It’s been a rough 2011.
Air Cargo World Magazine - Features
It’s been a rough 2011.
It is one of the ironies of the European currency union that if the European Union had applied its own rules about national economic debt back in 1999, Germany, one of the economic stabilizers in the current climate, would not have made the cut. The countries that went on to power the European economy initially lagged behind; it was the peripheral nations that roared ahead, throwing vast sums into building housing developments, business parks and roads.
As the world subsequently learned, these were roads to nowhere. The global financial crisis exposed massive holes in the public finances of the so-called “PIIGS” economies. Portugal, Ireland, Italy, Greece and Spain have terminated their lavish public expenditure programs, and consumers have slashed their personal spending. Jobless numbers mount. Further large-scale bailouts may soon be required.
Politicians are talking about the crisis, but are not dealing with it, believes Nikolas Dombrowski, Geodis Wilson’s Hamburg-based airfreight director. EU auditors have worked to save the sinking economy by imposing unpopular reforms, but are losing patience with Greece for its failure to follow conditions laid down as part of its financial bailout last year. Dombrowski argues, however, that officials lack the tools to enforce sanctions on profligate member states.
“It’s difficult to encourage them to change their behavior. Sooner or later, Greece will default. The question is: Who is next? Could Portugal or Italy follow?” he asks. “We in Germany — and to a certain extent, the French — have got to fund the euro now, but we’re getting the most out of the common currency. More than 60 percent of Germany’s entire export volume goes to the EU, so we have to keep the door open to those markets.”
According to the financial analysis firm Markit, manufacturing activity in August across the members of the Eurozone shrank for the first time in two years. Translated into freight volumes, the International Transport Forum found a significant second-quarter slowdown.
Air trade volumes in the EU’s member states, which had grown in February to 15 percent above 2008, pre-recession levels, shrank back to just 9 percent above pre-crisis levels in June. The ITF also reports that trade by air between China and the EU is decreasing, with only India countering the downward trend.
Even historically successful Eurozone trading nations, such as Ireland, will have a hard time exporting their way out of trouble. Analysts believe the government will soon divest its remaining 25-percent stake in part-privatized Aer Lingus as part of a €5 billion sell-off of state assets.
The government has kept its stake predominantly to protect Aer Lingus from a hostile takeover by its Irish rival Ryanair, which owns almost 30 percent of the carrier. It is now thought that Ryanair would be unable to take majority ownership on monopoly grounds even if it wanted to, given that the EU blocked a proposed merger between Aegean and Olympic earlier this year.
After receiving an €85 billion bailout package from the International Monetary Fund and the EU in 2010, Ireland’s economy grew by 1.3 percent in the first quarter of 2011, prompting foreign minister Eamonn Gilmore to describe the stimulus as “the recovery story of the Eurozone.” Yet Irish manufacturing activity shrank for the third month in succession in August and economists predict that the country’s main UK, U.S. and European export markets could continue to slow into the second half of 2012.
After a “fantastic” first quarter, Ireland’s leading GSA, International Airline Marketing, saw a significant drop off in June and July. “But we’re still 6-percent ahead year on year, after growth of 4 to 5 percent in 2010,” says managing director Ian McCool.
Airfreight forwarders adjusted rapidly to the impact of IBM and Dell withdrawing from production in Ireland 18 months ago, McCool says. There have been substantial new export flows, with shipments of pharmaceuticals and medical devices running particularly strongly to the U.S.
Belly-hold capacity direct out of Ireland on passenger services is sufficient to meet forwarders’ needs, according to David Sadlier, business development and solutions director for Kuehne + Nagel in Ireland. Freighter services have diminished in response to the shrinkage in computer hardware manufacturing, but shipments only have to be trucked to hubs in London or Paris to pick up an all-cargo flight if they are hazardous or bulky.
K+N has targeted pharmaceutical multinationals in the last five years and continues to pick up high-tech export traffic despite the high-profile plant closures, Sadlier says. However, the retail sector that fuels imports is weak. Instead of sourcing directly from Asia, many retailers have reverted to a more traditional business model and are buying from third-party suppliers who feed the market by road and sea from Europe.
“Take away the debt, and we could export our way out of this,” Sadlier says. “Ireland has the same management, ingenuity and drive that it had before. If the debt crisis is resolved, we can flip over faster than Europe’s other troubled economies.”
