Transparency in BAF Formulas: The Importance of Visibility as the IMO 2020 Deadline Approaches

Matt Muenster, Senior Manager of Applied Knowledge, Breakthrough. Image Credit: Breakthrough

The price of fuel, driven by the crude oil market, is the most dynamic and volatile cost component in transportation. Growing complexity in the marine landscape will add more fuel market uncertainty as 2020 nears. That's when the International Maritime Organization (IMO) will officially require carriers to meet more stringent sulfur emissions restrictions.

The added complexity and inherent costs associated with IMO 2020 have forced shippers and carriers to reassess BAF practices.

The Growing Pains of Adjusting to Change

The prospects of even greater fuel market uncertainty in the maritime industry encouraged carriers to discard previous bunker adjustment factors (BAFs), which are used to calculate how shippers reimburse them for the cost of fuel. New BAF programs are designed to ensure shippers contribute their fair share towards the increased costs that come with improving air quality at ports and on the high seas.

The challenge for shippers, however, will be gaining visibility to ensure accuracy in carrier fuel reimbursement. Research conducted on new BAF formulas, which are generally different for each carrier, reveal dramatic variations in actual fuel consumption and costs passed to shippers. This is occurring despite the fact that stated consumption factors are often similar across carrier BAFs.

For instance, data collected from a common trans-Pacific lane shows actual fuel consumption amounts across high- and low-priced carriers can differ by a factor of four. That is because, in practice, the common cost and consumption factors considered by carriers within BAFs such as speed, vessel size, efficiency and port prices are seemingly far from similar.

Another factor adding complexity is carrier sensitivity to baseline fuel costs. Carrier BAF programs may differ greatly in the way their unique equation responds to fuel price dynamics. Shippers need to understand how the fuel amount originally stated in a carrier's BAF formula during a bid will be adjusted as the prices for crude oil and refined products change.

It is possible that the most competitive fuel amount a shipper receives from a carrier during the bidding process will later exceed that of others, should certain factors push total costs beyond that of another carrier.

BAF Program Inconsistencies

No two carriers set prices the same way, and it's been that way long before IMO 2020 added complexity to shipper and carrier fuel reimbursement agreements. These regulatory changes, however, are exposing distortions across the numerous unique carrier and shipper BAF programs.

BAF programs are inconsistent in how they account for fuel consumption and price differences across geographies, resulting in drastic fuel cost differences from one carrier BAF to another.
BAFs also lack transparency, which allows for distortion. Establishing a baseline is difficult when carriers take different approaches to addressing IMO 2020. Since shippers may not know how and to what extent their carriers are changing fuel consumption practices, they may be left in the dark when it comes to understanding fuel costs related to ocean freight movements.

Yet, another factor for shippers to consider is that the cost of fuel has long been an incentive for carriers to improve fuel efficiency – even before the IMO 2020 sulfur regulations became an industry focus. Improved fuel efficiency provides cost advantages to carriers. Steaming speed has been leveraged to manage fuel efficiency for years; An 8,000 TEU vessel that reduces its speed by two knots, from 19 to 17 knots, may experience a fuel efficiency savings as high as 25 percent.  But, how do shippers know the extent to which operations adjust efficiency and therefore impact fuel consumption and fair fuel cost reimbursement? A comprehensive approach to marine fuel management can help shippers and carriers who want partnerships based on fairness and transparency.

How Data Provides Better Visibility

From a shipper's perspective it is important to align fuel reimbursement to market realities utilizing the best data inputs available, while maintaining a high level of transparency. This creates a fair and equitable platform for reimbursing service providers.

Shippers have generally lacked visibility into how they reimburse ocean carriers for fuel and what forms the basis of that cost. Yet, it is possible to gain insights with a fuel management solution that's based on reliable data that aims to make fuel a true pass-through cost and right-sizes shippers and carriers' exposure to this volatile commodity.

With traditional BAF methods, it's challenging for shippers to understand how each carrier's BAF program will react to fuel market dynamics. Because carrier BAFs vary so widely shippers are unable to ascertain whether a specific BAF program represents actual market costs when compared to other carriers.

A data-driven approach removes distortion from the equation. While this takes effort and expertise, it also involves millions of dollars in transportation energy spend per year for many shippers, making it a worthy pursuit.

Data based on trade lane realities can be analyzed and used to isolate distortion and inefficiencies, within a current BAF approach, leading to valuable insights. Better visibility through accurate data paves the way for a consumption-based fuel reimbursement strategy that accounts for geographic, fuel type, and regulatory considerations. Shippers need to use a fuel management program agile enough to take these fluctuating market conditions into consideration.

Replacing the murkiness of traditional BAF programs with comprehensive marine fuel management encourages fairness and accuracy for shippers and carriers alike. It can help remove price risk premiums and enable management of fuel as a pass-through cost.  In the end, moving toward transparency creates a more competitive landscape that allows carriers to discuss fuel less and refocus efforts on providing competitive freight rates and service to shippers.

While fluctuating fuel prices are inevitable, and regulations like IMO 2020 are adding to the complexity, organizations achieving transparency by leveraging data-driven solutions will earn a competitive advantage in the marketplace. Seeing things clearly makes it much easier to navigate change.