Air Cargo's Highs and Lows
Today's air cargo market is deeply divided. Integrators such as UPS and FedEx are soaring, while traditional air cargo carriers—choked by soaring fuel prices, excessive taxes, and government regulation—are experiencing serious turbulence. Buckle your seat belts, it's going to be a bumpy ride.
What a difference one year makes.
Before turbulent times struck the air cargo industry—in the form of rapidly escalating fuel prices born of tight capacity and hurricanes Katrina and Rita—it was having a banner year.
"We completed the post-Sept. 11 recovery period with a year of unprecedented growth in 2004," says Tom Crabtree, Boeing's regional director, cargo marketing, for Europe and Russia.
"Overall revenues for the U.S. domestic air freight and express industry increased 7.5 percent to reach $29.9 billion, according to the Air Cargo Marketing Group (ACMG), a Seattle-based research firm. This industry-wide total for 2004 was a new record, up about $600 million from the previous peak in 2000," Crabtree says.
A market snapshot of 2004 looked like this: The integrated express carriers—FedEx, UPS, DHL—continued to dominate. As a group, express carriers' U.S. market share was nearly 60 percent of the industry-wide ton-mile total, while scheduled freight share was 19.8 percent.
Express companies played a more prominent role in the international airfreight arena as well. International express grew 9.4 percent from mid-2003 to mid-2004 to reach 1.9 million shipments per day, notes ACMG. The big three integrators, along with TNT, make up the bulk of this field.
Import/export numbers for 2004 were also impressive. The value of U.S. air export shipments rose 12.3 percent to $235.7 billion, while the value of U.S. air imports increased 12.7 percent to $346.5 billion, according to The Colography Group, Atlanta. U.S. air export revenue surged 12 percent to $8.4 billion.
Asia was the fastest growing area for U.S. imports in 2004, with tonnage rising 16.5 percent. Not surprisingly, import gains were paced by China, where tonnage to the United States soared 31.1 percent.
Fast-forward one year and the market snapshot has changed. In July 2005, the price of oil jumped aggressively, and by September it hit the stratosphere. The impact on the air cargo industry—or at least one major part of it—has been stunning.
A Knock-Out Blow
Aircraft-operating companies in the airfreight sector break down into two basic groups: the airlines, and the integrated carriers such as UPS, FedEx, DHL, and TNT, among others. The two groups' current financial status couldn't be more different. The integrators are the "haves" and the airlines are the "have-nots."
Comparing the airlines and integrators is not apples-to-apples, however. The passenger side of the business is enormously complex—an aspect the integrators do not have to deal with at all.
The integrators continue to report healthy financial growth, while airlines are faring poorly in many cases. A number of seemingly intractable problems plague the airlines, and fuel costs top the list.
For the first time in two decades, fuel expense is the top cost category for U.S. airlines, adding billions of dollars to the industry's expenses in 2005 alone, and jeopardizing chances of profitability in 2006.
"Today's jet fuel prices are crushing, and could prove to be a knock-out blow for some carriers," warned John Heimlich, vice president and chief economist for the Air Transport Association, on Aug. 25, 2005.
He was right. On Sept. 14, Northwest Airlines Corp. and Delta Air Lines Inc. both filed for reorganization under Chapter 11 of the U.S. Bankruptcy Code. The two airlines cited the need to significantly reduce and simplify their cost structures as the reason behind their moves.
"We developed, and have been implementing, a plan to restructure Northwest outside of Chapter 11," explains Doug Steenland, Northwest's president and CEO. "Unfortunately, in addition to a non-competitive cost structure, our efforts have been overtaken by skyrocketing fuel costs. We can no longer continue to incur sizable losses and reductions in liquidity as we attempt to completely implement the plan."
Northwest expects its fuel bill for 2005 to hit approximately $3.3 billion. This compares to $2.2 billion for 2004 and $1.6 billion for 2003.
These fuel bills were part of the developments that led up to the Northwest and Delta announcements.
"In January 2002, the price of jet fuel on the spot markets averaged nearly 56 cents per gallon. Shortly before Katrina, the price stood at $1.87 per gallon. Following Katrina, the price peaked at $2.36 per gallon, and today it is at $1.92 per gallon, a 243-percent increase over four years," said Air Transport Association (ATA) President and CEO James May in testimony before the U.S. Senate's Aviation Subcommittee on Commerce, Science and Transportation in mid-September.
"Driving the price of jet fuel is the cost of crude oil, now hovering in the mid-to-upper $60-per-barrel range, and the additional premium that refiners charge to produce jet fuel—the so-called 'crack spread,'" May explained.