One solution being proposed to stem the crisis is to create deflation in the Eurozone by establishing two parallel currencies. If this doesn’t happen, Sadlier foresees the euro breaking up and Europe reverting to national currencies; this would be “a total disaster,” according to Lefteris Kaltsas, president and managing director of Greek Air Cargo, one of the largest Greek-owned airfreight forwarders.
Shippers in Greece airfreight small quantities of garments and shoes to the U.S. and other markets, and Kaltsas says local factories producing food and electronic goods have turned to manufacturing for export, as local demand has slumped. Some companies have relocated altogether to take advantage of lower taxes and cheaper labor in neighboring countries. Most of their production no longer flies directly from Greece, where the options have become more limited. Aside from the integrators, the only scheduled freighter flying into Athens, for example, is a weekly Lufthansa Airbus A300.
Air exports from northern Greece are trucked to Budapest or Vienna, which have attracted Macedonian and Bulgarian traffic away from Athens, thanks to the countries’ competitive pricing and greater range of destinations, Kaltsas says. While all the region’s hubs have lost volume, those carriers still serving Athens face higher handling costs.
To unify the market, GAC has a daily road feeder service linking Athens with Thessaloniki in the north of the country. Kaltsas is looking to develop an international service on the back of this in early 2012, consolidating shipments from Macedonia, Bulgaria and, eventually, Romania.
Alexios Sioris, cargo development manager at Athens International Airport, says cargo tonnage has underperformed even his conservative expectations, falling 11 percent in the first sixth months of the year. “It is questionable whether we will reach 90,000 tonnes this year. Only three years ago, traffic peaked at 122,000 tonnes. With origin-and-destination traffic, and especially imports, shrinking significantly, the only thing we can do from an airport perspective is to encourage transit traffic and make joint efforts to generate new flows.”
The International Monetary Fund has warned that the €110 billion rescue package agreed for Greece in May 2010 will not be enough unless the government clamps down on tax evasion. And Athens, like Dublin, may be forced into a fire sale of state assets.
Geodis Wilson’s airfreight volumes in southern Europe were down 3 percent in the first six months of this year, says Nikolas Dombrowski. Results for this region, comprising Spain, Italy and France, contrasted with central Europe and the Nordic region, which performed well for Geodis. Central Europe (Germany, the Netherlands, Belgium and the UK) was up 24 percent, confirming the two-speed Europe.
Italy has seen a 9-percent increase in air exports so far this year, led by fashion, leatherware and luxury goods, but with a solid underpinning of auto and motorcycle parts. However, a slowdown in industrial projects in markets such as Turkey and the Middle East has hit Geodis hard; its share of what remains a highly fragmented market has fallen back from 1.6 percent to 1.4 percent.
Lack of local capacity meant that 80 percent of Italian export airfreight was once trucked to airports such as Frankfurt, Paris and Brussels. The figure is currently less than 45 percent, with carriers such as Korean Air, Singapore Airlines and Emirates now operating freighters directly to Milan. This, and the fact that airfreight rates are lower than in Germany, has helped prevent modal shift. It’s feasible for exporters in eastern Europe to truck to Italy instead of using local airports such as Prague, Dombrowski says.
Geodis has also lost airfreight market share in Spain, suffering a 19-percent volume decrease in the first half, while the overall market grew by 9 percent. “We lost some business controlled from Latin America and Asia,” Dombrowski says. “Now, we’re coming up again, and I’m positive we can end the year level with last year.”
Spanish importers with a poor payment record will happily change suppliers in a bid to extend their credit line. Forwarders buying their capacity from airlines on fixed contracts were badly wounded by falling spot rates that would have meant taking a loss of anything from HK$6 to HK$9 per kilo, and this forced Geodis to reject textile import traffic.
In happier times, carriers were similarly lured by the prospect of massive fashion imports into Spain and tried operating freighters direct into Zaragoza, Dombrowski says. Some have been forced to withdraw from this superficially attractive market.
Problems look set to continue for the Eurozone if strong economic recovery doesn’t happen soon. There is no appetite, or funding mechanism, for bailing out larger economies should they fail.
