Ocean bid tip: diversify your carrier alliances!

With so many container lines out there to choose from it’s easy to forget that despite their numbers there really are fewer choices than it seems when you consider carrier alliances and vessel sharing partners. If you are large enough to deal in direct carrier contracts with container lines, then you would be wise to consider the various alliances and vessel sharing agreements when choosing carriers. As carriers’ fortunes (or misfortunes) become increasingly volatile the bonds of cooperation become even closer and decisions about capacity withdrawals and service changes are increasingly being made at the alliance level and not at the individual carrier level. More than a few Trans-Pacific importers learned this the hard way back in 2009-2010 when alliances suspended or withdrew capacity completely on major trade lanes. Those importers who only contracted with carriers of the same alliance were distressed to find that NONE of their contracted carriers were servicing the particular lane they needed. I have heard stories like this again and again, where an alliance made a significant change leaving the importer out to dry because they failed to diversify their carrier base beyond a single alliance.

So the first thing we need to do is identify: What is the difference between an alliance and a vessel sharing agreement?

• Vessel Sharing Agreement (VSA): Member carriers simply agree to share space on each others vessels in particular trade lanes. Space is allocated to each carrier on each others vessels at an agreed upon price on specific trade lanes.
• Alliance: Member carriers agree to not only share space on each others vessels but also jointly operate and decide on major service routes, new services being introduced, transit / service levels, and capacity controls. Each member carrier agrees to contribute a certain amount of resources (vessel size and number of vessels, space on each vessel, equipment distribution, etc.)

Obviously carrier alliances are a much tighter-knit group then casual vessel sharing agreements (VSAs) and the impact of their decisions will be greater on the individual carriers and their customers than would be under a VSA. The next question: who are these alliances / VSAs and which carriers belong to them? Based on current information (December 2011) here is a list of the various carrier alliances and vessel sharing agreements in the Trans-Pacific market:

New World Alliance: APL, Hyundai Merchant Marine (HMM), and MOL (Mitsui OSK Lines)

To the best of my knowledge, the dominant member and largest contributor to the alliance is APL. MOL is the smallest carrier of the three but offers some of the fastest and most direct services from Asia that the other two piggy-back on. APL has, in my opinion, the best network and fastest connections from Southeast Asia. From my personal experience, the New World Alliance has the fastest transits from Asia to the West Coast.

Grand Alliance: Hapag-Lloyd, NYK Line, and OOCL

To the best of my knowledge, the largest contributor to the alliance is Hapag-Lloyd, although all 3 lines are much closer in size (from a Trans-Pacific perspective) than the New World Alliance. Strong and dependable service from the Trans-Pacific and good transits overall.

CKYH Alliance: COSCO, K-Line, Yang Ming, and Hanjin

This alliance is the easiest to remember thanks to their generic name – the first initial of each carrier makes up the alliance. To the best of my knowledge Hanjin is the largest contributor to the alliance but COSCO, Yang Ming, and Hanjin are all somewhat similar in size and each has their unique strengths and weaknesses depending on the trade lane. From a financial standpoint, probably the riskiest alliance based on the individual carriers’ Financial Z-Score, a financial benchmark developed by Drewry. With the exception of K-Line all of the alliance members are in the Z-Score distress zone with Yang Ming and Hanjin near the bottom of the zone with low scores. I should note this is based on data on/about September 2011 and is obviously subject to change. And I am sure the individual carriers involved would dispute some of the figures used going into that Z-Score.

All that being said, the CKYH is a big alliance and has a wide variety of Trans-Pacific services to both coasts.

VSA – Evergreen and China Shipping

The two companies share vessel space to and from China and a few other major trade lanes. Evergreen is easily the much larger of the two and with far more reliable service. Quite honestly, I do not know what Evergreen’s benefit in this is, while China Shipping gets to market reliable Evergreen service with China Shipping rates.

