DRIVING THE NUMBERS:
A look at the trucking industry’s financial landscape
9
For-hire trucking in the United States is a
truly massive industry: the spot market alone
accounts for about $115 billion annually. It’s
also a massively inefficient marketplace: price
discovery is difficult, service commitments
are less than firm, seasonality is unpredictable
in its timing and magnitude, and spot rate
volatility negatively affects both shippers and
carriers.
There isn’t a good way to hedge against price
volatility in trucking: in periods of low demand,
shippers move their freight inexpensively and
carriers take losses; in periods of high demand
and tight capacity, trucks fetch high rates and
shippers’ margins shrink. There’s very little
either party can do to limit its exposure to
trucking rates, short of building a dedicated
fleet with drivers paid by the hour, because
even ‘contract freight’ agreements become
moot once the market moves enough.
Instead, everyone is at the mercy of a boomand
bust cycle.
Other industries have hedged their exposure
against price volatility through futures
contracts, which are essentially standardized
agreements to buy or sell something at a
predetermined price in the future.
What makes a successful futures exchange?
In the July 2018 issue of Energy Risk
magazine, recently retired Icap Energy
founder Paul Newman discussed his five tests
for a successful derivatives market: “there
must be a range of different reasons why
firms come to the market; there must be a
sufficient underlying spot market; there must
be enough volatility; there must be a credible
index; and it must be big enough.”
We believe that truckload transportation
passes all five of Newman’s tests. There is
certainly a range of different reasons why
participants would come to the market: for
every truckload mile driven in the United
States, there’s at least one party who wishes
the rate was higher and one who wishes the
rate was lower. As stated above, the spot
market is large: the industry is full of hundreds
of thousands of owner-operators who move
spot freight and drive the rates that shippers
and large carriers are exposed to. And as
readers of FreightWaves know, the truckload
spot market is extremely volatile.
As an example, according to DAT’s Rateview
tool, trucks driving from Los Angeles to Dallas
brought $2.38 per mile in December 2017, but
only $1.69 in February, a drop of 28.9%. DAT,
in fact, helps trucking pass Newman’s fourth
test, which is a credible index: DAT uses actual
transactions to assess the physical market
and it has a sound, published methodology
for quoting prices. Finally, trucking is ‘big
enough’, whether in terms of notional value,
the total amount of the commodity to be
hedged (we estimate 40 billion miles annually
are exposed to the spot market), and the
number of participants.
How would futures work for trucking? The
simplest analogy is in college football:
imagine that your alma mater is playing in the
Rose Bowl and you want badly for your team
to win. If you bet on your team to win, you’re
doubling down, and you’re emotionally and
financially exposed to the same outcome.
If they end up losing, you’re sad and you’re
out some money. But if you bet the opposite
of what you want to happen, if you bet that
your alma mater will lose, you’re not doubling
down but hedging. You’ll be okay no matter
what happens. That’s exactly how futures
trading would work for exchange participants
who have a commercial interest in trucking
rates: they bet the opposite of what they
want to happen. Truckload carriers would be
short, so if rates collapse, they’ve protected
themselves; shippers would be long the rates,
so if they go up, they’ve still got some miles at
a favorable price.
FreightWaves is building a trucking futures
contract with Nodal Exchange and DAT that
will launch on March 29. A crucial point of
distinction between freight futures and some
traditional futures contracts is that freight
futures will be financially settled, not settled
by physical delivery. In short, there is no truck.
Financially settled futures are actually quite
common: Brent crude oil futures are financially
settled; so are electricity futures. In other
words, if a shipper wants to buy 4,000 miles
from Atlanta to Chicago at $2 per mile over
a three month period and holds the contract
until expiration, a truck isn’t going to bump
the dock. Instead, the exchange will settle
the contract against the spot rate index for
that lane on that day. If the rate has gone up
to $2.50, the exchange will deposit $2,000
(4,000 * 50 cts) in the shipper’s account. If
the rate falls to $1.50, the shipper will pay the
exchange $2,000.
“DAT and Nodal Exchange are ideal
FreightWaves partners to launch the first
futures contracts for the trucking industry.
DAT is considered the de facto industry
standard, well-established for its benchmark
supply, demand and rate data for the
truckload freight market,” said Craig Fuller,
CEO of FreightWaves. “Nodal Exchange grew
from a cold-start exchange a decade ago to
quickly become one of the largest players
in the power markets. This entrepreneurial
achievement is a testament to the quality of
the exchange, clearinghouse, and culture of
the firm.”
Trucking Freight Futures 101
JP Hampstead, Associate Editor, FreightWaves