Calculation of Fuel, Currency, and Inland Freight Price Adjustment Factors for Military Marine Shipping November 2013 Final Report Bunker Fuel Adjustment Factor (BAF), Currency Adjustment Factor (CAF) and Inland Intermodal Adjustment Factor (FAF) Produced for: U.S. Department of Defense USTRANSCOM Produced by: U.S. Department of Transportation Research and Innovative Technology Administration Volpe National Transportation Systems Center Cambridge, MA Acronyms, Abbreviations, and Selected Technical Terms base rate freight price per cargo unit for carriage from A to B, without any fuel adjustment factor or other price supplements BAF bunker adjustment factor, a supplemental charge for additional fuel cost due to sudden increases in fuel prices base price fuel price per metric ton immediately prior to the announcement of a new base rate current price weighted average of bunker fuel prices of different grades and locations applicable in the present or immediate past cargo unit basic unit of cargo that the base price applies to, either a container (TEU or FEU) or a measurement ton of breakbulk cargo (MT) ECA Emission Control Area FEU forty-foot equivalent length container IBS Integrated Booking System, TRANSCOM’s freight management database MT Measurement ton, measure of volume of capacity taken up by breakbulk cargo TEU twenty-foot equivalent length container RoRo roll-on roll-off cargo, such as vehicles transported as breakbulk cargo TABLE OF CONTENTS 1. Executive Summary .......................................................................................................... 1 1.1. Bunker Fuel Adjustment Factor ............................................................................................ 1 1.1.1. Background ................................................................................................................... 1 1.1.2. USTRANSCOM BAF ........................................................................................................ 2 1.2. Currency Adjustment Factor (CAF) ....................................................................................... 6 1.3. Inland Intermodal Adjustment Factor (FAF) ......................................................................... 7 2. Bunker Adjustment Factor (BAF) ....................................................................................... 9 2.1. General Principles of a BAF ................................................................................................... 9 2.1.1. Sharing of Fuel Price Volatility .................................................................................... 10 2.1.2. Time Lag Between Purchase and Delivery of Service ................................................. 11 2.1.3. Isolating Volatility in a BAF .......................................................................................... 11 2.2. Change in Fuel Price ............................................................................................................ 12 2.2.1. Fuel Price Differential Buffer ....................................................................................... 12 2.2.2. Updating the Base Fuel Price ...................................................................................... 13 2.2.3. Emissions Control Areas (ECAs)................................................................................... 15 2.2.4. Mix of Fuel Types ........................................................................................................ 16 2.3. Fuel Consumption per Cargo Unit ...................................................................................... 16 2.3.1. Fuel Consumption per Vessel Voyage ......................................................................... 17 2.3.2. Speed ........................................................................................................................... 18 2.3.3. Vessel Capacity ............................................................................................................ 18 2.3.4. Utilization of Capacity ................................................................................................. 18 2.3.5. Input Substitution ....................................................................................................... 19 2.4. Risk Sharing ......................................................................................................................... 19 2.4.1. Hedging ....................................................................................................................... 21 2.4.2. Transparency ............................................................................................................... 21 2.4.3. Flagging and the Maritime Security Program ............................................................. 22 2.5. Industry BAF Practices ........................................................................................................ 22 2.5.1. The Transpacific Stabilization Agreement (TSA) ......................................................... 22 2.5.2. The Westbound Transpacific Stabilization Agreement (WTSA) .................................. 24 US DOT/Volpe Center - i - FINAL November, 2013 2.5.3. Maersk Line ................................................................................................................. 