The Air Cargo Market between China and the United States: Demand, Developments and Competition May

2007 Reed H. Tanger Kellogg School of Management Northwestern University

Contents
Introduction ................................................................................................4 Section 1: Overview of the Air Cargo Industry........................................7
Air Freight Services................................................................................................... 7 Dedicated Freighters versus Combination Flights ................................................. 9

Section 2: Growth Drivers in Chinese Air Cargo Traffic ......................11 Section 3: Trade Imbalance.....................................................................13 Section 4: Regulatory Changes ..............................................................17 Section 5: Geography of Chinese Exports and Air Cargo Hubs..........21
Yangtze River Delta: Shanghai ............................................................................... 22 Bo Hai Bay: Beijing.................................................................................................. 24 Pearl River Delta: Guangzhou ................................................................................ 25 Further Hub Developments..................................................................................... 26

Section 6: Air Cargo Carriers..................................................................30

U.S. Carriers............................................................................................................. 30 Federal Express ..................................................................................................... 30 United Parcel Service............................................................................................. 32 Northwest Airlines .................................................................................................. 34 Polar Air Cargo....................................................................................................... 36 Chinese Carriers ...................................................................................................... 39 Air China Cargo...................................................................................................... 39 China Cargo ........................................................................................................... 40 China Southern ...................................................................................................... 40 Yangtze River Express........................................................................................... 41 Shanghai Air Cargo................................................................................................ 41 Jade Cargo International........................................................................................ 42 Chinese Carriers Summary .................................................................................... 42 Third Country Carriers ............................................................................................ 43 Charter & Aircraft-Crew-Maintenance-Insurance (ACMI) Operators ................... 45 Competition and Growth......................................................................................... 46

Conclusion................................................................................................49 References................................................................................................51

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Figures
Figure 1: Total Trade between China and the U.S. ......................................................... 4 Figure 2: Exporter Shares of Asia to North America Freight ........................................... 5 Figure 3: Trade Imbalance between China and the U.S................................................ 14 Figure 4: Available China/U.S. All-Cargo Frequencies.................................................. 20 Figure 5: Key Chinese Regions for Air Cargo Operations ............................................. 22 Figure 6: Freight Growth at Shanghais Pudong International Airport ........................... 24 Figure 7: Geographic Concentration of Chinas Air Cargo by Region ........................... 26 Figure 8: Chinas Three Primary Cargo Hub Facilities .................................................. 29 Figure 9: Scheduled All-Cargo China Frequencies of U.S. Carriers.............................. 38 Figure 10: Scheduled All-Cargo Operations between Chinese & U.S. Cities in 2006 ... 47

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Introduction
With increasing globalization, the transport of cargo by air has become increasingly important. One market in particular is driving air cargo demand more than any other: China. Chinas development into a leading global manufacturer and global consumer has been staggering. Chinas worldwide trade was valued at $281 billion in 1995; it had increased to $1.77 trillion by 2006.1 Trade growth between China and the United States has been equally impressive. Trade of $57 billion between the two nations in 1995 has grown to $343 billion in 2006 (see Figure 1), with the U.S. as Chinas top trade partner.
400 350 Annual Trade ($ billion) 300 250 200 150 100 50

$343 billion

$57 billion
0 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006

Figure 1: Total Trade between China and the U.S.2

China has been the primary driver of global air freight flows and is expected to become the worlds largest air cargo market based on projected domestic and international traffic. The fastest growing air cargo market is that between China and North America with an annual growth rate of 18% in air freight traffic since 1995.3 The
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U.S. is responsible for nearly all of this North America trade with China. In 2000, China had already overtaken Japan as the leading shareholder of Asia/North America air freight tons with 28%; it is predicted to account for a 53% share in 2010 (see Figure 2).4

Share of Asia-North American Air Freight

100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0%

Asia to North America Air Freight (millions of metric tons) 1.7 2.1 3.1
29% 23% 5% 5% 6% 17% 20% 5% 5% 4% 13%

4% 7% 11% 21%

Rest of Asia Korea India Taiwan Japan

53% 44% 28%

China

2000

2005

2010F

Figure 2: Exporter Shares of Asia to North America Freight5

The explosive growth in traffic between China and North America is expected to continue, with forecasted annual growth rates around 10% over the next 20 years.6 Tonnage of air cargo will grow significantly as a result. The 2005 level of 11 billion freight-ton kilometers (FTKs), the standard measure of air cargo, is predicted to be 75 billion FTKs in 2025.7 The China/U.S. segment of the industry will hold a prominent share of this growth.i By 2025, air cargo traffic between China and North America alone will account for 17% of the worlds FTKs.8

Notation: The use of China/U.S. in this report refers to both countries combined and is bidirectional.

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A number of factors have impacted the air cargo industrys growth in the China/U.S. market. The growth in certain types of Chinese exports has fueled the industrys profits, while the continued trade imbalance represents a persistent challenge. Regulatory policies have limited expansion opportunities; however, gradual liberalization of the industry continues. Meanwhile, development of airport infrastructure on mainland China continues with hub facilities emerging in key manufacturing regions. Finally, a large number of air cargo carriers from the U.S., China and other nations are competing fiercely in the China/U.S. air cargo market, where profitability is assured for only the strongest carriers. This report examines these and other factors to produce an overall summary and evaluation of the current demand, developments and competition in the China/U.S. air cargo industry.

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Section 1: Overview of the Air Cargo Industry

Air shipments move 40% of the value of world trade, but only 1% of the total weight.9 Only the most time-sensitive and high-value commodities require the premium service of air transport. With costs seven to ten times higher than surface transport, air freight offers speed, security and reliability that complement not only high-value, lowweight items, but also products that are perishable or threatened by theft.10 Air cargo is also favored for time-sensitive products that suffer from obsolescence, such as computers, MP3 music players and cell phones, which are in high demand and have a short marketing life. In addition, products with high inventory carrying costs, such as medical devices and jet engines, are more likely to utilize air freight to avoid critical time-in-transit. Growth in the use of just-in-time (JIT) manufacturing processes, where particular parts must arrive for assembly at specific times, has also increased demand for air cargo. Indeed, auto manufacturers often transport critical components by air, to ensure their availability for final assembly.

Air Freight Services The air cargo offering generally falls into two categories: express and general freight. Express services typically cover the shipment of high-priority documents and materials as well as small packages. Companies operating in this market are often fully-integrated, meaning they provide not only the air service, but also the sorting and ground transportation that allows them to offer door-to-door services. Examples of worldwide integrated express service providers are well known, including Federal Express (FedEx), United Parcel Service (UPS) and DHL. General freight typically

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encompasses heavy cargo, including larger volumes of product, larger-sized product or freight that is less-time sensitive than express freight. Large loads of electronics, automobiles parts and items such as the medical devices and jet engines would be typically considered general freight. General air freight services are most often provided by direct air carriers that specialize in only the air transportation portion of the products journey.ii In this case, freight forwarders provide the remaining services, including ground transportation to and from final destinations. Freight forwarders contract directly with the air carriers and directly with shippers. Part of their function includes maintaining relationships with a number of air carriers and routinely consolidating various shipper loads for particular flights. As of 2005, freight forwarders handled more than 80% of all intercontinental freight tons.11 Integrated express carriers, direct air carriers and freight forwarders, therefore, share in the overall revenue from air freight services. The Air Cargo Management Group estimated that in 2003 the share of global air freight revenues was 31% integrated express carriers, 48% direct air carriers and 21% freight forwarders.12 While carriers debate the relative demand for express versus general freight in the China market, it is clear that both have important roles for the competitiveness of the air cargo industry.iii

Express carriers also typically transport a percentage of general freight as part of their air cargo operations. In their 2004 submissions to the U.S. DOT, FedEx and Northwest Cargo debated the relative importance of express and general freight. NWA argued that general freight was underserved by the current capacity of cargo service, while FedEx argued it was overserved.
iii

ii

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Dedicated Freighters versus Combination Flights Air freight is handled in one of two ways: (1) dedicated freighter aircraft or (2) the available belly capacity on passenger flights. Dedicated freighter aircraft transport only cargo, with freight generating all revenue. Freighter (all-cargo) carriers flying in the trans-Pacific market typically utilize long-haul widebody aircraft that can provide maximum capacity for freight. Typical aircraft include the Boeing 747 (B747) and the McDonnell Douglas MD-11. Express carriers, which typically fly shorter distances between stops, often utilize smaller freight aircraft such as the Airbus A300/310 and the Boeing 767. Combination flights are typically scheduled passenger flights with a percentage of belly capacity made available for express and/or general freight. Aircraft type vary significantly with airlines individual fleets and comprise both narrowbody and widebody aircraft. In most cases, a passenger airlines ability to generate revenues from freight carried aboard scheduled combination flights is critical to profitability. Projected belly freight revenues are carefully examined when a carrier is considering an expansion of long-haul passenger service, especially for the trans-Pacific markets. In 2004, freight forwarders estimated that belly capacity of passenger aircraft through combination flights was up to half the global capacity available to them.13 MergeGlobal confirmed this figure in 2005, stating slightly less than half of all intercontinental cargo capacity was supplied by the belly compartments of combination flights.14 For Asian air cargo, in particular, belly capacity has a significant role. Even for Hong Kong, a hub with extensive freighter service, up to 60% of air freight is carried in the belly compartments of passenger aircraft.15 The situation, however, is changing in

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the favor of dedicated freighter service. With Asian growth in freight volumes forecast to exceed the growth in passenger volumes in the years to come, the proportion of combination flight belly capacity will continue to decline.16 The inadequacy of belly capacity to support air cargo demand demonstrates the importance of dedicated freight service and will lead to an increase in the required number of freighter aircraft.