A full fiscal union of EU states is unacceptable to voters in those countries with stronger balance sheets, but the behavior of the money markets suggests this is inevitable for the euro to survive. If even one Eurozone member defaults or is forced out, then surely the great euro project will go the same way as all history’s previous attempts at currency union.
In early July, attorneys representing the interests of three U.S. carriers and the U.S. Air Transport Association flew to England to appear before the European Court of Justice. This wasn’t a house call; the attorneys were there to tell the judges that the EU’s emissions trading scheme — a cap-and-trade policy originally introduced in 2001 that will be applied to the aviation industry starting in January — is illegal when applied to airlines.
On Jan. 1, 2005, the ETS came into effect in Europe, providing guidelines for the emissions of factories and other land-based facilities. The European Commission decided three years later to apply their new rules to the aviation industry and set the 2012 start date. Carriers that fly into or out of Europe next year will have to keep track of their emissions and buy carbon allowances if the flight’s carbon footprint exceeds a pre-determined limit. Airline officials must keep track of emissions on the entire leg routing into or out of Europe.
Attorney Derrick Wyatt laid out a scenario for the European judges. Suppose, he told them, that a plane takes off from San Francisco on its way to London Heathrow. Emissions for the trip would occur in U.S. airspace (about 29 percent of the entire trip, he estimated), Canadian airspace (37 percent) and international airspace over the ocean (25 percent). He calculated that only 9 percent of emissions would occur in EU airspace, but the carrier would have to pay the EU for emissions from the entire flight.
“It is astonishing that a U.S. airline must acquire an EU license to cover its emissions at a U.S. airport or in U.S. airspace, but that is precisely what the ETS requires,” he concluded in oral arguments before the court. “This is incompatible with the exclusive jurisdiction of the United States to regulate such emissions.” Therefore, it’s illegal.
A preliminary ruling on the case is due this month. A full decision isn’t expected until next year, but foreign carriers should have a pretty good idea of the result soon.
To ease the airlines into this change in environmental guidelines, the European Commission has decided to give carriers a break next year. According to a report by Thomson Reuters Point Carbon and RDC Aviation, scheduled carriers will get anywhere from 20 percent to 100 percent all of the allowances they’d need to offset their 2012 carbon footprint as a gift from the European government. The firm found that the EU carriers will get an average of 61 percent of their needed allowances, with Lufthansa and other long-haul carriers getting an average of 81 percent of their needed allowances. The largest Asian carriers, the firm predicts, will receive an average of 63 percent of their needed allowances. The most notable U.S. carriers will receive an average of 64 percent.
“The biggest unknown now is the treatment of dedicated freight carriers — UPS, DHL and so on,” says the firm’s Andreas Arvanitakis. “The specific data needed does not exist for them, and the leasing and other commercial arrangements muddy the waters further still, but we estimate their free allocation to be on average 52 percent of what they need in 2012.”
The official government carbon calculations were to be published at the end of last month, and the firm expects the commission to issue 176 million free carbon allowances in 2012, a gift worth about €2.1 billion at the current carbon price of €12. Even with this head start, the firm projects that airlines will buy an additional 88 million allowances next year. In 2013, the costs to airlines will certainly rise.
“From 2012, airlines in the scheme will have to surrender one allowance for every tonne of CO2 they emit,” the firm found. “With this baseline, they have to buy about a third of what they will need at market prices.” Offsets built into the Kyoto Protocol — the Clean Development Mechanism and Emission Reduction Units, for example — could help reduce the cost to airlines.
WATCHING AND WAITING
This emissions plan, however forward thinking and environmentally friendly, has enraged the industry. Harsh denunciations have come from all corners of the globe. The U.S. case is being watched carefully by carriers around the world, even as officials prepare the necessary documentation to begin participation in the EU’s new policy.
“The points made by the U.S. carriers are fairly generic in nature, and it seems clear that if the court does find in favor of any of those points, they would probably apply equally to other foreign carriers,” says Andrew Herdman, president of the Association of Asian Pacific Airlines. “We view that very much as a test case, one that we will be watching carefully.”
The AAPA’s close watch over everything regarding the EU ETS isn’t anything new. Herdman and his colleagues have been in contact with the EU, both while the aviation rule was being debated and since it has been passed into law.