This premium has grown dramatically in recent years, and it exploded after Katrina. In 2002, it averaged $3.63 per barrel. Shortly after Katrina it peaked at $30 per barrel.
"For 2005, we estimate the premium average will exceed $15 per barrel, a 414-percent increase over four years. Airlines cannot survive with sustained jet fuel prices of $90 to $100 per barrel," May stated.
"Fuel costs today are unsustainable," agrees Mark Najarian, vice president, air cargo for American Airlines. "Last quarter we squeaked out a small profit, where last year at the same time our profit would have been substantial.
"The ramifications of increased fuel charges go beyond high operating costs," he adds. "It impacts the flow of traffic. Depending on what we need to charge for our airfreight services, shippers decide if they can absorb that cost or pass it on to their end consumer. Those calculations are happening at all companies.
"We've raised our fuel surcharge four times this year," he continues. "Are customers willing to pay? If fuel goes much higher, we'll start to see mode shifting or a slowdown in product shipping."
Another possibility is that airlines will rationalize schedules based on fuel expenses. Higher fuel costs could impact where and how often a carrier flies to a destination. "When you run the economics of fuel at $25, $50, and $75 per barrel, at some point you say, 'Serving this destination is not worth it,'" Najarian says.
"Unfortunately, the future is not bright for U.S. airlines," May warns. "Our latest forecast shows that we will pay $9.2 billion more for fuel in 2005 than in 2004. In 2005, for roughly 452 million barrels of jet fuel, the industry will spend $30.6 billion. It's no wonder we now project a $10 billion loss for 2005—on top of the $32 billion the industry lost from Sept. 11, 2001, through 2004."
International airlines are experiencing similar fuel sticker shock. "Oil is once again robbing the industry of a return to profitability," says Giovanni Bisignani, director general and CEO of the International Air Transport Association (IATA), based in Geneva.
"At $57 per barrel, the industry fuel bill for 2005 will top $97 billion. With a total industry turnover in the range of $400 billion per year, a fuel bill of $97 billion makes up 25 percent of our total costs." In less than two years, the total bill has more than doubled, he says.
Bisignani blames today's crack spread on price gouging by refiners. "We fully understand the principles of supply and demand," he says. "But it is difficult to see this as anything other than a $14-billion cash grab by the oil industry that is pouring salt into the wounds of a global crisis."
In the face of this daunting economic picture, airlines are searching for solutions. They are working to conserve fuel and increase operating efficiency—doing everything from measuring onboard weight more accurately and re-distributing belly cargo, to modernizing fleets with fuel-efficient planes.
These measures are making a difference. From 2000 to the first quarter of 2005, airline fuel efficiency rose 17 percent.
Fuel conservation measures can't entirely end the industry's financial nightmare, however. What's needed instead is "urgent structural change across the industry's value chain," says Bisignani. Efficiency gains in air traffic management would provide part of the solution, he notes.
"If we could save one minute on every flight," says Bisignani, "the industry could save up to $4 billion—and the environment would benefit from a 10-million-ton emissions reduction."
Through June of this year, 17 percent of flights were delayed leaving airports, and 22 percent arrived late, according to the Department of Transportation (DOT).
The cost of air traffic system delays is staggering. In 2004, 86.5 million air traffic control delay minutes drove an estimated $4.8 billion in direct operating costs for U.S. airlines, the ATA says.
Delayed aircraft also drives the need for extra gates and manpower on the ground, and cost airline customers—including shippers—millions in lost productivity and wages.
What's the solution? Upgrading to a satellite-based air traffic control system could reduce some of these infrastructure-related delays. "The present system, which depends on ground-based radars, is antiquated and inefficient," May says.
Today, aircraft must zig-zag their way across the sky, flying in the direction of one ground-based navigation aid and then another, literally connecting the dots. Area navigation, or RNAV, would allow for more efficient airspace use, increase the air traffic system's capacity, reduce flight delays, and decrease fuel consumption.
RNAV will increase Dallas-Fort Worth Airport's aircraft throughput by about 14 percent, for example, says Paul Railsback, ATA's director of operations. That would allow the airport to absorb its projected growth over the next 10 years.
Airlines attribute part of their financial woes to excessive taxes. "The time has come to relieve the industry from a crippling tax regime that has no parallel in any other transport mode or sector of the economy," says May.
In 1972, he notes, taxes and fees amounted to 7 percent of the total cost of a $200-roundtrip air ticket in the United States. That number has grown, and in the past few years, due to higher passenger facility charges and the introduction of the Sept. 11 fee, it has climbed to 26 percent.
