Application and Strategy in Futures Markets for 3PLs

 

How Freight Futures Work for 3PLs

 

The positioning of 3PLs going forward in the freight futures market is one that is often overlooked, but possibly the most important and the position that stands to lose the most.

 

Shippers and carriers are obvious and direct benefactors to price discovery, transparency, and fixed revenue/input costs. It is the 3PL, however, that assumes both roles of shipper and carrier, and maintains these roles concurrently and set opposed each other. Theoretically, and practically for that matter, a 3PL becomes the shipper when loads via contract and spot are awarded and the responsibility for shipment of these loads falls directly on that 3PL.

 

Conversely, those same loads will need transportation, placing the role and responsibility of a carrier on that 3PL as well. It is this duality of responsibility in the movement of freight that financially burdens a 3PL with risk associated to price volatility, be it both from upward and downward pressure on prices.

 

Ordinarily, one could rationalize that a business facing pressures from both perspectives on price could reasonably abstain from risk management procedures (assuming both pressures were relatively equal and any excess pressure from one side was a negligible amount written off as a cost of doing business). In this instance, the functionality of the 3PL is not uniformly spread across the spectrum of freight business.

 

It is our position that a 3PL faces downward pressure on freight rates on a macro level, particularly for spot market business, while simultaneously exposed to increasing rates on a micro level, particularly for contract business. We believe it is the fiduciary responsibility of every 3PL to maintain both a short futures position protecting revenue downside and a long futures position specifically for any contractual business and especially for contractual business in several key markets and in several key lanes, in order to maintain revenue and protect from possible losses linked to rising spot market rates.

 

At face value, maintaining both a long and short position in freight futures, albeit in different contracts, gives the appearance of a delta neutral position with only varying gamma levels defining the possible skew of the initial hedge. A more in-depth view of this market stance reveals the differences between the two positions and provides clarity in what each position achieves.

 

Firstly, it is entirely possible, and at times very probable, for the two positions to move in opposite directions. The aggregated national van rate is a tool that allows for a global revenue hedge. Lane specific contracts, while subject to overall industry and macroeconomic trends, will be intrinsically valued on conditions in the pairing of origin and destination locations. Truck capacity nationwide may be abundant causing rates to decrease, while massive warehouse inventories in LA and a rare snowstorm in Dallas cause the rate on that specific lane to skyrocket.

 

Lastly, a hedge strategy is only as good as its correlation to the underlying business it’s intended to protect. A 3PL that maintains sensitivity to freight rates in general with opposing sensitivity to specific lanes or shipments must defend against both vulnerabilities with the appropriate defense mechanism. Only hedges based in both contracts allow for precise risk aversion and protection of a company’s revenue.

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