25 2.5.4. Mitsui O.S.K. Lines (MOL) ............................................................................................ 26 2.5.5. Defects of the Commercial BAFs ................................................................................. 26 2.5.1. Positive/Negative Symmetry ....................................................................................... 27 2.6. Details and Results for 2013 USTRANSCOM BAFs .............................................................. 28 2.6.1. ECA factors .................................................................................................................. 29 2.6.2. Price Indexing Factors ................................................................................................. 31 2.6.3. Prices of Different Fuels .............................................................................................. 32 2.6.4. Prices at Different Locations ....................................................................................... 32 2.6.5. Fuel Consumption Factors........................................................................................... 33 2.6.6. Transit Time Estimation .............................................................................................. 36 2.6.7. Ship Characteristics per Lane ...................................................................................... 36 2.6.8. Model Calculation and Results .................................................................................... 40 2.6.9. Comparison of Fuel Consumption Factors and Transit Times with Maersk Lines ...... 41 2.6.10. Transhipment ........................................................................................................... 44 2.6.11. Input Substitution Factor ......................................................................................... 45 2.7. Risk Sharing Factor .............................................................................................................. 48 2.7.1. Buffer Threshold and Risk Distribution ....................................................................... 48 2.7.2. Base Price Bidding Process .......................................................................................... 49 2.8. 20-to-40 Foot Container Equivalence (TEUs vs. FEUs) ........................................................ 50 2.8.1. Weight versus Volume ................................................................................................ 51 2.8.2. Industry Survey ........................................................................................................... 51 2.8.3. Developing a USTRANSCOM Conversion Factor ......................................................... 52 2.8.4. A Network-Wide Conversion Factor ........................................................................... 53 2.9. All Factors Combined .......................................................................................................... 55 2.9.1. Technical Factor Comparison Between 2009 and 2013 Volpe Studies ....................... 55 2.10. Updating BAF Values ......................................................................................................... 61 2.10.1. Implementing the BAF ............................................................................................. 62 2.10.2. Transitioning to the New USTRANSCOM BAF .......................................................... 64 2.11. References ........................................................................................................................ 64 US DOT/Volpe Center - ii - FINAL November, 2013 2.12. Response to Industry Feedback on Volpe Study .............................................................. 66 2.12.1. Changes in the Volpe Model .................................................................................... 66 2.12.2. Lower Technical Factor ............................................................................................ 66 2.12.3. Commercial Practice ................................................................................................ 67 2.12.4. Transparency and Continuity ................................................................................... 67 2.12.5. Base Price Reset ....................................................................................................... 68 2.12.6. Symmetry ................................................................................................................. 68 2.12.7. Low Sulfur Fuel ........................................................................................................ 68 3. Currency Adjustment Factor ............................................................................................ 69 3.1. Introduction ........................................................................................................................ 69 3.2. Currency Risk ...................................................................................................................... 69 3.2.1. Managing Exchange Rate Risk ..................................................................................... 70 3.2.2. Implications for a CAF ................................................................................................. 