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Section 2: Growth Drivers in Chinese Air Cargo Traffic

Chinas dramatic increase in international air cargo traffic results from the explosive growth in China as a world manufacturing base. Between 1978 and 2002, Chinas Gross Domestic Product (GDP) grew at an annual rate of 9.4%.17 Over the same period, air FTKs grew annually at 18%.18 Chinas GDP annual growth rate has hovered between 7% and 11% for 2001-2005, and is expected to remain (though with a slight decline) above 7% through 2010 outpacing North America, Europe and the rest of Asia.19 Additional factors in air cargo demand growth result from Chinas status as the top destination - exceeding the U.S. - for foreign direct investment as well as its designation as host of the 2008 Olympics and the 2010 World Exposition. However, it is not just the growth in Chinas economy that demands freight service by air; it is the type of manufactured product. Chinas manufacturing growth has included the types of sophisticated electronics and industrial products that match the air freight offering. Chinese exports of high-tech goods, including computers, cell phones and flat-screen televisions have surged. These high-tech exports have surpassed all other consumer goods, such as textiles, in value shipped. In 2005, they represented 58% of Chinas exports to North America and Europe as compared to a 38% share in 1995.20 In addition, Chinese manufacturing now includes more final assembly and component integration, rather than simply the fabrication of individual components. For example, the number of computers assembled annually in China has grown from 840,000 in 1995 to more than 45 million.21 Typical eastbound air shipments from China to the U.S. are dominated by consumer goods and include electronics, industrial machinery, power generation

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equipment, apparel and games. It should be noted that the growth in Chinas economy has also increased its demand and consumption of foreign products, and thus, overall imports to China. Exported air shipments westbound from the U.S. to China more typically include small packages and items needed for manufacturing, such as electronics, machinery, power generation equipment, medical equipment and semiconductor machines. The fastest growing commodities for westbound air cargo are the intermediate materials and capital equipment that support Chinese industries. Using these items, Chinese manufacturing is able to supply finished products for the industrialized world.

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Section 3: Trade Imbalance

The imbalance in trade between China and the U.S. poses a significant challenge to the air cargo industry. Eastbound traffic flows are substantial, a result of strong Chinese export flows. Northwest Cargo reported load factors from China to the U.S. of 95.6% in 2003 and 96.2% in 2004, and continues to assert 95% is a reasonable target.22 Similarly, eastbound load factors exceeding 90% were reported by UPS in 2004 between Shanghai and the U.S.23 FedEx reported in 2004 that eastbound Shanghai-U.S. and Shenzhen-U.S. flights were operating with load factors of 98.1% and 96.5%, respectively.24 However, a significant and expanding trade imbalance between China and the U.S. continues to challenge the air cargo industry. In 2006, Chinese exports to the U.S. exceeded its imports from the U.S. by over $200 billion (see Figure 3). The air cargo industry is forced to accommodate this imbalance. In 2003, with 207,537 tons of cargo transported between China and the U.S., 148,067 tons were eastbound to the U.S. (71%), while only 59,470 tons were westbound to China (29%).25 The difference expanded in 2005. In that year, approximately 12 billion FTKs (80%) of cargo were flown eastbound from China to North America, while only around 3 billion FTKs (20%) were flown westbound.26 The trend is expected to continue. The ratio of China-U.S. air exports to U.S.-China air exports stood at 4.1x in 2005 and is forecast to be 4.3x in 2010.27 Air freight carriers serving the China/U.S. market, therefore, face an eastbound demand for service that is more than four times greater than westbound demand. Since a carriers costs are round-trip, and revenues are predominantly oneway (eastbound), the industrys profitability is increasingly challenged.

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350 300 Annual Trade ($ billion 250 200 150 100

$55 billion $288 billion

U.S. Exports China Exports

50 0
2 1 3 0 9 5 6 7 8 20 0 4 5 20 0 19 9 19 9 19 9 20 0 20 0 20 0 19 9 20 0 20 0 19 9 6

Figure 3: Trade Imbalance between China and the U.S.28

The trade imbalance is handled by the industry in several ways. One method is pricing. With strong eastbound demand and relatively weak westbound demand, profitability rests with strong yields on shipments from China. Eastbound traffic must effectively subsidize the westbound flights, with carriers charging significantly higher rates to serve the strong eastbound demand. Westbound rates are greatly reduced, as carriers battle to generate whatever revenue they can from limited traffic. Andreas Otto, Executive Board Member of Lufthansa Cargo, noted if air rates are $3/kg out of China, they might be only $0.10/kg into China, and stated the imbalance is a real danger and limitation on the industrys growth.29 According to one freight carrier executive, flights from the U.S. to China in 2005 averaged only about 10 tons of cargo.30 Such loads would hardly fill a B747 freighter aircraft, which has a cargo capacity well over 100 tons. Another executive indicated a 35% westbound load factor is a reasonable expectation.

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Carriers reported westbound load factors are difficult to compare effectively, however, as pricing to secure the more limited cargo to China can fluctuate significantly. Some carriers, for example, may charge unprofitably low prices to gain additional shipments and a higher westbound load factor. A second method for dealing with the trade imbalance is the implementation of westbound stops enroute to China. A number of carriers, for example, may fly routes in the eastbound direction direct from China to the U.S., but may add stops in Japan for westbound routes. Thus, westbound shipments between the U.S., Japan and China are pooled, sharing aircraft capacity that might otherwise be underutilized. FedEx pools demand through its use of round-the-world flights. Instead of only flying westbound from the U.S. to China, FedEx also offers eastbound service from the U.S. with several intermediate stops. Cargo is thus aggregated among the various regions served, thus ensuring the maximum possible loads into China. Continued eastbound service from China back to the U.S. completes the round-the-world flights with the strong loads of Chinese exports. A third tactic for managing the trade imbalance is leveraging hubs and networks. Operating an Asian hub allows China-bound traffic to be consolidated from different regions of Asia and the rest of the world, thus improving capacity utilization. The connecting flight into China could therefore include exports from multiple nations. Carriers based in the U.S. are able to leverage their U.S. hubs and North American networks. By first directing any North American China-bound traffic to the U.S. hub city, they are able to maximize the loads sent on connecting westbound flights to China. It is for this reason that Chinese carriers often suffer the most from the China/U.S. traffic

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imbalance. While they may fly strong loads eastbound from China, they lack the extensive North American networks of the U.S. carriers to aggregate westbound cargo. Guo Dongmou, aviation analyst with CITIC Securities noted, The freighters of Air China Cargo and China Cargo Airlines often fly empty into China.31 Such carriers are forced to survive from revenue gained through outbound cargo from China. To mitigate such positions, Chinese carriers have sought foreign partnerships to leverage networks and help ensure return flights are more fully loaded.32 It is worth noting that though the trade imbalance remains significant, exports from the U.S. to China are increasing. From 1998 to 2002, exports of goods and services from the U.S. to China grew 55%, compared to 5% growth for U.S. exports to the rest of the world.33 North America to China air cargo traffic is expected to grow annually at over 8% through 2025, though still outpaced by the forecasted 10% annual growth in the eastbound direction over the same period.34 While U.S. exports are clearly rebounding, the trade imbalance remains.

