is also involved in the FBX-based futures option. Container lines didn’t want to participate as they saw derivatives devaluing
their business in a high-capital expenditure, low-margin industry, while shippers largely didn’t see value in hedging against rate volatility
when ocean freight costs were relatively low.

But that picture has changed markedly since the onset of the COVID-19 pandemic. Rate levels, both contract and spot, have mushroomed
in 2021 with little sign of easing in 2022. Service levels, measured in sailing schedule reliability and the availability of containers at port,
have declined, creating a double whammy for supply chain managers to explain to their C-suites.

As freight costs have risen, and the need to carry more inventory to account for longer transit times for shipments has grown, shippers
and forwarders are increasingly more open to tools that help them hedge risk against a sea of uncertainty, principals with the Baltic
Exchange told JOC.com this week. The Baltic Exchange produces the Freightos Baltic Index (FBX) in tandem with Freightos, operator of
an online international freight marketplace. FIS said in a statement Dec. 17 it will offer container freight rate futures on the Chicago
Mercantile Exchange (CME), one of the largest futures and commodities exchanges in the world. The daily price of the futures contract will
settle against the FBX.

Meanwhile, Xeneta, a provider of rate benchmarking for shippers and forwarders, earlier this month partnered with financial index
provider Compass Financial Technologies to provide a freight-all-kinds (FAK) index based on short-term ocean contracts. Xeneta said in a
Dec. 9 statement that its index with Compass, called XSI-C, more accurately reflects what shippers pay for ocean freight.

“Many legacy indices do not reflect the large-scale trades made by some of the biggest companies in the world,” Xeneta said in the
statement. “They are mainly based on quoted prices, which are disproportionately indicative. Xeneta works with some of the largest
shippers in the world, so XSI’s data is not only timely but also relevant.”

XSI-C rates are available for a 40-foot container on eight main trade corridors, calculated and published daily, with rate validities of less
than 32 days. The FBX-CME futures contracts are available for a 40-foot container on six lanes, with a launch date of Feb. 28.

Little experience in hedging

Shippers in charge of freight capacity procurement are generally not experienced in using hedging tools, a fact that has hindered demand
for previous derivative and futures products, Bjorn Vang Jensen, vice president of advisory services/global supply chain at Sea-
Intelligence Maritime Analysis, wrote in a LinkedIn post about the FBX-CME contracts.

“Remember, people who buy freight are, as a rule, not knowledgeable about derivatives and futures,” he wrote. “Another failure point last
time is that people actually thought this was going to save them money. [Sellers of futures contracts] will need to explain very carefully,
and in big, bold, red letters, what ‘hedge’ means.”

Jensen acknowledged that broader ocean market dynamics have changed, but questioned whether those changes would be enough to
stir genuine demand for futures contracts.
 “It has been tried before, and failed miserably, but then again, nothing is like it was before,” Jensen wrote. “It is very important to note
that you are not buying space or equipment; you are hedging your cost exposure through a financial instrument. This misunderstanding is
exactly what caused the last attempt to fail, when prospective buyers inexperienced with futures eventually realized that they would not
be buying a physical service.”

Aside from the question of whether this iteration of ocean freight derivatives will gain necessary traction, the use of two relatively new
indices plays on an underlying theme in container shipping: most pricing indices are based on the rates paid by forwarders, rather than
those paid by shippers. Freightos’ rates are based on those transacted by forwarders using its rate management software, while Xeneta’s
is primarily based on contract rates from shippers using its benchmarking products.

Indices developed over the past decade, including the Shanghai Shipping Index, Drewry’s World Container Index, and those built by
Xeneta and Freightos, have largely served as benchmarking or price discovery tools as the process of ocean freight procurement has
evolved into the digital age. The advent of online quoting tools and, more recently, a push by container lines to secure multi-year contracts
with shippers, has meant these indices have a more direct impact on procurement.

Allied to higher overall freight costs, the appetite to use financial instruments as a tool to hedge has grown, Peter Stallion, container
broker at FIS, wrote on LinkedIn.

“Suffice to say the development of new physical contract styles that have been focusing on the guarantee of space on a shorter timeframe
have made cash-settled futures extremely attractive for both capacity buyers and sellers,” he wrote.

FIS has been conducting “off-exchange” futures contracts for the better part of 2021, the Baltic Exchange said in a Dec. 16 statement. The
underlying catalyst has been the dramatic rise in rates, which has changed market participants’ thinking about hedging, Stallion indicated
in the statement.

“The volatility that we have seen in the last 18 months has led many participants in search of hedging tools,” he said. “The launch of
these cleared contracts opens up the market to all participants, helping drive forward an efficient and universally beneficial market.”

Post Credit: Joc.com

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