Why Shippers Can Renegotiate Some Long-Term Contracts But Not Others

After a year of highly profitable freight rates, the container shipping business appears to be normalizing. In the past week, the overall SCFI (Shanghai Containerized Freight Index) spot rate index for shipments out of China declined by 9.7 percent compared to the peak recorded early this year. It is the third week in a row that SCFI index has been falling on major trade routes.

The situation is also similar for the other indices, particularly Drewry’s World Container Index (WCI). According to data published last Thursday, the spot rates fell by 8 percent week-on-week to $4,942 per FEU, representing a 52 percent decline below the peak of $ 10,377 recorded a year earlier.

However, this sudden decline unearths an interesting concern for contract shippers. For this category of shippers, the spot rates are much lower than the rates they negotiated in their contracts, which presents a dilemma whether to renegotiate or re-allocate the cargo into spot bookings.

The August issue of Xeneta’s XSI spot index report already showed that contract rates on the transpacific eastbound route were higher than spot rates.

Will ocean carriers entertain a renegotiation to accommodate these unprecedented changes?

Two carriers - Yang Ming and Hapag Lloyd - have given contrary reaction to this concern.

Yang Ming’s Chief Operating Officer Chang Chao-feng recently revealed that the carrier is facing pressure from clients to renegotiate freight rates.

“Because spot rates have plunged, we do face pressure from some clients demanding rate adjustments for long-term contracts. In principle, Yang Ming is offering short-term discounts in response to such requests. Even though the contract terms do not allow price revisions, Yang Ming is flexible to maintain long-term relations with clients,” said Mr Chang.

On the other hand, Hapag Lloyd CEO Rolf Habben Jansen ruled out any renegotiation of annual contracts with shippers.

“We don’t do that. Either you close a contract, or you don’t,” said Habben Jensen.

So, is there ambiguity in the types of contracts a shipper can sign with a carrier?

In a recent LinkedIn Post, Gordon Trouncer Downes, CEO of New York Shipping Exchange (NYSHEK) contended that not all “contracts” are contracts. That is, the contracts Rolf Habben was referring to could be different to those Chang Chao-feng talked about.

Trouncer went on to explain that there are generally two contract categories existing in the market today.

First are the traditional contracts, which are ambiguous.

“For example, these contracts may have minimum quantity commitment (MQC) the parties agree to fulfill over the course of the contract, but with no commitments as to which week the cargo will be shipped, or on which service. These contracts may even include penalties, or liquidated damages for non- performance, but without clear commitments it is practically impossible to prove who was at fault - thereby rendering these contracts unenforceable,” said Trouncer.

The second kind involves a growing number of new contract types where the commitments are clearly laid out on a weekly basis and the ports and routes are specified.

Hence, in this case, a carrier understands exactly what their obligations are, and the same applies to the shipper. It is then possible to track each party’s performance and consequences can be applied for non-performance.

Trouncer believes these innovations to contract types is good for shippers, as it offers them a range of options to meet their business needs.

“Shipper procurement managers now have a set of contracting tools which they can use to better manage their supply chain risk. For example, if a shipper needs predictable landed cost and consistent service levels, then they can enter into an enforceable contract. Alternatively, if they want flexibility to take advantage of low spot rates when the market softens, then the shipper can go for a more traditional unenforceable contract,” commented Trouncer.