Brokerage NSI on Backwardation and Contracts

by Paul Hardy, NSI
Tuesday November 16, 2021

A backwardated cargo market is throwing up some interesting market moves in the short term.

When the market is so steeply backwardated, there is a disincentive for suppliers to be long on product. Nobody wants to be sitting on cargo which is worth less and less. The solution is simple:

  1. You buy smaller clips and keep inventories light
  2. If you are suffering weakness in demand, then you maybe reduce your barge fleets temporarily in the large hubs (in the smaller ports this is not so easy to do)

This throws up though a couple of unintended consequences:

  1. Short-notice deliveries become more difficult
  2. Delivery premiums creep up, potentially raising profit levels in the short term for suppliers

The question is then, do you look to lock long-term contracts with delivery premiums rising to avoid further increases? I think it depends on sector, and am sure we will continue to see container lines continue down the term contract route due to high volumes and need for security of product. For other sectors it is a judgement on whether the squeeze on logistics will continue in the long term.

My view on this is simple, as demand rises:

  1. People will start to take more inventory
  2. Barges will come back on stream
  3. The shape of the forward curve may change

For a buyer the essentials are in the short term (Nov/Dec):

  1. Do not put any last minute enquiries into the market
  2. Put in a range with any nomination
  3. Have full supplier coverage in any given port
  4. Look at alternative ports as well as the main hubs. The elasticity of logistics will be different so arbitrage may fluctuate
  5. Most importantly, don't get panicked into locking high premiums for long-term contracts

After this period the consensus is the market will again find its equilibrium and delivery premiums will reduce. Our hope as brokers is the market will settle down to a level where the supplier can continue to make reasonable profit with a structural margin. This creates a long-term sustainable market and avoids many risks associated with quantity and quality for all market participants.

It is also important to note the increasing spread between 0.5% cargo and ICE MGO throughout 2021. So, while delivery premiums have increased a touch in the last weeks, the overall value of 0.5% material vs MGO against this time last year is so much cheaper.

The buyers that have lost out the most were those that locked 0.5% discounts to ICE MGO during 2021 -- many of which are now tens of dollars pmt off the market. If I was a buyer, I would be focusing on potential chances to lock the spread between 0.5% and ICE MGO over the next months if the spread continues to grow. If you look at the cost of producing 0.5% material as a % of MGO then there are clear levels where it becomes tempting to lock the spread.