Weight of Freight: US-Brazil fuel trade to play a leading role for MR tankers

Author Argus

Join our latest Weight of Freight podcast where we discuss current trends in the atlantic basin product tanker market with a special guest.

For this episode, Michael Connolly, Reporter - Freight, is joined by special guest Stefanos Kazantzis, Commercial Director at McQuilling Services, for a deep dive discussion on the Atlantic clean tanker market. 

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Michael: Hello and welcome to the Weight of Freight Argus podcast series. I'm Freight Reporter Michael Connolly and I'm joined here by Stefanos Kazantzis, Commercial Director of McQuilling Services.

Stefanos: Hi, Michael. Pleasure to be with you.

Michael: Today, we'll be discussing some current trends in the Atlantic basin product tanker market. So, to begin with the two major demand side factors that have affected the Atlantic basin market so far this year are the continued impact of the COVID-19 pandemic and the severe weather that led to widespread refinery outages at key refined product export points in Texas, during February and March. These factors have weighed on clean tanker rates across the Atlantic basin pulling the entire market below pre-COVID levels. For example, year-to-date, the key U.S. Gulf Coast to Chile MR tanker rate has averaged roughly 1.16 million dollars lump sum, compared with 1.27 million during the same period in 2019 before the coronavirus pandemic.

So, I'll start off talking about that COVID-19 pandemic, which cut global oil demand by 9% last year, according to the EIA, consequently weighed on exports across all markets. From 2019 to 2020, oil product exports out of the U.S. Gulf Coast fell by 18%, it's roughly 1.7 million barrels per day. And those decreased volumes were carried into this year. In the first quarter of 2021, only 1.5 million barrels per day of oil products were exported out of the U.S. Gulf Coast, which is down from 2 million barrels per day during the same period in 2019. And during the second half of the first quarter of this year, product exports out of the U.S. Gulf Coast faced further pressure from the Texas freeze, which cut refinery utilization in the region to an all-time low of roughly 41%, during the last week of February. Those low refinery runs persisted throughout March, which, as I mentioned, caused prolonged export inactivity in the market.

One of the consequences of this U.S. Gulf Coast inactivity was increased product shipments from Europe to the Americas to replace those lost U.S. Gulf Coast barrels. Europe to America's product shipments averaged 1 million barrels per day, during March, which is the highest in any month since April 2019 and up from just 650 000 barrels per day last March. We also saw some rare intra-Americas movements by Mexico's state-owned oil company PMI, which is normally active on the U.S. Gulf Coast-East Coast, Mexico, route. Amid the refinery outages in Texas, PMI imported [inaudible 00:02:36] from Puerto Rico, [inaudible 00:02:38], the U.S. Virgin Islands, and the U.S. Atlantic Coast.

Furthermore, the lack of U.S. refined product exports has been a factor causing Brazil to purchase Indian diesel from floating storage inventory sitting off of West Africa. U.S. refinery utilization has since recovered to 86% during the week ending April 9th, which is up from 76% during the same week last year. But export activity has remained limited, despite this increase, as refinery utilization remains down from 89% during the same week in 2019. Overall, these factors that have destroyed export demand on the U.S. Gulf Coast have led to relatively depressed freight rates, compared with pre-COVID levels. COVID has been another factor weakening refinery margins and, in some cases, causing closures in the Atlantic basin. Stefanos, how are you seeing these closures affecting the clean tanker market?

Stefanos: It's a great question, Michael. And I think this development is one that has not fully revealed itself to the tanker markets yet, a primary reason being that the reduction in product supply from the closure of PES, as well as the reorganization of PES refineries, have been masked really by the deeper demand disruption from the COVID pandemic. We believe this is likely to change and, potentially, dramatically for the product tankers, as we get into the summer driving season.

And, being in New York I can assure you that the population here is eagerly anticipating the warmer weather, which, combined with lockdown easing amid increasing COVID vaccinations, will, in our estimates, lead to a very strong gasoline demand environment. And, so, what was essentially not appreciated by the market referring to the closures will almost certainly result in increasing import requirements.

