Article 3: Hedging Applications for Trucking Carriers, Shippers & 3PLs

Logistics Management and Lakefront Futures’ Trucking & Derivatives Group are publishing a series of articles during August & September on the “A-Z” of trucking freight futures. This third article describes the hedging applications for trucking carriers, shippers, and 3PLs.

Previous articles in the series:

• Article 1: The Trucking Paradigm Shift & the New 3-Dimensional Market 
• Article 2: Trucking Freight Futures 101

Hedging Applications

The main hedging participants for trucking freight futures are commercial users: trucking carriers, shippers, and 3PLs.  While they each have a different hedging objective, their primary use of trucking freight futures is to hedge against the future risk of adverse changes in trucking rates.

As we all know, predicting the future direction of trucking rates is very challenging, as they can swing either way by 20%-70% in a matter of months as experienced in the last year.  The next best thing to a crystal ball is hedging a trucking rate with a trucking freight futures position and locking in a future trucking rate today. The hedger’s decision is not based on which way the participant feels rates will move in the future but instead whether the locked in rate is an acceptable figure for the hedging participant’s specific business. 

Trucking freight futures do not change anything with a participant’s operations.  The only thing that changes is that the uncertainty from a participant’s financial projections is removed and placed into the futures market. The premise of hedging with futures is that you do today what you plan to do in the future.  If you plan on purchasing something in the future (i.e. trucking capacity) then you would take a “long” position. Conversely, if you plan on selling something (i.e. trucking capacity) then you would take a “short” position.  A market participant can choose to enter into different directional lane freight futures contracts positions to hedge the trucking rates in specific lanes or hedge the overall corporate level revenue or trucking costs with hedges on one or more of the national/regional calculated indices.

Hedging Applications: Trucking Carriers

Trucking freight futures provide trucking carriers with multiple hedging and profiting applications.

Short Hedge: To hedge against the risk of decreasing trucking rates in the future, a trucking carrier as a “seller” of trucking capacity, would go short on the best fit trucking freight futures contract to protect its revenue streams.  If rates do end up decreasing, the drop in its revenues would be offset by the profits from the freight futures contract in the carrier’s futures account.

Example Short Hedge: A carrier wants to hedge the risk of trucking rates dropping by $.25 in 3 months on an anticipated load mileage of 10,000 miles. If rates do decrease by $.25 in that time frame, the carrier’s revenues would decrease by $25,000 ($.25 loss in rate x 10,000 miles).  However, if the carrier went “short” on the best fit contract at a price of $2.25 and the futures contract price dropped to $2.00, the $25,000 profit from the futures position ($.25 profit x 1,000 miles per contract x 10 contracts) would offset the decreased revenue.  Regardless of which way rates go the carrier is locked in at $2.20 (Assuming no change in a $.05 basis (or spread) between spot and futures prices).

Profiting Positions – Long or Short

A carrier might have a hedge via a short position on the December National U.S. Van contract to protect itself from decreasing rates in the future.  However, given a carrier’s unique insight on its active lanes, it can speculate on rate direction via trucking freight futures – either long or short.  If they are correct on rate direction, the carrier can use the profits generated from the futures position to offset lost income from some of its deadhead mileage or to bid more competitively on a contract with a shipper and increase its chances of winning the business.

Hedging Applications: Shippers

Long Hedge: To hedge against the risk of increasing trucking rates in the future, a shipper as a “buyer” of trucking capacity, would go long on the best fit freight futures contract.  If rates do end up increasing, the increased transportation costs for its shipments would be offset by the profits from the freight futures contract in the shipper’s futures account.

Example Long hedge: Trucking rates are currently $1.95 $/mile in a shipper's lane. However, the shipper is worried that in 6 months, trucking rates will increase to $2.20 thereby increasing its trucking costs by $25,000 due to the 10,000 miles that will be hauled at higher rates.   The shipper goes “long” on 10 of the January 2020 national dry van futures contracts at a contract price of $2.00.

If trucking rates increase by $.25 to $2.20, its trucking costs increase by $25,000 as expected.  However, the shipper profits on its “long” futures position by $25,000 ($.25 contract rate increase X 1,000 miles per contract X 10 contracts) which will offset the shippers trucking cost locking in a trucking rate for the future today. Regardless of which way rates go in 6 months the shipper is locked in at $1.95 (Assuming no change in a $.05 basis (or spread) between spot and futures prices).

Hedging Applications: 3PLs

Unlike the singular role of a shipper or carrier, 3PLs assume the role of both and as a result their profit margins are at risk from both upward and downward movement in trucking rates.  Dropping rates decrease its revenues and increasing rates increase its transportation costs – if either of these happen the profit margin is negatively impacted.

By creating a delta neutral position – where there are two offsetting positions so that they are neither long or short - 3PLs would be able to lock in an acceptable profit margin and not see their profit margins eroded by trucking rate volatility.

Conclusion

To protect themselves from adverse movements in trucking rates, that can have a significant negative impact to a participant’s bottom line, and to have a competitive advantage, shippers, carriers, and 3PLs should consider the important hedging benefits provided by trucking freight futures.  Trucking freight futures provide a way for a market participant to transfer the financial risk of trucking rate volatility to the futures market and eliminate the need for accurately predicting the direction of future trucking rates which are and will continue to be extremely volatile. 

Market participants can seek to fully hedge or partially hedge their position (s) with one or multiple futures contract positions. Participants can also use a dollar averaging approach to slowly add onto a futures positions as trucking rates increase or decrease. One of the most important factors in creating an effective hedge against trucking rate volatility aside from determining the appropriate size of the position and contract month (s), is utilizing the trucking freight futures contract whose underlying benchmark indices has the best correlation to the trucking rates that you are trying to hedge.  In that regard, market participants should seek the guidance of a trucking freight futures specialist to construct the optimal hedge before taking any position on their own.

In September, Logistics Management will be launching a new section to reflect the new 3-dimensional market – “Trucking Financial Markets 360°”.  This section will be published weekly digitally and monthly in print. This section will provide a comprehensive snapshot of the trucking spot, forward and futures markets along with the diesel/derivatives market and will be an invaluable resource for market participants in the new 3-dimensional trucking market. The content will be provided by Gary Saykaly who heads up Lakefront Futures’ Trucking & Freight Derivatives Group which helps market participants hedge trucking rate and fuel cost risk – [email protected].

*Past performance is not necessarily indicative of future results. The risks associated with trading futures and options are substantial. Futures and options trading are not suitable for all investors.