Ready for take-off? - Drewry

The recent rally in Asia to Europe spot market rates has improved carriers’ chances of securing higher 2017 contract rates. How much extra will shippers have to fork out?

It has been another typically volatile year as far as the spot freight rate market (i.e. rates with a validity of up to 30 days) is concerned with the weekly ups and downs once again being most obvious in the high-volume westbound Asia to Europe trade. Table 1 shows that in many respects 2016 has thus far played out very much like 2015 with very little difference in regards to the average weekly rate, standard deviation or highs and lows.

Table 1: Weekly Shanghai to Rotterdam container spot rates in 2015-16: averages, standard deviation, high-low (US$/teu)

(See Table 1)

However, this year does differ in one key aspect: timing. According to Drewry’s Container Freight Rate Insight the average Asia-Europe spot rate (excluding terminal handling charges) was approximately 35% higher in the third quarter 2016 than in the same period a year ago. This is important because spot market rates serve as the starting point for BCO contract negotiations, which for the Asia-Europe trade will be starting very soon. While some early-bird contracts start from November or December, most Asia to Europe contract rates run for 12 months from 1 January.
 
Therefore, the recent spike in westbound rates, which was somewhat inflated by the Hanjin situation, is a good omen for carriers heading into the contract season. At the same point last year spot rates were down by 55% year-on-year, which contributed to a 25% reduction in contract rates at the start of 2016 (see Figure 1).

Figure 1: Estimated Asia to Europe spot and contract rates in US$/40ft container (excluding THCs)

As a rule, contract rates should be more competitive than spot rates because they involve higher volumes over a longer period. Aside from the supposed discount they offer, many shippers prefer to use longer-term contracts as it allows them to budget accurately for the year ahead and ward off unexpected extra costs – for example most contracts will exclude GRIs and peak-season surcharges. However, as the chart below shows, such was the severity of the spot market crash that shippers would have been better off playing that market since early 2015. Figure 2 indicates that the spot market premium has only just returned in the third-quarter 2016. History suggests that the difference between spot and contract rates narrows through the cycle, which gives us further reason to expect contract rates to move closer to spot rates from the start of 2017.

Figure 2: Spot market 'premium' over contract rates on westbound Asia to Europe trade (US$/40ft container)

Figure 2: Spot market 'premium' over contract rates on westbound Asia to Europe trade (US$/40ft container)

Source: Drewry Maritime Research; derived from Container Freight Rate Insight

With the spot market finally emerging from its dark recesses Drewry believes that shippers will have to budget for increased contract costs in 2017. The big question is how much.
 
There are a number of deflationary factors we think will limit the increase to contract rates next year:
 
 * Rates in general fall much harder than they go up.
 * A number of BCOs will want to see some form of compensation for the fact that contract rates were more expensive than the spot market for much of the last year.
 * Carriers are still to publish their service offering from April when the mega-alliances go live and will need to appease nervous customers. It is unlikely that many shippers will want to renegotiate after the alliance restructure as the tender process is very time and resource draining.
 * Despite improving ship utilisation (mainly from slow-steaming and missed voyages) the Asia-Europe trade is still burdened with too much capacity and there are a lot of big ships arriving next year.
 * Shippers are generally better at negotiations and many have employed former liner staff to use their knowledge to gain the upper hand.
 
Any exporters or importers worried about how to explain to senior management that freight rates are now increasing can obtain independent, monthly rate benchmarks on 500+ routes globally from Drewry’s Container Freight Rate Insight. As the focus moves from cost reductions to cost increase minimisation or avoidance, we urge shippers to use the latest freight tender optimisation and advisory services available

Our view
 
Asia-Europe contract rates will probably increase next year for most shippers, but there are options available to them to minimise the damage.