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China concern: shine wears off air cargo's most important market

Slowing growth and overcapacity have taken the shine off air cargo's most important market in recent months. But is it a temporary glitch or a worrying sign of things to come?

Air cargo growth faltered in the first half of 2007, a fact that seemed to catch the sector by surprise. But was this just a blip? And has the air cargo industry only got itself to blame?

Looking at the figures, several interesting things emerge. One is that although anecdotally most airline cargo managers say the slowdown started in February, the statistics suggest an earlier beginning.

IATA figures show that the rot set in last October. Cargo capacity continued to grow at twice traffic levels throughout the slowdown, but throughout the period cargo lagged behind the passenger business. This represents an inversion of the conventional wisdom of the long-term Airbus and Boeing forecasts.

Arend de Jong
"If an important market like China slows down, we feel it in our results"
Arend De Jong, Senior vice-president of marketing and networks, Air France-KLM Cargo
Regional breakdowns of figures from three regional carrier organisations - the Air Transport Association, the Association of Asia Pacific Airlines and the Association of European Airlines - show that it was Asia, in recent years the powerhouse of growth for air cargo, that led the slowdown, and that European and US carriers suffered more on these routes than their Asian counterparts.

However, Asian carriers were not immune to the downturn. For instance, SIA Cargo, the cargo arm of Singapore Airlines, said in May the cargo outlook was "challenging", reporting growth of just 1.5% in traffic in the year to March, and a 77% fall in cargo earnings.

The newly combined Cathay Pacific and Dragonair cargo operations saw an 8.7% rise in cargo tonnage in the first half, but an 8.3% drop in yields. Hong Kong Air Cargo Terminals, the leading cargo handler at Hong Kong Airport, saw growth of less than 1% in the first quarter, blaming falling exports.

China seems to have had a large part to play in the slowdown, although it is hard to disentangle the effect of slowing growth and overcapacity - or indeed distinguish how much of the slower growth in neighbouring markets such as Korea or Taiwan was due to a fall in transit traffic out of China. The consensus from carriers seems to be that while the market out of China still grew in the first half, the rate of growth slackened to just a few percent, and the sheer volume of new capacity flooding in far outstripped the rise in demand.

This has hit home because in recent years outbound cargo from China has been driving profits at many carriers. Freighters out of China were easy to fill and at generous rates of $3 a kilo and above. This made up for weaker demand into China, as well as for maturity in other markets. Some estimate that China has provided as much as a third of air freight growth in recent years, and certainly most of the leading airports that showed strong growth in 2006 were associated with China (see top 50 cargo airport ranking p48).

But in May there were reports of spot rates as low as $1.80 a kilo, and even established carriers report trouble filling their aircraft. "Everyone has been used to the fact that operating a freighter from China meant it would be fully booked immediately. That is no longer true," said Carsten Spohr, chairman of Lufthansa Cargo.

Arend de Jong, senior vice-president of marketing and networks at Air France-KLM Cargo, admits that with about 50% of its total capacity deployed to and from Asia, the fall in yields out of China and related markets in Asia can't help but impact overall cargo earnings. "If an important market like China slows down, we feel it in our results," he says.

So why is growth slowing out of China, even as its economy booms? Korean Air, the world's largest non-express cargo carrier, which relies increasingly on Chinese transit cargo, believes the cause is intense price competition among China's new manufacturers.

"Industry, and especially the electronics industry, is deep in competition on both price and quality, and squeezes every possible saving out of the process," says Ken Choi, president of Korean Air Cargo.

Sea freight fights back

This has caused a shift to sea freight, though how permanent this will be is open to question (see p36). The lack of any hot new electronic product this year, and the rise in manufacturing wages, could also be factors.

The problem for carriers, however, is that China is a market they just can't afford to ignore. A few carriers have trimmed capacity - British Airways and Lufthansa have both reduced freighter frequencies slightly in the past year, and Air Canada abandoned its Boeing MD-11 freighter service to China. But for most major carriers, China is too strategic a market to leave. So the tendency is, as Choi likes to put it, to counter stiffer headwinds by pedalling harder.

Certainly Korean is continuing with its plans to start Grandstar, a joint venture cargo airline with Chinese forwarder Sinotrans in December, and is adding three 747-400 freighters to its own fleet this year. It also ordered five 747-8s and five 777 freighters at the end of last year, on top of an existing large 747-400 freighter conversion programme. Not all of this capacity will be deployed on direct or indirect China traffic, but it is a key focus of expansion for the carrier.

