Logistics Rewired: Air Market Update

Logistics Rewired: Air Market Update

Neel Jones Shah: Hello everyone, and thank you for attending today's webinar. My name is Neel Jones Shah, I'm the EVP of Air Freight Strategy and Carrier Development. And in this quick session, I'm going to cover the current air market and a few thoughts on what to expect over the course of the next few years when it comes to the airfreight market developments.

But before we begin, let's cover a few housekeeping items. On your screen, you'll see a sidebar to the right of the main stage. If at any time you need assistance during the live webinar, please message us in the help chat located on the sidebar. At the end of this presentation, we will hold a Q&A session. Please use the button labeled Q&A to ask a question at any time and we will do our best to answer as many of your questions as possible.

And lastly, on the menu bar located above the screen, you can find two links. The first is a short feedback survey for this webinar, and the second is a registration page for our next webinar, The State of Trade on June 22nd.

We move to the next slide, this is the mandatory legal language. So before we move on just this brief legal note, please keep in mind that all information provided in this session is based on the situation at this current time and may not be customized to your specific business requirements. We always recommend reaching out to a Flexport expert to discuss your particular session.

So now if we move on to the agenda for today, we're going to spend a few minutes reviewing the current air freight market and the conditions that exist and are likely to exist for the balance of 2022. And talk a little bit about long term air freight trends, and how we see this industry evolving over the long term. And I'm talking 2024 and beyond.

And then if there's time left, we will definitely leave a little bit of time to answer your question. So if we move on to, the current air freight market, I'm going to give you a little bit of a snapshot in terms of where we are on a global basis. So if we go to the next slide.

Total International Air Cargo Capacity Growth

We see that total international air cargo cargo capacity is down about 5% versus 2019. And for those of you have joined previous webinars that we always compare back to 2019 because the pandemic has skewed so much in terms of our historical comparisons. So we like to go back to 2019 because that gives us a view on where we stand sort of in non COVID impacted market conditions.

And as you can see from this chart, we're still down 5% on a global basis, we've been fairly stable on the Transpac, we've been a little ahead of 2019 capacity given the huge influx of freighter capacity. But one of the things that you'll note here on this particular chart is you see the significant reduction in direct capacity between Asia and Europe. We're down 52%, from Asia to Europe, and down 40% from Europe to Asia, and that's all of the result of the war in Ukraine, the closure of airspace, the cancellation of lots of passenger flights that were operating, but also the loss of many freighters, including all of the Russian registered aircraft.

Now we have seen some rerouting through the Middle East, you see that those numbers up quite significantly 16% and 13% respectively. So we are seeing rerouting of cargo that way. But the market to and from Europe and Asia has become a bit tighter.

In the Transatlantic capacity is coming back very very quickly. We were down, it was very red a couple of months ago, it's all come back and that's just due to the strong passenger demand in the Transatlantic Market. And we expect this trend to continue quite robustly. And so if we move on to the next slide.

Widebody Belly Transatlantic Air Cargo Capacity

We see very clearly what's going on in terms of belly capacity, particularly in the Transatlantic. If you remember from past webinars I've discussed the split in the market between freighter and passenger bellies. And pre pandemic we had about 50% of cargo that went on freighters and 50% in the passenger bellies. During the pandemic with passenger flying almost non existent internationally, that split became 85% freighters, maybe 15% passenger bellies.

And now we're starting to see it sort of revert back to where we have been historically. And if you look at passenger schedules, you see this very strong recovery in February, March, April and May. And in June when the traditional summer season starts, we're effectively back to pre COVID capacity in the Transatlantic. And actually what's interesting is that going forward into the winter months as we get towards the winter, the fall, September, October, November, the airlines are planning for significantly more capacity going forward even through the winter than they have traditionally. And this is just based on the strong demand trends we're seeing on the passenger side, the desire for people to take trips, and to enjoy experiences that they've missed out on for the past two years.

