The imposition of US Treasury Office of Foreign Asset Control (OFAC) sanctions on some COSCO tanker companies in October 2019 had a direct impact on only 3% of the tanker fleet, which in normal times would have had very little influence on the market
What was intended as a political gesture by the USA to push China towards reducing its support for Iranian crude oil has proven to be the catalyst for the greatest rally in tanker rates seen since 19731 with VLCC freight rates of US$460,000/day being quoted. Below is a look at the background and a timeline chronicling how recent external events have created the biggest tanker rate spike in a generation or more.
Demand fundamentals: Traditionally, demand for tankers rises in the last quarter as northern hemisphere countries build up crude oil and oil products stock for the winter. The winter of 2019/2020 was always going to see higher demand due to the transition from high sulphur fuel oil to low sulphur fuel oil. The summer saw a longer than usual refinery maintenance season as refineries geared up to switch from sour high sulphur crudes to sweet lower sulphur crudes to produce more low sulphur fuel oil. With the additional IMO 2020 marine fuel sulphur cap demand, Clarkson Research Services estimated that crude oil tanker demand in 2020 would rise by a firm 5% and demand for product tankers in 2020 by a firm 6%.
Supply fundamentals: Tanker supply growth has been weak. Poor earnings, declining access to capital due to banks retrenching from the sector, and uncertainty over energy technology to meet IMO GHG 2050 has led to a decline in ordering. According to Clarkson Research Services, the ratio of orderbook to fleet has been declining for months and as at September, the crude oil tanker orderbook was 27% smaller than 12 months previously and the ratio of orderbook to newbuildings stood at 9%. On the product tanker side, the year-on-year decline of the orderbook was 21% and the orderbook to fleet ration down to 6% of the current fleet. At the level of the fundamentals, the supply/demand balance was nearing equilibrium, a situation that would have led to an increase in rates without any geopolitical pressures.
Timeline: Progression of the tanker rates surge
Iran: a full timeline of the situation is available here.
16 September 2019: A key starting point for the current rates surge was the drone attack on the Saudi Arabian crude oil facility.
25 September 2019: Department of the Treasury’s Office of Foreign Assets Control (OFAC) takes action against COSCO companies. This and similar sanctions on Venezuela is digested by market, which collectively comes to the conclusion that fixing a tanker with a counter-party on the OFAC list or a counter-party that may be in a chain that dealt with a company or person on the OFAC list is too much of a risk. This action quickly narrows the range of tankers that appear to be ’clean’ reducing supply overnight by as much as a fifth of the fleet.
11 October 2019: Clarkson Research Services reports that VLCC average time charter earnings surpassed US$300,000/day.
14 October 2019: How long will the tanker rates surge last? Owners will scramble to take advantage of the boom, increasing supply and dampening the peaks.
14 October 2019: Jefferies’ tanker analyst Randy Giveans talking on CNBC noted that while the freight rate increases are remarkable, they are not too high to stall the trades. A month ago at US$28,000/day for a VLCC the freight was around 3% of the cost of the cargo. The rates are now around 7% of the cost of the cargo. There is still some way to go before importers balk at the shipping cost but the impact on refinery earnings may be a key factor.
16 October 2019: Values for a VLCC immediately available for work rise in value: a one-year old VLCC now valued at US$94M (1 August 2019 = US$90M) and a five-year old VLCC at US$74M (1 August 2019 = US$70.5M).
21 October 2019: The tanker rates surge may have fizzled out for the time being, but in the longer-term, demolition may be the key to market rates. The third week of October 2019 saw VLCC spot rates drop from the extraordinary highs of US$300,000/day and the rumoured rates of US$400,000 plus/day reported the previous week. It appears only a few VLCC spot fixtures went beyond the “on subs” stage and became firm fixtures. Clarkson Research Services reported “This week saw rates freefall as much of the business negotiated last Friday failed to be concluded and, with charterers having fixed so far forward, tonnage was released back into the market over the week.”