VSA – CMA-CGM, Maersk Line, and MSC

The three largest carriers in the world in terms of global capacity, and also, ironically enough, all of European origins, this VSA has the largest capacity and import volume into the United States from Asia. That being said, they also tend to have longer transits to the East Coast than average and MSC lacks 45′ high cube containers. They also tend, in my experience, to be a bit more bureaucratic and sometimes difficult to deal with. However, they have a lot of capacity to share with each other and hence can often provide space and rates that people need.

These 3 carrier alliances and 2 VSAs cover over 80% of the import container volume coming into the U.S. As a general rule, you can worry about VSAs less than Alliances.

With alliances, they can, and will, withdraw services as an entire group, completely ending a specific trade lane to a specific U.S. port. Now if you do all of your importing into Long Beach / Los Angeles, or possibly New York for those of you on the East Coast, you probably have little to nothing to worry about. But any other port in the U.S. – Oakland, Sea/Tac, Savannah, Charleston, or any inland inter-modal, etc. – and you should be aware that the possibility of one of the alliances ending, temporarily or permanently, services to your port / CY from one or more of your origins is possible. One company I knew had contracts with Hapag, NYK, and OOCL back in 2009 into Oakland only to be completely screwed when the Grand Alliance made a decision to completely stop calling Oakland out of Shanghai. Did they diversify their carrier base? Absolutely. But they made the mistake of unintentionally choosing carriers who all cooperate with each other in the same alliance.

Now, if your volumes are somewhat small and your origin lanes limited. this may not be a concern; you’d actually be doing yourself a disservice from a relationship and rate perspective to try and split up your cargo amongst too many carriers. However, for any large import shippers out there with multiple carriers and significant volume from key lanes, you absolutely should consider carrier alliances when making carrier decisions.

For example, if Yantian to Seattle and Savannah are two of your top lanes and you have a choice between 3 carriers, all within $100 in price of each other, but two of them belong to one alliance and one of them belongs to another, you’d be better off splitting some of your volume to the carrier in another alliance rather than assigning it all to one carrier or to all the same carriers in alliance.

Another thing you could do would be to allocate to the best value carrier but make sure you give some other origins to another carrier in another alliance whom you can rely upon as a backup should the other carrier alliance make decisions that would affect your business.

My general rule of thumb, if you have the volume, is to make sure you have contracts with carriers from at least two different alliances and one of the VSAs. Not only that but, if possible, try not to commit too much volume to one alliance or VSA over the other. That’s not always possible, but to the best of your ability you don’t want to do that. It’s difficult to count on a backup carrier to suddenly absorb a huge increase in volume when you only have a small MQC committed to in the contract.

For my company’s current contracts I think we fared very well from this standpoint, which we weren’t always able to do in the past because the numbers were not economically feasible. We have at least one carrier from each of the 3 alliances and 2 VSAs. So from a network coverage we truly have all our bases covered from a diversification standpoint. However, two of the carriers are small contracts so if we do run into trouble with the others and need to call on them to pick up the slack, we could have a problem. But with such a diversified carrier base the risk of that is very low.

We’ll try to keep this post updated from time to time as the Alliances and VSAs change. Bookmark this post as a handy guide to who’s-who in the Alliances and VSAs and remember to keep that in mind when negotiating with carriers and deciding which carriers you are going to do business with. Remember: you can easily diversify your carrier base and yet still put all your eggs in one risky basket if they are all of the same alliance.

Understanding Bunker Fuel: is there a relationship to crude prices?

Unless you work for an ocean container line, there seems to be a lot of confusion regarding bunker fuel costs and how they play into ocean container costs and BAF (Bunker Adjustment Factor – fuel surcharge for container lines).  This is especially compounded when folks look at the headlines in regards to crude oil prices and start asking questions about how those crude oil prices will affect bunker fuel.  While at the end of the day all petrol and fuel oils come from the same source, the way they are priced and handled are very different. This makes quick and simple comparisons and forecasts based on published crude prices very difficult. But that is, in fact, exactly what I am going to try to do in this post.

