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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

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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

21st 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.

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 growth of trade and air cargo

• 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.

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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.

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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

21st century.

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• 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.

Unfortunately, a number of factors that produced this success

story have reversed since the Great Recession of 2008

Post–recession realities

• (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

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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

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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-per-

pound. New product introductions that require large main-

deck 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.

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At the same time, 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

slow-steaming 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 747-400 and MD11

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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 747-400F

while carrying almost the same payload.

Given all these factors, 43 Boeing 747-400s 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 tri-

motors being retired.

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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.

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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-

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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.

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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 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.

“The future ain’t what it used to be”

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(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. 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

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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 re-

institution 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 American 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.

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• 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

747-8 freighters, more 747-400Fs 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.

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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

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can deliver the innovative services and efficient logistics support

the global market requires.

Thank you.