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Section 4: Regulatory Changes

The ability of the international air cargo industry to grow in the China/U.S. market has been dependent on necessary regulatory changes in recent years. Through the 1980s and 1990s, the air cargo industry was limited by Chinese regulation and policy constraints effectively serving as barriers to entry for foreign carriers. Barriers to foreign entry in China have been both hard and soft. For years, hard barriers have been the limited infrastructure available to aviation operations. Soft barriers have been policy constraints including domestic regulations, guidelines, institutions and administrative mechanisms. Institutional barriers included the conflict of interest created by Chinese domestic airlines ownership of major international cargo terminals. Time-consuming customs processes have also hampered air cargo growth at many Chinese terminals. Aviation policy provided perhaps the most significant soft barriers to the air cargo industry. Until recent years, all aspects of commercial air transport were governed by the restrictive bilateral air service agreements mandated at the Chicago Convention of 1944.35 China, as part of the bilateral agreement structure, has maintained conservative international aviation policies that have limited rights for air service between China and other nations. Chinas policies had also created an imbalance in operations since the limited international traffic rights were biased toward Beijing, despite Shanghais dominance in international trade in the late 1990s.36 As a result, air cargo that could not be accommodated in Shanghai had to be shipped to Beijing or Hong Kong for outbound transport (and vice versa). Overall, aviation policy resulted in a less than optimal network that limited the growth of the air cargo industry in China.

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China was accepted as a member of the World Trade Organization (WTO) in 2001 after years of negotiations. WTO acceptance required that China eliminate barriers to market entry in various service sectors by 2005.37 For the air cargo industry in particular, two major effects of Chinas WTO accession would relax previous barriers and facilitate growth. First, opportunities for foreign direct investment have greatly increased with more liberal ownership restrictions for freight transport providers. Since 2002, foreign investors have been allowed up to a 49% stake in a Chinese company, as long as no one investor holds more than a 25% stake; previously, foreign investors were limited to a total of 35% ownership.38 The new limits have facilitated partnerships between Chinese air cargo carriers and foreign companies, in addition to joint ventures between foreign air cargo carriers and Chinese ground transportation companies. The second significant effect of Chinas WTO accession for the air cargo industry has been more liberal policies towards air operations. In 1999, China and the U.S. implemented an expanded air services agreement (ASA) that increased available weekly frequencies for each countrys air carriers from 27 to 54 (of which 20 were for all-cargo operations), and also allowed the designation of one additional air carrier from each side.39 The move further enhanced competition in Chinas air cargo market. A much more liberal ASA was signed in July 2004, representing a significant move by China to further accommodate competition in the industry. The agreement stipulated a phased increase in weekly frequencies from the previous 54 to 249 per country through 2010, and allowed for the entry of five more carriers to the China/U.S. bilateral market over this period.40 Over half of the newly available frequencies, 128 for each side, were designated for cargo flights. Consistent with WTO requirements, the 2004 ASA was a

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major Chinese policy shift from a position of protecting relatively weak Chinese carriers toward liberalization of the air cargo industry to promote trade, foreign direct investment and economic development.41 A further development in China/U.S. aviation policies was announced by U.S. Transportation Secretary Mary Peters and Chinese Minister of Civil Aviation Yang Yuanyuan in May 2007. In addition to growth in the number of passenger flights, the new agreement includes elimination of all Chinese government limits on cargo flights and cargo carriers serving the two countries by 2011.42 The agreement will give U.S. air cargo carriers virtually unlimited access to China (and vice versa), fully liberalizing the China/U.S. air cargo industry. As part of a phased approach, up to three new air cargo carriers will be designated to serve the market between 2007 and 2010.43 The two sides agreed to begin additional talks in 2010 to negotiate a full open-skies accord that would effectively remove all limits from passenger operations, in addition to cargo operations, between the two nations. In summary, significant regulatory changes since the late 1990s have removed previous barriers for the air cargo industry in the China/U.S. market, including significant increases in service rights (see Figure 4). With significant policy liberalization by China, the industry is now poised for considerable growth to accommodate the continually increasing levels of demand.

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90 80

86

71
70

59
Weekly Frequencies 60 50

41
40 30

20
20

20

20

12
10 0 1996 1997 1998 1999

12

4
0 2000 2001 2002 2003 2004 2005 2006 2007 2011

Note: Represents number of frequencies available to each country

Figure 4: Available China/U.S. All-Cargo Frequencies44

Unlimited

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Section 5: Geography of Chinese Exports and Air Cargo Hubs

The geography of Chinese manufacturing and location of Chinese infrastructure and hubs are critical to air cargo operations between the U.S. and China. Prior to the bilateral agreements that today allow direct air cargo service between the U.S. and mainland China, Hong Kong served as the primary Asian gateway for Chinese exports and imports. Shipments from the mainland would be consolidated in Hong Kong for transport overseas. As a result of the bilateral agreements and ensuing direct service to new mainland hubs, in addition to Hong Kongs own capacity constraints, Hong Kongs status as a China hub was reduced to serving the southern region of the mainland. However, as recent as 2004, Hong Kong remained a dominant air cargo gateway accounting for 36% of Chinas total air cargo throughput despite the rapid growth of the mainland direct service.45 As of 2004, over 202,000 metric tons was trucked annually to Hong Kong for air freighter service to the U.S.46 In arguing for more direct service to mainland facilities, carriers have noted excess delays - especially in the express freight business - resulting from the necessary Hong Kong transfer for freight in and out of southern China areas such as Guangzhou (Pearl River Delta) and Shenzhen. UPS in 2004 used the Hong Kong situation to argue for more direct air service to Guangzhou, thus bypassing the time-intensive transfer to the mainland.47 As a result of Chinas booming manufacturing and export growth, the regulatory changes including bilateral agreements with the U.S, and the resulting demand for direct air cargo service to the mainland, there has been significant growth in air cargo hub facilities in mainland China. Geographic distribution of manufacturing and foreign direct investment have been key factors in the location of air hub facilities. For the air

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cargo carriers, these locations and the ability to serve them directly become integral to the success of China/U.S. operations. The three primary areas for direct air cargo service from the U.S. are the Yangtze River Delta (Shanghai), Bo Hai Bay (Beijing) and Pearl River Delta (Guangzhou) (see Figure 5).

Bo Hai Bay

Yangtze River Delta

Pearl River Delta

Figure 5: Key Chinese Regions for Air Cargo Operations48

Yangtze River Delta: Shanghai Shanghai has established itself as the dominant hub for China/U.S. air cargo. In 2004, the Yangtze River Delta region accounted for 11% of Chinas population, 20% of the GDP, 35% of foreign direct investment, and 30% of international trade.49 Shanghai is the largest air cargo market in China. It is a large manufacturing base for industries that typically ship by air including electronics, equipment parts and biomedical supplies,

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and is also a retail, financial and distribution center for other regions across China.50 The increase in business by foreign companies, including establishment of Shanghai offices, also drives demand for express freight service. The growth in Shanghais air cargo movement has been staggering, especially with the completion in recent years of Pudong International Airport. In 1980, Shanghais international cargo and mail throughput stood at 14,000 metric tons; by 2003, it had grown to 510,000 metric tons.51 In that year, air cargo tons through Pudong International Airport grew by 87.5%.52 In 2004, Shanghai accounted for 53% of total Chinese air cargo.53 Figure 6 displays Shanghais growth for domestic and international freight combined, where tonnage tripled between 2002 and 2006. Carriers tend to agree on the importance of Shanghai and forecast it will remain the fastest growing Chinese hub for the foreseeable future. FedEx, which in 2004 routed nearly half its traffic via Shanghai, called that citys region the most important mainland Chinese market for imports and exports, and noted average growth of 18% annually as of 2004.54

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2006 2005 2004 2003 2002 0 500,000 1,000,000 1,500,000 2,000,000

Annual Freight Tonnage

Figure 6: Freight Growth at Shanghais Pudong International Airport55

The commercial growth in the Shanghai area has not always been easily handled by the cargo carriers. Landing slots at Pudong Airport are scarce and overall infrastructure remains fairly limited. While infrastructure expansion continues, the constraints have forced operating costs to rise sharply in recent years. Northwest Cargo President Jim Friedel noted in 2005, Pudong is more expensive than Tokyo.56 Shanghai will most certainly remain the hub for eastern and central China. While it will also remain a significant gateway for all of mainland China, this role will likely be reduced in coming years with the development of other mainland hubs and further distribution of manufacturing throughout China.