Now, this recovery, while we're showing the Transatlantic, it's a very very different picture in the TransPacific and it's going to take significantly longer time for passenger demand to come back in this market. So that graph in the Pacific looks nothing like this, which is why we still expect freighter operators to be dominant in the TransPacific trade, whereas bellies are really taking over in the transatlantic. So if we move on to the next slide.

March 2022 Ranked as Third-highest Month for Air Cargo Ever

I just want to give a little bit of perspective on where demand stands. So we've talked a lot about capacity. So let's talk about demand for a second, and in spite of, March, which is the last month we have the full data for, in spite of March being sort of, let's call it anemic when it comes to growth, it only grew about 2%, it still ranks as the third highest month ever, for air cargo demand.

And so on the on the left hand side of this chart, you can see the 10 top months for air cargo historically. Okay, so this is going back, since the days we started collecting data, and you can see that nine of the top 10 months for air cargo, were actually during the pandemic, starting in mid 2021, and now even in ‘22, we're seeing some very, very strong months of demand.

So that's extremely significant. It goes to show that during the pandemic, and all of you on the call who are shippers have seen the level of demand for everything, as people shifted from services to buying merchandise really created some extremely strong air freight demand.

However, there are some clouds on the horizon that we all need to be very cognizant and aware of. So if we move on to the next slide.

Jet Fuel Has Doubles in 2022

The first thing that I want to talk about is jet fuel. If you ask me, what keeps me up at night, one of the main things that I worry about is the cost of jet fuel. Since the beginning of the year, it's actually doubled, it's gone from an index of about 240 in January to 480, and it continues to creep higher, it's actually the index is close to 500. If you look at the data from today, this is very concerning. When you look at the cost of operating a round trip between Shanghai and LA for example, the cost of fuel on that round trip has gone from $200,000 in January to $400,000 today. That's significant, it's a significant increase that obviously, the airlines cannot absorb and does get passed along to the forwarders and in turn to the shippers.

So what's causing this increase, obviously, the war in Ukraine is having a significant impact on capacity. Crude oil is is a global market, and reacts globally to any supply disruption no matter where it is in the world, and how contained it might be. And so we've seen the price of jet react to the war. We also have very tight refining capacity, there are no new refineries being built. And jet fuel is sort of a byproduct of other refining processes. And so we are seeing constrained capacity on the refining side for jet fuel which continues to keep its price quite elevated and potentially could even go higher.

Now, what could alleviate some of this is slowing global economic growth. And I know that we don't want to solve the jet fuel pricing by having the world go into a recession. But in reality, what we are seeing is global growth does slow down a little bit. Demand, particularly for the refined products that come out of crude should start to decline a little bit as well. We haven't seen that yet, but that would be the expectation, and that's probably the only thing that's going to help bring prices down because certainly the situation from the war is going to be long lasting. And we don't anticipate that resolving itself in the medium term at a minimum. So if we move on to the next slide.

Economic Conditions Are Rapidly Changing

You know, just finally wanted to bring in a couple of economic indicators, my colleague, Phil Levy is much better at doing this than I am, but I just want to bring in a few charts that he likes to talk about, that we do see some trends that are going to definitely impact supply chains.

You know, the first thing I want to talk about is inventory to sales ratio. And we talked a lot about during the pandemic of how the inventory of sales ratio had fallen to all time lows ratios that we've never ever seen before. And you can see from this graph, as we go back, and you look through the pandemic, depending on whether you're looking at building materials, durable goods and autos, for example, right. We can see how particularly for building materials and other durable goods, we see the inventory to sales ratio has basically come back to pre pandemic levels, companies have enough inventory.

In fact, if you listen to what's going on in the news, Target has made very public statements about the fact that they have too much inventory, and they're going to be initiating a lot of price reductions in order to work through that inventory.

But there are verticals that are still continue to suffer and suffer dramatically. Automotive is probably the most glaring, and you can see that the inventory to sales ratio for automotive is well below the historical levels, and is not expected to recover anytime soon. We're probably going to be faced with this sort of a crisis for the next year or a year or two at a minimum.

