China has become the air cargo market every carrier wants to serve. But is it a new giant, or a bubble in the making?
There is no doubting the biggest story in air freight of the past two years. The surging exports of China have been the main focus of growth for practically all the world's air cargo operators, and saved many of them from what otherwise would have been a weak couple of years. There is hardly a major freighter operator on the planet, it seems, that is not planning to increase its flights to China or pushing for China rights.
The reasons for this enthusiasm are not hard to find. Boeing estimates that the Chinese air freight market has grown at an average of 15% a year in the past decade, with exports up by 17% to the USA and 23% to Europe. According to Thomas Hoang, regional director cargo marketing at Boeing, that already puts China among the largest air freight markets for the USA, coming in last year at just a whisker below Japan.
At the same time, figures from US-based consultancy The Colography Group show China's air exports growing as a share of the world total from 1.6% by value in 1999 to 2.8% in 2002. In tonnage terms its share has risen from just over 3% to more than 5%. In 2002 alone Chinese air exports grew by around 45% calculates the Colography Group.
China is now largely accepted to be the sixth-largest economy in the world, having recently overtaken Italy, and is expected to become the third-largest by 2010 if current growth rates continue. If it stays on the same course, a few years after that it would emerge as second only to the USA.
Not surprisingly, growth of such dimensions is expected to have a major impact on air freight flows. Boeing's last last cargo forecast in 2001 put China on 1.3 million tonnes of air cargo compared to 6.8 million tonnes in North America. However, it now predicts that air freight from China to the USA will grow an average of 9.6% a year over the next 20 years, while to Europe it will grow 9.3%. Fuelling this growth has been a massive shift in manufacturing to China, as it becomes the world's ultimate low-cost producer and workshop to the world.
Cheap labour
European cargo airline Cargolux points out that in the 1990s US autoparts suppliers moved production from the USA to Mexico in pursuit of $2 an hour labour rates, they are now moving to China, drawn by labour rates of $1 an hour or less. Estimates of total cost savings achievable in China range from 25-40%.
Because of this, China is predicted to become the largest car producer in the world by volume by 2010. BMW, Citroen, Ford, Mercedes, Nissan and Volkswagen, all have major plants there, sparking demand for air-freighted spares and parts. China is also a growing force in another air-freightable commodity - mobile telephones. It has granted access to manufacturers such as Nokia and Samsung on the basis that they set up production facilities.
The country is also a leading producer of toys, footwear and electrical appliances, and when global textile and garment production quotas are dismantled in 2005 under World Trade Organisation rules, some predict it will also take over a significant portion of this trade from countries in southern Asia. There is even talk of the area around Kunming developing as a centre for flower exports.
In short, it is hard to imagine an air freight-friendly cargo where production is not moving to China. That has led to carriers scrambling for capacity. Shanghai has become the destination of choice for freighters, with most global operators now flying there.
One of the big problems for cargo carriers to China is the sharp imbalance on its routes, however, particularly on the transpacific. Ned Laird, managing director of Seattle-based consultants Air Cargo Management Group, puts the imbalance at 3 to 1 in favour of Chinese exports, while Hoang at Boeing suggests it might be even more dramatic. "Of the 675,000 tonnes of air cargo between China and the USA in 2003, roughly 500,000 tonnes was Chinese exports, so the ratio is more than 5 to 1," he says.
This obviously puts stress on carrier profits. Hoang claims rates were as low as 85¢ per kilogram and load factors as little as 25% from the USA to China in 2003. Flying the other way, out of Shanghai freighters were full at $2-2.25/kg. Charles Kaufmann, Asia-Pacific vice-president of air freight for DHL Danzas, the world's largest freight forwarder, questions how long this can continue. "Either rates need to increase dramatically out of China or demand needs to increase inbound. Currently neither is happening," he says.
Growth in Chinese consumer demand may help, but only slowly. Hoang sees imports to China from the USA growing faster than exports in coming years - at 11.7% a year - but only from a very low base. Ted Scherck, president of The Colography Group, is not optimistic. "I don't see the Chinese buying Western goods in anything like the volume we are buying theirs," he says.