Bo Hai Bay: Beijing Beijing has served as the air cargo hub for the Bo Hai Bay region and northern China. The Bo Hai Bay region in 2004 comprised 12% of Chinas population, 18% of

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GDP, 21% of foreign direct investment, and 19% of international trade.57 Since 1992, the area has been part of the Tianjin Economic and Technology Development Zone, which has fostered developments by major international investors.58 Motorola is one such example for the region and remains the largest foreign investor in China.59 While they serve as an important air cargo hub for China, Beijing and the Bo Hai Bay region do not have nearly the manufacturing base of Shanghai. In justifying its initial China service to Shanghai rather than Beijing, Polar Air Cargo noted that Beijings air cargo demand was already well-served by belly capacity on passenger flights.60 Nonetheless, Beijing remains one of Chinas three primary mainland hubs, and has undergone recent expansion to accommodate the broadening geographic expansion of manufacturing in China.

Pearl River Delta: Guangzhou The Pearl River Delta accounted in 2004 for 6% of Chinas population, 10% of GDP, 21% of foreign direct investment, and 35% of international trade.61 The region is not only significant for its machinery manufacturing, electronics and textiles, but is also the largest consumer market in China.62 Until recent years, nearly 90% of air cargo exports from the region were sent via Hong Kong, due to a lack of nearby airport capacity.63 The development in 2003 of the new Baiyun International Airport in Guangzhou has changed this situation for the Pearl River Delta. The airport is home to the largest cargo facility in China, second largest in Asia and third largest in the world, as of 2005.64 In terms of international air cargo tonnage, the airport now ranks third behind Shanghai and Beijing, with continued growth expected.

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Further Hub Developments Combined, the Yangtze River Delta (Shanghai), Bo Hai Bay (Beijing), and Pearl River Delta (Guangzhou) regions in 2004 comprised 80% of Chinas export volumes, 84% of its international trade, 75% of foreign direct investment, and 48% of Chinas GDP.65 Further, all three regions are expected to have annual growth rates of approximately 12-13% for air express and approximately 9-11% for general freight through 2008.66 Because of their commercial and economic importance, in addition to geographic location, it is expected China will continue development of these three major air cargo hubs effectively splitting air cargo service for the north, east and south portions of mainland China. Figure 7 shows the concentration of Chinas air cargo volume in these three key regions, which in 2004 comprised 89% of total air cargo volume and by 2024 are forecast by Airbus to comprise 92% of air cargo volume.

100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% 1996 2004 2024

Share of International Cargo Volume

Other
Pearl
Bo Hai
Yangtze

Figure 7: Geographic Concentration of Chinas Air Cargo by Region67

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While the role of the Shanghai, Beijing and Guangzhou hubs remains clear, the Chinese government continues plans for the development of additional air cargo hubs. The government announced in June 2004 that the General Administration of Civil Aviation (CAAC) would designate six air cargo hubs that would be operational in 2010.68 The first four would be Shanghai, Beijing, Guangzhou and a new operation at Wuhan Tianhe Airport serving central China.69 Two additional hubs would be located to serve northwest China, at either Xian or Urumqi Airports, and southwest China, at either Chengdu or Kunming Airports.70 The designation of new hub airports was intended to complement the central governments Go West campaign, which was launched to encourage growth in the interior of mainland China and provide a better balance of economics between the affluent coastal provinces and the rest of China.71 It continues to be debated whether this campaign will ultimately be successful in enticing investment and manufacturing to these other more remote regions of China. While there are a few early successes such as a new Intel factory in Chengdu, many remain skeptical. Wang Shouren, Secretary General of the China Shippers Association, remarked Go West is only a slogan, and cited lack of transportation infrastructure in the interior as the main reason for shippers reluctance to establish facilities in the less developed areas away from the coastal provinces.72 UPS President International David Abney noted, Moving west drives up the logistics costs. The infrastructure looks nice near the coast, but in the interior, theres still a lot of investment necessary.73

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With the degree of manufacturing and investment in Chinas interior regions uncertain, the establishment of major air cargo hubs beyond those at Shanghai, Beijing and Guangzhou remains unclear. Nonetheless, China has continued to make significant investments to improve air cargo-related infrastructure. Airports have been recently built in Shanghai, Guangzhou, Hangzhou, Zhuhai and Shenzhen (which hosts direct U.S. service by FedEx).74 Major expansions have occurred at Beijing, and also at Shanghais older airport, Hongqiao.75 A $2.16 billion expansion is underway at Guangzhous Baiyun International, an airport only a few years old.76 Clearly, the Chinese government has demonstrated its commitment to improving air cargo infrastructure for the three major hubs and beyond. Such continued investment in infrastructure will be critical in Chinas ability to accommodate growth in China/U.S. air traffic as a result of the May 2007 bilateral agreement to increase air services. Carriers have also recognized the importance of serving or at least being prepared to serve locations beyond Shanghai, Beijing and Guangzhou. In 2004, FedEx suggested direct service to Qingdao, which serves as the gateway to Shandong Province in eastern China.77 Designated as a Foreign Trade Zone, the region in 2003 attracted $4 billion of foreign investment by companies such as Hewlett-Packard, Coca Cola, Nike, Dupont and Lucent, which built a $200 million facility in the area.78 In summary, air cargo carriers operations continue to focus on the three key regions represented by hub airports of Shanghai, Beijing and Guangzhou. While Shanghai has already shown capacity constraints, continued expansion of facilities there will accommodate significant growth in the years to come. Beijing and Guangzhou both clearly have capacity for large cargo volume growth. Combining

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capacity with the geography of commercial activity in China, it may be a number of years before an additional air cargo hub would be established on the mainland. It will remain important, however, for the industry to closely monitor continued geographic distribution of manufacturing and economic development including the governments efforts toward this distribution. Even if the additional major hubs are not developed in the short-term, the potential development of sub-hubs may be warranted by new commercial activity in these other regions. These smaller volume demands could be served with smaller capacity aircraft by carriers operating from hubs elseware in Asia.

Figure 8: Chinas Three Primary Cargo Hub Facilities79

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Section 6: Air Cargo Carriers

While a limited number of air cargo carriers have the operational authority to serve the China/U.S. market, the degree of competition is very strong. Four U.S.-based air cargo carriers hold the rights to operate direct scheduled service into mainland China: FedEx, UPS, Northwest Airlines and Polar Air Cargo. Several Chinese carriers hold similar rights for direct operations from China to the U.S. In addition to these home country carriers, a number of other foreign flag or third country carriers also operate directly and indirectly in the China/U.S. market. Both the home country carriers and third country carriers also serve the China/U.S. air cargo market with a percentage of aircraft belly capacity on scheduled passenger flights. Finally, additional cargo carriers operate on a charter basis. Altogether the various operators produce a very competitive environment for the China/U.S. air cargo market.

U.S. Carriers Federal Express Based in Memphis, Tennessee, FedEx is the worlds largest express transportation company, providing express services to 215 countries and regions throughout the world, including every U.S. address.80 An integrated shipping provider, the company offers door-to-door delivery service utilizing its extensive air and ground transportation capabilities. In 2004, FedEx had the ability to connect 90% of the worlds GDP in 24 to 48 hours.81 FedEx began service to China in 1984, operating in Shanghai and Beijing using air transport capacity from other carriers. The company had to wait a number of years

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before operating its own air cargo flights to the mainland. In 1995, FedEx acquired all four of the original U.S. air cargo frequencies to China, having purchased these initial rights from Evergreen International.82 It began operating its own aircraft into China in 1996, connecting from its Pacific hub in Subic Bay, Philippines. Six additional China frequencies were acquired in 1999, and one additional flight was acquired in 2001, bringing FedExs total to 11 weekly frequencies.83 In 2004, when FedEx was proposing to be awarded additional China frequencies from the U.S. Department of Transportation (DOT), the carrier was serving Shanghai, Beijing and Shenzhen with MD-11 and A300/310 aircraft. In that year, FedEx reported China volume growth of 50% with an integrated delivery network serving 220 cities in the mainland.84 The DOT awarded FedEx with 12 additional frequencies in 2004, allowing the carrier to begin round-the-world service between the U.S. and China. With three more frequencies acquired for operation in 2006 and four additional frequencies for early 2007, FedEx now held rights for 30 weekly China frequencies, with direct service to Shanghai, Beijing, and Shenzhen.85 In addition to its core express business, FedEx air operations also accommodate general freight. The company estimated in 2004 that general freight accounted for approximately 20-percent of its total China/U.S. traffic.86 FedEx utilizes a number of hub facilities to support its Asian operations. Since 1995, the Subic Bay hub has allowed FedEx to effectively link North America and Europe with both North and South Asia.87 FedEx also operates a hub at Anchorage, where it began operations in 1989. The facility includes 258,000 square feet of floor space and room for 10 aircraft, and provides customs clearance for approximately 80%

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of flights from China to the U.S.88 FedEx also notes that the Anchorage hub is strategically located nine hours or less from 90% of the industrialized world, and allows connections with all major airports in the Asian markets within eight hours.89 Shanghai became the headquarters of FedEx China in December 2003 with a 65,000 square-foot sorting facility at Pudong International Airport.90 In January 2006, FedEx broke ground on a $150 million, 880,000 square-foot facility for an operating hub at Guangzhous Baiyun International Airport, planned to open in 2009.91 The facility will serve as the companys China operating hub. Finally, FedEx currently has an operating hub in Tokyo and its Asia-Pacific headquarters in Hong Kong. Notably, FedEx operates the worlds largest fleet of freighter aircraft. Though many aircraft are narrowbody models utilized for U.S. domestic operations, FedEx has over 200 widebody aircraft available for international operations.

