Complete Guide To Container Freight Derivatives
Content
Complete Guide to Container Freight Derivatives Clarkson Securities Limited
Contents Section 1 – Introduction to Container Fundamentals Section 2 – Introduction to Derivatives Section 3 – Introduction to the SCFI Section 4 – Introduction to Clearing Section 5 – Introduction to Swaps Section 6 – Introduction to Options Section 7 – Introduction to Hedging with Swaps Section 8 – Introduction to Index-Linked Service Contracts Section 9 – Introduction to Hedging an Index-Linked Service Contract .
Section 1
An Introduction to Container Fundamentals
Clarkson Securities Limited
World Container Trade ● The period 1997-2008 saw average growth in container trade of 9% per annum, with 6 years of consecutive double-digit growth 2002-2007. ● Growth slowed in 2008 to 4.3% from 11.4% in 2007 following the impact of unpredicted changes in world economic and financial conditions. ● With the global economic crisis biting hard, 2009 witnessed an estimated 9.0% contraction in global container trade to 124m TEU. ● Recovery in volumes on a wide range of
trades in 2010 to estimated growth global terms of led more than 12.9% in the in full year to 140m TEU, with current projection of 9.2% growth in 2011.
Global Box Trade 1996-2010 160
m TEU
Trade
Growth %
growth
140
20% 15%
120 10%
100 80
5%
60
0%
40 -5%
20 0
) ) 6 7 8 9 0 1 2 3 4 5 6 7 8 ) e ( e f ( 9 9 9 9 0 0 0 0 0 0 0 0 0 ( 9 9 9 9 0 0 0 0 0 0 0 0 0 1 1 1 1 2 2 2 2 2 2 2 2 2 9 0 1 0 1 1 0 0 2 0 2 2
Source : Clarkson Research Services
-10%
Global Demand Projection
Mainline Trades; through the years Asi sia a - US E/ E/B con conttai aine nerr trad ade e 60%
Asi siaa-Eur Eur W/ W/B B con conttai aine nerr trad ade e
% chan change ge yoy
50% 40% 30% 20% 10% 0% -10% -20% -30% -40%
6 6 6 6 0 - 0 - 0 - 0 l t n r u c p a J J A O
7 7 7 7 0 - 0 - 0 - 0 l t n r u c p a J J A O
8 8 8 8 0 - 0 - 0 - 0 l t n r u c p a J J A O
9 9 9 9 0 - 0 - 0 - 0 l t n r u c p a J J A O
Source : CRSL, PIERS, FEFC, ELAA, CTS
0 0 0 0 1 - 1 - 1 - 1 l t n r u c p a J J A O
1 1 n a J
Supply; Container Capable Capacity Global Container Capacity
• 16.3 millio million n TEU of of container container capable capa ble capacity capacity on ‘liner’ ‘liner’ vesse vessels ls at the start of 2011.
m TEU, start 18.0 year
16.0
Other
14.0
MPP Containership
• 14.1 millio million n TEU of of this provid provided ed by fully cellular containerships.
12.0
• Today Today’s ’s fleet domina dominated ted by fully fully cellular containership capacity capacity;;
10.0 8.0
other container capable supply playing a diminishing role.
6.0 4.0
• Cont Containe ainerr capacity capacity on order order also dominated by fully cellular
2.0 0.0 0 0 0 2
1 0 0 2
2 0 0 2
3 0 0 2
4 0 0 2
5 0 0 2
6 0 0 2
7 0 0 2
8 0 0 2
9 0 0 2
0 1 0 2
1 1 0 2
containership capacity.
Containership Orderbook ● The total contain containersh ership ip orderbook orderbook that remains at start of June 2011 is still large, with 4.1 million TEU on order equivalent to 27.7% of existing
containership containe rship capacity capacity – the 10,000+ 10,000+ TEU orderboo orderbook k numbe numbers rs 144 vessels vessels of a combined 1.9m TEU, equivalen equivalentt to 165% of the 10,000+ TEU fleet. ● Includes 1.1 million TEU scheduled for delivery in the remainder of 2011 and 1.5 million TEU for 2012 delivery. ● However, the containership orderbook has been subject to significant ‘erosion’ ‘eros ion’ as well as delivery delivery slippa slippage. ge.