But this is hardly a disaster: CRS notes that the average VLCC spot rate for the week ending 18 October 2019 converted into time charter equivalent earnings was US$96,000/day. While this was a sobering 69% fall on the week before, it is a level owners of VLCC newbuildings will be happy with – it covers opex and capex. For owners of older tonnage with mortgage repayments and interest paid off, the revenue will be extraordinary compared to recent months.
One such owner and operator of older VLCC tonnage, Ridgebury Tankers, may have completed the VLCC S&P deal of the year having sold three VLCCs to an unnamed Singapore buyer. Of course, such a deal would have been weeks, if not months in the making, but the spike in rates would have sealed the deal. According to CRS, Ridgebury Tankers sold three VLCCs: Ridgebury Artois (298,330 dwt, built 2001, Hitachi Zosen Ariake); Ridgebury Utah (299,498 dwt, built 2001, Daewoo; and Ridgebury Utik (299,450 dwt, built 2001, DSME), en bloc for US$98M or approximately US$33M apiece. The trio were purchased just under three years ago for US$22M each.
The increase in VLCC spot rates has been beneficial for time charter rates, too. At US$50,000/day for a one-year time charter, the VLCC rate is nearly double the average of 2018.
Another factor in the decline in spot rates was the diminishing arbitrage between US Gulf loading and Middle East loadings for delivery to Asia. Tanker tracking and analytical service Vortexa reports that several VLCCs that have regularly delivered US crude oil to Asia have been booked for Middle East and West African cargoes, breaking the pattern. “Hefty VLCC rates amidst narrow WTI crude oil discounts to Brent crude oil are expected to keep US crude oil to Asia arbitrage flows tight in the short-term, as competing light crude oil grades in Africa, Europe and the Middle East offer higher margins,” it noted in this week’s blog. Vortexa also reported that some Aframax tankers were converting from clean to dirty cargoes, and that newbuilding VLCCs were being offered dirty cargoes on their maiden voyage.
This clean to dirty activity will increase the capacity for crude oil cargoes, as will the speeding up of the VLCC fleet.
The market-driven swing in the crude oil fleet supply adds to the newbuilding-driven increase in tanker supply. BIMCO’s chief shipping analyst, Peter Sand, has pointed out that the short-term spike occurred against an increasing fleet supply. “While many shipowners are profiting in the short-term from market uncertainty, the medium-term outlook is contrastingly gloomy when focusing on the supply and demand fundamentals. Profitable freight rates in the mid-term future will certainly be impeded if ships, that were otherwise headed for scrapping, are kept in the fleet,” he wrote in a recent analysis of tanker fundamentals.
The rate of scrapping in the tanker fleet has fallen by 52% so far in 2019, compared to 2018 and is the lowest since 2007. The increased tonnage ordered in 2017-2018 is now being delivered. “In total, 53 VLCCs, adding up to 16M DWT, have been delivered through the first nine months of 2019. Alongside a slump in demolition activity, the total crude oil tanker fleet has grown at a staggering rate of 5.4% from January to September,” he said.
Tanker scrapping is unlikely to pick up soon. The firmer spot rates will keep tankers off the beaches of the Indian sub-continent but also the fall in demand from those acquiring large tranches of scrap metal. The last sale for recycling of an undamaged VLCC was 1996-built Watban (ex-TI Watban) sold for US$440/ldt. According to cash buyer GMS, scrap metal prices in India have declined, and the India rupee has depreciated, leading to a reduction in demand. Currently, offers for scrap are in the region of US$350/ldt in India, GMS reports.
25 October 2019: During the announcement of its Q3 2019 earnings, public listed tanker company DHT also revealed it has delayed installing the final six scrubbers in order to capture the current spot rate strength.
Notes: 1 - Clarkson Research Services president emeritus Dr Martin Stopford describes shipping cycles from the year 1741 onwards in his book Maritime Economics. Of shipping cycle number 19 (1973-1978) he quotes a broker report from the era that noted that in mid-1973 VLCC rates rose from US$2.5/dwt/month (approximately US$22,000/day) to US$5/dwt/month (c.US$44,000/day). VLCC values also rocketed: a 1971-built VLCC that cost US26.4M could achieve up to US$73.5M in 1973.