United Parcel Service UPS is a worldwide integrated express services and logistics provider based in Atlanta, Georgia. It is the worlds largest package delivery company, delivering nearly 16 million packages with 1,200 daily flights to 200 countries each business day.92 UPS provides door-to-door delivery service with extensive ground transportation infrastructure and air operations based from its Louisville, Kentucky hub. UPS first established a presence in China in 1988 through its partnership with Chinese delivery provider Sinotrans, a relationship that expanded in scope through the late 1990s.93 UPS commenced direct air service to China in 2001 with six weekly frequencies that it used to serve Shanghai from Anchorage. At Shanghai, UPS has

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enjoyed change-of-gauge rights, which allow connections from U.S. flights. For example, an arriving MD-11 flight from the U.S. terminating in Shanghai can connect with a Boeing 757 flight serving additional destinations beyond Shanghai. Rights for change-of-gauge frequencies allowed UPS to offer continuing service to its Asian hub in Clark, Philippines and also serve Beijing on the returning flights from Clark.94 In 2003, UPS established a partnership with the Chinese cargo carrier Yangtze River Express, which provided additional connections on the mainland. In 2004, when UPS proposed being awarded additional China frequencies from the U.S. DOT, it operated 24 all-cargo movements at Shanghai from its China/U.S. frequencies and corresponding change-of-gauge rights.95 The company noted traffic growth of 60% since U.S.-Shanghai service had begun in 2001.96 The U.S. DOT awarded UPS in 2004 with all 12 frequencies the company had proposed. This enabled UPS to bolster its Shanghai service to twice-daily (via Anchorage or Osaka) and also begin the first non-stop service between the U.S. and Guangzhou (via Anchorage).97 UPS secured three additional weekly frequencies effective March 2006, bringing its total to 21. With those frequencies, the carrier has provided nine weekly flights for U.S.-Shanghai service and seven for U.S.-Guangzhou service; it also has been serving Shanghai from Cologne, Germany five times weekly.98 To date, UPS has integrated its Asian network through an operating hub in Clark, Philippines. The company is now focused, however, on developing a new international air hub at Shanghais Pudong International Airport. As defined in the 2004 bilateral agreement between the U.S. and China, a U.S. carrier can secure specific hub rights in China, effective in 2007, if the requirement of 72 weekly aircraft movements is met.

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From its 21 China/U.S. weekly frequencies and complementing change-of-gauge service at Shanghai, UPS has been operating 76 takeoffs and landings per week in Shanghai.iv UPS will gain new flexibility through its hub qualification, including unlimited frequencies to and from the hub, from the U.S. and other locations. The new UPS facility in Shanghai is planned to open in 2008 and will link Chinas mainland with the rest of UPSs international network with direct service to the Americas, Europe and Asia.99 The facility will be built on nearly 1 million square feet of land and will accommodate UPSs planned up-sizing of aircraft from MD-11s to B747-400s.100 The hub will continue to facilitate UPSs successful ventures in China, including operations that now cover more than 330 cities. 101 To highlight its continued commitment to China, UPS is the Official Logistics and Express Delivery Sponsor for the Beijing 2008 Olympic Games.

Northwest Airlines Northwest Airlines is the only U.S.-based passenger airline to also operate dedicated cargo aircraft. A passenger airline with a history of extensive service in Asia, Northwest began service to Shanghai in 1947, carrying cargo in the belly compartments of passenger aircraft.102 The service was suspended in 1948 and resumed in 1984. In 1999, Northwest began its first scheduled freighter service to China with twice weekly service between Chicago and Shanghai (via Anchorage and Tokyo-Narita), and added a third weekly freighter flight in 2001, borrowed from its passenger operations.103

iv In 2005, newly liberalized rules allowed for 2-for-1 change-of-gauge rights, meaning that for every one U.S.-China frequency, two connecting flights can be operated. These change-of-gauges rights have allowed UPS to establish a high number of aircraft movements at Shanghai.

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In 2001, these three freighter frequencies complemented the belly capacity available on Northwests twelve weekly B747 passenger flights.104 In 2001, the company established Northwest Cargo as a separate entity focusing on the operation of its freighter aircraft. While Northwest Cargo focuses on general freight through relationships with freight forwarders, Northwest has also flown express freight under contract with DHL. As part of the U.S. DOTs 2004 offering for China cargo rights, Northwest received an additional six weekly frequencies which allowed the carrier to bolster its freighter service to Shanghai and also inaugurate new direct service into Guangzhou (from Los Angeles via Tokyo-Narita westbound and Osaka eastbound). Three additional frequencies were secured effective March 2006, and Northwest was awarded four more weekly flights, effective March 2007, allowing the carrier to make its Guangzhou service daily. The carrier has been operating B747 freighter service daily to both Shanghai (from Chicago via Anchorage and Tokyo-Narita) and Guangzhou, with a total of 16 China frequencies for cargo use. These cargo operations are in addition to the belly capacity used for cargo on Northwests passenger flights, which were operating with 21 additional weekly frequencies in 2007. In recent years, Northwest has employed the flexibility to shift frequencies between cargo and combination flight use. Northwests Asia service has been anchored by both its Tokyo-Narita hub, through which the airline enjoys unlimited Japan access for both passenger and freighter flights, and its Anchorage hub. The two major hub operations have allowed Northwest to establish a strong Pacific cargo network that includes service to points across Asia, including Tokyo, Osaka, Seoul, Hong Kong, Taipei, Bangkok, Singapore

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and Manila, as well as mainland China.105 The Anchorage hub has been a key facility for Northwest in interchanging trans-Pacific cargo. Fully expanded, the facility allows Northwest Cargo to handle up to eight B747 freighters simultaneously, and cross-load cargo among up to 40 freighter connections per day.106 In 2004, the Anchorage hub allowed interchange service to or from gateway cities comprising approximately 80% of China/U.S. cargo flows.107 On the U.S. side, Northwest Cargo operates from gateways including Chicago, Los Angeles, Cincinnati and New York.108 In February 2005, Northwest announced a codeshare agreement with Korean Airlines under a modified U.S. law that allows U.S. and foreign carriers serving Alaska to transfer international cargo.109 As a result, the two carriers have been able to engage in tail-to-tail transfers among Northwests and Korean Airlines Anchorage operations of 48 and 80 weekly departures, respectively, as of February 2005. The cooperation effectively expands the frequencies and Asian networks of both carriers, providing additional options to shippers.

Polar Air Cargo Established in 1993, Polar Air Cargo was purchased by General Electric in the late 1990s. In November 2001, it was acquired by Atlas Air Worldwide Holdings (AAWH) and became the scheduled service provider for AAWH, while Atlas Air focused on contract flying.v Together with Atlas Air and Polar Air Cargo, AAWH operates the worlds largest fleet of B747 freighter aircraft.110

Contact flying includes the common practice of ACMI, whereby a cargo operator offers an airline Aircraft, Crew, Maintenance and Insurance for specific flights on a contract basis.

