Outlook: ECA clouds a bright dirty freight horizon

Unresolved questions loom large over the implementation of long-heralded changes to sulphur regulations within the Emissions Control Areas (ECA) in Europe and North America as the shipping market steams into 2015. But, otherwise, the dirty freight market enters the new year in rude health.

Marine fuel sulphur limits are to be cut from 1pc to 0.1pc in European and North American ECAs from January, forcing a price rise of about $250/t on shipowners if they are forced to burn marine gasoil (MGO) instead of low-sulphur fuel oil. The Worldscale Association, which annually sets rates for tanker voyages globally, has calculated the fixed rate differential payable for voyages partly or wholly within the ECA using a 0.1pc sulphur marine gasoil (MGO) price of $920/t, against a 1pc cracked fuel oil cost in 2014 of $665.39/t.

The fixed rate differential for each mile steamed within the ECA in 2015 rises to $48.35, from $5.21 in 2014. This has ignited a debate among shipowners, charterers and brokers about how such a huge increase in costs to the charterer will be dealt with next year. As an example, the fixed rate differential for a typical voyage from Primorsk to Rotterdam increases to $138,522 from $14,926 this year.

In 2010, the ECA sulphur limit moved to 1pc from 3.5pc, but the price differential between low sulphur and high sulphur cracked fuel is much lower than the difference between low sulphur fuel oil and marine gasoil with 0.1pc sulphur, and this latest transition could have a longer bedding-in period. The crux of the problem for charterers and owners is that the differential is based on mileage and not the volume of oil physically consumed on the voyage.

What has so far been a fairly minor additional cost for charterers becomes immediately more onerous and charterers have expressed a range of concerns, pointing to the anomaly that the owner of a VLCC will receive the same compensation as the owner of a small ship that burns less bunker fuel.

"The small shipowner is overcompensated, and the large shipowner is undercompensated," one London-based crude oil charterer said, adding that "it will be a mess" as charterers look for ways to minimise the impact to their voyage costs.

The fixed rate differential could become an additional element in the negotiation on a ship, with charterers trying to share the burden of the increased cost. At least at the start of the year, when markets are supported by seasonal trends including weather-related delays and strong demand for ice-class ships, owners are likely to be in resolute mood and will resist charterers' attempts to negotiate discounts.

The mileage steamed within the ECA is recorded by the master of the ship on a voyage by voyage basis, but Worldscale Association guidance says "it is the responsibility of the contracting parties to agree the distance steamed within an ECA". This theoretically opens up the potential for charterers to request a reduction on the mileage as recorded, asking for a percentage discount to reduce the differential.

But brokers suggest this is less likely than the more simple approach of asking for a consideration to be built into the spot freight rate paid. An allowance for bunker costs is built into all the flat rates issued annually, based on the bunker fuel market between 1 October in the prior year and 30 September in the current year.

When bunker fuel costs are markedly higher than the price built into the flat rates, owners will try to claw back some of their increased costs by adding points to the spot rate agreed with the charterer. Conversely, when bunker prices are much lower than the in-built prices, increasing owners' earnings, charterers will argue for some consideration to be reflected in the spot rate. Neither strategy is always or even often successful, and in recent times falling bunker prices have not had any real and proportionate impact on spot freight rates, but this may be the simplest way for charterers to try to reduce the impact of the exponential rise in the fixed rate differential.

Broker Icap's head of research Stavroula Betsakou believes an allowance reflected in the spot rate is a more likely approach than initiating a discussion around the mileage: "It would be unprecedented to make the mileage negotiable, but the freight rate is negotiable".

A more substantial reduction would be achieved by agreeing to split the costs 50:50 between the laden and ballast legs. All Worldscale Association calculations assume a round voyage for a ship, in ballast and then laden.

"Owners want laden and ballast, and charterers want [to pay] laden-only compensation", said Betsakou, but charterers may find owners resistant particularly when an entire voyage is within the ECA. If a ship has to burn 0.1pc fuel for the whole voyage, laden and ballast, the under-compensation factor for the owner becomes more acute, and more acute still the larger the ship.

Some charterers will look at varying the route taken to reduce the mileage within the ECA. A London-based charterer told Argus an agreement has already been reached with two owners to change the standard route for ships sailing from the Baltic to the Amsterdam Rotterdam Antwerp (ARA) area, to ensure part of the voyage is not subject to the higher fixed rate differential.

Charterers suggest the Worldscale Association will have to rethink its response to the change in emissions legislation as early as 2015, when the next schedule is published.

Beyond the immediate financial headache the new ECA regime creates for charterers, there could be technical problems ahead, which will only be properly understood after the new sulphur limit has been in place for a year or more.

