Why contract and spot ocean rates are diverging

Ocean freight rates for cargoes moving under contracts on major East-West routes are falling slowly, whereas spot freight rates on the same routes have collapsed by 28% in the last three months , based on the latest published indices from Drewry’s Benchmarking Club (contract rates) and from its Container Freight Rate Insight (spot rates).

But why are the trends so different between the contract and spot segments of the ocean transport market (see chart)?

The latest free fall in spot rates was triggered by recent weaker Asian volumes and short-term price discounts by panicked carriers worried about losing market share.

The latest Drewry Benchmarking Club Contract Rate Index decreased by 3% between February and May, after having risen by 1% in the previous quarter. The May contract rate index includes new annual transpacific contract rates which were often renewed at similar or slightly lower rates than in the previous year. (Details of contract rates cannot be disclosed outside the Benchmarking Club.)

Shippers and beneficial cargo owners are able to capitalise on short-term changes in supply and demand and on the willingness of carriers to reduce spot rates. However, because contract rates commit both parties to a year or so – in a fluctuating market advantageous sometimes for the shipper and sometimes for the carrier – the carriers have agreed to only small reductions in contract rates for now.

In Drewry’s opinion (see June 2015 Container Freight Rate Insight), spot freight rates have reached the bottom of the latest cycle and will go up again during the peak season. So, the latest big fall in spot rates is, to some extent, only temporary; the carriers probably know it and build this into their forward pricing.

While contract rates and spot rates do not follow the same trends, there is a link between the two types of rates. For example, Drewry has advised some shippers to renegotiate their contract rates or their contract fuel surcharges, given that the markets for both oil and for shipping services have weakened since the summer of 2014.

We also know that some contract shippers have insisted that their carriers should let them ship at current ultra-low spot rates if they want to retain their business. Historically, when spot rates fell below contract rates, some shippers went back to the carriers and asked for the contracts to be reviewed.

There are opportunities for many shippers to reduce their ocean freight costs by benchmarking their contract rates and by switching some volume to the spot market (among possible procurement strategies), bearing in mind of course medium to longer term risks of switching volumes. But Drewry still does not expect contract rates to fall by 28% any time soon, even if this has already happened to spot rates.
Source: Drewry Supply Chain Advisors