Containership Orderbook 2.00
m TEU
100-999 TEU 1000-2999 TEU 3000-7999 TEU 8000+ TEU
1.75
no.
250
200
No. of ships
1.50 1.25
150
1.00 100
0.75 0.50
50
0.25 0.00
0 2011
2012
2013
2014+
Source : Clarkson Research Services
Carrier Capacities; growth gro wth June June 2010 2010 – Jun June e 2011 2011 ● May deliveries: approx 130,000 TEU ● Jan – Jun 11: appr approx ox 625 625,000 ,000 TEU ● Average size to date: just under 7,000
TEU ● Average size 2010: approx 5,250 TEU
Source: ASX
Orderb erboo ook k Imb Imbala alanc nce e Ord Containership Containe rship Orderboo Orderbook k As % Of Existing Fleet Fleet 100% 90% 80% 70% 60%
251 ships
50% 2.8m TEU
40% 30% 20% 10% 0% 100-999 TEU
1000-2999 TEU
3000-7999 TEU
Source : Clarkson Research Services
8000+ TEU
Slippage & Cancellation; Overview Scheduled vs Actual Deliveries 2009-10 000 TEU 2500
Sch edu l ed
● Graph shows scheduled vs actual deliveries.
Actu al
‘Non-del -delivery ivery’’ of 45% in in 2009. 2009. ● ‘Non ● Final figures for 2010 estimate at around 40%.
2000
● This factor has made a huge difference to the supply side of the container shipping industry compared with original expectations.
1500
1000
non-delivery ery currently currently running running ● Ytd 2011 non-deliv at c.30%.
500
0 2009
2010
2011 ytd
Cascading Trends % of TEU Deployed 8k+ TEU share of Transpac.
80%
3-8k TEU share of North-South 70%
1-3k TEU share of Intra-Regional
60% 50% 40% 30% 20% 10% 0% 6 0 n a J
6 0 l
u J
7 0 n a J
7 0 l
u J
8 0 n a J
8 0 l
u J
9 0 n a J
9 0 l
u J
Source : Clarkson Research Services
0 1 n a J
0 1 l
u J
1 1 n a J
How Much Slow Steaming Today? Far East-Europe Services, Q1 2011
Transpacific Services, Q1 2011
traditional service of 8 ships 28 26
20 18 16 14 12 no. of services
no. of 10 services 8
traditional USWC service of 5 ships; USEC service 8 ships
24 22 20 18 16 14 12 10 8 6 4 2 0
6 4 2 0 d r a d n a t s
p i h s 1 +
s p i
s p i
d r a
h s 2 +
h s 3 +
d n a t s
p i h s 1 +
s p i h s 2 +
s p i h s 3 +
Idle Boxship Capacity ● Having built up dramatically in 2008 and 2009, in 2010 the majority of the ‘idle’ fleet was returned to service. ● Idle capacity fell from near to 600 ships / 1.51 m TEU to around 150 ships in December 2010, moving from 11% to less than 3% of the fleet. ● Currently less than 1% of the fleet
Idle Containership Development 600 550
no ships
m.TEU
Charter owner
1.4
500 450 Operator 400
1.2 1.0
350 300
0.8
250
0.6
200
remains idle. ● As of June 2011 only 63 ships/80,000 TEU are are idling idling - all less less than than 3,300 3,300 TEU capacity
150 100
0.4 Million TEU idle
50 0
1.6
no. of ships
8 8 9 9 9 9 9 9 9 9 0 0 0 0 0 0 0 1 1 0 0 0 0 0 0 1 1 1 1 1 1 1 - 0 - 0 - 0 - - 0 - - - - - - - - 1 - 1 - - - - t b r r n g p v c b r r n l p v n b c c e e a p u u e o e e a p u u e o a e O D F M A J A S N D F M A J J S N J F
Source : Clarkson Research/AXS
0.2 0.0
Section 2
An introduction to derivatives and hedging
Clarkson Securities Limited
Derivatives;
a brief history
The use of derivatives has been around for centuries with its origins found in commodities, farming and agriculture. Futures/Forwards developed around producers of commodities and goods looking to hedge prices for their wares and remove their exposure to the volatility associated with supply and demand market characteristics. Trading became more sophisticated with the introduction of exchanges, in 1710 the Dojima Rice Exchan Exchange ge transformed conversion from rice to coin cointhe as currency. Later, in 1848 the ChicagoJapan Boardbringing of Tradethe was established and became world’s oldest Futures and Options Exchange. The later 20th and 21st Century saw enormous growth in the derivatives markets worldwide with a multitude of products and markets that are traded through exchanges, dealers, brokers, screens and online.