Firstly, the headlines you see on Bloomberg or CNN with the ever-changing prices on crude reflect oil futures. Basically, these are mostly large financial deals in multiple contracts between buyers and sellers who agree to buy and sell a specified amount of oil at an agreed upon price at some date in the future. In most cases, no actual oil is ever delivered or processed; the transaction is simply a financial one with cash being settled at the end of the day.

Bunker fuel, on the other hand, is a derivative of crude oil. In the simplest and crudest of terms, bunker fuel is the gunk that is leftover after refineries have processed all the more valuable fuels from the crude source. It is thick and heavy and must be heated before it can be used in an engine. It is difficult to store and transport. And it is ideal for large marine going vessels that have the heavy engines and fuel capacity to handle bunker fuel. Because of this, bunker fuel is not readily available like gasoline / petrol. It is mainly stored at or near major ocean ports and primarily sold and delivered via physical contracts to marine vessel interests. Because of this, bunker fuel prices vary widely from port to port. While there certainly are bunker fuel futures they are mainly utilized by the marine community and unlike crude futures the contracts normally entail actual physical delivery of the fuel. Also, like crude, there are a number of bunker fuel price indexes that the maritime community and their financial interests use.

For the purposes of this discussion I am going to focus on the prices published by the TSA (Trans-Pacific Stabilization Agreement) Carriers and because I reside in the U.S. this will be written from a Trans-Pacific standpoint. The TSA Carriers have agreed to their own index of bunker fuel prices which is a published weekly average based on bunker fuel prices to both the U.S. West Coast and U.S. East Coast. These weekly average bunker fuel prices are available publicly at the TSA website here:

http://www.tsacarriers.org/calc_bunker.html

They then take an average of the weekly average fuel price over the entire quarter and then set the next quarter’s bunker fuel price based on that average. It is this index and formula that most carriers use when assessing quarterly BAF (fuel surcharge) charges to adjust to rising / falling bunker fuel costs.

Because the media and public knowledge are largely geared around crude oil futures and prices, this can cause a lot of confusion when supply chain / logistics managers start talking about bunker fuel and what kind of BAF (fuel surcharge) they will have to pay. It’s only natural for others to immediately switch their brains to thinking about crude prices and the headlines for that day / week and try to make a connection to what this supply chain / logistics manager is telling them about future ocean freight fuel cost increases. And it’s also only natural for many supply chain / logistics managers to try and find a link or relationship between the same headlines they see every day regarding crude prices and the BAF charges they will have to pay in the future. So this begs the question: is there a simple and direct correlation between bunker fuel prices and publicly reported crude prices? And can that correlation be used to potentially forecast or understand where bunker fuel prices might be headed in the future?

Unfortunately there is NOT a simple and direct correlation between crude oil prices and bunker fuel prices. That being said, there is a very broad figure you can use to quickly derive a rough bunker fuel price from whatever crude oil price you see published or that someone in your company questions you on. I call this number the “Bunker Fuel Multiplier” and quite simply it is just a multiple of the crude oil price. I came up with this figure because I was constantly being asked within my own company, by multiple people over multiple years, what the bunker fuel was based on that day / week / year’s crude oil price. I was also constantly asked where bunker fuel, and subsequently BAF, was going to be in the following month / quarter / year given crude oil price assumptions.

So what we did was start tracking the TSA Weekly Average Fuel Price (WAFP) going all the way back to January 2006 through today.

Starting in May 2009, the TSA adjusted their formula to establish separate pricing for West Coast vs. East Coast. Prior to May 2009 our figures reflect the old TSA formula. From May 2009 onwards we just did a simple average of the West Coast and East Coast prices to come up with a single number to match the old formula. We then also tracked the average weekly futures price for NYMEX crude as well as the weekly BRENT spot price for crude:

From there we did a simple calculation of where the bunker fuel price for that particular week compared to NYMEX and BRENT from a multiplier standpoint. This is what we found:

Over the past 5 years, Bunker Fuel has been priced at an average multiple of 5.8x the price of NYMEX and BRENT. That means that over the long run you can take the price of NYMEX or BRENT and multiply it by 5.8 to get a rough bunker fuel price. So the next time someone in your company asks “what if fuel hits USD 200 per barrel next year? what will that mean for bunker?” you can tell them that might equate to a bunker fuel price of USD 1,160 per ton (USD 200 x 5.8).