Ships' engines are built to burn fuel oil, which has better lubrication properties than marine gasoil. The miles per tonne of marine gasoil is additionally lower than for fuel oil, the heavier cut, which has logistical implications for tank space but also potentially creates problems when a ship is sailing partly within and partly without the ECA.

According to one senior analyst: "The problem is switching from heavy fuel to lighter gasoil, which is more liquid. If crews have not been trained, there is potential for leakage". A loss of propulsion could also cause problems in congested areas.

"If ships are losing propulsion in the English Channel, this could be a problem," the analyst said.

An Aframax ship sailing from the Baltic to the US Atlantic coast will have to burn marine gasoil within the ECA at both ends of the voyage, and switch to heavy cracked fuel oil for the transatlantic portion. It is not clear if technical problems will develop over time and restrict the voyages some ships can perform, and only time will tell once the new sulphur limits are in place.

Shipowners have the option to fix scrubbers to their engines as a means of reducing emissions to within the legal limit while still burning high sulphur fuel, but there is a tipping point based on the savings against the cost of adapting the engine, which will vary owner to owner.

The ECA regime aside, the VLCC market is in robust shape heading into 2015, with rates on the key Mideast Gulf route to Asia Pacific hitting a 2014 high late in December. A lower oil price has subdued activity in some regions but China has increased imports in the fourth quarter, while minimal net fleet growth has underpinned the market to push rates up to around WS10-15 points higher than at this time last year.

Icap's Betsakou said China's buying has increased in the quarter but the most significant hike was in the same period last year, and the current additional demand comes on top of an already high baseline import rate carried over from last year. Increased refinery margins, along with a lower oil price accounts for China's increased appetite, Betsakou said.

"Chinese refiners can make good margins, and China is [now] a net exporter of products", she said.

"Zero fleet growth, more cargoes from west Africa east and from the Mideast Gulf to China because of more buying on the lower oil price", is how one Tokyo-based broker sums up the current strength in the VLCC market.

New ships have come into the market, but the net increase in the fleet after scrappings are taken into account is lower than in previous years. The Baltic and International Maritime Council (Bimco) said in a report earlier this month that the VLCC fleet has grown 1.1pc since 2013, while the Suezmax and Aframax fleets have contracted.

So far, 24 new ships have been delivered in 2014, according to a London-based analyst, with around three more scheduled for delivery by year end. The same total of 27 new buildings will hit the water in 2015, the Bimco report said, to keep the fleet in check.

But high freight rates at the beginning of 2014 attracted investors back to the VLCC shipbuilding markets and orderbooks increased. In 2016, 49 ships will be delivered to the market, according to the Bimco report, but in the interim analysts agree a more balanced supply will support a higher base line freight rate across the dirty tanker market.

Demand for crude tankers is exceeding supply for the first time since 2008 heading into January, according to the Bimco report, and analysts said a tighter shipping market increases the potential for volatility in freight rates across the board.

In January 2014 rates across all dirty tanker sectors soared, as a combination of weather-related delays, increased buying in Asia Pacific, with a liberal sprinkling of bullish sentiment among shipowners thrown in, created a perfect storm. Each sector drew strength from the others, to the extent that VLCC brokers in the Mideast Gulf market pointed to high Aframax rates in the Mediterranean as an influence on their market.

Conditions appear to be aligning to create a similar scenario heading into January, which has the potential to be "spectacular", according to one analyst, and the Aframax sector may provide the same bottom-up push as last year.

Another factor this year was the drop in Saudi Arabia's official formula crude price to Asia-Pacific buyers, which at a stroke increased demand and had the knock-on effect of increasing Suezmax traffic from west Africa to Europe. The return of Libyan oil to the market – while sporadic – helped Aframax and Suezmax owners, while a counter-seasonal spike in summer demand as oil prices shifted into contango added another fillip to owners' fortunes. Both sectors head into the new year in robust shape, and again the VLCC sector will draw support from both, allowing a virtuous circle of mutual benefit to develop.

But there are wide ranging areas of uncertainty that charterers, owners and shipbrokers are all wary of speculating upon.

"There are more unknowns this year than last year", one London analyst said, pointing to speculation around how low oil prices will go before supply is trimmed, including shale gas supply, whether the US Commerce Department's statement of 30 December clears the way for significantly increased exports in 2015, whether there is any change to the ban on US crude exports, and how political hot spots including Libya will pan out.

Many questions remain but a consensus view is that the dirty tanker market is in reasonable health, at least from an owner's perspective, heading into 2015.

jcw/ts/bw

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