71 3.3. Components of a CAF ......................................................................................................... 71 3.3.1. Eligible Currencies ....................................................................................................... 71 3.3.2. Baseline Rate ............................................................................................................... 71 3.3.3. Risk Sharing ................................................................................................................. 71 3.3.4. Technical Factor .......................................................................................................... 72 3.4. Updating the CAF ................................................................................................................ 72 3.4.1. Choosing Eligible Currencies ....................................................................................... 72 3.4.2. Establishing the Currency Baseline ............................................................................. 75 3.4.3. Risk Sharing ................................................................................................................. 75 3.4.4. Setting the Buffer ........................................................................................................ 75 3.4.5. Measuring Currency Volatility ..................................................................................... 76 3.4.6. Currency Buffer Zone Analysis .................................................................................... 77 3.4.7. Addressing Dominant Exchange Rates ........................................................................ 78 3.4.8. Risk Sharing Factor ...................................................................................................... 79 3.4.9. Technical Factor .......................................................................................................... 79 3.5. Conclusions and Recommendations ................................................................................... 80 3.6. References .......................................................................................................................... 81 US DOT/Volpe Center - iii - FINAL November, 2013 4. Inland Intermodal Fuel Adjustment Factor (FAF) .............................................................. 83 4.1. Introduction ........................................................................................................................ 83 4.2. FAF Methodology Development ......................................................................................... 84 4.2.1. FAF Inputs .................................................................................................................... 85 4.2.2. Base Period for Fuel Pricing ........................................................................................ 85 4.2.3. Fuel Price Data ............................................................................................................ 86 4.2.4. Truck Fuel Consumption Factors ................................................................................. 86 4.2.5. RoRo Shipments .......................................................................................................... 89 4.2.6. Reefer Container Shipments ....................................................................................... 90 4.2.7. Rail Fuel Consumption Factors .................................................................................... 91 4.2.8. Truck/Rail Competitive Break Even Point ................................................................... 93 4.2.9. Intermodal Long Distance Shipments ......................................................................... 95 4.3. FAF Methodology ................................................................................................................ 96 4.3.1. FAF Implementation Details ........................................................................................ 97 4.3.2. Sample Internet Site .................................................................................................... 98 4.3.3. Limitations of the FAF Methodology ......................................................................... 100 4.4. References ........................................................................................................................ 100 Appendix A: FAF Calculator ............................................................................................ 104 US DOT/Volpe Center - iv - FINAL November, 2013 TABLE OF TABLES TABLE 1: SUPERLANE BUFFERS 7 TABLE 2. ALTERNATIVE SHIPPING PRICING STRATEGIES 9 TABLE 3. SHORT AND LONG TERM METHODS FOR REDUCING FUEL CONSUMPTION 20 TABLE 4. TSA BAF FORMULA FACTORS 23 TABLE 5. EXAMPLE CALCULATION OF TSA BAF 24 TABLE 6. CALCULATION OF LOW SULFUR SUPPLEMENT 24 TABLE 7. WTSA BAF FORMULA 25 TABLE 8. MAERSK BAF EXAMPLE CALCULATION 26 TABLE 9. FUEL GRADES USED IN INTERNATIONAL SHIPPING 28 TABLE 10. TRANSCOM SHIPPING REGIONS. 