“Our objections to the scheme are essentially that in applying it to all foreign carriers for the entire length of the journey for both in-bound and out-bound services, the European
Union is overreaching its authority,” Herdman says. “We’ve been putting forward those views through a variety of channels.”
The AAPA isn’t the only foreign organization taking issue with the EU ETS. In a letter sent last month to Connie Hedegaard, the European commissioner for climate action, representatives from The International Air Cargo Association expressed their displeasure with the plan.
Calling the scheme illegal, officials wrote that the ETS violates international law and “encroaches upon the sovereign authority of each state over its own airspace.” TIACA executives also argued that the ETS is a catch-22: Instead of improving the environment, the scheme will actually prevent the aviation industry from investing in sustainable technologies.
To add another layer of dissent, the U.S. House of Representatives has introduced a bill that aims to “prohibit operators of civil aircraft of the United States from participating in the European Union’s emissions trading scheme.” The International Air Transport Association and other organizations have released statements commending the U.S. proceedings.
LACK OF ACTION
According to an EU spokesman for climate action, including aviation in the union’s emissions trading scheme is a direct reaction to the International Civil Aviation Organization’s lack of environmental progress. Issac Valero-Ladron says that after 15 years of seeing little movement toward a climate change directive, the EU voted to act on its own.
The aviation directive started gathering steam in 2009. While some aviation officials have suggested that the ETS can still be amended, Valero-Ladron says it’s basically set in stone. “This is not a proposal; this [is] adopted legislation,” he wrote in a document outlining the inclusion of aviation into the EU’s ETS. “We do not intend to back down or modify our legislation.”
As for the revenues generated from the scheme, EU spokesmen say it will be given over to European and third-world countries for research into environmental aviation technologies. “The EU member states will be reporting to the European Commission on how revenues have been spent,” Valero-Ladron said. “Our intention is that these reports will be made public.”
Those revenues, according to the letter sent by TIACA, could be quite significant. Officials estimated that the cost of purchasing carbon allowances will surge by $2.2 billion by 2020, rising from $1.3 billion in 2012 to $3.5 billion.
Representatives from the National Airlines Council of Canada and IATA filed written observations in the U.S. carriers’ court case. In the document, officials detail what impact the new law will have on the aviation industry. The cost of compliance seems to be a big sticking point, with money going to the EU instead of being devoted to new, environmentally conscious technology.
“The costs imposed, moreover, could actually lead to an increase in aviation emissions. By diverting revenues from the airlines, the EU ETS will, if anything, actually slow down the replenishment of their fleets with more fuel-efficient and GHG-friendly airplanes,” attorneys representing IATA and the NACC wrote.
In an added wrinkle, the attorneys brought up a few unintended consequences of the law. They wrote that carriers may simply choose to fly their most fuel-efficient planes into the EU, reserving older members of their fleet for other routes. Instead of solving the carbon-emission issue, this just pushes it off on other countries.
Finally, the attorneys believe, carriers will simply change their routes in order to be less vulnerable to the environmental changes. The ETS only applies to the last leg of the flight coming into the EU or the first leg leaving Europe, so carriers could simply add another stop to their flights. “Because airlines will only have to purchase allowances for those flights using EU airports, long flights to Europe will more frequently be routed through Middle Eastern and other nearby, non-EU hubs,” the attorneys wrote. “The EU ETS, then, actually creates perverse incentives for inefficiencies that could increase overall GHGs.”
AAPA’s Herdman agrees that there will be a few unforeseen consequences to the EU ETS. The new law could impact trade with Europe or could affect Toulouse, France-based Airbus’ business. Of course, the threats of individual carriers could be so much bellyaching, but then again, these words might have a real impact on the health of Europe moving forward. “A number of countries have indicated that they view this as a trade dispute,” he says. “That leads to retaliatory measures that may be related to the same industry, or they might be totally unrelated, but simply targeting interests from whatever state is in the crosshairs.”
Herdman concludes that if the EU ETS is enforced as it currently stands on the books, the aviation industry will owe the EU a lot of money. “It’s pretty clear that the total number of emissions will still grow for aviation even if other sectors are able to shift to non-carbon-based fuels and thereby ease their emissions,” Herdman says. “As a sector, we’re likely to be net buyers of certificates.”