Continued from last week
Charter contract enforceability
Participants in ocean shipping take it for granted that time-charter terms are enforceable and will generally be honored – which is not the case in all transport markets, including the U.S. domestic trucking market. In trucking, contract rates are sometimes derogatorily referred to as ‘paper contracts,’ as in ‘only good on paper, not in reality.’
If spot rates move against contract rates, trucking contract rates may not be honored. The lack of enforceability has spurred the creation of Trucking Freight Futures to give market participants more certainty in their freight costs and revenues.
In ocean transport, cargo shippers protect themselves from a potential rise in spot rates by signing long-term charter contracts. Long-dated ocean freight futures are largely bought by financial investors speculating on market increases, not by cargo shippers seeking to cap their freight exposure.
Long-dated ocean freight futures are largely sold by either financial interests or ship charterers seeking to protect themselves from falling rates. In the latter case, if rates fall below the charter rate, the charterer’s futures contract pays out, and that money is used by the charterer to offset its charter expense.
The whole system of freight price management in ocean shipping – the mix of spot versus term employment, the balance of operational and financial leverage – hinges on the enforceability of time charters. For insight on the enforceability aspect, FreightWaves interviewed Neil Quartaro, counsel at the New York office of Watson, Farley & Williams.
Quartaro highlighted both legal and reputational pressures that keep both parties in line. In the case of a ship owner breaching a charter contract, “you’ve got a maritime lien over the ship,” he explained.
A typical oceangoing ship can be worth anywhere from $20 million to over $100 million and is very easy to find. The threat of having your ship arrested and not earning revenue offers a strong incentive for owners to honor charter contracts.
If a charterer breaches the contract, the ship owner can sue, “and the owner would win,” said Quartaro, although he noted that collection is more difficult in the case of a charterer’s breach than an owner’s breach.
There is also significant reputational pressure that compels time charterers to honor contracts. “An opportunistic time charterer who is redelivering a ship early [before the original contract maturity] to take advantage of a decrease in rates is going to develop a reputation as an unreliable performer in the market very quickly,” he said.
“There is a very strong commercial pressure for a charterer to perform at the agreed rate. If they start getting into games where they’re functionally treating a time charter like a spot option, that will get out into the market and no one will time charter ships to them anymore,” asserted Quartaro.
Because period contracts in ocean shipping are largely solid and enforceable, time-charter activity, or the lack thereof, offers an important window on market sentiment. Once uncertainty clears on the IMO 2020 fuel-price effect, the time-charter picture will come into sharper focus.
*Source: Freight Waves
Concluded
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