A tumultuous year of ocean shipping prompts a rethink of contracts

Date: Thursday, March 11, 2021
Source: Supply Chain Dive

At some point, everyone was on the losing side of an ocean shipping contract in 2020.

When shippers' demand dropped in March of last year, they slashed their orders, leaving carriers to blank sailings in an attempt to manage capacity and cost. Then, when consumer demand jumped unexpectedly later that year, contract shippers struggled to find space as carriers decided to haul loads from the spot market because of higher rates.

The ocean shipping market rode these wild waves generated by the pandemic last year. While the waters have not yet settled, carriers and shippers are rethinking the way they contract with each other, experts said in interviews and in panel discussions at the recent TPM 2021 conference.

"A transactional price-based discussion alone, in my book, is never a good idea, but especially this year, is not really going to lead to the outcome that you're looking for," Vincent Clerc, CEO of ocean and logistics at A.P. Moller - Maersk, said during a TPM discussion last week. "It is really important that we understand what we're selling and what we're buying and how we're going to make it happen together."

Shippers are seeking increased redundancy and resiliency in their ocean shipping contracts this year. Carriers want to know shippers' volume is going to keep showing up and that orders won't be cut.

Priorities have "switched from costs to security of supply" for shippers, Philip Damas, director and operational head of Drewry Supply Chain Advisors, said in an interview.

Crocs is one company that's moving to prioritize redundancy in its next round of ocean service contracts.

"In ... previous years, I would say you need to balance redundancy with not eroding cost or volume optimization. This year, I think you need to protect your business and focus on redundancy and protection," Mary McNelly Crocs ' director of global logistics, said last month.

The issue with the traditional way of writing contracts and the culture in the ocean shipping market is that the agreements act more as "a general statement of intention and not a binding contract," Damas said. Parties have a rate they've agreed on, but there aren't any fees if a carrier rolls a shipment or if a shipper's cargo never arrives as expected — at least not fees that are actually enforced.

One example is the charge for "dead freight," which is a fee charged when a shipper doesn't use all of the space they have reserved with a carrier. Damas said the only time he's seen shippers charged is when a carrier goes bankrupt.

In an attempt to get contracts with more teeth, changes are playing out in how the agreement is structured and who the shippers are looking to contract with, experts said.

More commitment, more tiers
One change that has resulted from the pandemic is an increased interest in two-way commitments in shipping contracts. Shippers commit to giving carriers a certain level of volume, and carriers commit to enough space to move that cargo at an agreed-upon rate.

Carriers can charge shippers for failing to meet minimum quantity commitments. After capacity issues in 2020, many shippers have decided they would rather agree to pay this fee and ensure capacity than stick to traditional contracts and risk losing space.

NYSHEX, a platform and organization for helping to form two-way commitments between carriers and shippers, has seen increased demand from shippers as a result of the pandemic, CEO Gordon Downes told Supply Chain Dive.

"I think now, for the first time, a lot of shippers — in fact, all shippers — have been negatively impacted by what's happening in the market and suddenly the value of having a two-way commitment has become way more apparent," Downes said.

Clerc said he expects Maersk to do "close to 100%" of its business through two-way commitments within five years.

One problem for shippers in the last half of 2020 was rolled cargo. In December, CMA CGM rolled the highest percentage of its cargo at 51%, according to data from Ocean Insights. Part of the reason for this is that carriers made more by taking spot moves when that market began seeing sky-high rates.

Shipments moved over NYSHEX didn't experience the same issues, Downes said.

"We had 99% contract compliance, so incredible outcome compared to the industry average," he said.

He said the service level in a NYSHEX contract is very clearly spelled out. This means getting specific in the contract can be helpful: Details on the number of containers on a lane in a specific week or over a grouping of lanes in a certain period of time.

"We make sure that the carrier is providing very clear commitment as to what equipment and how much space they're going to give to give to their customer," Downes said.

The changes to the ocean contracts this year go beyond commitments. Shippers and carriers are also looking to innovate when it comes to the rates. This has played out in two ways: tiered rates and index-linked rates, according to Damas. The year-long fixed-rate, meanwhile, looks less appealing. Even if shippers could get a low, year-long rate, it didn't guarantee them capacity last year, he noted.

Tiered rates allow shippers to get one lower rate for fixed volume on a particular lane, and a second higher rate that ensures some level of flex capacity.

"That's completely new," Damas said of the tiered rates.

Index-linked rates fluctuate throughout the year but are tied to well-known indexes, such as the Shanghai Containerized Freight Index, or the Container Freight Rate Insight and World Container Index from Drewry, Damas said. This concept is also being explored in trucking contracts.

Damas expects that two-way commitments will likely stick around in the ocean industry as carriers have started controlling capacity more closely and shippers have more of an incentive to get that commitment. But it's hard to say if tiered rates are a permanent shift given how new they are, he said.

Changing up the carrier roster
Pricing and commitments are not the only ways ocean shipping contracts are evolving in 2021. The partners that shippers are turning to for capacity are also changing.

"A lot of carriers and shippers really damaged their relationships in 2020," Downes said. "And that has caused shippers to rethink how they treat carriers in 2021."

Shippers want to broaden their carrier base in 2021, Damas said.

But when it comes to the use of non-vessel-operating common carriers, it depends on who you ask. Damas said the shippers Drewry works with want to use more ocean carriers and fewer NVOCCs. But Downes said shippers are including NVOCCs "in their mix, just to provide optionality."

The benefit of an NVOCC is it already works with multiple carriers. So if shippers need to move cargo in a particular week and they have a contract with a carrier, but that carrier's ship is full, they might be out of luck.

"The NVOCC has the ability to shift that booking onto any other carriers," Downes said. "It provides a diverse base of service options through one contract party, and that can be very valuable to a shipper."

NVOCCs played an important role in 2020: helping shippers get capacity in the spot market.

There are downsides of NVOCCs. To start with, they mark up the cost of the freight, Downes said. The other issue is right there in their name: they don't have any vessels.

"Most of our customers believe that because the ocean carriers actually own and operate the vessels, they are the custodians of capacity and they have a better way to control it. And in some cases, they are not letting the NVOs secure this capacity as much as they had been in the past," Damas said, noting that this makes it harder for NVOCCs to commit to capacity.

Here is where things come full circle. The NVOCCs are also thinking about using two-way commitment contracts with carriers and shippers.

"That NVOCC then becomes accountable for providing the exact same level of committed service that the shipper would expect if they had contracted directly from ... a steamship line," Downes said.

Sooner rather than later
All of these contract negotiations are taking place earlier than usual as shippers are eager to make sure they secure capacity for the year on traditionally busy lanes, Downes and Damas said. In the past, some shippers thought it might be strategic to come to market late to see where the market lands after other companies have finished negotiations. Not in 2021.

"If the shipper is optimizing for having a resilient supply chain, then I would definitely encourage them to contract early and lock in as much as they possibly can," Downes said, adding that each shipper will need to make the decision on their own.

Contract negotiations can technically take place at any point in the year, but traditionally take place around March and April, according to Freightos.

"We can see the contracts that are moving into the stage of negotiating with their carrier, partner, etc. and that's earlier than we would see in typical years," Downes said.

And this increased focus on resilience and capacity will likely come at a cost to shippers, Dominique von Orelli, DHL Global Forwarding head of global ocean freight, said at TPM 2021.

"Freight rates will close for this contract season at a much higher level than at the last contract season," von Orelli said.


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