Derivative; A secur security ity whose whose price is dependen dependentt upon upon or deriv derived ed from from one or more underlying assets “Derivative” is a generic term for a number number of different contracts, contracts, the three most common being:
• Futur Futures/F es/Forward orwards s – An agreement agreement to buy or sell sell a specified specified quantit quantity, y, at a specified specified future date, at a price agreed today. The difference being that futures are exchange traded, whilst forwards are traded directly between two parties (OTC Over the Counter,) with more flexibility. • Optio Options ns – Gives the the Buyer Buyer (Holder) (Holder) the right but but not the obliga obligation, tion, to to buy or sell sell an asset at a specified time in the future. The Holder pays the Seller (Writer,) ( Writer,) a premium for having this option (right.) • Swap Swaps s – The exchang exchange e of floatin floating g for fixed fixed cashflo cashflows ws at a specifie specified d time in in the future future,, at a price agreed today, based on the value of the underlying,
Derivatives;
the Long and the Short of it
When talking about about our relationship relationship with the the underlying asset asset it is defined as either – Long: we own the underlying asset, and our risk is of prices falling Short: we want to own the underlying asset, and our risk is of prices rising The position we we take in derivatives derivatives to hedge is the opposite (in nearly all cases) of of the one held in the underlying asset Long underlying (Carrier has capacity) = Short hedge (sells to get offset if prices fall) Short underlying (3PL wants capacity) = Long hedge (buys to get offset if prices rise)
Volatility; tending to be subject to large price fluctuations The Container Freight Market is subject to volatility, and in recent years this has been on an unprecedented scale.
According to SCFI Data, the USD Per TEU rate on the EUR Route rose from $353 in March 2009 to $2,164 in March 2010, an increase of 613%. Since March 2010 it has fallen from $2,164 62%to $1,342 in January 2011, a decrease of
Hedging; a strategy designed to offset or reduce the effect of price fluctuations in an asset. t i f o r P
A farmer underlying) his wheat crop, after(long production costssows his break-even is $100/ton.
10
90
100
110
Price 10
s s o L
Any price above $100/ton will generate a profit and any price below $100/ton will generate a loss. He is currently at the mercy of the market for the eventual sale price of his wheat.
Hedging; a strategy designed to offset or reduce the effect of price fluctuations in an asset. t i f o r P
To hedge histo exposure to wheat the farmer looks the futures marketprices .
10
90
100
110
Price 10
s s o L
The Farmer (long underlying) can sell (short) wheat futures at $110/ton. Any price below $110/ton will generate a profit and any price above $110/ton will generate a loss.
Hedging; a strategy designed to offset or reduce the effect of price fluctuations in an asset. Combining his long underlying @ $100/ton and short future position @ $110/ton,
t i f o r P
shows he has secured a $10/ton profit on the wheat he produces.
10
90
100
110
Price 10
s s o L
If the price of wheat falls to $90/ton, he will lose $10/ton on his production cost but gain $20/ton future position, keeping his net profiton ofhis $10/ton. If the price of wheat rises to $120/ton, he will make $20 on his production cost and lose $10/ton on his future position, keeping his net profit of $10/ton.
