Oil and Tanker Markets Blown off Course by Virus
It has been the worst year in the tanker freight markets since the recession of the early 1990s. But as transport restrictions eased over Q3 this year, global oil stocks began to be drawn down, oil demand and prices started to rise again and the first shoots of an oil tanker market recovery began to show. Equity analysts began to get excited about oil tanker stocks and there was talk in the markets about consolidation as investment bankers sought M&A opportunities.
But the freight markets have since deflated as the public health response to the Omicron variant has once again restricted travel. What has happened and what is the outlook for the early part of 2022?
In October and November, refineries in the US and Europe were beginning their peak seasons. Demand was said to be brisk. In Europe, gasoline cracks rose to a four year high of USD 17.71 on 4th November. The US crack spread reached a high of 60 cents per gallon in early September, three times its level in February. But then Omicron arrived and crack spreads in Europe fell to USD 6.95 at the end of November, while in the US, they ended the month down to around 45 cents per gallon. Varying levels of cross-border travel bans have in Europe been added to lockdowns of varying severity in Germany, Czechia, Slovakia, Austria, Ireland, Greece and the Netherlands, with others bound to follow.
In China, oil imports fell to a 36 month low in October, at just 8.94 Mn bpd. Both state owned and private refiners reduced purchases. Sinopec sources told reporters, “Our crude stock was low but we dared not to buy more barrels for October as the crude price was too high” Inventories are at a 20 month low of 826 Mn barrels according to tanker tracking firm Kpler. Products exports also fell in October, by 4.6% to 3.95 Mn T. Export quotas are running out with 33.7 Mn T of distillates exports so far out of 37 Mn T of quotas for distillates and 11 Mn T of fuel oil. Both Sinopec and PetroChina have announced gasoil export cuts.
Oil demand and supply outlook
The IEA estimates that oil demand will recover to 96 Mn bpd this year from 91 Mn last year, then will grow to 100 Mn bpd in 2022 and onto 104 Mn bpd in 2026. The IEA estimates that OECD oil supply will flatline at 30 Mn bpd. Which is to say, any increase in shale output from N America only offsets falls elsewhere. The IEA only estimates OPEC supply to the end of 2020. OPEC’s own data inform our estimate of OPEC supply in 2021 of an average of 28 Mn bpd. We can’t tell what OPEC’s supply will be in future as it tends to react to prices, internal politics, relations with Russia, etc.
OPEC may respond to higher demand by increasing output. Presumably some of this will come into the Atlantic if North American oil export flatlines. Then if OPEC does not respond to higher oil demand – either to support prices or because it cannot – non OECD and non OPEC exporters will have to make up the difference.
Such countries include Russia, Kazakhstan, Azerbaijan, Bahrain, Oman, Mexico, Bolivia and Brazil, Equatorial Guinea, Sudan and South Sudan, Malaysia and Brunei. This would have big implications for seaborne oil trade.
But for now we assume OPEC can and will make up the difference in oil supply, roughly increasing output from 28 Mn bpd this year to 36 Mn bpd in 2026.
Russia though is not going to be the swing supplier for the post-pandemic world. Russian oil production in October was back to 10.077 Mn bpd, the peak was 10.92 in Jan-20, so Russia could produce another 0.8 Mn bpd, presumably for export – but whether as crude or as products is debatable. The Finance Ministry’s outlook, like the nation’s official oil statistics, do not give a breakdown between crude and condensate. That makes it difficult to assess how the production forecast lines up with OPEC+ deal, which only puts a limit on crude.
Russia's government expects oil output next year to be back near its post-Soviet high as OPEC+ eases production curbs. Russian companies may raise combined production of crude and condensate by 8% to 559.9 Mn T in 2022, and stay close to that level from 2023 to 2024, according to a draft budget submitted by the Finance Ministry to the government. Deputy Prime Minister Alexander Novak has said repeatedly that Russia will abide by its OPEC+ target, meaning the nation’s oil output will reach the pre-pandemic level by May 2022. OPEC and allies including Russia are reviving production idled in the depths of the Covid-19 pandemic. Each month the group will add 400,000 barrels a day to the market, of which about a quarter comes from Russia. The hikes are set to continue until all of the OPEC+ output curbs are rolled back.
Nor is the US going to drive global oil exports or by implication tanker demand. US production is back to 10.8 Mn Bpd, the peak was 12.996 Mn Bpd in Nov-19, so the US could produce another 2 Mn bpd – but not necessarily for export. It is worth noting that the Biden administration is actively discussing banning refined products exports and may reverse the successful recent policy of allowing crude oil exports to address supposed shortages at home which have driven up prices at the petrol pumps.
OPEC is back to 29.6 Mn bpd production (more than the IEA estimate) while the peak was 36.22 Mn bpd in Dec-16. Presumably then OPEC could produce another 7 Mn bpd -that’s nearly four VLCCs per day. So we have to conclude that OPEC will produce any extra oil required by a post-Omicron economic recovery in and beyond 2022. However, it could take until 2025 to get back to pre-Covid levels of oil demand given transport uncertainty, increases in electric and hybrid vehicle sales and the 'inflection point' in manufacturing, described recently by one auto executive as the point coming very soon when they stop developing internal combustion engine vehicles altogether.
Tanker fleet growing still
On top of all that, the tanker fleet continues to grow. The VLCC fleet will increase by 4% in DWT this year, assuming no more demolition sales. It will probably grow by 4% in the next two years given an orderbook of 8% now and dock availability in 2H 2023. the Suezmax fleet will increase 2% and the uncoated Aframax fleet 1%. The Suezmax orderbook is 7% of the fleet and the Aframax orderbook is 6% of the fleet, almost all for delivery within 2023. In the product tanker space, coated Aframaxes (LR2s, in the parlance) will grow 7% and MRs (40,000 - 55,000 DWT) 4%. The orderbook for LR2s is 12% of the fleet in DWT terms, deliverable mostly in 2022 and 2023; it is 7% for MRs.
What does all that mean for tankers?
Limited long-haul US-Asia tanker demand growth (especially given US-China strategic competition)
Limited scope for Russia to be a swing supplier
Asian buyers become more dependent on OPEC
Increasing propensity for oil to be refined closer to source in the Middle East.
Slow recovery in tonne mile demand at least until Omicron wave has passed
It doesn't look very encouraging for the tanker markets, frankly, at least until after Chinese New Year in 2022. If and when the race between vaccines and mutations starts to be won by vaccines, oil and tanker markets may be able to rally. But by then even more of us will be driving electric cars and eschewing business travel in favour of online meetings, depressing any recovery in liquid hydrocarbon fuel demand. Happy Christmas!