Overall, our expectation is for an increase of about 300,000 barrels a day in product imports and/or intra-U.S. movements of products. For tankers, we have positioned our trade-flow outlook to include an additional 100,000 to 150,000 barrels a day coming from Europe into the New York area and the larger PADD 1 region. You know, for us, you know, the European story also begins to make a little bit more sense in terms of increasing exports because we are seeing a recovery in refinery runs. There was some maintenance but that is slowly ending. And, at the same time, the demand environment in Europe, I would say, is trailing expectations. And, so, what you'll have is a buildup of length in the European system, which will conveniently, given the demand expectations in the U.S., you know, provide what we think is a very nice MR demand story, over the next few months.

You know, additionally, one of the larger trades for MRs historically into PAD 1 has been from East Coast Canada. But there we see, you know, the disruptions in the Come By Chance Refinery, you know, really put some downside pressure on that trade. Historically, it's been about 10 to 11 cargoes per month, if you look back to 2019 and before that. And, so, some of those will transition over to Europe, it's longer ton-miles, so, that's a positive. But we do wanna highlight that there is some, you know, risk from increasing product flows on pipelines, either from PAD 2 or PAD 3, which do have some additional capacity to meet the demand. So, overall, you know, the structural changes will lead to more MR tanker demand.

And having said that, one of the other, you know, very key structural changes that we see for the clean tanker space actually is gonna be found in West Africa. And, you know, it's one of these things where we kind of refer to it as the "mythical Dangote Refinery." I mean we've been highlighting the impending structural changes, both for clean and dirty tankers, from this development since 2019. From our understanding, this new 650,000 barrel a day mega refinery in Nigeria is scheduled to come online in the second half 2022 and ramp up, over a 6 to 12 month period, the target utilization rates. Which we estimate are somewhere in the 85% range. As such, the obvious implication is that there will be a lengthening in refined products in West Africa.

So, what does this mean for clean tankers? Well, it will almost certainly result in a significant disruption for both MR and LR tanker demand originating in Europe to the West Africa region. And it is not beyond, you know, logic to assume that this will lead to some margin pressure in the Northern European refinery complex. What can happen, from that standpoint? Possibly some consolidation. We can see some additional refineries convert to biofuels production facilities, something that has already been going on.

So, from a trade perspective, the majority of the European-West Africa clean trade is gasoline. And, so, one potential outlet for this disruptive product flow could be the U.S. Atlantic Coast due to the reasons we talked about earlier, which is the closure of some of the PAD 1 refineries and also the East Coast Canada one.

You know, at the same time, it's not all bad news in that the Dangote-refinery product supply of jet fuel, we think, will increase the length of that product in the region and, in our estimates, will require export movement. So, ironically, that will probably go back to Europe. And, so, despite the demand losses of gasoline trade from Europe to West Africa, we do anticipate an increasing backhaul movement, as we like to call it, to emerge, offering interesting and very, I would say, profitable deployment options, which usually will translate into higher cash flow for MR tanker owners.

You know, one other interesting thing to note, and you touched on this a little bit before, Michael, you know, what we've seen is a lot of, let's call it, VLCCs and Suezmaxes that are being delivered from, you know, Asian yards. Which are trading crude primarily but, for their maiden voyage, will take a clean cargo because of the length of gas oil in the Far East and they'll bring it into the West Africa region. You know, that certainly has been, you know, something to, you know, support some of the tanker demand here.

But, going forward, what we think is actually one of skepticism that, with a declining order book, for Vs and Suezmaxes, we actually believe that there will be less of that going on into the future and that will revert some of that traditional clean tanker demand back to product tankers.

And, so, there's a lot of implications from, you know, the West Africa mega refinery coming online. I think you know Europe, obviously, will face some downward pressure in terms of its exports into the region. But we could see some potential reversal of flows from West Africa into Europe, particularly of jet fuel.

Michael: Thank you, Stefanos, for that very interesting forward-looking insight on the Europe to West Africa trade. Looking at that trade currently, it has actually been one of the most resilient trades amid the COVID-19 outbreak and global recession. Product flows between the regions rose by 3%, to 480,000 barrels per day from 2019 to 2020, despite total product volume exports...or total export volumes out of Europe falling by 10%. Within the Europe to West Africa trade, we've seen a rising share of LR movements and a falling share of MRs carrying those cargoes. In 2018, LRs carried 35% of volumes on the route compared with 66% for MRs. But this year, LRs have carried 49% of the volumes, compared with 46% for MRs. This has had a knock-on effect of putting downward pressure on America's bound MR freight movements out of the European market because the MRs that previously were involved in the West Africa trade are now competing with the transatlantic cargoes.