Section 3
The Shanghai Containerised Freight Index
Clarkson Securities Limited
SCFI; Shanghai Containerised Freight Index
The SCFI is a weekly index produced by the Shanghai Shipping Exchange (SSE) covering covers 15 major tradelanes t radelanes ex Shanghai, each of which is given a weighting in order to calculate the Comprehensive Index. Each route is given a USD rate per TEU or FEU depending on the particular trade. It is representative of the current CY/CY cost of exporting one TEU (or FEU) of general cargo and includes: OFR, BAF/FAF, EBS/EBA, CAF/YAS, PSS, WRS, PCS, SCS/SCF, PTF/PCC. The Ocean Freight (OFR) portion will always be prepaid. The Surcharges may be prepaid or collect.
SCFI; Shanghai Containerised Freight Index 3000
15 route assessments given in USD per box format.
2500
2000
1500 FE-Eur, FE -Eur, $/TEU 1000
The unique Supply and Demand panel structure gives the SCFI balance and neutrality.
Transpac., Transpac ., $/F $ /FEU EU
It is independe i ndependently ntly audited by KPMG.
FE-S.Am, $/TEU
It is in essence a spot market barometer allowing the physical market to benchmark their contracts and assess the market potential.
500
0
9 9 1 0 1 0 1 0 1 0 1 0 1 0 1 0 1 0 1 0 0 9 9 0 9 0 9 0 9 0 9 - 9 0 - l 0 - - g - p - t - - v - c 0 - b - r - r - n - u - 0 0 l - - g - p - c t - - o v - c 1 c p o a r A p r a y J u a e M M A u S e O N D e F M A J u J A u S e O N D e
SCFI Panellists; Carriers CMA-CGM
K-Line
COSCO
Maersk Line
CSCL
MOL
Hanjin
NYK
HASCO
OOCL
Hapag Lloyd
PIL
Jin Jiang
Sinotrans
SITC
SCFI Panellists; Non-Carriers Orient Intl Logistics
Viewtrans
UBI Logistics
Richhood Intl
JHJ Intl Transport
Ever-leading Intl
SIPG Logistics Co
ADP Logistics
Orient Express Intl
Sunshine-Quick Sunshine-Quic k Group
Huaxing Intl
COSCO Logistics
Shanghai Jinchang
Sinotrans Eastern Co Ltd
Shangtex
SCFI; Why do we need an index?
In an opaque market a neutral index allows Shippers, 3PLs and Carriers to benchmark their performance so even if you are not shipping ‘spot’, the SCFI can show you how your contract rate compares. The spot market can give a valuable indication of where rates might be headed – particularly when combined with forward freight rates from ClarksonBoxCleve ClarksonBoxClever. r. An index also allows the development of Index-Linked Service Contracts (ILSCs), where freight rates are pegged against the SCFI.
Section 4
An introduction to clearing
Clarkson Securities Limited
The Clearing House
Clearing houses houses perform a vital role within within derivatives markets, markets, both for exchange exchange and OTC traded products. Acting as a central counterparty to trades, the clearing house house assumes the counterparty risk for trades and their settlement. Trading on a cleared basis has become much more prevalent in freight f reight markets following the overwhelming financial crisis majority financial and the of effects which it had trading on the drybulk market. freight derivative take place on a Today clearedsees bas the
Minimising Risk The clearing house, house, acting as as a central counterparty, counterparty, guarantees the settlement of traded positions in the event of default by one of the parties to the trade. It uses a residual system of margining requirements, position offsetting/netting and contains sufficient capital so that it can meet its obligations in the event of a default or market crash. The two types of Margin are – Depository Margin – An amount of cash placed placed with the clearing house when a trade is executed, based on the nominal value of the trade which is refundable on settlement. Variation Margin – This is cash which is either paid to or received from the clearing house on a daily basis. Your trading position is marked against the current market to determine if it is in profit or loss and accordingly you will either pay or receive settlement is also effected during the active tenor of yourcash. trade.In this way
LCH Clea Clearnet rnet and SGX Asia AsiaClea Clearr There are two clearing clearing houses which which offer clearing for CFSA contracts, LCH Clearnet in London Lond on and SGX AsiaClear AsiaClear in Singapor Singapore. e.
www.lchclearnet.com
www.sgx.com
How to get cleared?
