Focus: The cargo barometer

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A sharp first half recovery has put the air cargo business back to pre-crisis levels. But can it last, and has confidence in freighter operations been dented, questions Peter Conway in London

At the start of this year, 86% of top air cargo executives thought it would be at least two years before business returned to pre-downturn levels of 2007-08, according to a survey by consultancy Oliver Wyman. But there has been some rapid revision of opinions since then.

Niko Herrmann, a partner with the firm, says in May cargo traffic was 6-7% up on November 2007, the previous peak month, while IATA put cargo traffic in May and June at 6% above the same months in 2008. These figures put volumes back above pre-recession levels, after a 27.5% year-on-year rise in traffic in the first seven months of 2010.

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 ©Rex Features
Both organisations have been surprised by the strength of the recovery, sentiments echoed by cargo executives. Neel Shah, vice-president cargo for Delta Air Lines, reports that July was its best revenue month of the year so far - it is normally a slack time for cargo - and Carsten Spohr, chairman of Lufthansa Cargo, has gone from expecting a slow recovery in 2010 to predicting that it might be one of the carrier's better years. Everywhere, it seems, cargo managers are breathing a sigh of relief.

But can the recovery last, or are volumes about to take a downward turn again? Pessimists might point to the fact that, in July, IATA recorded traffic just 4% above 2008 levels, but whether this is a blip or the start of a downward trend remains to be seen. A major worry is that the recovery so far has almost certainly been driven by inventory replenishment by importers and retailers - just as the 20% fall in cargo traffic in the first half of 2009 was caused by a massive inventory overhang.

Brian Pearce, IATA chief economist, points out that now inventories are back to more normal levels, it does not mean cargo growth will stop, only that it will grow in line with consumer spending or industrial output. And whether either of those will continue to grow in the coming months is a macroeconomic question, not an aviation one.

The arguments have moved back and forwards across the world's newspapers in recent months. Are Chinese exports slowing? Will debt, foreclosures and unemployment cause US consumers to stop spending? Can the surprising German export recovery continue?

Anecdotally, carriers say they have seen little weakness of this kind, although some do point to isolated blips in a generally good picture. Shah from Delta says some airlines have reported a slowing in the key Shanghai market, but James Woodrow, general manager cargo sales and marketing at Cathay Pacific, says demand remains robust out of both Shanghai and Hong Kong. Woodrow also points to strong demand out of Japan in the normally slack month of August, and cites India and Latin America as other hotspots.

Most managers expect the coming August- November peak season to be a good one too, although perhaps not quite as good as the one last year, which marked the start of the recovery. But some are more bullish.

"When the world comes out of recession, demand spikes and so air is favoured," says Ram Menen, divisional senior vice-president cargo for Emirates. "There has been a little hesitation in the European market, but we are still very happy with the way it has bounced back. I think the fourth-quarter peak season will be very good, with a capacity crunch before the end of the year."

While traffic is back to pre-crisis levels, the same is not yet true of yields, which dipped as much as 40% for some carriers during the first half of 2009. Airlines report excellent progress since, but that has not stopped them pushing for further price increases as the peak approaches, with Lufthansa announcing an average 20% across the board rise in rates from October. Delta, too, is hoping to "make up ground" with October increases, especially in the US market.

CAPACITY CONTROL

In the first half, IATA shows capacity consistently growing only half as much as traffic in all global markets, even in booming ones such as Asia and the Middle East, helping push along the yield improvement.

A key reason for this is the number of freighters that were parked or retired during the downturn - 10% of the total global fleet, according to Boeing. A significant chunk of these were older, gas-guzzling aircraft such as 747-200s or even aged 727 freighters, which are not expected to return to service.

Cargo managers also believe - or at least, hope - the crisis has made carriers more professional. "This downturn has separated the boys from the men," says Spohr at Lufthansa Cargo. "It is now harder to open up a cargo airline, and that is something this industry badly needed. In the past it has been too easy to get into the freighter business."

It also helps that on the passenger side carriers have been cautious about bringing capacity back, ensuring that belly capacity growth for cargo is kept in check. "I think that carriers have really learned their lesson this time and are much more disciplined," says Shah. "At Delta we are being really conservative and will have just 1% growth in passenger capacity next year."

Most in the industry expect this capacity virtue to continue for at least a year or so. Thomas Crabtree, regional director, airline market analysis at Boeing, highlights that the airframer has only had orders for five freighters since the start of the downturn - four 777Fs from FedEx and one from Etihad - both placed earlier this year. "Everyone is shy of jumping in, but then it usually takes a year after the recovery for that to happen," he says.

Meanwhile, the freighter conversion market is moribund. There is no finance available in today's newly cautious investment environment for older aircraft, which have limited service lives. The number of 747-400 freighter conversions parked during the downturn has also given carriers pause, though many have now returned to service.

In the longer term, will all this capacity restraint continue? Has there even been a change in attitude among airlines towards freighters, with an increased caution about investing in them? On the face of it there is plenty of evidence that there has. Air France-KLM sharply downsized its freighter fleet during the downturn, selling two of the five 777Fs it ordered to FedEx and parking four 747-400 conversions operated by Martinair, now part of the Air France-KLM Group. Two 747-400ERFs have also been leased out.

