Last week, before I went to Cyprus Maritime 2019, I opined in Macro Macchiato that, “with so much macro-economic confusion, predicting shipping markets is even more of a mug’s game than usual.” Even I didn’t expect the tanker markets to behave so unpredictably. They have reacted to an unexpected alignment of supply-side constraints. With COSCO Energy Shipping and National Iranian Tanker Company VLCCs out of the market due to US sanctions, around 70 Very Large Crude Carriers – around eight per cent of the world’s VLCC fleet – has been taken out of circulation.
With the IMO 2020 regulations coming up, an uncertain number of oil tankers are sailing to ship repair yards this year to have emission-abatement systems (“scrubbers”) retrofitted, allowing them to burn 3.5% Sulphur content fuel oil from 1st January 2020 instead of switching to the new formula 0.5% Sulphur content fuel oil. Presumably others will follow during 2020. The net effect of these visits it to take several ships off the market every month for a few weeks at a time, further reducing the availability of ships for hire on any given day. Up to 30 more VLCCs are also reported as being used for storage of fuel oils in advance of the new fuel regulations, further reducing supply for the remainder of 2019 and maybe longer.
As it became clear last week that some charterers wanted to avoid any ship that had traded to Venezuela in the last year, because of US sanctions on its Latin American near-neighbour, even more VLCC’s became off-limits. When one of Iran’s own VLCC’s the Sabiti, was damaged in an assumed missile attack on Friday morning, charterers lunged for all available cargoes and ships. VLCC time charter equivalent rates reached an all-time peak of around USD 300,000 per day, depending on your calculations of speed and fuel costs.
Opinions vary about how many VLCCs are ‘active’ or ‘live’ globally but, by making so many of them off-limits, US sanctions on Iran, Venezuela and China have cut the supply of VLCCs by at least ten per cent. A ten percent cut in supply like that is equivalent to every ship in the world slowing down by 1.5 knots – which several ship owners advocated at Cyprus Maritime 2019 as a way of reducing shipping’s CO2, SOx and NOx emissions. Were they displaying self-interest, suspecting that such a reduction in effective supply would drive up freight rates?
Some analysts are suggesting that the combined effect of all these supply constraints has been to cut effective availability of VLCCs by 20 per cent. That seems a bit high to me, but even if it were the case, could the constraint last long enough to supercharge the seasonal market and keep tanker earnings high into the new year?
The trouble with making that prediction is that freight markets are second-order chaotic system. That is to say that they react to predictions about themselves. A first order chaotic system, like the weather, does not react to predictions about itself. To demonstrate how freight markets are a second-order system, consider that, if ship owners predict that the current freight bonanza is going to last any length of time, they will speed up their ships to try to get a second bite of the cherry – another voyage during the traditionally strong fourth quarter. That effectively increases the supply of trading ships, giving charterers more choice, which could drive down freight rates. If some ship owners think that current events are the lead-up to a cyclical up-turn (VLCC freight markets last peaked in 2015 as China built its Strategic Petroleum Reserve during a term of low oil-prices), they will rush to order more ships, killing off the cycle in the time-honoured fashion as all the new ships leave the shipyards.
But the current orderbook for VLCCs is only about ten per cent of the fleet, for delivery over about two and a half years, giving us probably only five per cent fleet growth in 2020 and 2021 before demolitions and further orders. Accordingly, many observers think that the supply-side fundamentals look positive for VLCCs for the next two years. As VLCC incomes rise, incomes for smaller Suezmaxes and Aframaxes follow suit, so the whole crude oil tanker market looks like it has solid supply-side fundamentals for the next few years.
In Cyprus last week there were many discussions about how long the orderbook can stay small. There seems to be a latent demand for newbuildings that can’t be financed by incumbent lenders, while ‘alternative’ sources of capital such as private equity funds, reported that the unleveraged returns available from ship operating are of little interest to them. However, a leveraged return on a VLCC earning six figures every day for a year or more presumably would pique their appetites.
And what of the demand side: is there genuine employment for all these oil tankers? It seems the answer is yes. The International Energy Agency reports that oil demand should grow by around 1 million barrels per day (Mn bpd) each year for the next five years, led by China and India, while oil supplies will be added to mostly by the US. Rearranged global oil markets with crude oil being shipped from the Atlantic and Middle East to North-East Asia will drive tanker demand quite nicely for a few years yet in spite of growing climate concern and an emerging consensus on a long-term path to decarbonization.
In the short-term, slower economic growth does not seem to be trimming China’s appetite for oil. According to data released by the General Administration of Customs today, China's crude oil imports in September rose 10.8% from a year earlier as refiners ramped up output amid stable profit margins and solid fuel demand. China, the world's top oil importer, imported 41.24 Mn T of crude, equivalent to 10.04 Mn bpd for the month – that’s five VLCCs every day, or 150 or so every month, accounting for a significant chunk of the available fleet.
The Take Away
I am broadly in agreement with other analysts that the fundamentals of the tanker markets look pretty good at the moment. I would even go so far as to say they look better than at any time since 2005, when the Chinese economic boom was in full swing and tanker owners had not yet embarked on the newbuilding boom that the single-hull tanker phase out of 2010 demanded. Those ships delivered just in time for the global financial crisis and tanker owners have faced a decade of austeerity since, cheered only when China filled its strategic petroleum reserve in 2014 and 2015. To take advantage this time, ship owners need to get hold of tonnage today. But their competitors are unlikely to want to sell with freight markets so frothy. So the orders for new ships will come and the cycle will turn again. Enjoy it while you can!