Why the container industry needs to replace BAF with a new pricing tool

Why the container industry needs to replace BAF with a new pricing tool

The container industry has an elephant in the room. It’s big, smelly and has some serious boundary issues. Its name is the Bunker Adjustment Factor and recently it has grown so large that market players can barely see each other behind its fat bulk.

It creates a lot of uncertainty and engenders a lack of trust in the supply chain, which is dangerous for everyone be it a carrier, a BCO or a logistics provider.

Why the container industry needs to replace BAF with a new pricing tool

With the prospect of volatile times ahead, and bunker prices likely to take the container industry on a wild ride, Platts has increasingly heard from the market that, more than anything, it needs a transparent and standardized tool for handling bunker prices in container freight. That is what Platts is aiming to provide by introducing new bunker surcharge indexes.

THE ROLLER COASTER

The good old days of shipping enjoying cheap bunker fuel are gone. IFO380 average prices have risen from around $144/mt in February 2016 to $405/mt in February 2018 and the trend is quite likely to continue until the end of the decade and beyond.

In fact, 2020 is expected to result in some serious spikes in bunker costs that the container industry has not faced before. The IMO’s 2020 global sulfur cap of 0.5% on marine fuels may change the game completely.

In broad strokes, if the global container fleet, which burns around 100 million tons of fuel annually, was to switch from 3.5% IFO 380 fuel to compliant Marine Gasoil (MGO) the extra bunker costs may be enormous. The spread between the two is already uncomfortably wide. The market is currently pricing gasoil futures in 2020 about $340/mt over high-sulfur fuel oil. Even if this spread remains the same, it would mean an extra cost of $34 billion a year.

Someone will have to pay this bill. However, it is almost naïve to expect that container lines will simply absorb them. They cannot afford to do it. So, they will have to pass the bunker expenses on to customers in the form of freight surcharges.

Hence, those who felt that negotiating the freight element in their contracts was stressful before may find the new decade upsetting, unless there is some change in the whole bunker surcharge pricing mechanism.

THE BAF ELEPHANT

Of course, exposure to bunker prices is not fresh news to the container market. The industry has been dealing with it for years, using the method called the Bunker Adjustment Factor or BAF.

BAF in essence is a tool for carriers to pass on extra bunker costs or savings to their customers.

Typically, in an annual contract, every quarter the carrier and its customer would be negotiating a surcharge on the agreed annual dollar per box freight in line with changes in bunker prices.

In theory this works well. In reality, carriers and their customers, each have their own ideas on BAF calculation formulas, which are often held close to the chest and include different assumptions and variables, like the bunkering ports, size of the vessels, consumption of fuel and, of course, its price.

And since the bunker fuel is priced in dollars per metric ton and BAF converts it to freight expressed in dollars per container, the differences in BAF calculation methods between counterparties leads to a lack of transparency and trust, and often ends up with one or both of them losing money and/or straining their relationship.

Certainly a BAF surcharge can be justified with completely valid reasons, usually outside of the carrier’s control. For example a shift in oil market fundamentals that causes a change in bunker prices or a disruptive regulation like the IMO 2020 sulfur cap.

However, with the lack of a standardized formula, it is hard for carriers to substantiate a surcharge to their customers, who have to deal with swings in freight and also justify them to other stakeholders in their supply chains.

When the stakes rise, along with the bunker prices, the limitations of the BAF system become even more noticeable. It really becomes that awkward elephant in the room, standing in the way of easy contract negotiation and risk management.

LIFE WITHOUT TSA

The fragility of the BAF system now looks particularly obvious to players on the head-haul container routes from North Asia to North America after the disbanding of the Transpacific Stabilization Agreement. TSA was a useful independent forum that provided a guideline formula for calculating bunker surcharges using S&P Global Platts Bunkerworld prices, which allowed some form of standardization and transparency.

Platts recently attended the TPM 2018 conference in Long Beach, California and spoke to concerned industry players about life after the TSA.

The overwhelming opinion among them was that things had become much harder and considerably less certain. All the little niggles of BAF came rushing back in, with the market struggling to cope with myriad different ideas between counterparties on which bunker prices and formulas should be used. A relatively simple process of a quarterly freight adjustment suddenly became an exercise in frustration.

And considering that 2017 annual contracts are running out on April 30, while 2018 contract negotiations are already being finalized and will come into force on May 1, the lack of a standardized bunker surcharge tool has made both carriers and their customers almost equally unhappy.

This is why Platts is keeping the TSA IFO 380 weekly bunker price assessment, which reflects an average between bunker prices in the ports of Hong Kong, Los Angeles and New York, published by Platts Bunkerworld. Also, Platts is working to replicate a low-sulfur average bunker assessment, replacing the disbanded TSA price. It will be added to the Bunkerworld sites in the near future.

These measures, in conjunction with daily bunker price assessments should help players to at least get through their current bunker surcharge negotiations without gaining more grey hair.

THE WAY FORWARD

While there are ways for the container industry to struggle through current contract negotiations, it will not help with the metaphorical elephant.

Bunker fuel trade patterns have changed and will continue to evolve. The fuel grades and ports used as guidance for bunker price surcharges may lose relevance quickly, especially in light of the new regulations coming into play and a potential price shock of 2020.

Can all of this be easily and accurately communicated in bunker surcharges during negotiations, using the current approach? It seems that the answer to this for the majority in the market is – NO.

That is why Platts is now working on a more permanent solution in the form of new bunker surcharge indexes, which would incorporate the most relevant ports, bunker types and grades and would be expressed in dollars per container.

This will simplify any surcharge negotiations for market players, allowing them to agree on the price against an independent, standardized benchmark, which will reflect current market practices and will be based on a transparent and thorough methodology.

The intention is to create an index that is agile enough to react quickly to market dynamics, reflecting them in both bunker price and dollars per container surcharge indexes. Also, in light of the 2020 sulfur cap, Platts will be assessing the new 0.5% low sulfur bunker fuel prices, starting January 1, 2019 and will include them in bunker surcharge indexes once the regulation comes into force.

Other factors such as LNG bunkering will also be considered and may be incorporated in the assessments in line with the market trend of introducing dual-powered engines, following the upcoming delivery of 22,000 TEU dual-powered container vessels to CMA CGM in 2020.

Platts is now seeking industry feedback on what assumptions and variables should be included in the methodology for bunker adjustment indexes for key head-haul routes. Please contact Andrew Scorer and Alex Younevitch to share your opinion and discuss what Platts is developing in the container space.

The post Why the container industry needs to replace BAF with a new pricing tool appeared first on The Barrel Blog.



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