Now, another interesting and key Atlantic Basin product movement or product route is the U.S. Gulf Coast to Brazil trade. The U.S. Gulf Coast to Brazil trade is primarily driven by diesel shipments and it was one of the more resilient trade routes in 2020, amid the COVID-19 outbreak, similar to the Europe to West Africa route. Volumes fell by just 13%, compared with a 17% drop in total exports out of the U.S. Gulf Coast.

Another key Atlantic Basin oil-product export route is the U.S. Gulf Coast of Brazil trade, which is primarily driven by diesel shipments. It was one of the more resilient trades in 2020, amid the COVID-19 outbreak, similar to the Europe to West Africa trade. Volumes fell by 13%, year-over-year, compared with a 17% drop in total exports out of the U.S. Gulf Coast. And even despite this drop, compared with the 2019 volumes, U.S. Gulf Coast to Brazil volumes remain 26% higher than in 2018. So far this year, we've seen U.S. Gulf Coast to Brazil volumes fall to just 195,000 barrels per day as the diesel arbitrage between the two countries has been persistently narrow throughout the year. Which some importers have blamed on Petrobras keeping domestic diesel prices artificially low. And, Stefanos, would you be able to provide some forward-looking perspective on the U.S. Gulf Coast to Brazil trade?

Stefanos: Yeah, it would be a pleasure, Michael. And yes, there's a whole lot to unpack when it comes to the U.S. Gulf-Brazil. But just generally, the expectations from East Coast-South America, you know, we're very interested in this trade, as, over the last few years, it has actually climbed [inaudible 00:11:54] the U.S. Gulf to Brazil MR2 trade into the number two ton-mile demand generator for MRs. It trails only the intra-Northern European trade. By the end of our forecast period, which is 2025, our models show that it will overtake the inter-Northern European trade for MRs as the top spot. So, certainly one that we wanna keep a close eye on.

Overall, what do we see? The annualized growth for this trade is likely to be around 6.3% over the forecast period. So, what is going on that gives us this level of optimism? You know, of course, baked into the regional demand outlook is an economic recovery from the COVID pandemic. And, recently, the IMF revealed about a 2.5% annual growth rate over this, you know, long-term period. This increase in economic activity will flow through to oil demand.

At the same time, we do note that the Brazilian refinery complex has remained fairly underinvested with utilization rates stable and, therefore, the increasing demand will not be offset by higher regional products and, therefore, require growth and imports. We do wanna highlight that Petrobras has stated their intention to sell some of the refinery assets. And there is a chance that a new investor can modernize these units and increase the product supply, although we remain skeptical that this will be a reality.

So, at present, we remain constructive on this flow for the medium term. However, over the short term, meaning the next 3 to 6 months, our analysis of the product balances does not reveal any material improvement for clean tankers. So, the optimism for tanker owners is warranted but likely a year away from actual fruition.

Finally, and just kind of thinking about it as a puzzle piece, the implications from the West Africa refinery could also include Brazil. What do I mean by this? As Northern European gasoline supply gets longer due to reduced demand from West Africa, we note that in East Coast South America the actual growth in product demand will be shifted a little bit towards gasoline. And, therefore, gasoline imports will likely increase. We find that the opportunity for these lost European gasoline barrels, that were originally going to west Africa, could also flow to Brazil.

At the same time, another consequence of the West Africa refinery, as it relates to the U.S. Gulf-Brazil voyage, is that the reduction in LR1 demand from the Northern European trade into West Africa could increase LR1 supply in the Atlantic Basin and, specifically, the U.S. Gulf. Therefore, what you mentioned earlier, where the LR1s are kind of cannibalizing some of the current European trades in West Africa we think could also become a reality for the U.S. Gulf to East Coast South America trade where you could see some of that let's call it friendly competition between MR2 and LR1 tankers.

