Explaining Ocean Container Rates
When it comes to the price of transporting goods from one place to another, ocean container rates are a bit different from rates in other modes of transport in the way they are negotiated and governed. Generally, when people refer to ocean container rates, they are either referring to fixed-rates (“contract rates”), or variable-rates (“spot rates”).
For all containers moving in and out of the U.S., rates (both contract and spot rates) are required to be filed with the Federal Maritime Commission (FMC) 30 days in advance of the containerized cargo being shipped. This adds an additional layer of complexity to the way ocean container rates are negotiated and governed.
In order to effectively explain the process through which ocean container rates are negotiated and managed, we will examine a specific trade lane known as the trans-Pacific Eastbound. This trade lane currently comprises the vast majority of container volumes for U.S. shippers, and represents container volumes moving on vessels traveling from China and the rest of East Asia to the U.S.
Before we get started, here are a couple of terms to know about ocean container rates and the parties involved in rate negotiations:
TEU: twenty-foot equivalent unit; TEU is a measure of volume in units of twenty-foot long containers
FEU: forty-foot equivalent unit; FEU is a measure of volume in units of forty-foot long containers
BCO: A BCO is a Beneficial Cargo Owner which is a term used in these contracts to represent the actual U.S.-based shippers (i.e. Walmart, Target) that are the actual owners of the cargo being contracted and shipped in containers.
NVOCC: An NVOCC is a Non-Vessel-Operating Common Carrier. This term is used to define parties that are Federal Maritime Commission (FMC)-licensed resellers of ocean freight (i.e. Expeditors, Kuehne & Nagel), which means these parties are able to “lease” space on the ocean carrier’s vessels, and issue ocean bills of lading documents to BCOs, therefore assuming responsibility as the actual ocean carrier during a shipment.
MQC: minimum quantity commitment; the minimum volume of TEUs that the BCO must allocate to the ocean carrier or the contract will be null and void
When are fixed-rate ocean contracts negotiated?
For most of the last decade, the timeline for contracts has revolved around the timing of Chinese New Year. During this time, most of China takes two to three weeks off of work, and demand drops off as a result with U.S. shippers not being able to get any freight moving from their suppliers. But, once this holiday is over and China goes back to work, ocean carriers turn their focus to the upcoming contract year, and begin negotiating with the largest volume BCOs in terms of TEUs.
The Process for Ocean Container Contracts
Ocean carriers will begin ocean contract negotiations directly with BCOs who handle the most annual container volume. These largest volume shippers include Wal-Mart, Target, Home Depot and Lowe’s and are a few of the groups of BCOs that will receive what is known in the industry as “Tier 1” rates.
Tier 1 fixed-rate contracts: These are among the cheapest fixed-rates that ocean carriers have contracted because these BCOs are negotiating and allocating a tremendous amount of volume to the ocean lines (in many cases thousands of TEUs per year). Therefore, ocean carriers are willing to provide these BCOs with a price discount for their guaranteed volume on their weekly voyages. For a BCO to achieve “Tier 1” rates, it must usually ship over 10,000 TEUs annually or roughly 200 TEUs per week. Once these rates have been finalized and mutually agreed upon, the BCO and ocean carrier sign an MQC stating the minimum volume of TEUs that the BCO must allocate to the ocean carrier. Once ocean lines have set rates with the largest shippers, they start to move down the line and start negotiating with the largest NVOCCs in the industry (Expeditors, Kuehne + Nagel, C.H. Robinson, etc.).
Tier 2 and Tier 3 fixed-rate contracts
After they are done locking-up contractual rates and have a good idea of per-week allocation for each of their vessel routings and services, they will move further down the line to BCOs and NVOCCs that have between 5,000 to 10,000 TEUs annually and will provide them with “Tier 2” rates, and then down the line again, to BCOs and forwarders that have between 2,000 and 5,000 TEUs and provide them with “Tier 3” rates. Lastly, they try to contract whatever substantial volume BCOs and NVOCCs are left and provide rates slightly above “Tier 3” rates.
How are Fuel Surcharges Calculated for Ocean Container Rates?
In recent years, it has been common for these contracts to be subject to what is known as a floating, quarterly “bunker adjustment factor” (BAF) surcharge. This BAF surcharge is a per TEU calculation for fuel that lies within each of the fixed-rates and spot-rates mentioned above. This is very similar to a fuel surcharge in truckload contracts, as they are subject to adjust quarterly with the market rate for bunker fuel. In recent years, this is becoming increasingly common and will be especially true of this year’s contracts due to the upcoming low sulfur fuel mandates set forth by the International Maritime Organization (IMO) that will require ocean carriers to burn a lower sulfur fuel to help reduce emissions.
How do ocean carriers determine and manage rate levels?
While spot-rates are a good indication of whether fixed-rates for the new year are going to be higher or lower than the previous year, they are not the only consideration for ocean carriers when setting these new rate levels. Anticipated demand in this trade lane for the upcoming year also plays an enormous role, as well as potential operating cost increases that carriers may face over the year. For these reasons, ocean carriers have become much more effective at managing their operating costs by forming alliances with other ocean carriers, and by removing capacity through the use of blank sailings (also known as “skipped sailings”). A blank sailing refers to an ocean carrier canceling a vessel rotation within a given service routing, or just canceling one port call out of a given vessel rotation. Carriers do this to decrease capacity within a service routing so that it keeps ocean rates elevated. Since the vast majority of ocean services on the trans-Pacific Eastbound are managed by three ocean alliances (comprised by nine ocean carriers), this has become a very effective method for controlling ocean container rates in the spot market.