Air freight: carriers need to look to alternative modes to address margin declines

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10 March 2011, Oil

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The political events unfolding in the Middle East and Africa have driven crude oil prices above the $100 per barrel (bbl) mark. Excessive speculative activity in the oil futures market over the prevailing geopolitical tensions could prove detrimental to the global economic recovery, as it pushes fuel prices higher and thus increases fuel costs for the transportation industry. Of all the modes of freight transportation, air freight has the highest energy consumption levels, due to the high speeds involved. Increasing oil prices are threatening to dent the demand for air freight services from shippers and freight forwarders due to higher fuel surcharges.

The aviation industry accounts for roughly 8% of total energy consumption in the transportation sector. Fuel has traditionally been the second largest cost item after labor in the airline industry; in 2005, fuel costs accounted for around 18% of total operating expenses. However, with fuel prices currently remaining at high levels, the fuel bill has become the largest operating cost component for an airline. The International Air Transport Association (IATA) estimates fuel costs to now represent 29% of the total operating costs in 2011, up from 26% in 2010, which is badly hitting the profit margins of the airline industry. The margin impact will be felt across the air freight industry, with the top players in terms of freight ton kilometers flown, such as FedEx Express, UPS Airlines, Korean Air Lines, and Cathay Pacific Airways, being impacted the most.

The IATA has recently raised its Brent crude oil average price forecast for 2011 to $96/bbl from $84/bbl. After taking into account the roughly 50% of the expected fuel consumption being hedged, industry fuel costs are expected to rise by $10bn to reach a total of $166bn in 2011. As a result, the IATA has downgraded the net earnings for the airline industry to $8.6bn in 2011 from the $9.1bn estimated in December 2010, roughly half of the $16bn earned in 2010. On its expected industry revenues of $594bn for 2011, this translates to a net profit margin of 1.4%. This is despite the strong demand forecast for air transport, with cargo growth forecast for 2011 at 6.1%. Higher revenues will not be sufficient to absorb the rise in oil prices and prevent the shrinking of profits from 2010 levels. As per the IATA, every dollar rise in the price of oil increases the costs of the airline industry by $1.6bn.

To maintain margins in the face of rising aviation fuel prices, logistics companies now need to look for cost-efficient modal optimization. Economies of scale for any mode of transport come from its lower fuel consumption per unit of mass being transported. The two most energy-efficient modes are rail and maritime shipping. In 2008 when oil prices set new highs, many shippers diverted their traffic from air to ocean freight. Thereafter, this trend continued during the economic slowdown.

Another interesting development over the recent years of tight economic conditions was that most logistics companies started considering road and rail as alternatives for air freight. As a result, there has been a notable shift from air to road over the last few years, especially in the domestic/intra-continental express market. Rail also offers significant potential for the express and freight market, given that substantial investments are flowing into the development of rail networks globally, and that rail service levels are also improving.

Datamonitor believes that in the current situation when consumer demand is recovering and timeliness to market is important, while the ocean vessels are still on the slow steaming mode, ocean-borne shipping is not a close substitute for air cargo. Thus, as of now, the viable alternatives for air freight are rail and road for domestic/intra-continental deliveries and the usage of intermodal (i.e. leveraging road and rail networks along with air routes) for international deliveries, to cut down costs. Datamonitor suggests that there is a need for logistics companies to partially shift their air freight volumes to road and rail or to intermodal to combat the current surge in fuel prices. Apart from the modal shifts, they also need to focus on streamlining other operations to contain operating costs, such as reducing labor costs by using automation in warehouses, as well as through IT upgrades.

Source: Datamonitor

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