And just kind of thinking more broadly about the Atlantic Basin and where we see some, you know, really interesting developments, again, we kind of point to the U.S. Golf. It's an interesting topic for us, which is NAFTA. And it's gonna relate to the U.S. Gulf but also to other West of Suez refining centers. You know, first and foremost, when you think about NAFTA, you always think about Asian demand. Because they have a large petrochemical facility and complex and the growth in the petrochemical sector is quite rosy. A similar outlook, you know, can be found for a product like LPG, and these two products, LPG and NAFTA, you know, will compete with each other with short-term volatility often determined by current pricing arbs.

So, putting just some numbers in context behind this, we think that Asian...and when I say "Asian," I mean Far East and Southeast Asia. NAFTA demand will grow, you know, offsetting even some additional regional NAFTA supply. But this growth will outpace that supply by about 400,000 barrels a day, over the next few years. And, so, that means more imports.

So, traditionally for NAFTA, the Middle East balances out the deficit in Asia with its pretty large surplus. And, in fact, we do foresee that this trade will also grow but, likely, only cover about 25% of the growth in the Asian NAFTA deficit. So, what does this mean for the Atlantic Basin, you know, situation? Well, it means that the Asian petrochemical plants will need to source NAFTA from other regions and, in our analysis, these regions are really more pronounced in the West of Suez markets. One of the West of Suez's areas where we see NAFTA length increasing is the U.S. Gulf, but we also find increasing exports to Asia from the Mediterranean and also, you guessed it, West Africa.

Here's the interesting part. While we do envision direct flows from the U.S. Gulf to Asia happening, particularly on LR1s, when available, we believe that a Hub and Spoke paradigm will probably develop as relates to NAFTA flows from west to east. Specifically, we project that MRs will be increasingly used to ship U.S. Gulf NAFTA to the Med, [SP] which will also receive MR flows of NAFTA from West Africa. In effect, we think the Med will act as a receiving terminal, which, combined with local NAFTA length, is likely to be aggregated onto LR2s and ship to Asia offering the receivers the economies of scale that the LR can offer. We think this is a very positive development for LR tankers. If our analysis proves to be true, since we also project significant growth in distillate volumes transiting the canal from Middle East to Europe, basically these same vessels that are doing that frontal trade will find an increasing amount of volume for a backhaul trade of NAFTA from Europe to Asia offering, again, very interesting opportunities for tanker owners.

Finally, you know, kind of coming back to the MR segment, we think it's a positive. However, you know, what we do wanna point out is that the the increasing flow of NAFTA from the U.S. Gulf to Europe will likely offset our call for lower gas oil shipments out of the U.S. Gulf into Europe. After all, you can't project increasing distillate flows to Europe from the Middle East and not back out something, something will have to give. And, unfortunately, what we do think is that something will be the U.S. Gulf gas oil, which, in turn, will be pushed more into Central and South America.

Michael: Speaking of the U.S. Gulf Coast to Asia NAFTA trade, we've already been seeing a sharp increase in those shipments, over the past few years, to serve that rising demand. In 2018, roughly 70,000 barrels per day of NAFTA were shipped out of the U.S. Gulf coast to Asia, compared with 123,000 barrels per day last year. And now, this year, so far, that number has been 143,000 barrels per day. And that continued rise in Asia-bound NAFTA shipments out of the U.S. Gulf Coast that Stefanos alluded to would be a major boost for the clean tanker market because of the long-haul nature of that route, which would help tighten up tonnage supply in the region. And this could even have a positive knock-on effect for the European market by drawing tonnage from there to the Americas because Americas' rates would be boosted.

Now, looking at which vessel class has been most supported by the more active NAFTA trade, based on current trends on the route, it's likely that MR tankers would benefit because, over the past 3 years, they've been gaining increasing shares of volumes on the route. In 2018, MRs carried less than 50% of U.S. Gulf Coast to Asia NAFTA volumes, whereas, last year, they carried two thirds. And, so far this year, they've carried three quarters. However, one wild card in this trade is LPG which competes with NAFTA as a petrochemical feedstock. So, if LPG continues to gain market share as an Asian petrochemical market feedstock, then that would be a negative for MR tanker and LR tanker demand. So, speaking of shipments that go through the Panama Canal, it seems like West Coast-South American imports are also on an upward trend. What are you seeing there, Stefanos?