The second thing that we're obviously all keeping an eye on and those of you filled your tank with gas or gone grocery shopping in the past 30 days, you can see the impact that inflation is having. And while real income growths are in the five to 6% range with inflation between eight and 9%, people obviously have less disposable income. So this is this is concerning, people are going to have to make some hard decisions now and what they buy. And we also see that people because of the pandemic, and because there's so much pent up demand for services, people are making the choice to have experiences, as opposed to buy stuff. And that's clearly going to have an impact on supply chains and on demand, going forward.

We're starting to see the early stages of that. We're starting to see orders placed by existing customers down dramatically, year over year. And we should see the impact of this start to filter through in the back half of the year. So definitely some clouds on the horizon, that we all need to be extremely aware of. So if we move on to the next slide.

So that's sort of the current conditions right. And look, it, the market is still quite volatile. June is turning out to be quite a slow month, even though China has emerged from their lockdowns, many factories haven't restarted anywhere close to full production. They're expected to over the course next 30 to 60 days. And then there is a lot of pent up demand for orders that haven't been placed over the past three months. So we do expect a relatively strong end to the year. And we think there will be a lot of demand particularly for air freight given congestion that still exists on the ocean, given the contract talks that are going on between the labor union, the port workers union, in the US and the end the port, so we do anticipate disruption there. So air freight will definitely be a beneficiary of that. But to what extent still remains to be seen.

But let's sort of not talk about the next few months, and let's talk about the next few years in terms of what we see as some long term trends that are emerging in the industry, and how you as shippers should sort of begin to prepare for what I see as a new reality when it comes to air freight. So if we move to the next slide.

Air Freight Trends: 2024 and Beyond

So if we move to the next slide, there are about five key trends that I want to talk about here. And I'm going to spend just a few minutes going over that. First and foremost, this industry like any industry needs a very stable sort of opportunity for the stakeholders to make a reasonable return on their investment in order for them to continue to invest in infrastructure, in technology, in the assets that are required to keep our supply chains moving. This industry hasn't been known as an investable industry in the past, it's been characterized as, two boom years, followed by six years of very very difficult economic conditions, and that cycle does not facilitate investment. It doesn't facilitate the sort of behavior that we need the stakeholders in this business to have in order to keep us moving forward, and the industry capable to absorb things like the COVID crisis, which we found we were very incapable of responding to.

So one of the big trends as we move forward, first its airfreight growth is going to be fueled by international ecommerce fulfillment. International ecommerce fulfillment, I'm talking about B2C fulfillment is in the very very early stages. And we see the large ecomm players like Amazon, like Alibaba, with their logistics arm China and others, really, really having a positive outlook on international ecommerce fulfillment, and actually allowing anybody in the world to order any SKU in their fulfillment centers and get it within three to four days. This is an enormous shift, it's creating demand. And we anticipate that this part of the market is going to grow at 20% plus compounded annual growth rate for the next 10 years.

And what it means is these ecommerce players are creating demand, but they're also absorbing enormous amounts of capacity. They've placed orders for many many new aircraft, they own all the conversion slots on wide body conversions that are happening not only for medium range aircraft, like the 767, but now long range aircraft like the 777, 83300, etc. So this is a trend that very early stages and is going to be fueling air cargo growth for years to come.

The second big trend that we have in this industry is we are in a perpetual long term labor crisis. With this, this has been going on in the industry, maybe for the past seven or eight years, but it was very manageable. What the COVID crisis exposes the fact that this industry has a real labor issue. And the fact is, is that we are perpetually churning employees in this industry, and perpetually behind the hiring curve. Most ground handlers in North America for example, have a churn rate of 40% for the ground staff. And I know in your businesses, if you had a churn rate of 40%, you'd find it pretty hard to run your business. Well, they're also facing a crisis when it comes to running their business effectively, because they're so under leverage when it comes to labor.

