Commoditizing air freight
Two logistics executives set to launch a weekly rate index for air transport.
Since its inception, the Shanghai Containerized Freight Index has given ocean freight shippers an accurate portrayal of spot export container rates out of Shanghai on a variety of lanes.
Populated by liner companies and freight forwarders, the data generated by the index is invaluable for judging the health of the container market. Shippers and analysts may use the data to see where trends are heading, but brokers and others see the data as the base for container freight swap agreements, which allow for hedging against the sea freight market. The index has become much more than a tool for transparent pricing, and has created a derivative market out of shipping containers, bringing about the commoditization of the shipping container.
John Peyton Burnett, managing director at Hong Kong-based Kong Team Logistics Ltd., and Robert Frei of JCL Logistics hope to eventually create a similar type of multi-user index for air cargo.
This fall, the two logistics executives will launch the first weekly air cargo pricing index, dubbed the TAC Index, concentrating on key air cargo lanes out of Hong Kong. The index wouldn’t be a sea change for the air cargo industry, but it would allow shippers to benchmark rates on certain lanes, and eventually open the market to commodity trading.
Built upon house and master air waybill information provided by forwarders, the index would present a picture to shippers of what they should be paying for air transport services on any given lane. Burnett said the participating forwarders are drawn to the fact that the index is setting up a derivatives market for air cargo.
“Generally speaking, the basic model for how air cargo is traded really hasn’t changed in the last 50 years,” Burnett said. “What we’re essentially trying to do is to bring air cargo in line with the other commodity markets.”
As with the ocean index, Burnett sees two types of users for the subscription-based TAC Index—consumers like airlines, shippers and forwarders, and financial players looking to trade a new type of commodity or analysts tracking the marketplace. One of the criticisms of the index is that it’s pushing all trading toward the spot market. Burnett said this is only half the picture.
Airlines would prefer long-term contracts for their air freight, but will benefit from the index because they can synthetically sell cargo space on their planes years down the road by using the data in the index, Burnett said. This, he added, will make investors happy, and will provide a clearer picture regarding future activity, a big advantage when signing up for new aircraft. Buying new planes has always been a gamble based on projections for the future made by Boeing and Airbus and this will take some of that uncertainty out of the equation, he said.
Data is now rolling in from forwarders, and the task is now sorting through what they have to get the index up and running. Burnett and Frei had been striving to create the index, something they said the air cargo industry has needed for a while, for the past 10 to 15 years, but information technology capabilities always made a comprehensive index practically impossible. Now, armed with enough data—which, in some cases, is two to three years of archival information, depending on the technological inclination of the forwarder—Burnett will start the index focusing on city pairs out of Hong Kong. He said the index will likely show rates between Hong Kong and major U.S. airports like John F. Kennedy International Airport in New York, Los Angeles International Airport and Chicago O’Hare International Airport. Other first pairings will likely show pricing between Hong Kong and Amsterdam, Frankfurt and other major air cargo cities.
“Effectively, the top 50 city pairings represent 50 percent of the market by revenue. What we would be doing is focusing on those trade lanes; that’s what we’re most interested in,” he said. “Initially, because we are getting our data out of Hong Kong, we would be focusing on the main city pairings out of there.”
While Burnett has a rough date in mind for launching the index, he said it all depends on how much data they receive.
“We’ve still got to do some more analysis on the data. We’re not going to go unless it’s correct,” he said. “If we had a few more providers coming online, we might wait a little bit.” Burnett noted that recent press attention has garnered increased interest in the index, which in turn has helped bring more consumers and data providers to the table.
He continued, “We’ve had some of the big shippers call us up and say, ‘You get going, and as long as the data are good, we’re supporters of this.’”
In addition to being a benchmark tool, shippers will benefit from the index, Burnett said, by being able to see air cargo as an insurance product. He explained shippers might be able to pay a premium toward insuring that freight rates don’t climb above a certain barrier. As an example, a shipper would pay a fee to ensure that pricing doesn’t rise above $3.50 per kilogram. If pricing stays at or below that level, the shipper loses the fee, but if pricing suddenly soars, that tiny fee would save the shipper from an unanticipated expense.
“The immediate benefit for the shipper will be when negotiating price, as they will have a benchmark to work from, like they do in the other commodity markets,” he said. “The indexation of the sea container market, which is a few years ahead of us, is now really starting to take hold.”
