Index-linked air cargo contracts take off

The air cargo industry has witnessed a rapid increase in the use of index-linked agreements (ILA) since the start of the pandemic as firms look to protect themselves against contract breakdowns due to swings in rates.

John Peyton Burnett, managing director of airfreight rate data firm TAC Index, said that prior to the outbreak of Covid-19 there were plenty of conversations around ILAs but they were never executed.

Today, ILAs totalling more than $500m have been executed with more in the pipeline, he said.

The development comes after fixed deals had broken down during Covid when the contract price had moved away from the market price.

This occurred across the market impacting lessors, lessees, airlines, forwarders and shippers.

For example, in cases of high demand and rates, airlines could terminate BSA agreements and move the aircraft over to the more lucrative charter market.

Forwarders may also fail to honour agreements, charge a premium or offer delayed services when demand is high.

However, Burnett said ILAs can be used to help manage risk by ensuring that both parties would pay or receive the going market rate.

Initially, parties were monitoring rate indices like the TAC/Baltic Exchange index and then renegotiating when prices diverged from the contract rate.

An ILA essentially automates that process.

There are different ways an ILA can be implemented, with the simplest being to fix a default rate then adding a cargo rate surcharge, which is similar in structure to a fuel surcharge.

If an index moves above or below a pre-defined percentage then a new cargo rate can take effect. Floors and ceilings can be added.

Monthly or quarterly averages can be used as the settlement price to take noise out of the data signal.

Another advantage of market indexation is to detach pricing from service during negotiations.

“Indexation allows for contract negotiations to be more focused on service levels rather than pricing,” he said.

They also help shippers’ logistics division to secure a budget increase to the finance department when prices rise as an index is an independent price reporting agency, rather than relying on the forwarders’ figures.

He added that index-linked deals are also helping some companies secure longer term deals as both parties know that they will pay or receive the market rate for the length of the deal.

In contrast, fixed-price deals tend to be shorter in duration in order for companies to re-negotiate pricing more often to stay in line with the market.

Looking ahead, indexes could also be used as a hedging tool, Burnett said.