The historic undulations in the container freight market are currently feeling more like a rollercoaster ride. During the COVID-19 pandemic, the cost of moving a 40-foot container across the Pacific peaked at $10,377 in September, 2021, and rates on certain shipping lanes spiked $1,500 in a single day. Then, just when shippers were drawing breath and concluding that sort of thing wasn’t likely to happen again any time soon, we got the closure of the Suez Canal route through the Red Sea, and news that a water shortage meant less traffic through the Panama Canal. At the same time, the financial windfall of skyrocketing rates has encouraged shipowners to buy huge quantities of new tonnage. That’s likely to drive rates down. Until some other “unforeseen” event drives them up again. 

Meanwhile, the last few volatile years saw a rash of broken contracts. Carriers refused to take cargo they had contractually agreed to move. Shippers, too, reneged on volume commitments, looking for better rates from shorter-term contracts or the spot market. 

“It’s a recurring problem in contract liability in ocean container freight — you negotiate a contract for a year relative to what the spot market did last year. But, when there’s significant fluctuations that don’t reflect that reality, then there are incentives to not honor the contract,” says Judah Levine, head of research at Freightos, an online ocean freight marketplace and platform. “Enforcement is a problem. Parties don’t really sue each other for not showing up. It’s more of a framework, and then you re-negotiate, but there’s resentment on both sides. And that feeds into the next round of negotiations.”

The relationship between beneficial cargo owners (BCOs) and ocean container carriers (OCCs) has always been, to put it bluntly, combative, subject to the brutal arithmetic of supply and demand. But these aren’t Taylor Swift tickets; companies falling foul of the dynamic are going out of business. Take Bed Bath & Beyond, which filed for bankruptcy in April, 2023. It has sued Yang Ming Marine Transport, Orient Overseas Line and Mediterranean Shipping Co. for performance issues and over-charges during the pandemic, which it claims contributed to its demise. 

The cure does not appear to be litigation; shippers rarely sue carriers, and vice versa. Complaints to the Federal Maritime Commission, of which there was a rash against all top 10 OCCs in 2022 and 2023, may provide a forum for companies such as Bed Bath & Beyond to cite commercial damage from carriers reneging on contracts, but they are officially about demurrage and storage fees. Even the Ocean Shipping Reform Act of 2022, Levine says, offers little redress, being “mostly about demurrage, not much about honoring contracts,” he says.

Read More: Bed Bath & Beyond Suing MSC for $300M

So perhaps it’s time to take a different tack. The entire logistics and transportation industry has recently adopted, however sincerely, a rhetoric that skews toward the relational — where parties involved in a business relationship collaborate to get a better outcome for both. 

What if we could level out the rollercoaster and drive the rancor out? Some think long-term, index-linked container freight contracts could be the answer. But these have been on offer for more than a decade, and shippers and carriers continue to shy away from them.

“To procurement professionals who have tried working with other commodities, it makes little sense that this hasn’t happened,” says Bjorn Vang Jensen, founder and chief executive officer of Nanooq Management Consultancies.  

Read More: Can Index-Linked Contracts Bring Sanity to the Liner Trades?

What might make index-linked ocean container carrier contracts more attractive is to hedge the risk of rate volatility more completely by adding derivatives such as forward freight agreements (FFAs). Might this finally be the magic lever that tips the container freight industry into adopting index-linked contracts?

An FFA is a financial forward contract that allows ship owners, charterers and speculators to hedge against the volatility of freight rates. It gives the contract owner the right to buy and sell the price of freight for future dates. So a BCO can buy future freight low, then cash in if the rates go up, to compensate for being charged a higher freight rate by the carrier. And, on the other hand, carriers can sell future freight high, hedging against a drop in rates. FFAs can be bought on the Singapore Exchange (SGX) and Chicago Mercantile Exchange (CME) futures and options trading exchanges. 

“There’s a lot of confusion because some people think index-linked equals derivatives," says Vang Jensen. "They are separate things, but the two can be combined. The lack of acceptance is crux of the problem. Index-linked contracts combined with derivatives could actually create a completely predictable freight rate environment.”

But ocean shipping doesn't have a track record of exploring the attractions of densely complex financial instruments.  “Freight has a reputation for being stuck in its ways,” says Levine. “It’s not the first attempt to do this.”

Vang Jensen says the solution is to put the decision to utilize derivatives to bolster the advantages of index-linked contracts into the hands of the finance department, which has everyday experience with such things. “CFOs say we do index-linking with everything else — metals, oil, fuel, plastics. So it’s not at the purchasing level that resistance exists. It’s at the operational level, down at the coal face, where they’re buying and selling freight. There’s no better feeling than being the freight guy who takes advantage of a sliding rate and gains a million dollars. It’s a terrific feeling.”

By the same token, the downside, when rates spike, can create terrible feelings. And the fact that the last few years have brought many of those scenarios actually means that freight buyers have been experiencing all the disadvantages of index-linked freight contracts without the benefits.

“The other excuse for not going into an index-linked contract that I’ve heard frequently over the years is that ‘the company is not ready for that,’ or ‘the company can’t manage that,’” Vang Jensen says.  “By now, those two should be up there with, ‘letting our employees work from home would never work.’” He argues that the period since April, 2020 has, for nearly every BCO and carrier out there, been one long index-linked contract. “But your company has managed it,” he points out. “And, because it has managed it, your company is obviously now ready for it.” 

Peter Stallion, head of container freight futures at Braemar, which offers expert investment, chartering, and risk management advice to the shipping and energy markets, expressed optimism during a webinar on the derivatives for freight futures, hosted by Freightos in May, 2024, entitled “Ocean Container Contracts: Perennial Flaws, and Potential Solutions.” 

“I think the penny’s dropped,” he said, citing “a lot of excitement,”  at least from shipowners that have very limited scope to renegotiate time charters. “But people are sitting on the fence. These are people who take a long time to adopt anything new. It takes a lot of effort to get this going.”

It’s not as if the shipping industry is a total stranger to the concept. “There’s an example, already, in bulk shipping, which has faced a similar situation, and has shifted over to floating contracts,” Levine explains, saying derivates have been widely deployed in bulk shipping since 2008. “The parties can decide how much rate exposure they want to take on [via contracts], and how much they want to take on with derivatives.”

But, Levine points out, derivates markets take a while to mature. And there needs to be reliable price discovery; otherwise there will be disagreements about where to set the rates and what to hedge against. That means attaching the contracts to a reputable freight rate index, such as the Container Trade Statistics Index or the Freightos Baltic Index. 

Why not simply use derivatives to hedge against existing container freight contracts? Because “regular” contracts are simply less reliable, as dramatically demonstrated over the past few years. “Derivatives are much better deployed where the risks are better known, and an index-linked contract creates such an environment,” Vang Jensen says.

“With a properly constructed index-linked contract that’s effective and fair, you will have volume guarantees and space guarantees,” says Vang Jensen. “Unlike most of the so-called contracts we sign in ocean freight today, it’s virtually unbreakable, except by bankruptcy, both ways.” Both BCOs and OCCs have to stick with the agreements, including the pre-determined responses to market fluctuations. “Now, they can’t play the market anymore.”