2017 and 2018 saw the airfreight market climb a cumulative 13.1% in terms of volume
By Peter Stallion of Freight Investor Services 10/12/2019
2017 and 2018 saw the airfreight market climb a cumulative 13.1% in terms of volume, with a 12.3% increase in yield in 2018 according to IATA, pushing the market beyond a $100bn valuation.
This bullish attitude, as it always does in a runaway market, encouraged an outlook of perpetual, if slowed, growth: IATA forecast 3.7% growth from January 2019.
Instead, 2019 has proved a veritable disaster (albeit with a smattering of success stories) – a deadly result of mixing the end of shipper inventory cycles, with a diverse range of macro-economic dampers to freight price and volume liquidity, compounded by an uncertain and often maddening geopolitical landscape.
Trade wars, political turmoil, volume decline and fuel uncertainty all conveniently compounded around the epicentres of cross-border commerce. By June 2019 IATA had revised its growth figures to flat, while the actual air freight price on several core lanes from Asia to Europe and North America had gone into a form of recession.
The ramifications for this were obvious, and without naming any names, the vast majority of the air freight market (carriers, forwarders and their myriad of service providers) saw declines in revenue, and a squeeze on margins ranging from mild, all the way through to crippling.
Forwarders and airlines were rationalised, reorganised, reformed, acquired and dissolved.
Despite some areas of growth in 2019 that buck the trend (imports to Mexico, transhipments from South East Asia, an end-of-year e-commerce boost, even fish from Scandinavia to Asia), pessimism has bled through into contract and spot forecasting for rates in 2020.
But rather than present an analysis of the previous market, the focus for us at Freight Investor Services is the impact the 2019 market has on the marking of contract prices in
Q1 2020. It affects everything from the block space agreement rates (hard and soft blocks on either floating or fixed prices) struck between carriers and forwarders, to the innumerable contracts struck between forwarders, shippers and their service providers.
The 2020 BSA time bomb
General pricing wisdom and negotiating positions for new rounds of block space agreements between airlines and forwarders, and subsequently annual contracts between forwarders and shippers, rely on a loose prediction of the future market. More accurately, they carry over the previous year’s market, mix it with the current market, and result in a contract that typically ends up as a compromise in terms of price, in return for a guarantee of revenue and capacity.
At the start of 2019 the market price was still high, despite reports of declining volumes. Forward growth predictions encouraged BSA prices that fell in line with the 2017/2018 market trends of stable slack periods and a booming Q4 peak.
But instead 2019 saw, in the majority of cases, BSA prices end up well above the Q1,2,3 and 4 average open and spot market rates. It was a serious problem for forwarders, damaging the performance of the BSA market, and an absolute disaster for the co-loading market, forcing the resale of capacity below net prices.
While relatively high contract prices created a temporary safety net for airlines, the increasing frequency of dead freight leading to a premature drop-out of the market at key slack periods weakened the strength of contracts. And even with the contract safety net in place, airlines still recorded severe declines in airfreight revenue and a squeeze on margin as volumes dropped out.
In 2020, this safety net is being substantially reduced as forwarders, with a few notable exceptions, continue to reduce BSA volume.
The low current market price, and the debacle of this year, lowers the negotiable rate airlines can charge forwarders for their contracts. Forwarders may well be forced into this position anyway, as the visibility of the slack 2019 market will arm shippers looking for an at-the-market or below–market tender rate in 2020.
Shockingly, we have even run into instances where peak contract prices issued by airlines in Q3 2019, for the Q4 2019 – Q1 2020 period have been dumped, in a desperate rush to secure the business required to meet budget targets.
The reduction of long-term contract volume, price and stability has wide–ranging consequences, particularly on the ability of airlines to guarantee budgets that meet revenue and profit red lines. The lack of a predictable revenue stream at a sustainable price puts greater emphasis and risk on the use of the spot market to meet budget targets. All the while, the inherently volatile forward market remains impossible to predict, enhancing the already prevalent risk involved in physical capacity transactions.
A classic case for risk mitigation that fits the airfreight market like a glove.
Traditionally, freight businesses would manage such a damaging market though the pluck and business acumen of individuals and businesses in developing physically backed risk management techniques. Methods, such as parking aircraft, reducing contract volumes, passing over costs, typically come with a panoply of negative side effects (inclusive of poor service delivery, higher budget risk, and risk to client-supplier relationships).
This is no longer the case. The risk management tools that are widespread in most markets globally, are now available in airfreight. The window for excuses in shrinking rapidly.
Freight Investor Services has been pursuing the use of air freight derivatives to manage price risk, trading the first contract in August 2019. The challenge has been market exposure and education; the requirement to manage price volatility is already apparent.
Air Freight Forward Agreements (AFFAs) hedge both the contract between airlines and forwarders, and the subsequent contract between forwarders and shippers. Offsetting the cash difference between a contract rate and the open market rate (recorded immediately and independently by the TAC Index since 2016) has the potential to fix all of the pricing problems that were incurred by either airlines, forwarders or shippers, in every recordable market from 2016 through to 2019.
Hedging a fixed rate contract offers the opportunity to maintain contract volumes, create a more beneficial contract price and secure the contract against the movement of the market. All the while, most of the perceived risks of derivative–based hedging are categorically avoidable.
The cashflow offset created by the AFFA means the seller of capacity can maintain volume, create a more beneficial price, and guarantee service delivery regardless of market movement. The buyer retains control on capacity and service, the contract performance is ensured by a cashflow offset should market rates increase.
For airlines this means a strengthening of contract volumes, price and a mitigation of forward risk.
Forwarders maintain their control on capacity, price and service while retaining the ability to take advantage of market opportunities.
Co-loaders could remove the risk of loss associated with block space agreements (a significant problem in 2019) while retaining the resale advantage should market rates increase.
Shippers can guarantee service, while paying the equivalent of market rate, regardless of whether market fundamentals prove challenging.
And the standard contracting processes between airlines, forwarders and shippers are not disrupted. Block space agreements, series charters and long–term contracts can be negotiated, tendered and agreed at all levels of the market as usual – however these physical agreements are enforced and insured by the AFFA, with contracting achieved centrally, immediately and in a cost-effective manner.