In order to place trades with a clearing house it is necessary to open an account with General Clearing Member (GCM). The GCM is a financial financial institution which which manages and and administers margin requirements for its clients. Eachbusiness clearing house ho use a specified specified GCMsare which are authorised auth to enter theirs clients into into thehas clearing houselist anof and d these available onorised the clearing house houses webpage.
Section 5
An introduction to swaps
Clarkson Securities Limited
Swaps; the exchange of cash-flows
A swap contract provides buyers and sellers the opportunity to exchange fixed for floating cash flows. In Container Freight Swap Agreements (CFSAs) the Buyer and Seller agree a Contract Price which is fixed and receive a floating price through the settlement of the contract. They then offset the cash received or paid through the settlement against their physical freight position to level up their overall profit and loss.
The bottom line; back to basics When talking about about our relationship relationship with the the underlying asset asset it is defined as either either – Long: we own the underlying asset, and our risk is of prices falling Short: we want to own the underlying asset, and our risk is of prices rising The position we take in options to hedge is the opposite of the one held in the underlying asset Long underlying = Short hedge (sells to get offset if prices fall) Short underlying = Long hedge (buys to get offset if prices rise)
The mechanics; what makes a Container Freight Swap Agreement (CFSA) Contact Price: The price agreed between Buyer and Seller. The Buyer believes it will be above this value, while the seller believes it will be below. Route: CFSAs are traded against against the Routes which which the SCFI Index Index reports freight data on. Contract Period: The The period over which which the CFSA is settled, settled, with the minimum being one month. Volume: CFSAs are traded for a specified volume of TEU or FEU per per Month. Settlement: CFSAs are settled against against the monthly average of the relevant relevant SCFI Route. Route.
Swaps; how it works To hedge against freight rates rising, we can buy a CFSA contract, we will use the gain made on our swap contract to offset the higher physical spot price of freight. With an agreed contract price of $1,650/TEU we can see the profit/loss below. t i f o r P
We can see that the maximum theoretical loss this position can sustain, is $1,650 (if it fell to 0.) The
50
1550
1600
1650
maximum theoretical profit this position can make is unlimited.
1700
Price
50
s s o L
The settlement works such that, for every $1 decline, the position will lose $1, and for every $1 rise, the position will make $1.
Swaps; how it works To hedge against freight rates falling, we can sell a CFSA contract, we will use the gain made on our swap contract to offset the decreased revenue from the lower spot price of freight. With an agreed contract price of $1,650/TEU we can see the profit/loss below. t i f o r P
We can see that the maximum theoretical loss this position can sustain is unlimited. The maximum
50
1550
1600
1650
theoretical profit(if this position make is $1,650 it fell to 0.) can
1700
Price
50
s s o L
The settlement works such that, for every $1 decline the position will make $1, and for every $1 rise, the position will lose $1. .
Section 6
An introduction to options
Clarkson Securities Limited
Options; the right but not the obligation An option provides the buyer with the right, but not the obligation, to buy or sell an asset or product when when certain criteria criteria and market conditions have have been met.
There is a price to pay for having this right, the premium, which is payable to the seller that grants the option.
Options are very much like insurance, a premium is paid, so that that should an event event occur, the buyer of the policy is re-compensated by the seller.
The bottom line; back to basics When talking about about our relationship relationship with the the underlying asset asset it is defined as either either – Long: we own the underlying asset, and our risk is of prices falling Short: we want to own the underlying asset, and our risk is of prices rising The position we take in options to hedge is the opposite of the one held in the underlying asset Long underlying = Short hedge (sells to get offset if prices fall) Short underlying = Long hedge (buys to get offset if prices rise)
Calls and Puts; the two types of option Some may wish to protect again the market rising, whilst others may wish to protect against the market falling.
A quick recap: Buyers benefit from a rising market / Sellers benefit from a falling market.