The second thing is on the pilot side, I think many of you have probably read in the news about the dramatic global shortage of pilots. This is not a situation that's going to resolve itself in the next six months to a year. This is a five to 10 year problem. I think you've probably seen even recently, just last week, Southwest for example, canceled 20,000 flights over the summer, Delta trimmed 100 flights a day from their schedule. Lufthansa has done something similar. And so you know, I could the list goes on and on. But these airlines are facing significant shortage of pilots. And that is going to keep, and then so that means there's quite a bit of demand for pilots that are available, which again makes it difficult from a cost structure perspective for freighter carriers even to hire.

And so we need a lot of investment by the stakeholders in this business in technology, to help automate as much of this industry as possible, because right now we have labor, doing a lot of work that could be automated, but because of the things I mentioned earlier about how this industry has always been living hand to mouth, people haven't had the CapEx available to invest in that automation. So if we move on to the last couple of trends that I'm going to spend the last five minutes going over.

Air Freight Trends: 2024 Beyond

The third big trend that I see happening, and we see it in the very early stages is what I just talked about investment, investment in technology and infrastructure. We all know that asset owners and actually everybody involved in the supply chain has generated quite reasonable margins over the past two and a half years and they're finally have some spare CapEx leftover to start investing in the future. We see airports beginning to build new cargo handling terminals, we see a host of airlines and freight forwarders and ground handlers implementing new technology. And we've seen a number of entrepreneurs enter this industry in order to find ways to help automate us out of the labor crisis that I described.

And so, we're at the early stages of this, we need this pace to keep up and actually even expand. So we need airports, airlines, ground handlers, everybody to invest very heavily, not only in technology, but also in the physical infrastructure in order to handle cargo. I'm sure that all of you on this call have some sort of horror story about how your cargo got trapped in an airline terminal for days, if not weeks on end during the height of the COVID crisis. That's just because we didn't have the infrastructure to be able to handle the volume, we have to invest our way out of this situation so we don't face it again, in the future. So that started, but we've got to keep our foot on the pedal there. And the final two trends.

Air Freight Trends: 2024 Beyond

Well, in order to be able to do this, right, I mean, we have to have rates, air freight rates that actually support this continued level of investment. And I'm not talking about the rates that we've all been exposed to over the pandemic we're rates got to close to $20 a kilo, in the Trans Pacific, but I am talking about rates that are significantly higher than what we had pre COVID. So I think the days of $3 a kilo from Shanghai to LA are really in our rearview mirror. And we're probably looking at long term rates that are going to be 35 to 40% higher than where we were pre COVID. Again, in order to make this an investable industry, for all stakeholders to earn a respectable return on investment, so they continue to invest and protect our supply chains.

And we found out how vulnerable or supply chains are, I think we all we, to a certain extent, everyone in this industry took the supply chain working for granted. And when it didn't it caused enormous issues, and we're not out of the woods, we've got a long way to go to get to equilibrium. But there, we are beginning to see a little bit of light at the end of the tunnel. But again, it's going to continue to require massive investment.

Air Freight Trends: 2024 Beyond

And then finally, and I threw this in sort of at the last second here, but we there are a lot of data points now that shippers, particularly very big shippers are going to be optimizing for reliability, versus cutting every penny out of their cost structure. Because at the end of the day, cost isn't king if your stuff doesn't show up, right. And so when you run a tight supply chain, when you need stuff to arrive on Tuesday that was booked to arrive on Tuesday, there's a lot of cost involved if it gets there on Thursday, or even later. So that's why optimizing for all reliability is very important. We see a lot of evidence of traditional single mode shippers, now looking at multimodal solutions. So if you're only an ocean shipper, you're actually now doing ocean and air to balance your supply chain and diversify some of your risks. We are seeing trends of nearshoring and onshoring. We think those will accelerate, it obviously depends on the vertical year and how easy it is to do that. But those trends are going to continue to reduce dependence on the long haul supply chains.

