Trade Patterns and the Future of International Air Cargo

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Derrick McDonald
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1 Trade Patterns and the Future of International Air Cargo FWS IATA Speech March 11, 2014 (slide 1 title slide) Good morning. Thank you for this opportunity to participate in an important discussion of air cargo and how we can meet some of the issues facing it. I d first like to say that on behalf of more than 300,000 FedEx team members around the world, we are deeply saddened by the loss of the Malaysian Airlines flight Friday and extend our deepest sympathy to the families of those who were on it. I know all of us here today will keep them in our thoughts. Transformation through Innovation is a great theme for this symposium because today the air cargo industry is in the midst of 1

2 a profound transformation that requires new ways of thinking about our future. However, that future is unlikely to be analogous to the industry s Golden Age of the 1990s and early 21 st century. To understand where we re going, it s important to review the macroeconomic and technological factors that led to air cargo s spectacular growth. The growth of trade and air cargo Surveying the devastation of World War II, American leaders like Secretary of State Cordell Hull believed the integration of world markets would be essential to rebuild countries ravaged by the war. The General Agreement on Tariffs and Trade, or GATT, was the result, and America s opening its markets was a key element in the recovery of Germany and Japan, (slide 2 Asian Tigers) in the emergence of a strong European economy, and in the rise of the Four Tigers of Asia Hong Kong, Taiwan, Singapore, and Korea, where significant investments in manufacturing in the 60s, 70s and 80s lifted tens of millions out of poverty. 2

(slide 3 Cargolux freighter) The backbone of these networks was the Boeing 747F,

3 Trans-Pacific and Asia-to-Europe air shipments of electronics and auto parts were integral to the development of sprawling supply chains throughout the world. (slide 3 Cargolux freighter) The backbone of these networks was the Boeing 747F, introduced in 1971, with economics that were a quantum jump over previous generations of air freighters. 3

4 It s important to note that America s post-world War II embrace of free trade was based on geopolitical considerations as much as commercial calculations. (slide 4 FedEx logo slide) Accordingly, the United States relatively open markets were often sacrificed to more mercantile practices of some trading partners. As normalized relations were restored with China, and the GATT morphed into the WTO, the stage was set for the most phenomenal economic transformation in the modern era the export-driven rise of China and its accession in 2001 to the WTO. Hundreds of millions of people were brought out of poverty in China and other nations such as India and Brazil that embraced more liberal global trade in the 1990s and early 21 st century. 4

5 High value-added products particularly electronics saw air cargo grow on average at two and a half times the rate of world GDP for two decades. Post recession realities Unfortunately, a number of factors that produced this success story have reversed since the Great Recession of 2008 (slide 5 China dragon) China s fantastic economic growth has spawned significant wage increases that dampen exports, and China has adopted an Indigenous Innovation policy which favors local companies over foreign competitors despite WTO prohibitions to the contrary. Partly as a result, China s logistics costs are about 20% of GDP vs. 9 to 9.5% in the U.S. Such inefficiencies make it hard for the Chinese economy to evolve to a more 5

6 consumer-driven economy vs. their current model based on exports and infrastructure investment. One big reason trade is no longer growing rapidly is the rise of protectionism, not just in China but around the world. Over the last few years almost every trading nation has instituted policies that permit greater regulatory intervention in the trade processes often justified by overzealous security considerations. Unfortunately, in many other cases, the protectionism is overt and politically driven. History shows that protectionism whatever the justification stifles competitiveness, innovation, and consumer choice. The result of all these factors is that exports have been declining with most major trading partners since CY 2010, as you can see in this chart. (slide 6 export trends for top FedEx markets). Another unique factor in the air cargo sector is the miniaturization of electronics which represents about half the 6

tonnage transported by air (slide 7 semi-conductor billings). Not only is there less weight being transported, but price reductions driven by technology have reduced the value-perpound.

7 tonnage transported by air (slide 7 semi-conductor billings). Not only is there less weight being transported, but price reductions driven by technology have reduced the value-perpound. New product introductions that require large maindeck freighters have slowed considerably as the market for electronic devices has been satiated. Perhaps most important, over the past decade fuel prices have increased fourfold (slide 8 rising fuel costs), substantially raising air transportation vs. ocean shipping costs. 7

Moreover, low interest rates have reduced the carrying costs for inventory on sea voyages, while ultra- large container ships have reduced unit costs.

8 Moreover, low interest rates have reduced the carrying costs for inventory on sea voyages, while ultra- large container ships have reduced unit costs. And at the same time, ocean transport has become more reliable with more sailing frequencies per lane offered by carrier alliances. Combined with improved shipment information, fuel-efficient slowsteaming container ships allow products to be landed at the destination port with great predictability. The rapid growth of international air passenger traffic and modern efficient long-range twins such as the B777, A330, B787, A350 and the recently launched 777-8/9 have created an increasing amount of low-cost underbelly lift and more origin and destination pairs, particularly over the rapidly growing hub networks in the Middle East. Finally, new fuel-efficient, twin-engine freighters in the form of the 777F (slide 9 777F) and the A330F provide airlift with much lower unit costs than the and MD11 8

9 freighters that were the workhorses of the air cargo Golden Age previously mentioned. To give just one example, a 777 freighter flight from Hong Kong to Anchorage costs $30,000+ less than a F while carrying almost the same payload. Given all these factors, 43 Boeing s are parked in the desert and six have been scrapped while 20 and 4 MD- 11s respectively have met the same fate. The two following charts (slide 10 Widebody Freighter Aircraft, All Time) (slide 11 Active Large Widebody freighters by Type) show the dramatic decline in the available legacy fleet and the emergence of the new modern twin freighters and the Boeing 747-8F, which is substantially more fuel-efficient than the 400s and McDonnell Douglas trimotors being retired. 9