The situation is somewhat better on European routes, given that Europe's manufacturers invested there earlier than their North American counterparts, particularly in the automotive sector. Laird puts the imbalance to Europe at 3 to 2.5. Hoang calculates China-Europe exports at 250,000 tonnes and imports at 175,000 tonnes in 2003, a ratio of 1.4 to 1, but he sees a slightly worsening trend, with imports to China growing 9.1% a year in coming years, while exports grow 9.5%.
These imbalances have not deterred operators to date - the prize is too big - but Scherck thinks they should. He points out that in the past Europe, Asia and Latin America have all seen short-term booms based on one-way traffic, which then collapsed due to the over-optimism of participants. "In each case, the area was expected to be the engine for future growth, but in each case, though no one entity invested too much, together they produced overcapacity."
Market size debate
The problem is that no one can agree on the size of the market. Optimists point out that development is currently concentrated around the coast of China, and predict a huge boom as its interior opens up. The Chinese government has a Great Western Development Strategy, which is attempting to shift production inland and has had some success with automotive suppliers and semiconductor companies such as Intel and Infineon.
But how quickly the interior will open up is open to question. Poor surface infrastructure and other inefficiencies have made many investors reluctant to invest inland. Most air freight is still centred around a few east coast cities. Kaufman at DHL Danzas says its key focus is currently on places such as Fuzhou and Wuhan, which are an easy truck drive from Shanghai, for example. Elsewhere, David Hoppin, principal with US consultants MergeGlobal, reckons only Beijing, Guangzhou, Nanjing, Shanghai, Shenzhen and Xiamen are viable as significant international air cargo gateways into China. Boeing says western areas of the country account for just 15-17% of the nation's air freight tonnage.
One thing that would speed inland development are more domestic freighter links. But Laird thinks such services will take time to develop, because Chinese companies still consider the expense, rather than the speed, of air freight costs compared with trucking. Hoang agrees. "They are at the stage the USA or Europe were at in the late 1970s and early 1980s," he says. "They are missing the opportunity cost - the advantage of getting to market earlier with air freight."
Boeing predicts a change, with a domestic market for 147 737-sized freighters and 50 757-sized ones in the next 20 years. Currently, the tally is almost nil. Unlike in Russia, where the end of the Cold War left large numbers of surplus military Antonovs and Ilyushins to be used for commercial air cargo, China has only three domestic cargo operators: Hainan Airlines-owned Yangtze River Express which operates four 737 freighters; privately-owned Shanghai Airlines which recently leased a 737-300 while it awaits delivery of two converted 757 freighters; and China Postal Airlines, owned by China Southern, which has ambitions to be a Chinese UPS.
While Chinese government policy on encouraging such domestic airlines is unclear - and Hoppin at MergeGlobal thinks it would be worth China subsidising them to open up the interior - it does show signs of using traffic rights to encourage foreign carriers to fly freighters to secondary airports. In 2003, Singapore Airlines was allowed to start direct freighter routes from China to the USA, providing it routed them through Nanjing or Xiamen, for example.
But in the past 18 months, China has also been increasingly generous with cargo rights without such stipulations. Malaysia and the UK were recently given fifth-freedom rights for cargo to selected countries, for example, while Australia and Thailand got full open skies.
Why the generosity? Wu Zhou Hong, deputy director general of international affairs and co-operation at the Civil Aviation Administration of China (CAAC), insists liberalisation is still on a case-by-case basis, but confirms the CAAC looks more kindly on carriers wanting to fly to secondary cities, particularly in the west and north-east of China.
Extra capacity
Hoppin at MergeGlobal thinks there is a bigger picture - that the Chinese government "is become more and more concerned with the smooth movement of exports, even at the expense of local carrier profitability". Wu does not entirely disagree, conceding that "our national development needs more capacity and we have to find a way to meet that demand using foreign carriers". But he adds: "Our intention is that in the process of liberalisation our carriers will have the chance to become stronger."
