Matt Muenster, Senior Manager of Applied Knowledge, Breakthrough. Image Credit: Breakthrough
The separation of fuel and freight describes one of the positive contracting amendments to come from IMO 2020. Despite a past common practice of using all-in rates, carriers and shippers have generally separated fuel and freight costs in contracts during 2019.
Much of the shift from all-in rates was initiated by carriers to improve their chances of recovering IMO 2020-related fuel costs. Shippers may have found this an unwelcome change from conventions, but developing separate budgets for fuel and freight costs is imperative to procure freight competitively. This approach provides much-needed transparency between fuel and freight costs, simplifies quantification of fuel exposure to understand risk, and realizes the full impact of fuel efficiency enhancements.
Visibility of Fuel and Freight Costs
Fuel is the most volatile cost component of moving goods to market. This volatility should not influence the freight rate portion of overall transportation spend. Similar economic demand fundamentals drive a positive correlation between freight and fuel costs, but the strength or weakness of this correlation is determined by supply side fundamentals.
Separating fuel and freight costs from an all-in rate enables shippers to accurately account for the variance of these costs independently
For example, eastbound transpacific spot rates decreased by more than 20 percent year-over-year during the second quarter of 2019. Over the same period, the most relevant transpacific bunkering hubs saw high-sulfur fuel oil and low-sulfur marine gasoil prices fall closer to five percent.
Without transparency of freight and fuel market dynamics how would a business account for this difference? What about the consequence of failing to accurately account for change while the market trends upward? Separating fuel and freight costs from an all-in rate enables shippers to accurately account for the variance of these costs independently.
Quantify Fuel Exposure to Understand Risk
Visibility to fuel cost is critical for budgetary considerations. The growing number of policies recognizing costs associated with freight transportation externalities – like the toll of emissions on human health and climate change – should demonstrate the obvious value of capturing consumption and emissions metrics.
One of the most critical questions that needs to be answered as emission regulations tighten is "who pays for it?" Shippers who understand their transport fuel consumption will gain clarity of their exposure to growing policy risk as the cost of emissions increases. Clear consumption data position shippers to develop preventive strategies to manage and mitigate costs tied to the emission-intensity of their supply chains.
Realize Fuel Efficiency Benefits
The coming IMO regulations demonstrate the direction of emissions policy and encourages continued research and development of cleaner, more efficient energy for maritime transport. The IMO requires finalized short-term carbon reduction measures by 2023 which will expand to mid-term carbon reduction measures of 40 percent by 2030.
The economic incentive to reduce fuel consumption and produce fewer emissions is clear. Shippers who accurately account for fuel consumption will be able to benchmark, creating opportunities to reduce costs and direct freight toward the most fuel and carbon-efficient carriers.
Focus on Fairness and Accuracy
Separating fuel and freight costs does not come without challenges. Fuel amounts need to be calculated in a transparent, fair, and accurate manner for shippers and carriers to accept fuel as a pass-through cost.
When fuel is managed as a pass-through cost, shippers and carriers can focus their attention on negotiating competitive contracts based on service, capacity, and price
Recent commentary from shippers indicates a need to interrupt contracts with unacceptable rate increases. This elevates the importance of making fuel a pass-through cost. Fuel market volatility and the practice of revisiting and disrupting contracts – whether through carriers' emergency bunker surcharges of the past or by shippers' demands to potentially do so during the IMO 2020 future – does not improve industry relationships and takes attention away from improving the service of moving freight.
When fuel is managed separately with a market-based approach like Breakthrough's Marine Fuel Management program, shippers can understand how each line item drives costs in their budget. When fuel is managed as a pass-through cost, shippers and carriers can focus their attention on negotiating competitive contracts based on service, capacity, and price.