On Monday afternoon at Transparency19, Addison Armstrong, executive director of trucking freight futures at FreightWaves, moderated a conversation between Nodal Exchange, where freight futures are traded, DAT, whose rate indexes the futures contracts are settled against, and K-Ratio, a commodities trading advisor based in Chicago advising carriers and shippers on hedging strategies.
Danny Gomez, senior director of energy markets at Nodal Exchange, Don Thornton, senior vice president at DAT Solutions, and Pat Draut, principal at K-Ratio, participated in the discussion, which focused on hedging strategies and broadening access to the futures market.
Trucking freight futures contracts began trading on the Nodal Exchange in March. These futures contracts are designed to help shippers, carriers, and 3PLs hedge against spot market volatility. Market participants can buy or sell contracts representing 1,000 miles on seven individual lanes, three regional baskets, and a national average. As Gomez said, Nodal Exchange is the buyer to every seller and the seller to every buyer, vetting market participants and eliminating counter-party risk.
The seven regional lanes are Seattle to Los Angeles, Los Angeles to Seattle, Los Angeles to Dallas, Dallas to Los Angeles, Chicago to Atlanta, Atlanta to Philadelphia, and Philadelphia to Chicago. The ‘West Coast basket’ averages both LA – Seattle lanes, the ‘Southern basket’ averages both LA – Dallas lanes, and the ‘East Coast basket’ averages the Chicago – Atlanta – Philadelphia triangle.
Trucking freight futures contracts are financially-settled, meaning that traders realize gains and losses in cash without moving trucks, similar to Brent crude oil contracts, which are financially-settled without the delivery of oil.
In a standard hedging strategy, market participants with exposure to the physical market (i.e. the real-world price of truckload capacity) would try to offset their risk by taking positions in the market that are the opposite of their ‘natural’ positions. A truckload carrier would naturally be ‘long’ spot rates, meaning that carriers benefit from higher rates; shippers are naturally ‘short’ spot rates, meaning that they benefit from lower rates. Carriers hedging their natural position in the market would sell freight futures contracts (or be ‘short’ spot rates) and shippers would buy freight futures contracts (or be ‘long’ spot rates).
Imagine that futures contracts for the spot rate from Los Angeles to Dallas in April 2019 were trading at $1.60 per mile. A carrier that was short the contract would lock in the option to ‘sell miles’ at $1.60; if actual spot rates in the physical market fell to $1.50, the carrier would realize a gain of $0.10 per mile. That gain in the futures market would help offset the fact that the carrier’s trucks in the real world were making less money. A shipper that was ‘long’ the rate by buying a contract would pay $0.10 per mile if rates fell to $1.50, but that loss in the futures market would be offset by the fact that the shipper was able to buy truckload capacity at lower rates in the physical market.
“It couldn’t be a better time for the shipper to come in,” Draut said. “The forward curve is pretty flat, with only a 14 cent delta at the highest point,” the best situation for shippers to enter the market and lock in low rates.
“Not hedging is the risky behavior,” Draut argued, pointing out that shippers and carriers exposed to the spot market and not trading freight futures contracts are left utterly exposed to the whims of the market, with no way to control their costs and revenues.
Thornton explained that the freight futures lanes correlate to a large majority of all spot rates between DAT’s 18,000 origin/destination pairs: the seven lanes chosen capture about 84% of all spot rate movement.
“If you’re running from Madison to Tallahassee, you’re going to find out that it looks a lot like Chicago to Atlanta,” Draut added.
But market-specific seasonality can cause breakdowns in those correlations at certain times of the year, Draut cautioned. A carrier moving goods from Boise to Phoenix who is short the Seattle to Los Angeles contract might face an unwelcome surprise in December when Christmas tree season spikes spot prices on that lane without a corresponding rise in rates in the Boise – Phoenix lane.
“You can run into trouble if you’re not monitoring these correlations, and we’re working with Don and DAT to better understand how these correlations form and break down,” Draut said.
Armstrong and Gomez discussed feedback from traders and potential new offerings in the market, including reefer contracts and weekly, rather than monthly, contracts. The conversation also covered ways in which Nodal Exchange and K-Ratio were working to expand access to the futures market. Currently, the exchange has a high barrier to entry in terms of the provable assets of market participants, in order to ensure that traders can cover their positions and remain solvent.
Those requirements prevent most individuals — for example owner-operators — from participating in the market, but Draut said that K-Ratio was exploring ways to create mutual fund-style products that individuals could invest in to hedge their exposure to spot prices. A fund that was short the national average, for instance, would deliver gains to owner-operators when spot prices dropped.
“Owner-operators are knocking down the door,” Draut said, “but there’s a barrier to entry. We’re working on how we can develop a fund to let small players not necessarily trade on their book of business, but have some kind of protection.”
Gomez said that the Nodal Exchange was attacking the problem in two ways: looking at services that members who qualify but haven’t traded may need, and players who may not qualify but need access to risk management tools.
“It’s something we’re currently working on,” Gomez said, adding that he can’t give a date on when those new account structures will be ready, “but in the near future we’ll have more access.”
Image sourced from Pixabay
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