Modal shift from ocean set to buoy air freight for months

Air cargo rates likely to stay strong but volatile for several more months and potentially several years, with modal shift from a disrupted ocean market continuing until at least this summer, according to freight forwarding and other sources.

Air freight rates seem likely to stay strong for several more months and potentially several years, with modal shift from a disrupted ocean freight market also set to buoy air freight until at least this summer, according to freight forwarding and other sources.

But high levels of uncertainty and volatility are set to persist that make long-term capacity and pricing agreements risky for freight forwarders and their customers.

Kuehne + Nagel (KN) CEO Detlef Trefzger last week said he believed there was little or no sign of a collapse, even a minor dip, in air freight yields on the horizon as the main factors determining their current buoyant levels – the air capacity squeeze due to the loss of passenger belly-hold space, and disruption in sea freight flows due to problems in the supply of empty containers and port congestion – are likely to remain unchanged in the foreseeable future.

“The market at the moment is driven by a significant lack of ‘belly’ capacity,” said Trefzger. “We are around 90% down on the normal ‘belly’ capacity that we have seen in the networks globally in 2019.” Most of the belly-hold passenger capacity that is currently available is only on intra-Asia routes, with belly space on other markets greatly diminished.

Long-term capacity loss

“And while it’s anybody’s guess, we do not expect this capacity to come back and be available before 2024, 2025,” explained Trefzger. “We might see a slight decline in (air freight) yields in 2022, but that’s speculation. It really depends on alternative capacity, which is belly capacity.”

Trefzger highlighted that ongoing ocean freight issues were also playing a significant part in keeping air freight yields bullish.

“The market is tightening because there is additional demand coming into the networks from, say, time-critical shippers who cannot rely on sea logistics anymore. For example, in Long Beach, they have to wait 16 days to get their container unloaded at the port.”

Margin improvement

KN’s gross profit to EBIT ‘conversion rate’ margin reached 41.4% in the final quarter of last year, with Trefzger revealing that the modal shift in shipments from ocean to air freight – in order to maintain supply chains – had been an important contributing factor in the stellar performance.

“That, for sure, led to higher yields and also to the volume development (in air freight). In addition, the cargo mix was different because perishables was under pressure and the perishables portion of our total volume has been reduced relative to the rest; and that, all together, led to the figures we saw in Q4.”

As to whether there is an end in sight to the issues related to the supply of containers, port congestion and dock labour shortages, Trefzger does not expect an improvement in the immediate future. “Container supply is tight, because the demand is there, but we have congestion at the ports – which is driven by all the health and security measures the pandemic has caused,” he noted.

For the container situation to ease, handling at the port terminals needs to be speeded up, he added. “We would not expect this to be solved before the summer (this year) and it depends on vaccination and on other health safety measures.”

Strong end to Q1

Mads Ravn, executive vice president for air freight procurement at freight forwarder DSV, told Lloyd’s Loading List he is expecting “a very strong end” to the first quarter for air freight, mainly due to the ocean freight congestion, followed by a slight easing in air freight charter prices and commercial capacity costs.

“The ships sitting on the West Coast are a massive issue for us here in the United States,” highlighted the US-based executive. “But it’s not only a United States issue; it really trickles down to Latin America as well, Mexico, also from Europe, and also the outbound out of the US – where things are getting really tight now, which rarely happens.”

Those ocean freight challenges were also clearly apparent on the air freight side – “as a result of a massive ocean shipment commodity that would normally never fly being converted to air freight.” That conversion was “a result of months of delays” to ocean freight – where freight had been “either sitting idle, waiting to get unloaded, or you couldn’t get equipment”.

Ocean space out of China easing

He said ocean freight space out of China to the US, “seems to have eased up a little bit” in recent weeks, noting: “Even after Chinese New Year, we’re not seeing nearly as strong a movement there as we would have expected. But from an air freight perspective, there are still massive delays on the ocean side, which will then convert into air freight, which is also why we’re expecting a very strong finale here to Q1.”

On the ocean export side from China to the US, he noted: “There are still some constraints on equipment, but from getting capacity, it is starting to balance out to some degree –potentially as a result of what’s going on with the delays”.

He said it was unclear whether demand was now dropping on a longer-term basis, or whether, to a certain degree, ocean freight customers may have reduced demand after asking “does it even make sense to continue just to throw more freight into a big black hole”?

