Air Cargo Braces For a Slow Down
With slowing demand and rising fuel putting a damper on revenue, today's smart air carriers are adding fuel-efficient freighters and optimizing route capacity to prepare for the inevitable global upswing.
By Karen E. Thuermer -- Logistics Management, 11/1/2008
Let's cut right to the chase: The prospects for the air cargo industry seem to be all doom and gloom at this stage in the game. Why? Well, it can all be boiled down to slowing demand and high oil prices.
A revised industry financial forecast released by the International Air Transport Association (IATA) in September predicts airlines to post losses of $5.2 billion in 2008 based on an average crude oil price of $113 per barrel ($140 for jet fuel). “The situation remains bleak,” says Giovanni Bisignani, IATA's director general and CEO. “The toxic combination of high oil prices and falling demand continues to poison the industry's profitability.”
In fact, more airlines have gone bust in 2008 than in the aftermath of 9/11.
“A few years ago fuel made up 15 percent to 20 percent of total costs. Today some carriers now face costs of about 30 percent to 35 percent—depending on the aircraft they use,” adds Nils Haupt, Lufthansa Cargo AG spokesman.
Based on a market price for oil of $120 per barrel, British Airways' reports that its total fuel costs are set to rise by around £1 billion this financial year. “Indeed the current price is actually higher than this,” says David Shepherd, British Airways World Cargo (BAWC) senior vice president Europe and the Americas.
When all is totaled, fuel is expected to contribute 36 percent to rising operating costs for 2008, up from 13 percent in 2002. And of that $5.2 billion that the IATA expects the global airline industry to lose in 2008, $5 billion of that is North American airlines—making them the hardest hit by this industry crisis, while profits for carriers in the Asia-Pacific will shrink from $900 million in 2007 to $300 million this year. IATA predicts European carriers' profits to tumble seven-fold from $2.1 billion in 2007 to $300 million in 2008, and those in the Middle East to drop by $100 million to $200 million. Latin American and African carriers' losses will deepen to $300 million and $700 million, respectively.
Managing through the storm
It's safe to say that the escalating cost of fuel has had a negative impact on just about every single aspect of the air cargo industry. But that's not the only problem air carriers are facing these days. Eroding financial markets, particularly in the United States, and the threat of recession is having a major impact on the number of flights and routes air carriers offer today. Even high flying Middle East carriers are feeling the pinch.
“Slacking customer demand and modal erosion in some traffic lanes has been quite noticeable,” comments Ram Menen, Emirates divisional senior vice president of cargo. In fact, adds Menen, the impact of the weaker market conditions mainly driven by the low U.S. dollar parity, the sub-prime crisis in the U.S., and the high cost of energy have created a perfect storm scenario. “Our business is very reliant on the health of the world economy,” he says. “But, by managing the downturn, we are on track with what we had forecasted.”
Part of Emirates' management scheme has been to rationalize capacity according to demand by downsizing some routes and adding capacity on others. Consequently, its China/Dubai and European capacity remain status quo. Menen adds that the carrier's African routes have been adjusted and freighter capacity added on the Lagos route. “India also has seen a double digit increase in capacity via increased passenger belly capacity,” he says.
Last year, Emirates suspended its freighter operation into JFK because of severe cargo imbalances and pressure on yields, but added an extra service to Toledo, Ohio, that doubled its capacity on that route.
Likewise, AF-KLM Cargo is scaling down its planned rate of capacity growth for the next winter. Its capacity is expected to grow by 2 percent instead of 4 percent and it's consolidating operations by moving its U.S. activities under the same roof.
Northwest Airlines is canceling international passenger flights between Detroit and Dusseldorf, Germany, and Hartford, Conn., and Amsterdam and is temporarily suspending flights between Minneapolis/St Paul and Paris.
Delta Airlines is revamping its cargo business by pairing back its unprofitable domestic flights and growing its international network. In early June, for example, Delta launched nine new flights across the Atlantic.
“These are the flights for which customers are willing to pay and flights that continue to generate an operating margin,” says Neel Shah, Delta vice president of air cargo. In addition, Shah adds that Delta—like many others—is cultivating recession-proof customers such as pharmaceuticals and perishables by building a $14 million warehouse at its Atlanta hub.
Carriers are also pumping up value-added services to help contribute to slacking revenues. American Airlines (AA) Cargo, for example, is expanding its express freight product, Expeditefs, guarantee to include its truck feeder service. “By making this expansion, AA Cargo enhances its ability to provide customers priority boarding and faster hub connections to any of the more than 250 AA Cargo destinations on four continents,” says Carl Frey, manager of AA Cargo's Operations Center.