Except for a brief spike in freight traffic in 2010 (slide 12 Freight Traffic Growth) when post-recession inventories were finally replenished and electronic product

10 Except for a brief spike in freight traffic in 2010 (slide 12 Freight Traffic Growth) when post-recession inventories were finally replenished and electronic product introductions were accelerating, all these factors have put significant pressure on commodity airport to-airport air cargo yields which have been declining in real terms for two decades. 10

When combined with 5-6% underbelly capacity growth driven by increasing global passenger demand, further capacity

11 As you can see by this chart (slide 13 Current Freighter Capacity Growth Exceeds Demand), current freighter capacity exceeds demand. When combined with 5-6% underbelly capacity growth driven by increasing global passenger demand, further capacity reduction will be required to staunch yield declines for commodity air freight. On the other hand, given the integration of worldwide buyers and sellers due to the ubiquitous marketplace of the Internet, door- 11

to-door shipments of smaller packages and light freight shipments continue to grow, and cross-border e-commerce is providing a boost to this sector.

12 to-door shipments of smaller packages and light freight shipments continue to grow, and cross-border e-commerce is providing a boost to this sector. However, most national customs systems are far behind the needs of this market which will impede its growth if systems are not modernized to better handle this type of traffic. Door-to-door global small shipments are increasingly carried by the integrated networks of FedEx, DHL and UPS, which have dense and highly efficient pickup and delivery systems. (slide 14 triangles) Thus, the global air express business continues to grow as does global sea trade, with both sectors gnawing at the traditional airport-to-airport air cargo market. Moreover, yields on this type of commodity traffic have been declining in real terms over 20 years making traditional freighter services profitability very challenging. 12

13 It s important to note that the express carriers use both indigenous aircraft and, for less urgent shipments, the prolific underbellies of passenger carriers. FedEx s ExpressFreighter and SuperExpressFreighter routes (nonstops in excess of 5,000 nautical miles) provide unparalleled door-to-door transit times for Priority shipments to and from almost any point on the globe. For our Economy service we often use the underbellies of partner carriers that provide FedEx door-to-door deliveries one or two days later for more price-sensitive Economy Express shipments. Finally, for heavier bulk shipments, our FedEx Trade Networks forwarding unit can move this traffic in a variety of cost-effective ways with reasonable transit times, whether by air or sea. The future ain t what it used to be The macroeconomic picture for world trade, regardless of shippers needs, however, is not good in the near term. As noted before, protectionism is on the rise. 13

(slide 15 protectionism is up) Last year, the top 20 world economies passed 23% more protectionist measures than in 2009. A few examples: Argentina has passed 168 measures since 2009.

14 (slide 15 protectionism is up) Last year, the top 20 world economies passed 23% more protectionist measures than in A few examples: Argentina has passed 168 measures since Could the recent crisis there be somewhat related? Canadian interests recently opposed lifting de minimus clearance limits, perceiving such a change as injurious to their livelihood. Last month, FedEx couldn t ship pillows, which were in short supply, to Olympic athletes in Sochi because Russian customs restrictions would cause a six-week delay in delivery! And despite the efforts to date on initiatives such as the Trans- Pacific Partnership (TPP), the Transatlantic Trade and Investment Partnership (TTIP), NAFTA 2.0, and the Trade in Services 14

15 Agreement (TISA), prospects for more robust trade liberalization are not good in 2014 in part because of the U.S. election cycle. Both Democrats and Republicans are even resisting the reinstitution of Trade Promotion Authority (TPA), which gives the U.S. President the ability to negotiate trade deals with only an up or down vote by Congress. And absent TPA, there is no possibility of America again leading the way as it did for over 50 years towards more open markets. This is indeed unfortunate as history shows innovation, investment, and larger markets have been the main drivers in improving living standards and reducing poverty around the world. In this regard, according to a 2012 analysis by economists Petri, Plummer and Zhai, the TPP has been estimated to add about $295 billion a year to the world economy. And the London-based Centre for Economic and Policy Research estimates the TTIP to add around $130.5 billion a year to the U.S. economy alone. Also, if enacted, the agreements would create millions of jobs around the world in many sectors including ours. Over the last several years, trade growth has decelerated from two and a half times world GDP in the first part of this century to much lower levels. 15

16 It s no surprise then as the following chart shows (slide 16 World Trade Volume vs. Global Real GDP) both global trade and air cargo have flat lined. Absent a change in the outlook for overall global trade and given the introduction of over 200 efficient 777, A330, and freighters, more Fs and MD-11Fs will have to be retired. Their economics simply cannot compete with the more modern airplanes. Moreover, underbellies will be increasingly attractive for the smaller shipments that do not require Priority service. All of us may wish for a return of the halcyon days of double-digit air cargo growth, but we are creatures of much larger forces and the winds are not favorable (slide 17 Industry Context ), as this chart illustrates. 16

We at FedEx are committed to extolling the demonstrable benefits of growing world trade and pushing our politicians hard to look at the greater good of endorsing the new

17 We at FedEx are committed to extolling the demonstrable benefits of growing world trade and pushing our politicians hard to look at the greater good of endorsing the new treaties mentioned before. (slide 18 FedEx logo slide) We hope everyone involved in our industry will do so as well. In that way, we can ensure that a transformed air cargo industry 17

18 can deliver the innovative services and efficient logistics support the global market requires. Thank you. 18

Economic Outlook & Traffic Performance

Economic Outlook & Traffic Performance CARGO CHARTBOOK Key points After a very volatile first quarter, so far in Q2 air cargo markets appear to be back down to end-2014 levels 2015 Q2 2014 was a comeback year for air cargo, freight tonnes carried