If it were not against the backdrop of a global pandemic, the first few months of 2020 would have been a joyous time for the tanker market, but this remarkable run is not sustainable
Even before the outbreak of Covid-19, tanker market fundamentals at the start of 2020 favoured the tanker owner and operator. As Concordia president and chief executive officer Kim Ullman has noted, in retrospect, there was “relatively good growth in the global economy, good demand for oil, balanced stock levels and few ship deliveries.”
Adding to the equation was the relatively benign impact of the IMO 2020 sulphur cap. There was no loss of power on hundreds of vessels during the fuel transition and for the most part, there was no shortage of low sulphur fuel oil or blended fuel either. The outlook for Q1 2020 was rosy but not spectacular.
By February, average VLCC spot earnings were a little weak at US$26,500/day, according to Clarkson Research Services (CRS). But in the background, a significant change to global oil demand was taking place, following the realisation that the flu-like sweeping the world was unstoppable without a vaccine. Governments worldwide swiftly concluded that the only way to slow its spread throughout the population was total lockdowns. The drop in crude oil demand from the lack of air travel and commuting was initially thought to be short and shallow, at around 500,000 b/d or approximately 0.5% of global demand; but by early March it was clear, drastic demand destruction was taking place.
At any other time, the oil producing nations would have swiftly agreed to cut production to support the crude oil price. At the early March 2020 OPEC+ meeting, Saudi Arabia proposed a 1.5M b/d cut in oil production. But in a move for which tanker owners would be forever grateful, while the rest of the oil industry looked on in exasperation, Russia disagreed and Saudi Arabia sought to punish its rival to the crown of cheapest oil producer by opening the taps.
“By early March it was clear, drastic demand destruction was taking place”
After the failed meeting to cut production, Saudi Arabia swiftly booked 14 VLCCs for April loading from Saudi Arabia at ever increasing rates, which soared from US$35,000/day to double that in a single day. Some reports claimed the Saudi Arabians had booked the last available VLCC for April loading at US$200,000/day.
By April, the cartel of oil producers realised that increasing crude oil production made little sense if there was no demand. A new deal to cut OPEC output by 10M b/d was announced: crude oil production would be adjusted by 10M b/d beginning on 1 May 2020, for an initial period of two months; then by 8M b/d from July to December 2020; and by 6M b/d from January 2021 to April 2022.
However, the new deal was based on much lower historical figures. It is now estimated that Saudi Arabia and its OPEC allies actually increased crude oil production by 12M b/d in April 2020. The crude oil flowed into the market without demand and the price fell, with the resulting contango leading to another rush to buy crude oil and store it. On paper, the futures price of crude oil was higher and the possibility of making a short-term profit when demand returned made exciting economics.
This led to the price of crude oil at Cushing, Texas, the main US hub, going negative for the first time ever. The crude oil tanks at the key Cushing pipeline hub in Oklahoma were close to capacity, with the unusual situation of pipeline operators refusing to transport oil unless there was ullage available at the delivery point. This blatant lack of demand for crude oil caused panic among derivative traders holding futures contracts for West Texas Intermediate (WTI) crude oil for May delivery, producing the negative US$37.63/bbl WTI crude oil price.
The situation in West Texas remains unresolved and looks set to repeat at the end of the next round of futures contracts. Indeed, the situation is likely to be exaggerated when several Saudi Arabian-chartered VLCCs arrive in the US Gulf with their April-loaded crude oil. Given that the US is producing approximately 2M b/d more than its own requirements and that the Saudi Arabian refinery at Port Arthur, Texas, has a nominal capacity of 600,000 b/d, it is highly likely that these tankers will join the expanding fleet of floating storage.
The other Saudi-loaded VLCCs are heading across the Pacific to the US West Coast. According to shipping data service Vortexa, the four-year average of floating storage off California has been 4M bbls. By the end of April 2020, 13M bbls of tanker storage of crude oil lay off the California coast, with another 13M bbls due to arrive, mainly from Saudi Arabia.
CRS estimates that since the start of March, global tanker storage has more than doubled, from 95M bbls to 257M bbls. Some 39 VLCCs have joined the storage fleet in the last month. How many VLCCs are available for storage? Speaking in early April 2020 at the 14th Annual Capital Link International Forum, which this year was conducted entirely online, Euronav chief executive Hugo De Stoop said: “[If rates are high enough] the entire VLCC fleet is available for storage.”
But the growth in storage and its impact on rates has a dark side. It masks the threat to earnings. The extraordinary rates being earned in the tanker sector have no basis in an underlying fundamental growth in demand for tankers. Maritime Strategies International director of tanker markets and energy Tim Smith noted that whilst much focus is understandably on the near-term oil glut, MSI does not view the upturn in tanker earnings as sustainable – it is being created by a loss of underlying demand, not growth. In his opinion, there are major headwinds on the horizon.
“If rates are high enough the entire VLCC fleet is available for storage”
“The loss of demand is primarily (and currently) being driven not by macroeconomic factors but by government directives. Knowing when restrictions on movement will be eased is of course impossible, but when this does happen the increase in oil demand is likely to be rapid. Lower prices will only stimulate this.”
Importantly, whilst the demand drop and subsequent recovery may be quite fast (although it perhaps doesn’t feel like it now), the production cuts by OPEC+, whilst insufficient in the near term, are a sustained commitment. No predictions about OPEC+ are precise, but if we see oil demand normalise (if not fully recover) across the course of H2 20, this will be accompanied by falling global supply, from both OPEC and non-OPEC producers,” he said.
“As a result, the inventory situation will start to reverse. At this point, we will start to see more negative conditions develop in the tanker sector.”