"Today, U.S. airlines pay $11 billion a year into the Aviation Trust Fund, and what do they get in return?" asks May. "Certainly not services worth anything approaching that amount. About $6.5 billion goes into financing the FAA operating budget, not its capital budget. And a large chunk of that goes into services for general aviation—the operation of private planes or corporate jets."
Excessive government regulation also makes the airline industry's hit list. The industry is lobbying for lawmakers to complete the deregulation they started in 1978.
"The government should give airlines greater freedom to achieve the mass or economies of scale needed for survival," May argues. "Air France's buy-out of KLM, for example, is a harbinger of change. Our government should not prevent similar consolidation within the U.S. airline industry."
"No matter how well any U.S. carrier transforms its business, none of us will be as strong as we should be—much less in a position to compete in the emerging global aviation industry—if the regulatory environment we operate in doesn't change," argues Glenn Tilton, United Airlines' CEO.
"Since deregulation in 1978, U.S. government policy has encouraged the maximum number of domestic carriers and discouraged meaningful consolidation, preventing strong national carriers from emerging."
Bilateral restrictions and a limit on foreign investment also inhibit international growth, Tilton says.
"While U.S. carriers struggle for survival, many of our global competitors have returned to profitability," he says. "They are consolidating across national boundaries, buying new aircraft, and investing in vastly improved products.
"With the support of their governments and regulatory policies that encourage growth, major airlines around the world are merging across borders to create 'super-carriers,'" Tilton adds. "Without a coherent U.S. aviation policy that reverses the bias against airline size, and removes the barriers that prevent us from constructive consolidation, U.S. carriers will be unable to compete on a global scale."
Finally, the air cargo sector must dig out from under its mountain of paperwork. Despite all the advances in technology, air cargo processes still are highly paper- dependent.
An average cargo consolidation shipment travels with up to 38 documents per master air waybill at a cost of $30. Over the course of one year, the industry ships the equivalent of 39 747-400s full of paper. Only 15 percent of today's air waybills are electronic.
Efforts are underway to migrate to a global paperless environment by 2010. The initiative, called IATA e-freight, could save $1.2 billion per year because it will help eliminate duplication, accelerate processing times, and improve overall data quality.
Air carriers also look to technology as a way to give shippers greater access to lift capacity while at the same time reducing costs for both parties.
"We've had continuous communication with many of our customers on using web-based portals—ours and others—to access our capacity," says Spencer Dickinson, American Airlines' managing director, cargo marketing. "This is an efficient way to make bookings for both sides."
In stark contrast to the airlines, the leading integrated carriers' financial performance blooms with health. The steady stream of expansion announcements issued this year by UPS, for example, makes this apparent.
In August, UPS ordered eight new Boeing 747-400 freighters; in May it announced plans to construct five regional freight hubs at airports across the country; in April UPS Philippines unveiled plans to expand its three-year-old intra-Asia air hub; and in January the company bought 10 A380 super-jumbo freighter aircraft made by Airbus.
FedEx and TNT N.V., the Dutch integrator, also report similarly positive growth. For its first quarter ending Aug. 31, FedEx Express posted revenue of $5.1 billion, up 11 percent from last year's $4.6 billion. FedEx International Priority's revenue grew 13 percent for the quarter, while its average daily package volume grew 6 percent. U.S. domestic express package revenue increased 8 percent.
On Sept. 7, FedEx announced the first overnight express link between India and China as part of its new eastbound around-the-world flight, which connects Europe, India, China, and Japan with the FedEx Express U.S. hub in Memphis, Tenn. In July, FedEx CEO Fred Smith unveiled plans to build a FedEx hub at Guangzhou Biayun International Airport in China, slated to open in 2008.
And TNT's express division says it is on track to reach its target of a 10-percent operating margin in 2007.
Obviously, the integrators, like the airlines, are affected by fuel price escalation, but with the help of alternate revenue streams, they appear relatively unfazed by it.
"The fuel price hikes have not had a huge impact on our business," reports Scott Roby, manager of long-range planning, UPS Airline. "We've still had a lot of growth, especially in Asia."
Like its integrator compatriots, UPS passes an appreciable portion of the fuel price increase to its customers as surcharges. As of Oct. 3, UPS raised its fuel surcharge cap to 12.5 percent on next-, second- and three-day air and U.S. international air services.
As global supply chain complexity increases, integrators are providing more solutions than ever before.
"Some customers just want us to ship their packages," says Roby. "But many others want us to provide value-added and customized solutions. Our customers want us to be involved in their business; some want us to take over logistics operations for them." And shippers are willing to pay for that convenience.
As we head into a new year, integrators are poised to continue their high-flying success, while the airlines struggle to gain ground. Will 2006 bring a new flight plan and a reversal of fortune?