It is certainly true that while the three main Chinese carriers all operate intercontinental freighter services to both Europe and the USA, they have so far made a remarkably small inroad into the cargo market. Described by Hoppin as "far ahead of the pack" is China Southern, which has two Boeing 747-400Fs, with a third on its way. It has freighter partnerships with KLM into Amsterdam and TNT into its European hub in Liège in Belgium. It is also seen as a candidate for the SkyTeam alliance, but while Marc Boudier, executive vice-president cargo for Air France, says he has had "interesting discussions" about cargo co-operation with China Southern, nothing has materialised as yet.
Meanwhile, China Cargo Airlines, the cargo arm of China Eastern, has three Boeing MD-11 freighters, flying five times a week to Europe and 10 times a week to the USA. Air China has three 747-200 freighters and a long-standing partnership with Lufthansa Cargo, but this has failed so far to bring it into the German carrier's WOW cargo alliance. Nor did anything result from cargo talks between Air China and Northwest Airlines a few years ago.
Laird says the problem with the Chinese carriers is that they do not have experience with the big US and European global freight forwarders that control much of the world's air freight. "They do well outbound, but struggle inbound. They are reluctant to take advice, though they are beginning to learn," he says. Other analysts say the problem is that they have focused too much on competing domestically on passenger routes.
As to possible foreign winners in the China air cargo game, the question is wide open. More than one analyst wonders whether foreign carriers are overstretching themselves to gain first-mover advantages. As Hoppin says: "All the big players will successfully enter the market, but the question is, at what cost?"
Kaufmann at DHL Danzas tips Russian operators as surprise successes. "They can still enjoy the good yields westbound, but have lower costs and so can more easily subsidise their eastbound operations," he says. "Furthermore, by flying through intermediate hubs, they can stack revenue on multiple sectors." One Russian carrier he may have in mind is Volga-Dnepr, which recently started 747 freighter services from Europe to China via Russia under the Airbridge Cargo brand.
One question mark hangs over those airports and airlines which currently act as transit points into China. Hong Kong is one example and Korean Air is another. Analysts are split into two camps here, some say there is enough growth for all, while others say these transit operators will slowly lose out to direct flights.
For Hong Kong, many see the major test as the opening of Guangzhou's new Baiyun airport this year. Opinions differ as to which cargo carriers will start service to Baiyun. Laird, for one, expects several carriers to sign up, but still says its effect on Hong Kong will be muted. "They will draw cargo that currently goes down the highway to Hong Kong, but many manufacturers will still prefer to deal with Hong Kong rather than the paperwork at Chinese airports," he says.
Korean competition
Ken Choi, president of Korean Air Cargo, is convinced China is a major opportunity. "The door is not yet fully open, but in the next two to three years it will be. In the future, China to the USA will be our main market," he says. He is unfazed by competition. "There is never enough capacity into China, so there is always potential for us to tranship cargo."
Choi also points to the huge amount of cargo flying between South Korea and China, particularly as South Korean companies invest in their big neighbour. This is another interesting aspect of China's growth. Whereas its Asian neighbours once feared it as low-cost competition, they now acknowledge it as the engine of intra-Asian cargo growth. Flying components and supplies to Chinese factories has proved a lucrative business for airlines in the region.
Malaysia is one example that might have been expected to feel the wind of Chinese competition. In the 1990s, its island of Penang was a boom area for electronics and a magnet for air cargo operators. Surprisingly, that is still the case. JJ Ong, senior general manager cargo for Malaysian Airlines, says Penang has lost some manufacturing to China, but has seen growth in high end production by the likes of Dell and Intel. "In fact manufacturing for electronics is predicted to grow at 11-13% this year," Ong says. "A lot of stuff is made in China, shipped to Penang for assembly and then moved to the USA, which is ideal traffic for us."
REPORT BY PETER CONWAY IN LONDON
Source: Airline Business