However, while this is a nice, simple, broad indicator it is very broad. As I mentioned, there is not a clear and direct link between crude oil prices and bunker fuel prices. Just look at the Bunker Fuel Multiplier chart above; within that 5-year average of 5.8 there are weeks and months – and years – where the multiplier was anywhere from 4.8 to 8.1 times the price of crude. For example, if we were to break down the Bunker Fuel Multiplier by calendar year:

2007 = 5.4

2008 = 5.3

2009 = 6.1

2010 = 5.9

2011 = 6.3

Also, for 2011 there has been a huge divergence in the bunker fuel multiplier between NYMEX and BRENT. Again, look at the above chart and notice the huge divergence between the NYMEX and BRENT. For 2011 the NYMEX multiplier is 6.8, meaning that bunker fuel has averaged 6.8x the price for NYMEX crude. But for BRENT the multiplier has been 6.3x, meaning that bunker fuel has averaged 6.3x the price for BRENT crude. The reason behind this is because in 2011, for reasons I do not know, NYMEX has been trading at a 10-20% discount over BRENT over the course of the year. Whereas prior to 2011 the two prices were nearly identical. If there was a change in how the BRENT spot price is calculated and published, I do not know it.

Because of the volatility in oil and bunker fuel prices, not to mention the variances between NYMEX and BRENT, the Bunker Fuel Multiplier can vary widely from month-to-month and year-to-year. With that in mind, I always provide a range when folks ask me where bunker fuel will be in the future based on crude oil assumptions. For example, if someone asks me where bunker fuel might be at USD 100 per barrel, I would tell them “probably in the range of USD 580-630 based on historical averages”.

So to wrap it up:

• Bunker fuel is a derivative of crude and therefore there is some correlation between crude oil prices and bunker fuel prices.
• By comparing current and long term prices of the TSA Weighted Average Bunker Fuel Price against NYMEX and BRENT crude prices we can determine a simple “bunker fuel multiplier” that makes it handy to at least come up with a rough estimate of where future bunker fuel levels will be based on any crude oil price assumption.

Why would being able to roughly forecast bunker fuel prices be useful?

• Bunker fuel is a prominent component of ocean carriers’ actual vessel operating costs.
• Base ocean container rates fluctuate based on the actual cost of bunker fuel the carrier thinks they will have to pay.
• BAF (Bunker Adjustment Factor, or fuel surcharge) charges are configured and added onto the base rate you pay for ocean freight once bunker fuel levels exceed a certain amount for that quarter.
• BAF charges are additional / on-on-top-of the base rates you will pay to carriers.
• Therefore, understanding when and how your carrier will asses quarterly BAF charges, not to mention how much they actually pay for bunker fuel configured into your base rate, allows you to actually plan and forecast for future rate increases.
  • Or to help you when putting together your freight spend budget for the next year.
  • Or to help you understand where container freight rates might be headed when it comes to negotiating new ocean carrier contracts.

For too many companies, BAF surcharges and actual bunker fuel costs are little thought of or not understood at all. Too often companies simply defer to whatever their carriers tell them and go along with whatever the consensus is. And as lengthy and technical as this post is, this is actually a very simplistic way of looking at and calculating potential future bunker fuel and BAF costs using the simple price of crude oil. There are certainly other, probably better, ways of looking at and trying to forecast future bunker fuel costs and plan for potential cost increases or decreases. Regardless, the more control you have over understanding what affects the carriers’ costs and bottom line and how those costs may or may not affect you will only help you plan better for the future, as well get a handle on your total supply chain costs. I hope my simplistic methodology can perhaps help others to think along these tracks so they can be better prepared during ocean contracts season.