Call Options: Gives the buyer the right, but not the obligation to buy an asset. Put Options: Gives the buyer the right, but not the obligation to sell an asset.
The mechanics; what makes an option Container Freight options share many similarities with a CFSA contract such as Volume, Route, Settlement. Below however are the characteristics which make them different. Strike Price: The price agreed between Buyer and Seller, upon the assets value reaching this point, the option can be exercised (depending (depending on the exercise conditions, see below.) Exercise Type: Defines when, and how the Option is exercisable. Container Container Freight options opti ons are “Asian” “Asian” – the strike price price is determin determined ed using an an average average of the asset asset value over the contracted period, with the Option being automatically exercised if it settles above (Call Option) or below (Put Options) the strike price. Premium: The premium is the price payable by the buyer, to the seller. The premium is calculated using a pricing model. In Container Container Freight Options this takes the form of a USD pe perr TEU/FE TEU/FEU U forma formatt i.e $15 pe perr TEU. TEU.
Options; the benefits
Flexibility – By being able to to choose which which strike price is best fitted to manage manage each risk accordingly,, there are opportunities that can be gained which are not available in the accordingly swaps market. Risk – As a buyer of options, options, the only capital placed at risk is the premium that is paid paid to the seller, should the strike price not be reached and your option remain un-exercised, then the most you can ever lose is the premium.
This means you can create floors or ceilings for container freight prices, at a level which is appropriate to your needs with the only, at risk capital, being that of the premium.
Call Options; how it works To hedge against freight rates rising, we can buy a Call Option (which gives us the right, but not the obligation to buy.) With a Strike Price of $1,600 and a Premium payable to the Seller of $50/TEU, the profit/loss is display displayed ed below. We can see that the maximum loss sustained from this strategy is the $50/TEU Premium that we pay the Seller. Once the Contract settles
t i f o r P 50
1550
1600
1650
1700
Price
50
s s o L
we receive a pay out from our options position on any rate above $1,600 $1,6 00 – In order to retur return n a profit we must also recoup the capital spent on the Premium, so our break even is $1,650, with anything above being profit.
Put Options; how it works To hedge against freight rates falling, we can buy a Put Option (which gives us the right, but not the obligation to sell.) With a Strike Price of $1,650 and a Premium payable to the Seller of $50/TEU, the profit/loss is display displayed ed below. We can see that the maximum loss sustained from this strategy is the $50/TEU Premium that we pay the Seller. Once the Contract settles
t i f o r P 50
1550
1600
1650
1700
Price
50
s s o L
we receive a pay out from our options position on any rate below $1,650 $1,6 50 – In order to retur return n a profit we must also recoup the capital spent on the Premium, so our break even is $1,600, with anything below being profit.
Section 7
An introduction to hedging with swaps
Clarkson Securities Limited
Hedging with swaps; an example
We will nowfrom takethe a look at how toofconstruct a hedge using a swap sw ap contract; first perspective a buyer and then aposition seller of ocean freight. Buyers of ocean freight face the risk that this cost will rise. To mitigate this risk they will hedge using a long position, that is they will buy a swap contract. Sellers of ocean freight face the risk that their revenue will fall. To mitigate this risk they will hedge using using a short position, position, that is they will will sell a swap swap contract.
The buyers hedge; an example The buyer faces faces uncertainty regarding the potential potential for rises in freight cost during the typical peak season of Q3. Having budgeted for 12 months of freight cost with a premium weighted on the peak season period, but being unable unable to fix their freight exposure, they remain at risk of exceeding their costing and eating into their profit margins should freight rates rise above their estimates. To mitigate this risk they will hedge their Q3 position using a swap contract.
The background; planning and analysis
The buyer will import 500 TEU/Month during Q3 from China to the UK. Their analysis of the market means that the budget for Q3 shipments is $1,500/TEU. They will hedge 70% of their total volume during the Q3 period, 1,050 TEU, which equates to 350 TEU/Month. The remaining 30% of the volume will not be hedged so they can gain a small amount of downside potential potential should rates not rise above their budget.
