Quarterly Transportation Market Update: Air cargo market continues to face stiff headwinds

The air cargo industry is in a quagmire. In early 2010, the International Air Transport Association (IATA) reported that the industry was realizing its “best year in a decade” despite high fuel costs hovering around $110 a barrel. Today, fuel prices are dramatically lower, but most air cargo carriers continue to be challenged due to the fact that competitors are adding dramatically more capacity. In the meantime, an abundance of airlines from the Middle East are expanding around the globe.

Despite the challenges, the industry has staged a modest comeback over the last year. In August 2015, freight markets stabilized after two months of decline, with total cargo volumes down only 2 percent compared to the end of 2014. “While a sign of stabilization is welcomed news, all is not well in the air cargo industry,” says Tony Tyler, director general and CEO of the International Air Transport Association (IATA). “Even though world trade volumes have slightly picked up, the industry will have to work hard to match 2014.”

Industry experts say that to increase yields, air carriers need to offer better prices and expand their services to sway shippers to utilize more air cargo. Brandon Fried, executive director of the Airforwarders Association, suggests that the current situation provides an opportunity for shippers to urge their forwarders to take advantage of the market situation by negotiating favorable carrier rates on their behalf.

Challenging factors
A number of factors are currently pulling on the air cargo industry’s woes, including weaker than expected global economic growth; a softening of growth in China and emerging markets in Asia and South America; the rebalancing of the Chinese economy toward domestic consumption; and, of course, a strong U.S. dollar. 

“The slowdown in China, combined with the strength of the dollar, has contributed to a drop in air cargo demand,” remarks Fried. Given that China and markets in Asia depend heavily on air cargo to ship some goods—especially electronics and other high value goods—a decrease in demand for air cargo has created a carrier capacity glut in many markets.

IATA statistics now point to the Middle East and Africa as offering the best opportunities for significant air cargo growth in today’s market. The reason is straightforward: More air carriers are operating in those markets, and consumer demand for goods shipped via air freight is up. Dubai-based Emirates SkyCargo finds that while cargo load factors for the industry lag behind passenger numbers, the carrier is experiencing stronger growth than many airlines.

“Emirates SkyCargo continues to outpace the industry with year-over-year revenue up 9 percent for the 2014-2015 financial year,” says Nabil Sultan, senior vice president of the SkyCargo division. He attributes this growth to the carrier’s diverse route network, modern fleet, and new technologies.

“Our extensive network of destinations combined with our fuel-efficient fleet gives us a tremendous advantage,” adds Sultan. “Given that yield is a result of supply and demand, we do have a number of points within our network with high demand from our customers.”

According to Sultan, SkyCargo offers customers access to 147 destinations across six continents, many of which are in the Asia-Pacific region and its home in the Middle East. This year it started service to several new destinations, including Columbus, Bali, Multan, Orlando, and Mashhad. Bamako and Bologna are scheduled to join its network later in the year, with new direct daily service from Dubai to Panama City scheduled to begin in February 2016.

On the equipment side, SkyCargo took delivery of four new aircraft in September, including one Boeing 777F, two Boeing 777-300ERs, and one A380 aircraft. “Today our fleet rests at 239, including 13 freighter-only Boeing 777 aircraft, with an average age of 6.5 years,” adds Sultan.

Top Offender: Overcapacity
IATA research indicates that carriers operating in the Asia-Pacific, Latin America, and North America trade lanes are facing the greatest negative impact of the global economy. “With the continued drop in export orders for Chinese manufacturing, it is hard to say if the decline has bottomed out,” states a recent IATA report.

Latin American airlines report a decline in demand of 7.3 percent year-on-year with capacity expanding 0.8 percent. The large fall reflects the continued economic struggles of Brazil and Argentina, while regional trade activity has not created stronger airfreight demand.

IATA also indicates that North American airlines experienced a decline of 3.3 percent year-on-year while capacity grew 4.4 percent. Airlines in the region have experienced a significant fall in freight tonne kilometers (FTK) volumes since the end of congestion at West Coast ports, according to IATA data. More fundamentally, any improvement in economic performance does not appear to be driving stronger air freight demand.

“We definitely see potential in the Middle East and Africa, but are aware that the big markets—China and the U.S.—exert the strongest influence on how successfully we can fly,” says Michael Goentgens, a spokesman for Lufthansa Cargo. “China and the U.S. are markets where it’s especially difficult now to fly at a profit.”

According to Goentgens, overcapacity—the well-known bane of the industry—further aggravates yields on many routes. “Pressure exists almost everywhere on yields, precisely because of overcapacity,” he states.

The fact that the world economy is not growing in accordance with increased availability of aircraft cargo space is the albatross around air cargo executives’ necks. “Capacity is growing at about 6 percent worldwide, while GDP increases are marginal at 1 percent to 2 percent,” reports Jan Krems, president, United Cargo. “Meanwhile, cheaper fuel has made freighters more economical to operate, and this is making an impact on the balance between growth and available space.”

