Heavy going for all-cargo airlines Jul/Aug 2014

The global recession that started in 2008 clearly depressed air cargo demand more than passenger demand, and high fuel prices have added to the industry’s problems. But with most major economies around the world now recovering, it would be reasonable to assume that the air cargo market would turn up in parallel. However, that isn’t proving to be the case, and more fundamental changes to the structure of the market appear to be taking place.

According to IATA the twin drivers of weak demand and increased belly capacity on passenger aircraft meant that air cargo industry’s yield fell in 2013 for the third year in succession. Air cargo tonnage increased by less than 1.1m tons between 2010 and 2013 – but revenue decreased by 10.4%, to $67bn, over the same period.

Tony Tyler, IATA's CEO and Director General, said that: "2013 was a tough year for cargo. While we saw some improvement in demand from the second half of the year, we can still expect that 2014 will be a challenging year. World trade continues to expand more rapidly than demand for air cargo. Trade itself is suffering from increasing protectionist measures by governments. And the relative good fortunes of passenger markets compared to cargo make it difficult for airlines to match capacity to demand."

Boeing’s biennial World Air Cargo forecast was last published in 2012, but even then the manufacturer noted: “More worrisome is the slowing long-term growth trend. Since 2001, world air cargo traffic has only grown 3.7% per year. The global economic downturn, rising fuel prices, and improving surface transport mode options have dampened air cargo growth”. However it added that “On the other hand, long-term projected economic and international trade growth, the continuing globalization of industry, increasing adoption of inventory-reduction strategies, and ongoing renewal of the world freighter fleet with more efficient capacity should help world air cargo traffic growth return to a rate closer to historic norms.”

In that report Boeing observed that freight yields have declined at an average rate of 4.2% per year over the past 20 years, although it points out that “the most recent decade saw a slight yield increase of 0.9% per year, compared to the 9.0% average annual decline recorded in the preceding decade”.

Airbus’s latest Freight Forecast was published more recently, in October 2013, and stated: “There is no disguising the difficulties faced by freight carriers in recent years. On a worldwide basis, freight traffic growth has been impacted in the years following the global financial crisis that struck in 2008, and this has very clearly affected air freight. These recent difficulties, combined with pressure from other modes of transport have caused some to question whether there has been a longer-term shift away from air freight.”

On the other hand, even with a relatively small volume share of the global cargo market (and even if it is shrinking), the value share of air cargo is substantial – estimated at around 30% of the value of all cargo transported. And though weak, overall cargo demand is still growing. Today 35% of goods produced across the globe cross national borders (compared with 20% in 1990), according to a report by MGI, which adds that the flow of goods internationally has now recovered from the global recession and is higher than its pre-recession peak of 2007.

However, the MGI report adds that the direction of the trade in goods internationally is shifting, and that “emerging economies now account for 40% of goods flows, and 60% of those go to other emerging economies — so-called South-South trade”. In fact South-South trade has quadrupled its share of the global goods trade since 1990 (see chart above), and that share is of a sharply growing overall market in global goods; the market was worth $3.3 trillion in 1990, but increased to $17.5 trillion in 2012.

This has major implications for airlines, and signals a need to develop freight routes into these emerging economies. But at the same time as a shift in where international trade is occurring, there is also a shift as to just how goods are being transported internationally, with air cargo starting to see the effects of a “mode shift” — a switch away from air to surface transport.

Modal shift to sea

An analysis by Seabury presented at the IATA World Cargo Symposium held in March this year revealed that the “market share” of air has dropped from approximately 3% of total international containerized trade in 2000 to around 1.7% in 2013, with average annual growth in ocean trade over the 2000 to 2013 period of 7.4% significantly exceeding growth in air shipments over the same period, of 2.6%.

However, Seabury says the underlying cause of this loss of market share for air shipment was only partly due to the mode shift; there were two other factors.

First, there is a “commodity mix effect”, with higher growth of products that are typically shipped by sea versus those that are shipped by air; an example of this is higher growth of ‘raw material’ commodities.

Second, there is also a “value effect”, with higher growth of cheaper products, which typically require cheaper sea freight — such as higher demand for ‘low-end T-shirts’ manufactured in China and sold in western Europe by discount retailers.

But even stripping out the effects of commodity mix and value, the modal shift is still significant, and it occurs across all product groups. The four biggest shifts from air to oceanic cargo (excluding commodity mix and value effects) over the 2000 to 2013 period have been in high technology goods, fashion goods, perishables and raw materials.