Cathay Pacific also added its sixth converted 747-400 freighter in July and deployed it on transpacific service. It has two more to come, plus six 747-400ER freighters, which it has ordered new from Boeing for delivery from next May. Meanwhile, there is no doubt a freighter service to China continues to be the badge of respectability for a whole raft of other carriers worldwide.

At the same time, Chinese carriers have also been pushing for a greater share of their country's cargo traffic. Air China and China Cargo Airlines have both started new freighter routes to Europe in the past year, while new entrants such as Great Wall Airlines, Jade Cargo, Shanghai Airlines and Yangtze River Express have branched out into long-haul routes, and have ambitious further plans.

Yield pressures

Ron Mathison, director and general manager at Cathay Pacific Cargo admits this has led to a "land grab mentality" which has caused the sharp reductions in yields. But he believes this will give way to "more rational and commercially minded pricing and capacity development" as the market matures.

The good news from Air France-KLM's point of view is that it did spot an upturn in the Chinese market from June onwards - an observation supported by statistics from IATA and the airline organisations. De Jong even says tonnage in late August was equal to that at the height of last year's peak in October.

Northwest too points to some signs of recovery in July and August, but says the results are only modest. Bad news for de Jong, however, is that yields out of China have not recovered along with volumes, and are down 5-10% at least. And Lufthansa Cargo said in September that it saw no signs of recovery.

The big question is: will a strong peak season out of China in the remaining months of this year put global air cargo growth back on track, and how will other macro-economic trends play out? Fuel prices remain at record levels, there are some signs of US economic growth faltering, and while the low dollar is stimulating US exports, it could throttle European export recovery.

This has been providing some consolation for Asian and European carriers flying into Asia in recent months, with several carriers reporting that Chinese consumers are developing a growing taste for luxury European goods. This trend could go some way to addressing the heavy imbalance in cargo traffic between China and Europe, which leaves carriers dependent on east-bound loads for round-trip profitability. But can it survive the strengthening euro?

And will overcapacity prove a temporary problem, or is it a growing long-term trend? It is certainly one that is not only confined to China. One interesting effect of the fuel price rises in the past two years has been a rush of orders for more fuel-efficient new and next generation freighters - in particular the 777-200LRF and 747-8, but also the newly launched A330-200 freighter. Even Boeing admits this trend caught it by surprise.

Start-ups grab 747-200s

Even before these new freighters are delivered, major carriers such as Air France and Nippon Cargo Airlines have been rushing to retire their gas-guzzling 747-200 freighters. These aircraft have not disappeared from the market, but have instead been snapped up by start-up carriers. This is true particularly in Europe where Ocean Airlines of Italy and Cargo B of Belgium have queued up to find a new home for Air France's retiring 747-200 freighter fleet.

The established carriers in both Europe and Asia are clearly betting that some of these new airlines, along with some of the Chinese start-ups, will turn out to be unsustainable. "Some players are just buying into markets, but in the long-term an airline must cover its costs to succeed, and this will eliminate certain players in the future," says Lufthansa Cargo. "Apart from lower capital costs for their aircraft, it is difficult to see what advantage these new entrants have on direct operating expenses," adds de Jong.

Both Air France-KLM Cargo and Lufthansa Cargo also talk of focusing on quality and reliability, hoping that better service will win in the end. But in general, it seems, they and other established carriers must just hunker down and hope the winds of competition don't blow too fiercely for too long.

Cargo security scare averted

The industry faced its worst nightmare in the summer, when a new US security law mandated the physical screening of all cargo on passenger aircraft within three years.

Ever since September 2001 the air cargo industry has warned that such a measure could potentially stifle the sector. To prevent this, it has been carefully educating the US Congress and the Transportation Security Administration in the virtues of the so-called "layered approach". This involves not screening cargo from known shippers, and instead focusing physical inspection on freight from unknown shippers.

But this did not satisfy certain US lawmakers, who saw no reason why cargo should not be 100% scanned, just like passenger baggage. This, however, ignores the fact that cargo is denser, more complex and harder to screen than passenger baggage, and scanners powerful enough to screen full pallets are slow and expensive. The new law raised the spectre of cargo having to be supplied to airlines loose, which would add heavily to lead times at airports.

However, assiduous industry lobbying led to the insertion of a clause to say cargo screening "may include a programme to certify the security methods used by shippers", which US airlines interpret to mean screening can take place on the premises of government-certified forwarders or shippers. That interpretation has yet to be tested by lawyers, but for the moment it seems transatlantic belly cargo has been saved.

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