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A general freight carrier, Polar has operated uninterrupted Asian service since 1994 and was awarded the authority to operate between the U.S. and Japan in 1996.111 In 2001, the U.S. DOT awarded Polar three weekly frequencies for service between Hong Kong and Korea. Coinciding with the establishment of an operating hub at Incheon, Korea, this enabled Polar to serve the Hong Kong U.S. market via Incheon. By 2004, Polar had experience serving China directly on a charter basis and also indirectly via Hong Kong and the Incheon hub. At the time, its gateway cities included in the U.S., Chicago, Los Angeles, Anchorage, New York, Atlanta and Miami, and in Europe, Amsterdam. Polars network included not only North America, Asia and Europe connections, but also service to Australia, the Middle East and South America. The carrier was therefore well-positioned in its proposal to the U.S. DOT in mid-2004 to pursue direct scheduled frequencies into mainland China. In its 2004 proposal, Polar proposed serving Shanghai with nine weekly frequencies from both Chicago (ORD) and Los Angeles (LAX), including connections at Anchorage and Incheon. Polars campaign was successful. The U.S. DOT designated Polar as the single additional carrier authorized for scheduled service to mainland China. Polar therefore became the fourth U.S. carrier after FedEx, UPS and Northwest to secure this authority. The DOT also awarded Polar with the full slate of nine weekly frequencies the carrier had proposed for its initial Shanghai service. The first six of Polars new China frequencies was made available in August 2004. In late 2006, Polars China service was further bolstered with a U.S. DOT award of three additional weekly frequencies beginning March 2006 and four additional frequencies, to be made available in March 2007. With these additional rights, Polar

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launched service to Beijing, complementing its Shanghai service.112 Altogether, Polar now held rights to 16 weekly China flights. The previous indirect China service via Hong Kong has been all but replaced by the new direct service to the mainland. Polar estimated that 95% of its China traffic was routed through Shanghai by April 2007.113 By all indications, Polars performance in China has been strong. The operational hub at Incheon has helped Polar to leverage against directional imbalances and season fluctuations through pooling of cargo shipments and flexibility for changing demand.114 The established Incheon hub also allowed Polar to quickly integrate its new China service into its existing network. As a result, the carrier was able to initiate service quickly and better compete with foreign carriers by expanding options to shippers. Edward Hernandez, Senior Vice President of Sales & Marketing, noted for Polars initial quarter of scheduled operations, China exceeded all our expectations.115

Weekly Frequencies

Polar: 16 FedEx: 30

Northwest: 16

UPS: 21

* Northwest also holds 21 combination flight frequencies

Figure 9: Scheduled All-Cargo China Frequencies of U.S. Carriers in 2007116

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Chinese Carriers The CAAC has taken recent steps to increase the competitiveness of the Chinese air carriers. As already discussed, ownership restrictions on Chinese companies were eased so that foreign companies could now purchase up to a 25% stake in a Chinese airline, with combined foreign stakes of up to 49%. This has helped to foster valuable partnerships for Chinese carriers. In October 2002, three new aviation groups were launched by consolidating the ten carriers under CAAC control.117 The resulting three anchor carriers Air China, China Eastern and China Southern accounted for 80% of domestic flights in 2007. The three airlines have flown cargo on passenger flights and have also structured the primary all-cargo carriers established in recent years. In addition, a number of new Chinese all-cargo start-up airlines have begun operations.

Air China Cargo Launched in 2003, Beijing-based Air China Cargo is one of Chinas two largest cargo carriers.118 In 2004, it operated ten B747 frequencies to the U.S., eight from Shanghai and two from Beijing.119 In 2006, the carrier assumed all dedicated freighter operations from Air China, the 51% stake-holder in Air China Cargo.120 In the China/U.S. market, the airline provides freighter service between Beijing, Guangzhou and Shanghai, and Chicago, Los Angeles, San Francisco, Portland, Dallas-Ft. Worth and New York.121 This complements combination service from Beijing and Shanghai to Los Angeles, San Francisco and New York.122 As of June 2006, 35 total flights were

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operated between Asia and the U.S.123 In 2007, Cathay Pacific Airways was planning a joint venture with Air China and Air China Cargo, whose minority owners were CITIC Pacific (25%) and Beijing Capital International Airport (24%).124 The joint venture would likely help Air China Cargo improve load factors and competitiveness in Asia.

China Cargo Shanghai-based China Cargo is the second of Chinas two largest cargo carriers and the first Chinese company to specialize in air cargo. It was launched in 1998 and is 70% owned by parent China Eastern Airlines.125 In 2004, China Cargo operated with 11 U.S. frequencies, with MD-11 service from Shanghai to U.S. cities including Los Angeles, New York and Chicago.126 It has since expanded U.S. service, with routes from Shanghai to Los Angeles, New York, Chicago, San Francisco, Dallas-Ft. Worth and Seattle.127

China Southern Guangzhou-based China Southern is the only carrier of the three largest Chinese airline companies to not have established a dedicated cargo unit. The carrier received authority from the U.S. DOT to provide all-cargo Shanghai/Shenzhen-Chicago service (via Anchorage) beginning in August 2004, with its two U.S.-China weekly frequencies.128 In addition to freighter service to Chicago, the carrier also provides combination service between Guangzhou and Los Angeles.129 In 2007, China Southern was actively planning to launch a dedicated cargo unit after establishing foreign

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partnerships.130 In May 2007, the airline confirmed it was in talks with Air France-KLM to explore cargo joint-venture possibilities.131

Yangtze River Express Yangtze River Express is the cargo unit of Hainan Airlines and is 49% owned by three Taiwanese companies, including Taipei-based China Airlines, which holds a 25% stake in the company.132 The carrier opened an air route to the U.S. with service between Shanghai and Los Angeles (via Anchorage), and in early 2007 was awarded rights by the U.S. DOT to operate three weekly freighter flights from Shanghai to Anchorage, New York and Boston.133 Since the airline previously owned only six narrowbody Boeing 737 freighter aircraft, the carrier leases B747 aircraft for its U.S. service from ACMI-leasing providers.134 As already discussed, Yangtze River Express operates mainland China service in partnership with UPS.

Shanghai Air Cargo Shanghai Air Cargo was granted its license by the CAAC in June 2006, when it had three freighter aircraft, including one MD-11.135 The carrier opened a route between Shanghai and Los Angeles in July 2006 with leased B747 aircraft.136 Shanghai Airlines holds a 55% ownership stake in Shanghai Air Cargo, which it formed in partnership with Taiwans Eva Air (25% ownership).137

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Jade Cargo International Based at Shenzhen in Chinas Pearl River Delta, Jade Cargo International is a joint venture of Shenzhen Airlines (51% ownership) and Lufthansa Cargo (25% ownership).138 It began B747 service to Europe in August 2006 and plans twice weekly service to Houston (via Vancouver).139 With six additional B747 aircraft on order in 2007, Jade Cargo is poised to continue an expansion of U.S. services with scheduled operations.140

Chinese Carriers Summary As of 2004, Chinese carriers competed in the China/U.S. market with 23 weekly frequencies.141 In parallel with U.S. carriers, the Chinese carriers have acquired additional China/U.S. operating frequencies as part of the 2004 bilateral agreement between the two nations. However, unlike the U.S. carriers, Chinese carriers have been unable to utilize all frequencies available to them, as profitability continues to be a challenge on U.S. routes. The carriers still lack the U.S. networks needed to ease the directional trade imbalance, resulting in extremely low yields for westbound flights. In addition, the carriers have been subject to high fuel costs. While Chinese carriers can purchase on the open market at international destinations, they have been required to use government-approved suppliers in the domestic market where costs were often higher than for competing carriers.142 A China Eastern executive acknowledged in 2007 that for the U.S. routes, we cannot make money. We cannot see any room to reduce costs.143 The May 2007 bilateral agreement will allow further opportunities for Chinese carriers to compete in the China/U.S. market in the coming years, but partnerships and

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consolidation in the industry will remain critical. Despite the challenges, significant growth is still expected by the Chinese cargo carriers. Airbus expects Chinas longrange freighter fleet to grow from 22 aircraft in 2006 to at least 117 in 2025, mainly as a result of the new bilateral agreement and continued growth in international cargo demand.144

Third Country Carriers Third-country carriers also have a major presence in the China/U.S. air cargo market, especially in the general freight category. Various freedom rights have allowed a number of carriers to operate either from their home countries via China to the U.S. (and vice versa) or from China via their home countries to the U.S. (and vice versa). As a result, these foreign carriers can offer either one-stop or even non-stop service in the China/U.S. market. In addition to dedicated cargo service, the carriers can utilize significant amounts of belly capacity on combination passenger flights. Both Singapore Airlines and Qantas Airways have been granted 5th freedom rights, allowing them to provide non-stop cargo service between China and the U.S. Under 5th freedom rights granted in May 2003, Singapore has operated B747 freighter flights from Singapore to Xiamen and Nanjing, China for continued service to Anchorage, Los Angeles and Chicago.145 Freighter flights have since been added between Beijing and Los Angeles. The airline also provides extensive combination service between China and the U.S. via its Singapore hub. With its 5th freedom rights, Qantas has been providing freighter service from Shanghai direct to Los Angeles, Chicago and New York. It has also been operating combination service between China