Finally, shippers will benefit from the index by cutting down on the tedious task of price discovery. To do this, forwarders will submit multiple bids on a regular basis for a large shipper to measure the going rate for air cargo shipments across a number of providers. The index has the potential to get rid of this step of the bidding process.
“An index can make the market more efficient by removing this price discovery component,” Burnett said. “Parties can then focus their efforts on other issues such as service. For example, some parties might be willing to procure capacity at a higher than market price, but they expect a better level of service.”
The TAC Index won’t be entering a completely open market. Since 2004, Drewry has published WorldACD, a monthly service that provides volume, revenue, yield and product type data on trade lanes. The data can also be analyzed on a macro-level, taking a measure of an entire region or country. According to World ACD, it gets these data sets by recording 2 million air waybills each month, generating shipment data from more than 15,000 forwarders and over 50 airlines. Drewry also publishes a monthly air freight index, measuring the average price of a kilogram of freight paid by forwarders on key East-West trading lanes.
Recently, Drewry announced that it had strengthened its cooperation with the forwarder network WACO System. The two entities have collaborated since 2012, as WACO has provided data for Drewry’s monthly reports, and Drewry has helped the network’s forwarder members unearth market trends.
Joost van Doesburg, who has served as the air freight policy manager at the European Shippers' Council since 2011, said the main reason his group supports the index is that it will bring a measure of accountability and transparency to air cargo pricing. As more capacity comes into the market, he said the spot market will become even more important than it is today, and the index will help shippers navigate that market effectively and efficiently.
“Many shippers see this industry as a commodity, but we are lacking such an index,” he said. “I really hold the belief from my shipper’s role that this will become a reliable index.”
One of van Doesburg’s main crusades is accountability regarding surcharges levied by carriers to cover security and fuel expenses. With the fuel surcharge, he said, shippers have never seen an accurate correlation between the price of jet fuel and the amount of the surcharges. When fuel goes up, so do the surcharges, but when fuel gets cheaper, these surcharges don’t always immediately follow the flow of the market. By allowing shippers to compare indexed pricing with surcharges levied by carriers, this index will bring a contentious practice more into the open, he said.
“Shippers still believe, and we have all the proof necessary, that, indeed, logistics service providers use the surcharges to reduce their debts or to increase their yields,” he said. “We think that surcharges should not be created for that purpose.”
Van Doesburg said he believes there’s a fundamental flaw in the air cargo industry and, while the TAC Index has certainly been welcomed by shippers as a step toward creating a transparent and healthier air cargo industry, the index is not a panacea. Shippers, he said, should be focused on the price of air cargo, but this is not their only concern. Reliability of air freight services and the quality of transportation are very important factors in the market that need to somehow be quantified.
A measure of quality regarding air cargo transportation would help stem the tide of shippers leaving for cheaper modes. He noted shippers either leave air cargo for ocean transport, which is, of course, slower but cheaper, or integrator services, which are fast and reliable with high service quality, but are expensive.
“You don’t know as a shipper what’s a good airline. You don’t know what is a good freight forwarder. You only know one thing, what is a good price for this service,” he said, referring to the “structural” crisis in the market.
Shippers, he said, will embrace the new index because there’s no down side for them.
“In the eyes of a shipper, there is no threat, no reason to not take this action,” he said. For many shippers, they will embrace it, and they will start to use it, and they will start to monitor in a very easy way the price developments.”
To encourage these shippers to return, carriers and forwarders need to invest in new systems that bring the correct measure of quality to the air cargo industry. This would require the establishment of quality and reliability metrics, but van Doesburg said this would help prop up an industry that has been using the same methods for decades. He noted shippers are also deciding to leave the industry, or not rely as heavily on air cargo because they believe things will never change.
“Shippers can pay a little bit extra to invest in more reliable and higher quality services that are, of course, a little bit more expensive. So quality and reliability should become an extra dimension in our industry,” he said.
This is outside the initial scope of the TAC Index, which hopes to mature into something akin to its much older ocean brother, the Shanghai Containerized Freight Index. For now, though, the industry seems abuzz with anticipation for a legitimate new development in the volatile, unpredictable air cargo market. Burnett is happy starting from ground zero, striving to make a difference.
“You need to go into an unstable market. If the market was flat, then there’s no point in setting up a derivative instrument,” he said. “The bulk sea freight guys are 30 years ahead and using more advanced financial instruments to fine tune risk—with us, at the beginning, it would be quite basic, and we’ll build from there.”
This article was published in the September 2014 issue of American Shipper.