And then really believe that for many shippers, a consistent access to capacity will be critical. We've even seen some of the largest shippers in the world take on long term asset risk chartering airplanes under long term contracts and we've seen many forwarders that traditionally wanted to be asset light, now taking on a lot of long term asset risk. So the business has changed. We've evolved, we've really, I think did a great job through this crisis, but it exposed a lot of problems with the industry and now it's we're going to have to mobilize an industry wide effort in order to make sure that we solve these problems. So we don't face this crisis down the road.

So right here we're exactly at five minutes to the hour. If we have any questions I would be happy to answer them, I don't know Carol if we have any anything queued up. Okay, so I do see a couple of questions here, the first question is, what impact do you think new CEO Dave Clark will have on the air freight side? And do you think he will bring best practices from Amazon? First and foremost, we at Flexport are extremely excited to welcome Dave to the Flexport family. He's starting in early September, so I'm sure we're going to get his views on the air freight side of our business. I think he's going to bring a tremendous amount of experience, a lot, obviously, a lot of it from his days at Amazon. So we look forward to absolutely benefiting from that.

Second question is also to what extent does Flexport use booking platforms like Freightos? And do you have any concerns about FedEx, Qatar Airways being investors in Freightos? So I'm not going to comment specifically on Freightos and some of their investors, we see a lot of the platforms, several airlines have invested in all of the platforms out there. We do use Freightos as web cargo net, we use cargo.one, we're a big believer in these platforms. We're also believer in direct connecting with our core airlines, and we do that as well. So we're a tech company. We like automated solutions, and we're gonna pursue those as aggressively as we can.

The next question, how are direct flights from places like Sri Lanka and India to LAX looking? Are there any recommended options? So, this is a trade lane, even pre pandemic there were obviously never any flights between Sri Lanka in the US, I don't think there were any nonstop flights, typically those flights routed through the Middle East or potentially a European hub. I think that you're starting to see demand recovery, particularly on the passenger side, between the US, Europe and India. And so we do see capacity coming back in, whether or not we're going to see recovery of capacity directly into the West Coast remains to be seen. I would anticipate that you're probably not going to see a lot of nonstop or super direct routings to places like Sri Lanka or India from LA, those are primarily from the East Coast, but there plenty of one stop options from a number of airline partners we work with, for example, that can get you to those destinations, so that you will always have options.

Next question, how do you see the air freight rates in the next 12 months? Should shippers go for long term contracts or do spot buying? I think it's a great question, I think over the next, let's call it six months of the year. While June is a slower month, it's because the lock downs in China really haven't reverse themselves yet, we are anticipating a pretty strong into the summer, there should be quite a bit of demand. And given the fact that passenger flying has not resumed in the Pacific and will not resume for the balance of this year, we anticipate that rates will climb a bit from where they are today. How much remains to be seen? But I would see rates going up a good 10 to 25% from where they are today for the balance of the year, but nothing like we experienced, let's say in 2021.

And I think it's always good to have a balance of procurement behavior. I mean, you should never put your eggs in one basket, go long term or spot 100%. Because this market is proving to be a little unpredictable. And so just like we do, we have a combination of procurement strategies, we have long term dedicated capacity, we have shorter term BSA's. And then we also buy capacity in the spot market. I think it makes sense for everybody to diversify their risk a little bit and do that.

And I think we have time for maybe one more question I'll take really, really quickly. This question is, in your opinion, considering a US shipper importing from China, what is the best time to go out on airfreight RFQs and perhaps to what frequency? So RFQ's are a lot of work. I think that we see RFQ is being handled across the you know, in a wide variety of ways. Most of the in depth and detailed RFQ that we see are done on an annual basis because they typically take weeks to implement and to get the data back. So it's really difficult to do on a quarterly basis unless you're doing a rate refresh. So an RFQ on an annual basis, potentially a rate refresh on a quarterly basis is probably what's going to make the most sense and give you the right balance between sort of service and cost.

So that's all we have time for today, I want to thank everyone for joining the webinar, and remember on June the 22nd, Phil Levy will be doing his next state of trade update. So thank you all very much, have a great rest of the week and weekend.