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and the U.S. via its Australia base. Notably, both Singapore and Qantas have been providing direct China/U.S. cargo service only in the eastbound direction; westbound flights have been using different routings to return to the carriers hubs, which mitigates the China/U.S. trade imbalance.146 Both China Airlines and Eva Airways provide all-cargo service between Taipei and the U.S., employing 6th freedom rights for cargo connecting from China.147 Both China Airlines partnership with Yangtze River Express, and Eva Airways partnership with Shanghai Air Cargo help to provide connecting service between the mainland and Taipei. China Airlines and Eva Airways also both utilize combination flight belly capacity between Taipei and the U.S. Asiana Airlines and Korean Airlines both serve the China/U.S. cargo market using 6th freedom rights. The carriers provide service between Chinese cities and Seoul, South Korea, with connecting all-cargo service between Seoul and the U.S.148 Belly capacity is also available on their carriers combination flights between Korea and the U.S. Japan Airlines (JAL) and Nippon Cargo Airways, the cargo unit of All Nippon Airways, both serve the China/U.S. market with 6th freedom rights covering flights between China and Japan, with connecting all-cargo service from Japan to the U.S. In 2007, JAL was providing freighter service between the U.S. and Tokyo-Narita, Sapporo and Nagoya; Nippon Cargo was operating freighters between the U.S. and TokyoNarita, Nagoya and Osaka.149 Both JAL and Nippon Cargo parent All Nippon have extensive passenger service between Japan and the U.S., providing additional belly capacity for cargo.

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Cathay Pacific Airways and wholly-owned subsidiary Hong Kong Dragonair both operate all-cargo service between Hong Kong and the U.S. In addition to operating from a hub that is still responsible for a significant amount of southern Chinas air cargo, the airlines both operate combination service between the mainland and Hong Kong.

Charter & Aircraft-Crew-Maintenance-Insurance (ACMI) Operators In addition to the scheduled air cargo carriers, charter and ACMI providers also serve the China/U.S. market. As already noted, ACMI operators provide the aircraft, crew, maintenance and insurance to air carriers on a contract basis. Such an arrangement allows an airline to quickly add capacity for a particular route and specific period of time. The ACMI providers relationship is with the customer airline rather the shipper or freight forwarder. ACMI providers are subject to operating restrictions depending on the customer airline and its home country, but do actively have a role in the China/U.S. market on behalf of the hiring carriers. Charter operations for air cargo are typically unscheduled services in the general freight segment, with a direct interface between the charter carrier and shipper. In 2003, over 50 charter all-cargo China/U.S. flights by U.S. and Chinese carriers were approved by the CAAC.150 An additional 75 charter flights were authorized by the CAAC and U.S. DOT for the twelve months commencing with August 2004.151 In addition, the 2004 bilateral agreements permitted unlimited charters between city pairs not served by the scheduled all-cargo services of Chinese carriers.152 A number of charter carriers provided direct service between China and the U.S. in 2006. Air Atlanta, Atlas Air, Evergreen International, Gemini Air Cargo, Kalitta Air,

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Southern Air and World Airways all provided service between Shanghai and U.S. cities.153 Direct Hong Kong-U.S. service was provided by Atlas Air, Evergreen International, Gemini Air Cargo, Kalitta Air and Southern Air.154 FedEx also provided charter services between U.S. cities and both Shanghai and Hong Kong in 2006.155

Competition and Growth In summary, a large number of air cargo carriers compete in the China/U.S. market, creating an extremely competitive environment. Examination of the U.S. DOT T-100 market data allows an overall review of the carriers providing direct (non-stop) service between China and the U.S. in 2006. Figure 10 provides this summary, which illustrates not only the extent of direct China/U.S. service, but also the main routes of commonality between the various carriers. Since it remains a cargo gateway for southern China, Hong Kong is included in the summary. Los Angeles, Chicago and New York (Newark and JFK) are clearly the leading U.S. gateway cities for China cargo service. The three cities are responsible for 64% of air exports to China and 55% of imports from China.156 Beyond these gateways, Figure 10 displays significant service between China and Dallas-Ft. Worth, San Francisco, and Anchorage, as expected due to its strategic interchange location.

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Shanghai L.A. Chicago New York Dallas San Francisco Anchorage Other Eastbound Air China X X X X Portland China Cargo X X X X X Seattle FedEx X X X Memphis, Indianapolis, Oakland NWA X X X Polar X X X Qantas X X X United X UPS X Portland Westbound Air China X X X X Portland China Cargo X X X X X Seattle China Southern X FedEx X X X X X Memphis, Atlanta, Oakland NWA X X X Seattle Polar X UPS X Beijing L.A. Chicago New York Dallas San Francisco Anchorage Other Eastbound Air China X X X X Portland FedEx X Memphis Westbound Air China X X X X Portland China Cargo X X X X X Seattle FedEx X X X X Atlanta, Oakland Guangzhou L.A. Chicago New York Dallas San Francisco Anchorage Other Eastbound UPS X Westbound UPS X Honolulu Nanjing L.A. Chicago New York Dallas San Francisco Anchorage Other Eastbound Singapore Airlines X X Westbound None Shenzhen L.A. Chicago New York Dallas San Francisco Anchorage Other Eastbound China Southern X FedEx X X Memphis Westbound China Southern X Tradewinds Airlines X Tianjin L.A. Chicago New York Dallas San Francisco Anchorage Other Eastbound Singapore Airlines X Westbound None Xianmen L.A. Chicago New York Dallas San Francisco Anchorage Other Eastbound Singapore Airlines X X Westbound None Hong Kong L.A. Chicago New York Dallas San Francisco Anchorage Other Eastbound Cathay Pacific X X X X X Atlanta FedEx X X X Memphis, Indianapolis, Oakland Hong Kong Dragon Air X NWA X Wilmington, OH Polar Air Cargo X Singapore Airlines X X X Transmile Air Service X X UPS X Portland, Honolulu Westbound Cathay Pacific X X X X X Atlanta FedEx X X X X Memphis Hong Kong Dragon Air X NWA X X X Wilmington, OH Polar Air Cargo X X Singapore Airlines X X X Transmile Air Service X X UPS X Honolulu Notes: Reflects 2006 all-cargo scheduled operations between China and U.S. cities, as reported to the U.S. DOT New services added by carriers in 2007 were not yet available in T-100 data New York service includes both Newark Liberty and JFK Airports ACMI scheduled operations are included (i.e. Tradewinds Airlines)

Figure 10: Scheduled All-Cargo Operations between Chinese & U.S. Cities in 2006
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In addition to the direct carrier services summarized with Figure 10, a large number of carriers provide additional and extensive amounts of cargo capacity through their operations via Asian hub airports. This includes not only the U.S. carriers operating over non-China Asian hubs, but also the large number of third country carriers. Altogether, over 20 carriers are providing extensive air cargo service in the China/U.S. market through direct or indirect operations. Given the unlimited rights for China/U.S. air cargo services becoming available in the next several years and continued increases in China trade, additional cargo carriers are likely to enter the market. As a result, the potential for excess capacity will continue to be an issue in the China/U.S. market. Even with the operating limitations prior to the May 2007 agreement, there had already been concerns that new entrants would upset the yields of cargo carriers, especially as they offer price discounts to gain initial market share. One example is the rise in capacity for the Shanghai-Los Angeles route. 2002-2003 eastbound prices from Shanghai to Los Angeles were around $5/kg; in October 2005, after new service had been initiated, prices dropped to $3.10/kg.157 With westbound flights already financially challenged due to the directional trade imbalance, reductions in eastbound yields from new capacity will continue to test the industry. It is clear only the most competitive carriers will be able to operate profitably. Of particular importance will be a carriers ability to leverage airline partnerships and extensive networks on both sides of the Pacific to generate the highest possible loads, while maintaining cost efficiencies.