29 TABLE 11. EMISSIONS RESTRICTIONS ON OCEAN SHIPPING 30 TABLE 12. POLICY STRATEGIES FOR CONTROLLING EMISSIONS 30 TABLE 13. SHIPOWNER RESPONSE STRATEGIES TO EMISSION REGULATIONS 31 TABLE 14. AVERAGE CONTAINERSHIP FOR LANE 1, BY FLAG 35 TABLE 15. AVERAGE RORO SHIP FOR LANE 7 BY FLAG 35 TABLE 16. COMPOSITE US FLAG SHIPS 36 TABLE 17. CHARACTERISTICS OF U.S. FLAGGED VESSELS BY LANE 37 TABLE 18. CHARACTERISTICS OF ALL VESSELS BY LANE 39 TABLE 19. SAMPLE MAERSK SERVICES USED AS A PROXY FOR TRADE TECHNICAL FACTOR COMPARISON 42 TABLE 20. NUMERICAL EXAMPLE OF INPUT SUBSTITUTION 47 TABLE 21. INTERACTION OF BUFFER THRESHOLD AND RISK DISTRIBUTION FACTOR 49 TABLE 22. TEU/FEU CONVERSION FACTOR 55 TABLE 23. TECHNICAL FACTOR COMPARISON (0.8 FOR INPUT SUBSTITUTION FACTOR, 0.75 FOR RISK FACTOR) 55 TABLE 24. FINAL TECHNICAL FACTORS BY LANE, INPUT SUBSTITUTION (0.8) AND RISK SHARING FACTOR (0.75) 58 TABLE 25. TIMING FOR UPDATING PRICE AND TECHNICAL FACTORS 61 TABLE 26: TRADE WEIGHTED SUPERLANES 73 TABLE 27: SUPERLANE CURRENCIES 74 TABLE 28: EXPECTED CURRENCY VOLATILITY 77 TABLE 29: SUPERLANE BUFFERS 78 TABLE 30: TECHNICAL FACTOR COST STRUCTURE 80 TABLE 31: TRUCK FACTORS 87 TABLE 32: INTERMODAL RAIL FACTORS 92 TABLE 33: RAIL FUEL FACTORS 92 TABLE 34: TRUCK/RAIL COMPETITIVE BREAK POINT 94 TABLE 35. CONUS INLAND FUEL SURCHARGES (FAF) PER DRY CONTAINER. EFFECTIVE JUN-13 99 TABLE 36. CONUS INLAND FUEL SURCHARGES (FAF) PER DRY CONTAINER 105 TABLE 37. CONUS INLAND FUEL SURCHARGES (FAF) PER REFRIGERATED CONTAINER 107 TABLE 38. CONUS INLAND FUEL SURCHARGES (FAF) PER TRAILER 109 TABLE 39. CONUS INLAND FUEL SURCHARGES (FAF) PER SHIPMENT UNIT 111 US DOT/Volpe Center - v - FINAL November, 2013 TABLE OF FIGURES FIGURE 1. 2009 AND 2013 VOLPE TEU TECHNICAL FACTOR COMPARISON FOR SELECTED ROUTES (0.8 FOR INPUT SUBSTITUTION FACTOR, 0.75 FOR RISK FACTOR) 4 FIGURE 2. 2009 AND 2013 VOLPE BREAKBULK TECHNICAL FACTOR COMPARISON FOR SELECTED ROUTES (0.8 FOR INPUT SUBSTITUTION FACTOR, 0.75 FOR RISK FACTOR) 5 FIGURE 3. DAILY FUEL CONSUMPTION FACTOR, MAERSK VS. 2013 METHODOLOGY. 6 FIGURE 4. CUMULATIVE PRICING ERROR WITH INCREASING TIME SINCE QUOTE. 10 FIGURE 5. INCORRECT OR FIXED FUEL PRICE BASELINE. 14 FIGURE 6. EAST COST AND EUROPEAN ECAS, 2013. 15 FIGURE 7. WORLDWIDE AVERAGE FUEL PRICES BY TYPE, 2007-2013. 32 FIGURE 8. IFO 380 (HS) PRICE BY PORT, 2007-2013. 33 FIGURE 9. DAILY FUEL CONSUMPTION FACTOR, MAERSK VS. 2013 METHODOLOGY. 43 FIGURE 10. AVERAGE TRANSIT TIME BY LANE, MAERSK VS. VOLPE 2009 METHODOLOGY. 44 FIGURE 11. VOYAGES LINKED BY TRANSSHIPMENT. 45 FIGURE 12. GRAPHIC REPRESENTATION OF TEU/FEU CONVERSION FUNCTION. 54 FIGURE 13. 2009 AND 2013 VOLPE TEU TECHNICAL FACTOR COMPARISON (0.8 FOR INPUT SUBSTITUTION FACTOR, 0.75 FOR RISK FACTOR) 57 FIGURE 14. 2009 AND 2013 VOLPE BREAKBULK TECHNICAL FACTOR COMPARISON (0.8 FOR INPUT SUBSTITUTION FACTOR, 0.75 FOR RISK FACTOR) 57 FIGURE 15. FUEL PRICE DIFFERENTIAL, WITH THRESHOLD. 63 US DOT/Volpe Center - vi - FINAL November, 2013 US DOT/Volpe Center - vii - FINAL November, 2013 1. EXECUTIVE SUMMARY This report describes the refreshing of the USTRANSCOM Economic Price Adjustment (EPA) factors for use in the USC-7 contract. The three EPA factors developed by Volpe in 2009 are the starting point for this update, and these are the Bunker Fuel Adjustment Factor (BAF), Currency Adjustment Factor (CAF) and Inland Intermodal Adjustment Factor (FAF). 1 The basis for the development of each factor in 2009 was re-examined as part of the current refresh. This was done through reviewing current industry practices, relevant EPA related literature or articles, and any changes in the general container shipping market (e.g., emission regulations), to determine whether the underlying methodology used to develop the EPA factors in 2009 would need to be revisited. Based on the market review, the methodology used for the CAF and FAF factors was left unchanged. The introduction of the Emission Control Areas (ECAs) meant the BAF methodology had to be revised to incorporate this change in the container shipping market. 1.1. Bunker Fuel Adjustment Factor 1.1.1. Background The introduction of ECAs since the 2009 EPA study represents a significant market change that requires an update of the BAF factor methodology. In particular, the BAF methodology needs to now include a mechanism to capture the effect of the ECAs on carrier fuel costs. Under these emissions regulations carriers are required to burn cleaner, more expensive fuel in protected waters and near ports, but are allowed to burn the cheaper bunker fuel on the open ocean. The US and Europe have imposed ECAs within 200 nautical miles of their shores, in which ships must burn low sulfur fuel. This means the BAF factor must include additional functionality to isolate carrier use of three types of fuel, IFO380 (bunkers), LS380 (low sulfur fuel for use inside an ECA), and MGO (which is typically burned when a container ship is in port), depending upon how much time spent at sea, within an ECA and in port. Additionally, prices may need to be taken from a broader set of worldwide ports to account for any regional price differences. In contrast, the 2009 version of the BAF only accommodated two fuel types from two U.S. ports and did not account for the presence of ECAs. Outside of the adjustment to accommodate the ECAs, the basic structure of the BAF model remained broadly the same as the version developed in 2009, except for some modifications discussed below. 1 US DOT/Volpe Center, Calculation of Bunker Fuel, Currency, and Inland Freight Fuel Price Adjustment Factors for USTRANSCOM Commercial Shipping Contracts, (July 2009). US DOT/Volpe Center -1- FINAL November, 2013