Stefanos: Very interesting as well. In West Coast-South America, we're expecting approximately 200,000 barrels a day of additional capacity to come online later this year and into the next. We have some modernization efforts happening in Peru and also some plans in Ecuador. And, so, naturally this leads to increasing supply of refined products once these refineries do come online again. Which has the potential to temporize the demand for imports. However, we do note that the demand in this region is also expected to rise, although the pace of vaccinations will certainly play a determining role in the trajectory of this growth.

Now, understanding a little bit about some of these refineries coming online and these modernization projects, we think the yield structure for these refineries is going to be a little bit more tilted towards gasoline. And, so, we see a more stable and even upward move in gas, oil, and jet fuel imports into the region But, again, we're a little bit more bearish on the growth of gasoline imports.

With that in mind, we are inclined, given the planned conversions of several U.S. West Coast refinery units into biofuels facilities, along with recovering gasoline demand in that part of the U.S., really reduces our expectations for MR demand trading this route. Meaning the U.S. West Coast-West Coast South America. However, we do believe that a larger portion of MR demand trading into West Coast South America, and particularly for the distillates, will be revealed actually from the Asian complex where gas oil continues to be oversupplied. The U.S. Golf MR trade to West Coast South America transiting through the canal, as you mentioned, we think will likely remain stable as well after years of what I would say is exceptional growth leading up to the current time. So, there are, what we think, some positives here, particularly MRs trading from the Far East into West Coast South America. I would say one negative, meaning U.S. West Coast into West Coast South America, and then a bit more of a neutral outlook in terms of U.S. Golf into West Coast South America.

If you look at the mileage considerations for those developments overall, I mean you have to point to the longer mileages from the Far East into the region basically substituting, in some cases, the West Coast U.S. flow into West Coast South America. So, I think, on the aggregate, it's a positive but there are some nuances that we have to think about.

Michael: So, we've been talking a lot about the demand side and, so, I'd like to transition to talk a little bit about the supply side. I know we've been currently seeing a pretty low LR order book, do you have anything to share about that, Stefanos?

Stefanos: Yeah, of course. You know, the demand side is important but, certainly, in terms of modeling rates and earnings, the supply side is, if not as important, potentially even more important. And, so, we do agree, I mean the contracting for clean tankers has been trending lower over the last few years. We've seen owners' preference, you know, really being for crude tankers, particularly in the run-up to IMO 2020. So, the order book percentages for MR tankers is ranging somewhere between 3% and 10%, depending on the size. Also, the IMO capabilities. And, as you mentioned, the LR order book is at multi-year lows, particularly for the LR1 which currently has, you know, a 0.5% order-book statistic.

So, what do we see here as a result of this slowdown in ordering? Our analysis shows that deliveries scheduled for MRs in 2022 are the lowest in over a decade, while only four LR tankers are scheduled during this time, these being LR2s. We do have a little bit of age [inaudible 00:23:16], particularly for your pump room type MR2s. And some new age restrictions in places like the Middle East will likely increase the amount of deletions that we see for this tanker segment. So, the combination of low deliveries and more deletions will continue to press down on the net fleet growth expectations and likely to add support for the MR utilization in the context of what we talked about in the earlier part of this conversation, which is increasing demand. And, so, this interaction of demand and supply, in our models at least, has consistently led to a firmer freight market, and we expect the same to occur this time.

Michael: Now, the broader demand side is looking a bit more bearish in the short term, [inaudible 00:24:01] any major geopolitical events, such as a sharp OPEC production increase or an oil-price crash, clean taker rates are likely to remain fairly weak through the summer, as the global economy and oil demand continue to recover from COVID-19. According to the EIA, global oil demand is expected to recover by 6% this year, roughly 97 million barrels per day. But that will still remain below 2019's demand of nearly 100 million barrels per day. Argus Analytics forecasts that global oil or global gasoline demand will peak in 2021 during the third quarter at roughly 24 million barrels per day, which is well below 2019's peak of 35 million barrels per day.

So, that wraps up this episode of Argus' Weight of Freight. Thank you, Stefanos, for joining us today. Thank you too for listening, and until next time. Thank you

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