A Flash in the Pan? (Macro Macchiato 29/10/19)
Earlier this month I gave a presentation to an invited audience of oil tanker owners. This in itself is not unusual. What was unusual on that particular day was the ballistic rise in oil tanker earnings. The freight market was spooked by US sanctions on elements of the COSCO ship owning behemoth, by Exxon’s refusal to hire any ship that had visited Venezuela in the last year, by US sanctions on Iran, by attacks on ships in the Middle East (it was an Iranian tanker that ironically was attacked on the day)…it was getting silly….the tanker market was like a spooked horse, ready to bolt at the sight of a piece of litter in the road. According to the Baltic Exchange, average VLCC daily earnings rocketed from USD 40,658 on 1st October, to USD 240,735 on 11 October. Some headlines even quoted USD 300,000 a day, though it later transpired that no fixtures had been concluded at that level.
Last Thursday, the 29th October, the US State Department issued a waiver until 20th December, relieving the sanctions on COSCO Shipping Tanker (Dalian) Co. Ltd but not on related company COSCO Shipping Tanker (Dalian) Seaman and Ship Management Co, Ltd. Presumably there will be one or two cargo owners who will be relieved by this temporary waiver. But this isn’t a wide relaxation of the restrictions on oil tanker operations.
How has the VLCC freight market responded to the change? VLCC daily earnings had already subsided to USD 65,704 the day before the State Department’s announcement. After it they fell further to USD 58,762 and by yesterday they were down to USD 53,706. That is pretty much where one would expect them to be at this time of year. The fourth quarter of every year is peak season for VLCCs as oil demand rises as temperatures fall in the the Northern Hemisphere winter. Our own model had VLCC earnings pegged at an average of USD 59,423 for Q4 this year (and USD 47,612 for Q1 2020, in case you’re asking).
What interests me in all of this is that VLCC rates have subsided pretty much to where they should be for this time of year, on the back of all that has happened this year, even though there has been very little change in the supply-side constraints in the oil shipping markets. The sanctions on Iran and Venezuela remain in place. Relatively few charterers will obtain relief from the sanctions waiver until 20 December on certain COSCO group vessels. The increased war risk for trading in the Middle East remain in place. The VLCC fleet has still grown by around 50 ships a year for the last three years which is more than enough to compensate for the loss of any sanctioned ships. Some VLCCs have scheduled appointments in dry dock this quarter to fit scrubbers, but others have postsponed their trip to the yard to take advantage of the seasonal peak in rates.
On the demand side of the freight market, longstanding trends remain steady. Most oil import growth continues to come from China and India. Most new oil in the global markets is coming from the US, which continues to grow its oil exports, while most established oil continues to come from Russia and Saudi Arabia, who with the US all produce around 10 Mn bpd, contributing together around 30 per cent of global oil production. Trade lanes have not been turned upside down. While VLCCs did speed up by around one knot for October to date, their operating speeds remain down long-term and will probably stay below the long-term average as IMO 2020 looms ever closer with its higher fuel costs.
What was it then that for a brief moment in early October this year caused tanker freight rates to go stratospheric, before returning to expected levels for the time of year?
The Take Away
Students of statistics learn that time series data contain four elements: cyclicality, seasonality, trend and randomness. These four elements are each subject to their own internal variability and their composition of a time series can vary with time. Indeed randomness can vary randomly, which has always caused me to wonder at the chaos that surrounds us. In the tanker freight market, we have been at the bottom of the cycle which peaked in 2015 as China filled its strategic petroleum reserve. We have been entering peak season – Q4 – but the short-term trend for tanker earnings has been flat this year (see chart). So the random element of the time series briefly took over. We call it sentiment.
Even with increasing levels of transparency in freight markets, with voyage optimisation, algorithms predicting short-term trends and optimal loading dates, with IMO 2020 preparations in full swing, a combination of factors led to a short-lived bubble in sentiment which nominally drove daily earnings to a record level. Of course, not all VLCCs were fixed in the two weeks from 4th to 23rd October when earnings were over USD 60 k / day: not all owners benefited. But they will all benefit from ongoing firm sentiment and confidence when dealing with skittish charterers