The Trade; managing the risk The buyer calls calls Clarkson Securities Securities Ltd. (CSL) to place an order to buy a Q3 contract on on the SCFI EUR Route for 350 TEU/Month. CSL markets the buyers interest and finds a suitable counterparty for him to trade with. A trade is then agreed as follows – Contract Route: SCFI EUR Contract Period: Q3 2011 (July 2011/August 2011/September 2011/September 2011) Contract Price: US$ 1,500 / TEU Volume: 350 TEU / Month
Settlement;
the Buyers result
In order to settle the contract, the average of the SCFI EUR over the corresponding month is used (this average is known as the Settlement Price) and then marked against the Contract Price. If the Settlement Price is above the Contract Price, the buyer receives the difference from the seller and vice-versa if it is below.
The sellers hedge; an example The seller faces uncertainty regarding the potential for declining freight revenues during the winter period of Q4. Having forecast the potential supply/demand characteristics characteristics of the market and facing the typical lull after the peak season, they remain at risk of freight revenue falling to the extent that it would eat into their profit margins. To mitigate this risk they will hedge their Q4 position using a swap contract.
The background; planning and analysis The Seller has 9 vessels of 9,000 TEU, homogenous intake 7,200 TEU, on their Weekly Asia/Europe Service during Q4. They have 40% of each vessels capacity which is exposed to spot cargo and will hedge 80% of this capacity during the Q4 period. The remaining 20% of the capacity will not be hedged so they can gain a small amount of upside potential should rates not fall below their breakeven. With 13 weeks in Q4, this means there will be 13 WB vessel sailings during that that time. 13 x 7,200 TEU = 93,600 TEU 40% of 93,600 TEU = 37,440 TEU 80% of 37,440 TEU = 29,952 TEU 29,952 TEU / 3 (Months/Quarter) = 9,984 TEU / Month, rounded to 10,000 TEU Their breakeven even return per TEU is $1,250 and they wish to try and secure a profit margin on top of this figure.
The Trade; managing the risk The seller calls Clarkson Securities Ltd. (CSL) to place an order to sell a Q4 contract on the SCFI EUR Route for 10,000 TEU/Month. CSL markets the sellers interest and finds a suitable counterparty for him to trade with. A trade is then agreed as follows – Contract Route: SCFI EUR Contract Period: Q4 2011 (October 2011/November 2011/December 2011/December 2011) Contract Price: US$ 1,400 / TEU Volume: 10,000 TEU / Month
Settlement; the Sellers result
In order to settle the contract, the average of the SCFI EUR over the corresponding month is used (this average is known as the Settlement Price,) and then marked against the Contract Price. If the Settlement Price is below the Contract Price, the seller receives the difference from the buyer and vice-versa if it is above.
Section 8
An introduction to Index-Linked Service Contracts Clarkson Securities Limited
Indexation; flexible pricing
One of the problems with typical container freight contracts is that they are designed to offer no flexibility in pricing once they have been agreed. This means they come under increasing stress the further the spot market moves away from the contracted price. price. Carriers feel pressure to take take higher paying spot cargo, cargo, or will introduce additional additional surcharges in a rising market, while Shippers prefer to move their cargo to another Carrier offering cheaper rates in a falling market. The way to overcome this is to use a system of flexible pricing which pegs freight prices to the prevailing market conditions and thus provides provides both sides with the opportunity opportunity to benefit from market conditions which favour them.
A typical year; the ups and downs Below is a diagram of a fairly typical t ypical year in container freight. The blue line represents the fixed rate contract and the red arrow the stress which it faces as spot rates diverge
e t a r t h g i e r f t o p S
Time – 1 year du Time durati ration on Quarter 1
Quarter 2
Quarter 3
Quarter 4
Contract Stress; how & why
As seen on the previous page, fixed rate contracts come under pressure the more the spot rate diverges from them. With little to prevent either Carriers or Shippers taking advantage of the market conditions despite their contracts, the stress of volatility is all it takes for the relationship to be broken. It follows then, that the greater and more frequent the volatility, the greater and more regularly this stress is felt with the resultant breakdown of contracts. Whilst in a perfect world a fixed rate contract would offer stability, the reality is vastly different, even contracts between big players players in the market are often not worth the paper they are written on.