Also in 2009 Delta ditched the last of 14 747-200Fs operated by Northwest Airlines and Japan Airlines ended its 50-year history as a freighter operator at the start of October. Meanwhile, a string of independent cargo operators have ceased operations, including Cargo B of Belgium, UK-based MK Airlines and Arrow Air of Miami.

It is tempting to see this as the freighter business in retreat, especially as Air France-KLM openly says its decision was motivated by the desire to restore yields and to make the most of the belly capacity of new long-haul passenger aircraft such as the 777-300. But Pierre Olivier Bandet, Air France-KLM Cargo's senior vice-president marketing, revenue management and network, says it is too simplistic to see this as a rejection of freighters.

CUTBACK CHOICES

"Given the fall in the market we had to cut capacity, and because belly and combi capacity was not in our control, freighters had to play a dominant role," he says. But he stresses some opportunities need dedicated freighters and rejects the idea that Air France-KLM is planning to exit the business, or even confine its freighter operations to Martinair.

Similarly, the Northwest freighters were a special case, says Neel Shah. "They had run their useful life and we would have had to spend tens of millions on heavy checks and engines, and we didn't see a payback on that. It was the fact that Northwest didn't embark on a fleet renewal strategy five or six years ago that sealed the fate of these freighters."

But Shah's relief at not having the freighters is obvious. "I don't reject the decision for a minute," he says. "Getting rid of the freighters has probably added $200 million to Delta's net income this year. You have to be disciplined about these decisions and take the emotion out of them." Shah has no inherent objection to freighters and does not rule out Delta getting back into them in a few years, if there is an economic case. He cites the example of British Airways, which announced in July that it would be replacing its three leased 747-400 freighters with larger 747-8s in 2011.

Jude Winstanley, head of network and freighters for British Airways World Cargo, says that freighters make sound economic sense, because by feeding cargo from Asia to Heathrow they enable it to get better yields on its transatlantic belly capacity. "If you took the freighters away, yields on the rest of our belly network would decline, in some cases quite significantly," he says.

Ram Menen at Emirates agrees, seeing freighters as the best way to maximise belly yields on his carrier's rapidly expanding passenger fleets. The size of that expansion means he ultimately expects to make use of 10 747-8Fs and eight 777Fs ordered on behalf of Emirates by Dubai Aerospace.

Nor are these the only carriers expressing faith in the future of freighters. Cathay Pacific has 10 747-8Fs on order and Korean Air five, while Malaysian Airlines upgraded its fleet of four leased 747-200Fs in May with three 747-400Fs from Southern Air. The carrier also said in late March that it would buy two Airbus A330-200Fs. "At Cathay, we firmly believe that having freighters and belly capacity provides us with a competitive advantage," says Woodrow. "The investment case for 10 747-8 freighters may be harder to make due to their cost, but they will increase our capacity into key markets and allow us to maximise the geographical position and advantage of our Hong Kong hub."

PASS IT ON

Freighters that Air France-KLM downsized have found willing users. Two of its parked 747-400 conversions went to German independent, Air Cargo Germany, which has survived its first year of operations despite launching in the teeth of the downturn.

Another two went to AirBridge Cargo, the scheduled freighter arm of Russia's Volga-Dnepr Group, which also leased the two Air France 747-400ERFs. It has been busy adding routes across Europe in the past year, with Wolfgang Meier, its executive senior vice-president sales and marketing, saying the Russian market and its position astride Europe-Asia routes give it plenty of scope to grow.

AirBridge may be something of an exception among the cargo independents, however, as it is well-financed with a unique geographical advantage. As Spohr at Lufthansa suggests, there is a sense among industry observers that one effect of the downturn may be to squeeze the independents in the future and instead favour fewer larger operators with better access to finance. Whereas there was once a multiplicity of freighter operators, many using old converted freighters with low capital costs, now higher fuel prices and the shortage of finance for older aircraft is forcing carriers that want to stay in the cargo business to focus on newer equipment.

Crabtree at Boeing certainly thinks he has detected such a trend in the past three years, and admits that in Boeing's 2010 fleet forecast it downgraded the predicted number of freighter conversions as a result. Niko Herrmann also sees the emergence of fewer, stronger cargo players in future, with the nascent merged national cargo carrier of China being a prime example.

As well as lower operating costs and higher utilisation rates, newer freighters also have the advantage of commonality with passenger fleets, something that seems to have helped both the 777F and the A330F. Otherwise it is hard to imagine that Etihad would have bought two A330Fs and one 777F, as it did earlier this year, or Qatar Airways two 777Fs. Meanwhile, the 747-8, which has not attracted many passenger orders, is likely to remain popular as a cargo aircraft because of such unique capabilities as its nose door, and its sheer size, with a payload of up to 130t.

One last factor that could influence freighter uptake is the availability of belly capacity, but there seems to be consensus that this will not change radically as a proportion of cargo capacity in years to come. At Lufthansa, Spohr points out that for every 777-300 that acts like a daily freighter with its generous 25t of belly capacity, there are Airbus A380s or long-range Airbus A340s and 777s that have sharply reduced belly loads.

"For this reason, I do not think belly cargo will take share from freighters as some others seem to believe," he says. This view is supported by Ram Menen, despite the huge passenger aircraft orders at Emirates. "Freighters will remain at 30-40% of our cargo capacity. Particularly as we fly longer routes with passenger planes, we will need freighters to take care of the belly capacity we lose."