The culprit, industry experts say, is an enormous number of new aircraft joining carrier fleets. Case in point: Cathay Pacific Airways just took delivery of its 70th Boeing 777 aircraft.  With its fleet also comprising of 53 777-300ERs, 12 777-300s and five 777-200s, Cathay now holds the title of being the largest operator of 777s in Asia.

Airlines are also grabbing up the new fuel-efficient Boeing 777 aircraft that offer very large capacity in their belly holds. “In particular, the B777-300 ERs offer twice as much capacity in terms of volume and tons compared to the Boeing 747-400 passenger aircraft it replaces,” says Jean-Claude Raynaud, spokesman, Air France KLM Martinair Cargo (AFKLMP).

Market adjustments
Air carrier executives do not expect the overcapacity situation to change anytime soon. Most, however, are adjusting business models to include more efficient aircraft with large belly holds.

For example, United improved its performance by replacing less fuel-efficient aircraft, particularly in long-range, high-demand markets. “The Boeing 787 Dreamliner was the first of these new-generation aircraft to join our fleet,” remarks Krems. “United currently has 22 Boeing 787s with 33 more to be delivered, and we also have 35 Airbus A350-1000s and 100 Boeing 737 MAX 9s on order. Deliveries of these two new aircraft begin in 2018.”

Today United flies more than 400 daily departures from its Newark hub to over 150 destinations worldwide. This fall its enhancing service between Newark and Europe.  In May 2016, it will commence nonstop service between its San Francisco hub and Xi’an, China, with 787 Dreamliner aircraft.

“This will be the first trans-Pacific service to Xi’an operated by any airline, and United will be the first U.S. airline to serve the city,” Krems says. Currently, United operates more nonstop U.S.-China flights and flies to more cities in China than any other U.S. airline.

Consequently, Krems reports that the carrier is outperforming the overall market year-over-year. “In a year of little to no cargo growth among major U.S. carriers, the most recent reports show a 6.8 percent increase in United Cargo revenue through June and a 7.4 percent increase in cargo ton miles through August,” he says.

According to Goentgens, Lufthansa Cargo is responding to the market’s capacity issues by being pro-active and practicing “demand-driven” capacity management. “We can adjust our route network very swiftly, adding new routes where required by our customers,” he says. “For example, we operated a seasonal service to Saigon this summer.”
Simultaneously, Lufthansa is investing in products targeted to specific industries. An example is oil and gas where large and heavy spare parts need be flown regularly to specific destinations at short notice. Consequently, the carrier has put in place an oil and gas team that stays in regular contact with customers in the sector. Lufthansa Cargo also added a non-stop connection from Houston to Stavanger, Norway, using 777F aircraft.

“Our new pricing system, to be introduced as of the upcoming winter schedule, will hopefully provide a further boost,” adds Goentgens. “There will only be one surcharge in the future, and that will replace and be much lower than the current surcharges for fuel and security. This will enable us to reduce special processes such as negative rates and will make us more convenient and a lot faster for our customers.”

To further lower costs, the carrier implemented what it calls “Lufthansa Cargo 2020,” a strategy to tackle tomorrow’s challenges today. “Although we have postponed our decision to build a new logistics center in Frankfurt, we are still on track with, or have already successfully implemented, other important pillars,” Goentgens says. These “pillars” consist of five new 777Fs, a partnership with ANA, and a new IT system to be rolled out by the end of the year.

To reduce overcapacity, AFKLMP began to downsize its freighter fleet a few years ago. The effort has been completed in Paris and will terminate in Amsterdam in Summer 2016. “Our full freighter fleet will be re-scaled to a final number of five, including two 777F based in Paris and three 747-400 ERF (KL-MP Cargo) based in Amsterdam,” Raynaud explains.
“We’re also sticking to our policy of loading primarily the belly holds of our passenger aircraft first.”

Partnerships to gain momentum
AFKLMP is also continuing to form partnerships with other carriers, much akin to how ocean carriers are trending toward alliances. A recent example is the interlining special pro-rate agreement (SPA) AFKLMP signed in September with China Southern, also a member of SkyTeam Cargo.

The SPA offers a combination of wide-body and main-deck capacity on the Europe-China leg and access to an extensive network of unique destinations from their respective hubs. AFKLMP will serve the main cities in Australia and supply main-deck capacity to Hanoi or Ho Chi Minh from the China Southern Cargo hub at Guangzhou.

Paris-Charles de Gaulle or Amsterdam Schiphol will provide China Southern Cargo with access to capacity to the North and South Atlantic markets—including Atlanta, Miami, Sao Paulo, and Buenos Aires—as well as capacity to Africa, with both European hubs serving Lagos.

“Apart from competition existing between airlines on a regular and everyday basis, air cargo carriers also face competition from sea freight, which should in no way be underestimated,” Raynaud adds. “Sea transportation has improved in terms of quality and speed, and now it’s imperative that air carriers need to maintain and step up the quality service in air cargo.”