He added: “I think we don’t know the answers to that yet. But what we’re seeing at least is that it’s not as challenging getting space and capacity as it was just a few weeks ago, one month ago (on the ocean side, ex-China to the US).”

Months of delays in inventories

But even if the ocean supply situation does ease, the pressure from modal shift to air freight will continue for some time, believes Ravn.

“If you think about the hundreds of thousands of containers that are sitting off the west coast, that gives you an idea that it’s not going away any time soon,” he explained. “Here we’re talking about months of delays in inventories. So, we do expect that this will continue for quite a while, even though things have eased a little bit out of China in terms of getting capacity. We do expect that this will continue for months to come; the ocean situation, will not correct itself until this summer at the very earliest.”

Less explosive post-CNY

Ravn said air freight demand ex-China since the end of Chinese New Year (CNY) had been “less explosive” than expected, but it was rising rapidly now.

“When we came out of Chinese New Year, we didn’t see as explosive a start as we expected. But we are seeing it coming now for the rest of March, which is also one of the reasons why we have decided to take on more capacity also on the transpacific. We already had the capacity in place on Asia to Europe lane, but we are also looking at adding more out of Hong Kong now into Europe for Q2.

In addition to the additional air freight charter capacity DSV has already announced, it is looking to add once- or twice-weekly B747 round trips out of Hong Kong into Luxembourg.

Many factories remained open

As to why air freight demand ex-China since CNY had been lower than expected, he said: “We credit that to the fact that many factories remained open. They simply continued throughout Chinese New Year. So, we think things balanced out as a result of that.

“But capacity wasn’t pulled to an extent we normally would see during Chinese New Year, either; they continued flying with the backlog. So, that is more than likely the reason why that we didn’t see as explosive a start up after Chinese New Year.”

Rebound in yield to the US

He said the year had started out with “quite a bit of a drop” in air freight prices from China to the US, which continued all the way to Chinese New Year.

“We are, however, seeing it going up quite drastically now again. We haven’t hit the million-dollar mark for charters yet coming in on the transpacific into the United States, but we are getting closer. There is no more capacity on the lane. And if you wanted to charter now here in mid-March, you’re more likely will be hitting the million-dollar mark again.”

He believes this return towards million-dollar air freight charters will be “short term”, adding: “We don’t believe that’s going to stick for very long. But it does look like it will happen for just a couple of weeks towards the end of Q1.”

Long-term contract indicators

After that, longer-term contract indicators suggest rates will moderate from these exceptionally high levels, although they are likely to stay elevated compared with average annual prices

“We see long term contracts being offered out of China – they typically run from April to April – and there we are seeing signs that that yields for long term block space agreements are significantly lower,” noted Ravn. “So, while there’s no more capacity coming into the market, we can see that the price point is nowhere near that million-dollar mark.”

Cheaper rates than 2020

He continued: “While I don’t want to comment yet on what that (air freight rate) will be, as we’re still in final negotiations, we can tell that both out of Hong Kong and out of China, that it will be at a significantly lower price point than what we have seen so far – and also significantly lower than what the average was in 2020.”

That’s the case on the on the commercial capacity side.

“But the commercial side will drive the charter pricing; there is no more charter unavailability. So that could come at a significantly higher price point than the commercial market. But it’s typically a good indicator of where the market will land.”

Uncertainty and volatility beyond Q2

But high levels of uncertainty and volatility are set to persist that make long-term capacity and pricing agreements risky for freight forwarders and their customers – and for carriers looking to maximise their returns.

Beyond the second quarter, Ravn believes the pricing environment is difficult to predict because of uncertainty over whether further capacity will be returned to the market.

Limited opportunities for long-term BSAs

And there are also limited opportunities to set up the normal long-term blocked space agreements (BSAs) this year with carriers, as was the case in the second half of 2020.

“It is limited. It is driven by Asia. It’s driven by a few carriers in Europe who want to entertain it,” Ravn notes.

“However, it doesn’t make a lot of sense either to sign up on a 12-month agreement or even six months at this point. We do anticipate that there will be more capacity in the market, from early Q3. And when that happens, it is also fair to assume that rates will slide to some extent. It’s too early to say exactly how much that will be, but it’s fair to assume, which is also why long-term pricing – when you talk about six months or 12 months, whether it’s towards the customers or from the carriers – it simply doesn’t make a lot of sense at this early stage.”

Risky volatility

That risk is particularly high given the current high prices and the extent to which that could change if a lot more capacity comes back in.