United Cargo also recently expanded its U.S. to Europe offering by introducing a temperature-controlled product with selected partners. “The startup of this service has been very successful, and we will be expanding it in the third and fourth quarters of 2008 and throughout 2009,” says Kyle Betterton, vice president, United Cargo.
Paradigm shift
In short, the industry is undergoing a paradigm shift. “The old rules don't apply any more and the new rules are not yet written,” Menen says.
In fact, IATA predicts that for 2008 freight volumes will only grow 1.8 percent, half the pace of expansion seen in 2007. And the difficult times are expected to continue into 2009. “While we expect the bottom line to improve by about $1 billion next year, the industry will be $4.1 billion in the red next year,” calculates Bisignani. “This crisis is re-shaping the industry in more severe ways than the demand shocks of SARS or 9-11.”
To build network strength and revenues, the industry is seeing a wrath of mergers such as the one between Delta and Northwest Airlines (NW), which is nearly complete. “From a network standpoint, this merger will be phenomenal,” says Shah. “It will marry Delta's strong Latin America, Middle East, and Europe service to Northwest's strengthens in Asia.”
It will also create a four-way joint venture with SkyTeam member Air France-KLM and make it easier for Air France and KLM customers to select routes across the Atlantic from Paris and Amsterdam given the geographically dispersed hubs a combined Delta-NW network will offer. A strong hub system is critical to carrier operations since it allows them to cover more regions while more effectively and efficiently utilizing equipment. “Today it's better than being a point-to-point carrier,” says Michael Wisbrun, chairman joint cargo management committee, Air France-KLM Cargo (AF-KLM Cargo). “It focuses you on only one system.”
AF-KLM Cargo is currently seeking full control of Amsterdam-based Martinair and has started lobbying the European Commission to obtain clearance for a 100 percent holding. Martinair is owned jointly by KLM and Danish shipping group Moeller-Maersk.
“We want to strengthen our basis,” Wisbrun emphasizes. “Martinair can integrate and bring better profitability to our customers.”
That's the same reason airlines are forming joint cargo ventures like that signed on June 2 between AF-KLM Cargo and China Southern.
“If we are successful, we will get closer to what could open the door to creating a separate airline,” Wisbrun says. The new airline, to be called AE (Asia Europe) and based out of Guangzhou, would fly intra-Asia, between China and the U.S., and between China and Europe, and have its own aircraft.
Similarly, Lufthansa teamed up with Deutsche Post's DHL Express to form AeroLogic. The new company will commence operations in April 2009 and be based in Leipzig, Germany. With a price tag of around $22 million, AeroLogic is estimated to generate annual revenues of some $770 million starting in 2011. The cornerstone to its operation will be its eventual fleet of 11 Boeing 777-200 long range freighters.
Staying airborne
Fuel efficient fleets of aircraft are also critical for airlines to weather the industry's current stormy climate. This year Continental took delivery of 30 new advanced technology 737-900er/800s, that carry three more tons of cargo than the older less fuel efficient 737 Classics. While Continental reduced passenger capacity 6.7 percent this fall, its new planes actually increased cargo capacity.
“We have the newest jet fleet among U.S. major network carriers,” states Tony Randgaard, Continental Airline's manager of cargo marketing. “We haven't reduced our wide cabin cargo capacity one bit.”
BAWC has ordered six new Boeing 777-300ER aircraft for delivery beginning in 2010. “They are 23 percent more fuel efficient than the Boeing 747-400 and give us additional flexibility in the long-haul fleet,” says Adam Carson, senior manager revenue management, BAWC.
In October, Air France (AF), which operates one of Europe's youngest aircraft fleets, is launching three 777 freighters out of Paris (CDG). Meanwhile, Emirates has phased out its lone B747-200F and accelerated the phase-out of its three A310-300Fs. “We will be inducting new B777F capacity in six months and a couple of B747-8Fs in 16 months,” reveals Menen. “This will give us the expansion capacity when the market picks up.” This will also give Emirates the position of running the most cost-efficient and environmentally-friendly cargo capacity in the years to come—important factors as the industry makes its way through its “market correction” period. “And the market is bottoming out,” Menen adds.
If Menen is correct, the industry should start to see positive movements with market conditions and improvements within the next 12 months.
“The current downward trend in oil prices and the strengthening of the U.S. dollar against the Euro are good signs,” observes Menen. “The current turmoil in the U.S. stock market will further clean up and eventually strengthen and help further redefine the market fundamentals to firmly adjust to the 21st century realities.”
Supply chain fundamentals should also be adjusted at that time, as air cargo once again becomes a part of strategic logistics operations—then longer term growth of the industry should get a further boost.
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