Loss of underlying demand, not growth, has driven an unsustainable upturn
The Covid-19 pandemic has had a dramatic impact on the oil and tanker markets, both in terms of current commercial conditions and the outlook for markets.
With much of the world in lockdown, global oil demand has collapsed. The IEA estimates Q2 will see global demand down 23M b/d. MSI expects annual oil demand to fall by about 8% this year overall, dependent on a concerted recovery in Q4.
The supply of crude to the market has not been quick to react to this precipitous decline, as OPEC producers have grappled with how to respond to the loss of demand while protecting their national interests.
Following the failure in agreeing a plan of cuts by the OPEC+ group of countries in March, April has seen a massive cut approved after intensive negotiations. The move commits to reducing output by 9.7M b/d from agreed baselines at the start of May for a period of two months.
For the second half of 2020 the reduction is 7.7M b/d with 5.8M b/d pencilled for 2021. Along with the cuts from OPEC+, we are also expecting reduced production in other countries, particularly the US, where oil production is likely to fall by around 2M b/d across 2020.
Conversely to the vast majority of industries, the tanker sector is benefiting in this volatile environment with floating storage acting as an alternative ‘escape valve’ for excess oil as land storage approaches capacity.
Over Q2 we are going to continue to see massive excess, collapsing crude prices and further oil market turmoil. We will probably see further policy shifts and production adjustments from OPEC+ this quarter too.
“Less trade, more ships – the double whammy that has killed markets after an inventory surge”
Floating storage will continue to play a major part in absorbing the surplus, keeping earnings at exceptional and elevated levels in the near term in what has been a very strong market across March and the first half of April.
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. There are major headwinds on the horizon.
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.
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.
The timing of future inventory drawdowns may be difficult to predict, but they will happen and when they do it will be on a huge scale. This will further suppress trade volumes as refiners use stored crude rather than requiring further purchases, suppressing future import demand.
When inventories draw, floating storage will also return tanker tonnage to the market. In the past this has been the double whammy that has killed markets after an inventory surge: less trade, more ships.
We have seen previously the detrimental effects on tanker market fundamentals when OPEC cuts combine with demand shocks (2009), and when temporary storage builds driven by excess have reversed (2016-18). The situation we are currently in will combine both of these elements, but at much greater scale.
Tim Smith is director of tanker markets and energy at Maritime Strategies International