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Conclusion
China has established itself as a global economic power, and is expected to expand its position in the years to come. Trade between China and the U.S. is at an alltime high and is expected to maintain strong growth, including the high-tech commodities and time-sensitive products that require transport by air. The China/U.S. air cargo industry, which has already sustained record growth, is set for continued expansion, though in an increasingly competitive environment. Many of the barriers that once limited the growth of the industry are being removed as a result of significant policy liberalization by the Chinese government. Infrastructure is being expanded, more foreign direct investment is permitted, and agreements with the U.S. continue to increase the service rights for air cargo carriers. As demanded by the geography of Chinas manufacturing centers, operations continue to focus on Shanghai, Beijing and Guangzhou as the three major air cargo centers, with Shanghais Pudong International Airport the clear leader. Despite government efforts, these three are likely to remain the dominant hubs until a more significant shift in manufacturing and expansion of suitable infrastructure occurs. Significant investment in expanded infrastructure continues at the three major hubs to accommodate increasing operations. Competition in the industry remains intense. While U.S. exports to China are increasing, the overall directional trade imbalance requires careful management by air cargo carriers. The growing number of carriers operating in the China/U.S. market is also strengthening competition. Over ten carriers already offer scheduled, direct allcargo service between China and the U.S. Including the carriers that provide indirect service through Asian hubs outside China, over twenty carriers are providing extensive,

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scheduled all-cargo and combination services between China and the U.S. With the heightened competition, profitability will depend on a carriers ability to operate efficiently, raise rates, leverage route networks and hubs, and establish partnerships for both air and ground operations. The May 2007 agreement between China and the U.S. will fully liberalize the China/U.S. air cargo industry by 2011, effectively removing limits from an industry that remarkably began in earnest just 12 years earlier with the 1999 air services agreement. The unprecedented economic growth by China has driven unprecedented expansion in the air cargo industry, an industry that will remain critical for trade between China and the U.S. for years to come.

Author
Reed H. Tanger can be contacted at rtanger2007@kellogg.northwestern.edu

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References
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Polar Air Cargo Submission, U.S. DOT 2004 Cargo Designation, Docket OST-2004-18468. FedEx Submission to U.S. DOT, 2004. 55 Source of Data: Airports Council International, 2007. 56 Putzger, Jun. 2005. 57 UPS Submission to U.S. DOT, 2004. 58 FedEx Submission to U.S. DOT, 2004. 59 FedEx Submission to U.S. DOT, 2004. 60 Polar Air Cargo Submission to U.S. DOT, 2004. 61 UPS Submission to U.S. DOT, 2004. 62 Northwest Airlines Submission to U.S. DOT, 2004. 63 Northwest Airlines Submission to U.S. DOT, 2004. 64 International Freighting Weekly, U.S. hands out extra China air cargo rights, February 2005. 65 UPS Submission to U.S. DOT, 2004. 66 UPS Submission to U.S. DOT, 2004. 67 Source of Data: Airbus, 2006. 68 China News Digest, China to have six cargo hubs by 2010, June 2004. 69 China News Digest, 2004. 70 China News Digest, 2004. 71 Putzger, Jun. 2005. 72 Putzger, Jun. 2005. 73 Putzger, Jun. 2005. 74 Fung, et al., 2005. 75 Fung, et al., 2005. 76 Putzger, Ian, Land of the Rising Hubs, Air Cargo World, April 2007. 77 FedEx Submission to U.S. DOT, 2004. 78 FedEx Submission to U.S. DOT, 2004. 79 Source of Map: Website: www.maps-of-china.com, 2007. 80 FedEx Submission to U.S. DOT, 2004. 81 FedEx Submission to U.S. DOT, 2004. 82 FedEx Submission to U.S. DOT, 2004. 83 FedEx Submission to U.S. DOT, 2004. 84 FedEx Submission to U.S. DOT, 2004. 85 Website: www.fedex.com, 2007. 86 FedEx Submission to U.S. DOT, 2004. 87 FedEx Submission to U.S. DOT, 2004. 88 FedEx Submission to U.S. DOT, 2004. 89 FedEx Submission to U.S. DOT, 2004. 90 FedEx Submission to U.S. DOT, 2004. 91 Roberts, Jane, FedEx adds trips to China, Memphis Commercial Appeal, August 2006. 92 Website: www.ups.com, 2007. 93 UPS Company Presentation: UPS and China Your Ticket to a Growing Market, March 2007. 94 UPS Submission to U.S. DOT, 2004. 95 UPS Submission to U.S. DOT, 2004. 96 UPS Submission to U.S. DOT, 2004. 97 UPS Submission to U.S. DOT, 2004. 98 Haoting, 2006. 99 Associated Press, UPS to open China hub in Shanghai, April 2007. 100 Associated Press, 2007. 101 UPS Company Presentation, 2007. 102 Northwest Airlines Submission to U.S. DOT, 2004. 103 Northwest Airlines Submission to U.S. DOT, 2004. 104 Polar Air Cargo Submission to U.S. DOT, 2004. 105 Northwest Airlines Submission to U.S. DOT, 2004. 106 Northwest Airlines Submission to U.S. DOT, 2004. 107 Northwest Airlines Submission to U.S. DOT, 2004. 108 Northwest Airlines Submission to U.S. DOT, 2004. 109 IFW, 2005. 110 Website: www.polaraircargo.com, 2007. 111 Polar Air Cargo Submission to U.S. DOT, 2004. 112 Atlas Air Worldwide Holdings, Corporate Overview, September 2006. 113 Polar Air Cargo 10th Anniversary Update, www.polaraircargo.com, 2007.

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Polar Air Cargo Submission to U.S. DOT, 2004. Putzger, Jun. 2005. 116 Author Compilation; Sources of Data: U.S. DOT 2004 Cargo Designation: U.S. DOT Order to Show Cause and submissions of FedEx, UPS, NWA and Polar. 117 Fung, et al., 2005. 118 Haoting, Jul. 2006.; and Haoting, Lu, CITIC planning Air China cargo sale, China Daily, November 2006. 119 Northwest Airlines Submission to U.S. DOT, 2004. 120 Santiago, Annette, Air China Cargo to take over cargo ops for Air China, Aviation Daily, July 2006. 121 Santiago, 2006. 122 U.S. DOT, Bureau of Transportation Statistics (BTS), T-100 Market Data, 2007. 123 Traffic World, Air China Cargo adds Dallas freighter, June 2006; and AFX International Focus, Air China Cargo to launch Beijing-Dallas Fort Worth service, June 2006. 124 Lloyds List, Cathay Pacific poised to buy out other investors stakes in Air China Cargo, May 2007. 125 Haoting, Nov. 2006. 126 Northwest Airlines Submission to U.S. DOT, 2004. 127 U.S. DOT, BTS, T-100 Data, 2007. 128 Northwest Airlines Submission to U.S. DOT, 2004. 129 U.S. DOT, BTS, T-100 Data, 2007. 130 Shanghai Daily, 2006. 131 Asia Pulse, China Southern in talks with Air France over JV cargo airline, May 2007. 132 Haoting, Jul. 2006. 133 Cargo Facts Update, February 15, 2007, www.cargofacts.com 134 Asia in Focus, Taiwan, China to jointly build air cargo transport enterprise, January 2006. 135 China Industry Daily News, Shanghai Air Cargo Starts Operation, July 2006. 136 China Industry Daily News, 2006. 137 Francis, Leithen, China special: Set to deliver the export market, Flight International, October 2006. 138 Website: www.jadecargo.com, 2007. 139 Website: www.jadecargo.com, 2007. 140 Agence France Presse, Air cargo traffic soars, fueled by Chinas role as world production center, October 2005. 141 U.S. DOT Order to Show Cause, U.S. DOT 2004 Cargo Designation. 142 Putzger, Ian, Chinas Turn, Air Cargo World, October 2005. 143 Stanley, Bruce, Will China gain in air deal?, Wall Street Journal Asia, May 2007. 144 Airbus, 2006. 145 Fung, et al., 2005. 146 U.S. DOT, BTS, T-100 Data, 2007. 147 U.S. DOT, BTS, T-100 Data, 2007. 148 U.S. DOT, BTS, T-100 Data, 2007. 149 U.S. DOT, BTS, T-100 Data, 2007. 150 Northwest Airlines Submission to U.S. DOT, 2004. 151 Northwest Airlines Submission to U.S. DOT, 2004. 152 FedEx Submission to U.S. DOT, 2004. 153 U.S. DOT, BTS, T-100 Data, 2007. 154 U.S. DOT, BTS, T-100 Data, 2007. 155 U.S. DOT, BTS, T-100 Data, 2007. 156 U.S. DOT Order to Show Cause, U.S. DOT 2004 Cargo Designation. 157 Putzger, Oct. 2005.
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