It has been a bleak time of late in the crude oil tanker sector, with the supply/demand dynamic souring rates and little on the horizon to raise much cheer
“Since records began crude oil tanker earnings have never been this bad.” So says chief shipping analyst at BIMCO Peter Sand. It is a grim outlook, but sadly accurate. Earnings for Very Large Crude Carriers (VLCCs) in the first half of 2018 were as low at US$6,001 per day on average, with a Suezmax tanker earning US$10,908 per day and an Aframax making US$9,614 per day; all heavily loss-making levels for an industry which needs a much-improved market balance to lift freight rates above break-even levels into profitable territory.
Having enjoyed a very strong 2015, that saw the highest freight rates for crude oil tankers in seven years, 2016 was a step down, but still profit making. But as the crude oil tanker fleet kept growing faster than demand in 2017, loses returned to the industry, after three profitable years.
And it has been downhill from there, according to Mr Sand: “2018 has been absolutely horrible for crude oil tankers, with freight rates and the fleet utilisation rate falling to a record low level. The total crude oil tanker fleet has not grown at all in 2018; in fact, the VLCC and Aframax fleets specifically have not been growing over the past 12 months.”
Further, Mr Sand points to the freight market, which is severally impacted by very weak demand growth, “Overall, the freight market is oversupplied. The key to higher earnings lies within a very low fleet growth and a return to normalised demand levels.”
“2018 has been absolutely horrible for crude oil tankers, with freight rates and the fleet utilisation rate falling to a record low”
When can we expect crude oil tanker freight rates to deliver profits to owners and operators again? And when will overcapacity be significantly reduced? Most likely we must wait until the second half of 2019 before an improved market balance will drag the industry out of the red.
But could anything exacerbate a recovery? Since the beginning of 2018, massive demolition activity of excess capacity in the crude oil tanker sector has resulted in an unchanged fleet size. This activity is a critical driver for a recovery. Some 13M dwt was demolished in the first half of 2018. Moreover, a different oil market balance may also cause a return to an oil price contango (contango is a situation where the future price of a commodity is higher than the spot price). An oil price contango is likely to indicate an increased demand for tankers for floating storage.
When conducting a fundamental analysis of the crude oil tanker market the focus is on calculating the utilisation rate of the fleet, with the aim of developing a strong correlation between that and the actual freight rates. For the dry bulk market, that correlation is very strong, and BIMCO has used this to show the road to recovery for the dry bulk market. For the crude oil tanker market, the correlation is weaker, but still strong enough to rely on for directions – so is the market going up or down?
In the short term, freight rates may react more strongly than the underlying tanker market fundamentals indicate; 2018 is an example of that. The first half of the year has seen a very serious deterioration of freight rates when compared to 2017, a drop which the medium- to longer-term fundamental changes alone cannot explain.
Therefore, changes to the utilisation rates mostly give an indication of the direction of the market, up or down (much more than a specific freight rate level). For that reason, BIMCO keeps its focus on changes to the supply-demand balance, rather than forecasting specific freight rate levels for the coming years.
For the supply side, it is important to acknowledge the impact of floating storage. When low, it is irrelevant, but when it becomes widespread it provides a positive trigger to the market, as the available trading fleet becomes nominally smaller. The correlation between freight rates and utilisation improves quite a lot when adjusting for floating storage, as we do here.
Floating storage in the mix
Taking floating storage into the calculations provides a better understanding of the volatility experienced over recent years and particularly the improvement in freight rates seen in 2015. That year saw a significant increase in floating storage from 2014, where 20 units on average were deployed. During 2016, an average of 44 VLCCs were used for storage, meaning that the nominal fleet growth, as measured by dwt only, was more than reversed by capacity ‘taken out of active trading’ for floating storage purposes.
In 2016, the amount of floating storage was even higher, but inefficiencies in fleet operations that also contributed to a reduction in active fleet growth in 2015 had eased –driving supply-side growth higher than demand-side growth. That resulted in freight rates reducing from 2015 to 2016. 2017 saw a low level of floating storage, meaning that the supply side grew faster than the nominal fleet development. As supply (adjusted for floating storage) significantly exceeded an otherwise solid demand growth, freight rates and fleet utilisation rates dropped.
“At the moment, 110 VLCCs are left on the order books, and that is the figure that matters”
Floating storage is a key element of the dynamics of the crude oil carrier market, due to its impact - when it becomes big enough - and its unpredictable nature, which reflects the very volatile oil market. It is a dynamic that we do not see in other bulk trades.
Asian demand is increasingly dominating the market. The general trend over the past 10 years has been one of oil demand and oil imports growing in China and India; with oil imports contracting for the most part in North America. Crude oil tanker shipping has benefitted from longer sailing distances to China, but naturally needs Chinese import volumes to continue to grow, even if North American imports are not likely to reduce much further.
The outlook is that the supply side will command the future. At the moment, 110 VLCCs are left on the order books, and that is the figure that matters. The order book also holds 50 Suezmax and 124 Aframax tankers, but that does not really impact the bigger picture. The VLCCs are scheduled for delivery within the next 33 months. Naturally, owners are in intense talks with shipyards about possible postponements of delivery dates as the market is bad right now.
In BIMCO’s opinion, it seems safe to say that the supply side holds the key to an improved freight market – and a change of the utilisation rate provides the direction of the market. Keeping crude oil tanker demolition activity high while holding back on contracting new ships is required to tame fleet growth, today and tomorrow. How big a task the supply side is faced with will depend very much on the future demand for floating storage capacity. A big juicy oil price contango in 2019 would have a major positive impact on freight rate levels. It is not possible to predict if a significant contango will materialise and that is why we cannot make a firmer prediction as to when real improvements will appear. Demand-side growth may ease the way towards healthier freight rates, but its support in the coming years seems uncertain and cannot be relied upon.
As BIMCO has said before, 2018 is set to become another loss-making year for the crude oil tanker industry. Looking ahead, the year when the industry will return to profitable freight rate levels depends on the supply side growing (adjusted for the use of floating storage) at a much lower level than the demand side. Small improvements to the fundamental balance will not be enough to turn around the market.
Snapshot biography: Peter Sand
Mr Sand joined BIMCO in 2009 and holds the position of chief shipping analyst. He is responsible for analysing the commercial markets for dry bulkers, tankers and containerships. Taking the offset in global economics as the analytical starting point for all seaborne trade, he assists management and members with insight into many different aspects of the shipping industry.