“And this is also what we’re advising our customers: stick to a shorter-term perspective right now rather than trying to go back to the normal 12-month arrangement,” explains Ravn. “It doesn’t make a lot of sense right now. You’ll be paying a high rate for the first six months and then it’ll balance out in the other end.”

TAC Index

This is consistent with observations by air freight rates analyst TAC Index, whose data is used by price hedging organisations such as the Baltic Exchange’s Baltic Air Index and Freight Investor Services (FIS) to help minimise price volatility risks.

Robert Frei, business development director for TAC Index, noted: “We presume the spread of spot rates – month-on-month and intra-month volatility – remains high, and given the much higher pricing levels compared to a year ago, this has a major impact.”

For example, looking at the Baltic Air Index’s BAI-PVG01 lane, from Shanghai to Europe (PVG-EUR), “if you are 10% off with your procurement today (RMB 3.20) compared to 2020 levels it would have meant a deviation of 18%. Assuming gross margins of freight forwarders being around 8-10%, we can conclude this is an immediate loss,” Frei explained.

“We presume the spread of spot rates is likely to remain high, so up-to-date pricing information on a weekly basis is an absolute necessity to manage these volatile periods.”

Charter network capacity

And in the meantime, DSV is increasing its charter network capacity – in a mix of long-term, multi-year commitments and shorter-term arrangements, reflecting this market volatility.

“It’s a mixed bag. We do both very short term and we do long term,” said Ravn. “We have signed as long as to mid-2023 on some transpacific flights and we’re signing as short term as six weeks until we see what’s going to happen in Q2.”

“We need to be able to stay at exactly where the market is. Our customers expect that. Everybody’s growing frustrated with higher expenses when it comes to your logistic needs. And we also need to be there for our customers, and ride the market downwards – as we also asked for customers to help us take it upwards. When rates were increasing, we had to also ask for increases that felt outside of the contract.”

Supply uncertainty

The greater uncertainty in the market now, for the second half of this year, is over what’s going to happen with capacity rather than on the demand side, Ravn believes.

“On the demand side, we don’t see any uncertainty. We expect that’s going to continue to increase,” he explained. “We are much more concerned about the capacity; and there is no more capacity out there. There are only freighter or passenger freighter flights that could be available as more capacity.

“It comes at a very high price point and only certain commodities or a certain yield will be able to carry that. Fortunately – or unfortunately, depending on what side you’re on – we are hitting that price point out of Europe now where you will start to see more passenger freighter flights coming in as the yield has continued to grow. And then it starts to make sense again.”

Forward pricing analysis

In a recent summary of air freight pricing and demand trends, Peter Stallion, head of air and containers at Freight Investor Services, highlighted that there had been “some substantial ups and downs in February as we finally see Asia export markets come off, shedding several dollars off the per kilo price with much of the price action occurring post-Lunar New Year as demand slips away”.

On Asia-Europe routes, he said prices had been slipping since the beginning of February  – “with an uptick at the start of March lifting prices in line with a forward market that has been priced in well in advance. Prices remain ‘backwardated’, however, remaining well above their 2019 levels. Much of the sentiment remains long-term bearish on the back of a projected recovery in the airline passenger market.”

Backwardation is when the current spot price of an underlying asset is higher than prices trading in the futures market.

US bumpy ride

The Asia to US market “has had a very bumpy ride”, Stallion noted, highlighting that “after gaining serious support mid-month (in February), the price has since crashed, and then risen back up again”.

He confirmed that “a big driver for rate support has been Sea-Air conversion”, noting: “Depleted inventories in the US had been exacerbated by port congestion and fed back into the airfreight market, which had since spiked once again.

“Forward pricing has been equally volatile, with pricing only calming down near the back-end of the month after constantly correcting in line with the volatile physical market price. Index prices were in fact tempered by the large amount of charter capacity on forwarder charter networks across the Pacific.”

Ex-Europe, he said prices “continue to be supported by low passenger volumes and vaccine cargoes”, adding: “Much vaccine cargo remains ‘well-managed’ without much spiking of prices. Instead, prices remain relatively flat, month on month, with ‘backwardation’ in the forward curve pricing in a slight ‘return-to-normal’ from Q3 21 onwards.”

He concluded: “The market remains extremely uncertain largely as a result of capacity, rather than demand – IAG recently forecasted that they would not return to 2019 passenger travel levels until 2023.”

Source: Lloyd’s