the ability to adapt
Evolution; Price volatility is a result of markets which are driven by b y supply and demand fundamentals. The container shipping industry has seen changes recently to bring about greater competition in the market, such as the removal of certain conferences. Long-held ideas such as engaging long-term fixed contracts are proving to be unsuited to the in new dynamics of rate the market. With volatility here to stay and further anti-trust regulation being almost inevitable, index linked pricing mechanisms represent an efficient and cohesive response to the changing nature of the market
how it works using the SCFI
In practice; Carrier and Shipper enter into an Index Linked Service Contract for an agreed period. Volume is committed for the agreed period, with a weekly volume entitlement being specified, incorporating incorporating both a minimum and maximum volume. Individuall vessel volumes to be advised prior Individua prior to sailing, as per per Carrier guidelines. The base freight freight level is ‘all in’and in’and calculated from the relevant relevant weekly SCFI Route(s), as published by the SSE. Freight is calculated calculated with an agreed percentage percentage variation, or an agreed discount / premium, to the SCFI Route price.
Section 9
An introduction to hedging Index-Linked Service Contracts Clarkson Securities Limited
timing
Hedge Positions; Having agreed an Index Linked Service Contract (ILSC) both Shipper and Carrier are now in a position to look at hedging against the parts of they year when the fundamentals will not be in their favour. Shipper hedges are in red and Carrier hedges are in blue.
e t a r t h g i e r f t o p S
Time – 1 year d Time durat uration ion Quarter 1
Quarter 2
Quarter 3
Quarter 4
swaps and options
Hedging tools; In order to create positions which either limit cost or secure revenue in conjunction with with an ILSC, Shippers and Carriers can use swaps or options. Shippers need to protect against rates rising so they will either buy swap contracts or buy call options (the right but not the obligation to buy,) for the appropriate period Carriers to protect against rates so they will either swap contracts putneed options (the right but not the falling obligation to sell,) for thesell appropriate period.or buy
a rising market (swaps)
Shippers; The Shipper buys a swap contract to cover Q1 (Jan/Feb/Mar) @ $1,000 / TEU.
1200
Jan settles below the level he bought. He uses the cheaper spot
1100
cost of Index-Linked freight to offset the swap loss. 1000
Feb and Mar settle above the level he bought. He uses the cash made Jan
Feb
Mar
on the cost swapofcontract to off-set the higher Index-Linked freight.
a rising market (options)
Shippers;
1200
The Shipper buys a call option to cover Q1 (Jan/Feb/Mar) @ $1,000 / TEU Strike for $25 / TEU Premium.
1100
Jan settles below the level he bought. He only loses the cost of
1000
the premium whilst still getting some benefit of the cheaper spot cost of Index-Linked freight. Feb and Mar settle above the level Jan
Feb
Mar
heon bought. Heoption uses to theoff-set cash made the call the higher cost of Index-Linked freight.
a falling market (swaps)
Carriers; The Carrier buys a swap contract to cover Q3 (Oct/Nov/Dec) @ $1,200 / TEU.
1200
Oct settles above the level he sold. He uses the higher spot revenue of
1100
Index-Linked freight to off-set the swap loss. 1000
Nov and Dec settle below the level he sold. He uses the cash made on Oct
Nov
Dec
the swap contractoftoIndex-Linked off-set the lower spot revenue freight.
a falling market (options)
Carriers;
1200
The Carrier buys a put option to cover Q4 (Oct/Nov/Dec) @ $1,200 / TEU Strike for $35 / TEU Premium
1100
Oct settles above the strike price. He only loses the cost of the
1000
premium whilst still getting some benefit of the higher revenue of Index-Linked freight. Nov and Dec settle below the strike stri ke Oct
Nov
Dec
price. usesto the cash the made on the putHe option off-set lower revenue of Index-Linked freight.
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