Fred Smith, CEO of FedEx, points out that a unique factor in the air cargo sector is the miniaturization of electronics which represents about half of all tonnage transported by air. He says: “Not only is there less weight being transported, but price reductions driven by technology have reduced the value-per-pound. New product introductions that require large main-deck freighters have slowed considerably as the market for electronic devices has been satiated.”

This shift from air to ship cargo is more prevalent on certain routes, particularly intra-Asia, Transpacific (from Asia to the Americas) and from Asia to Europe. The link between all these markets is Asia, which clearly is growing in importance in world trade, and yet routes to, from and within the region are switching more and more cargo from air transport to ocean shipping.

The battle for air cargo

Given these structural challenges, what are the implications for air cargo carriers? As can be seen in the chart opposite, the top two cargo airlines in 2013 (by total scheduled freight tonne km carried) were the two so-called “integrators” — FedEx and UPS, which between them carried almost a third of all freight carried by the top 10 carriers.

Those statistics though are skewed by the fact that Fedex and UPS have huge businesses in the US, and if this is taken out (so as to consider international freight only), these integrators fall down the ranking (though they are still substantial international freight carriers — see chart above). But the leading international freight carrier is Emirates; and Cargolux is the only all-cargo airline in the top global freight carriers (see Aviation Strategy, June 2014 for a profile).

Many cargo analysts believe that the all-cargo airlines will not survive the challenge from Emirates and others, with one saying: “There is so much passenger belly hold capacity that freighter operators are having to compete on price, which is hurting their yields. Load factors at the moment are relatively good – sales are not a problem; it’s price that is the issue.”

Certainly more efficient, modern aircraft, such as the 777-8/9, 787 and A350 not only have belly capacity but are operated on origin and destination long-haul routes – often into Asia, which is a direct threat to all-cargo carriers.

While demand for air cargo is increasing (albeit slowly) year-on-year, it’s not rising as fast as the growth in passenger aircraft capacity, thanks partly to huge order from the Gulf’s super-connectors (see Aviation Strategy, November and December 2013, and February 2014). Between them, Emirates, Qatar and Etihad have 504 widebody aircraft on order, and of course these passenger aircraft will arrive with an equivalent uplift in belly capacity.

Looking at the current Airbus and Boeing order book, there are 2,648 widebody passenger aircraft on firm order, with one analyst estimating they will offer the same capacity as around 520 777Fs. That’s substantially larger than the outstanding firm orders for 120 dedicated freighter aircraft from Airbus and Boeing.

Airbus forecasts that the dedicated freighter fleet will grow from 1,645 as at the beginning of 2013 to 2,905 by 2032, with more than 870 new-build freighters being required over the next two decades, plus another 1,859 passenger aircraft being converted into cargo carriers. For its part Boeing predicts that the freighter fleet will increase from 1,738 as of 2011 to 2,198 as at 2031, with 935 new production aircraft and 1,819 freighter aircraft converted from passenger models.

Chance to survive?

All this spells trouble for the pure all-cargo airlines. Some are responding by retiring or parking older freighters that are no longer fuel efficient, but others are taking a more drastic option. Evergreen International Airlines, for example, was an Oregon-based all-cargo specialist that was established back in 1975 and which operated a fleet of 24 747s until it ceased operations in December 2013, after the cargo market became tougher and the company found it difficult to service its large debts.

What else can the all-cargo carriers do to avoid demise? One answer may be to partner with passenger airlines, though the major global carriers will have little if no need to add what may be marginal freight capacity compared with their existing belly hold. Alliances with medium-sized passenger airlines are potentially more feasible, with all-cargo carriers adding dedicated onwards cargo capacity into key trading zones as extension of passenger routes.

Worryingly, surveys of freight forwarders identify price as the only sure way that air cargo can reverse its share of overall cargo carried, and that’s the one area to which all-cargo carriers are most vulnerable, since freight is their only revenue stream. The massive passenger airlines, however, are more flexible in the rates they will take in order to fill their belly holds (though of course in public they say they maintain the highest possible freight rates).

In March this year Des Vertannes, IATA's global head of cargo, said that one way the air cargo industry could fight back against the encroachment of ocean transport is by reducing average end-to-end transit times significantly; the average end-to-end transit time for air shipments is between six to seven days, and according to historical data that transit time has stayed the same since the 1960s.

Faster transit "would really make a difference to our value proposition; faster delivery times, coupled with competitive quality benchmarking and more efficient processes, will enable air cargo to compete and win new business." He added that he was certain the industry could meet that goal by the end of the decade — but that’s a relatively long timeframe for a sector under such pressure.