The Crude Report: Dirty tanker rates to face “painful” recovery

Author Argus

We welcome a special guest from Gibson Shipbrokers in this next installment of The Crude Report podcast series.

It has been a year since the historical spike in dirty tanker rates back in March 2020. It is a sad anniversary for shipowners, who now suffer from extremely low or even negative earnings. However, with the oil industry making unsteady exit out of the pandemic, is there a recovery in sight for tanker rates too?

In this episode of The Crude Report, Richard Matthews, Head of Research at Gibson Shipbrokers, joins Argus’ Head of Freight Alex Younevitch, to discuss the impact of Opec+ ongoing production cuts, projected fleet growth and illicit trades by older vessels on crude freight in 2021 and beyond. 


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Richard Matthews, Gibson Shipbrokers
Alex Younevitch, Global Head of Freight, Argus Media
Richard Matthews
Head of Research
Gibson Shipbrokers
Alex Younevitch
Global Head of Freight
Argus Media

 

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Transcript

Alex: Hello. And welcome to this special podcast episode featured on both the "Weight of Freight" and "The Crude Report" podcast series from Argus Media. My name is Alex Younevitch and I'm the global head of freight at Argus.

It is not close to the end of the first quarter of 2021, which is a great time to have a closer look at freight cost in the crude oil market. Right around this time last year, the dirty tanker freight rate went quite crazy and shot to historical heights. Back then, they were driven by a perfect storm of factors like the boost in oil production, contango, and floating storage. Then came the virus and the grand collapse in rate. And now, exactly a year later, the freight is still at the bottom after being bear for quite a few months now. So, is there a respite in sight for ship owners? And if there is, where will it actually come from?

To answer these questions and more, I'm joined here today by Richard Matthews, head of research at Gibson Shipbrokers. Richard, thanks for joining.

Richard: Pleasure. Thank you for having me.

Alex: Great. So, I want to start by giving a little context here. We're recording this on March 17, and according to Argus data, last year, freight on the U.S. Gulf Coast to China, the LCC [SP] route was around $69.50 per ton. And now, it is around $16.50 per ton. That is a 76% drop year-on-year. And rates have been depressed for months. So, how did it get so bad, Richard?

WOF Dirty tanker rates to face painful recovery - Limited Edition graphs

Richard: Well, I think there's a few key kind of factors to consider. Obviously, the demand drop driven by the pandemic is the primary cause. But as you've alluded to earlier, if we go back to this time last year, we had a huge increase in production from the Middle East. We had a big rush for floating storage, and we had a big collapse in demand. But that collapse in demand was masked or obscured by the floating storage that we had. So, we had vessels tied up for long periods of time storing oil. But, of course, as we've gone through last year, we've seen Opec controlling production, instigating large production cuts. And, of course, as demand has slowly started to recover, we're seeing vessels coming back from floating storage. But, of course, as these vessels come back from floating storage, because demand is still weak and because supply has been constrained, there's not enough cargoes for these vessels.

Alex: So, in short then, considering that we had a long period now of low rates, should we expect anything in the year the same spike that we had last spring in this spring?

Richard: Unfortunately, no. And something exceptional would have to happen to see that. And right now, we see very good discipline within Opec. And, of course, we have good vessel availability. So, it looks unlikely. But tanker owners are always optimists.

Alex: Yeah, the eternal optimists, is what I say. So, let's talk about Opec+ then for a second, since you mentioned them. They threw quite a bit of a curveball earlier this month. They surprised, I think, quite a few people, especially analysts by sticking with the production cuts. What do you think is the actual impact of that on the tanker market? And we're talking both short-term and long-term.

Richard: Sure. I mean, in the short-term, there's no spin you can put on it. It's negative. Of course, we were hoping to start seeing flows increasing and that would, of course, increase demand within the tanker sector. We were never expecting a huge change, but we had hoped for something. So, in the short-term, undoubtedly, negative. But as you just said, you know, tanker owners are the eternal optimists. And when we look at this and we try and take a positive spin from it, we see it in the fact that what Opec are doing right now is going to draw down inventories significantly. And that means, when demand does come back, and when supply does come back into the market, we're likely to see a stronger uptick in seaborne trade.

Alex: So, it would cover both the normal chartering and also filling up the stocks again.

Richard: Yes.

Alex: Okay. So, if we are talking Middle East or exports from the Middle East, it's quite a popular opinion and, I think, quite a correct one that Middle East exports to places like India, in places like China, it's not actually the best route when it comes to ton-mile demand. Just because they're short-term. The ton-mile demand, there is always an element of distance in that. So, in this current situation where we have Middle East crude coming out of the Middle East. Will we see more of an advent of routes on longer haul trades from the U.S., maybe other places, going to these?

Richard: Well, we'd like to think so. But I think we have to sort of manage our expectations a little bit here. You know, if we look at where the growth in crude supply is likely to come from over the next 12 months, primarily, that's going to be Opec and Opec+ countries. But the vast majority of that is likely to come from the Middle East. And, of course, as you just said, Middle East crude going into India isn't particularly brilliant for ton-mile demand. Going to China is okay. It's a sort of medium haul route. Generally speaking, that will have a good effect. But what we'd really like to see in the tanker market is a big increase in crude coming out of the U.S. or coming out of the Caribbean and Latin America, going to India and hopefully going to China. Because, of course, that's the biggest impact on ton-mile demand.

But I think, realistically, over the next year, we're not expecting to see much growth at all coming out of the U.S. unless prices continue to rise and we see more wells being drilled. And we generally assume there'll be no change in countries like Venezuela, again, unless something changes on the sanctions side. So, really is the Middle East that we'll primarily be looking at.

I think, one thing to add to that is that the Indian government is looking to diversify crude supply away from the Middle East. And you may see Indian buyers taking a bit more U.S. where they can, a bit more West Africa, possibly a bit more from Northern Europe and the FSU.

Alex: Will this make a dent in the rates? Will it hold them up or it's not enough demand coming from India diversification [crosstalk 00:06:31]?

Richard: It's not enough on its own. It will help, but certainly, we need an increase in supply from the Middle East coming as well, albeit that going to the far east rather than, let's say, India.

Alex: Fair enough. So, in this case, what are the realistic scenarios in the next 12 months that could actually boost ton-mile demand?

Richard: Well, firstly, we've got to see the demand coming back and we've got to see the oil supply coming back. So, you know, in our expectations, we're relatively...we call it realistic. Some people call us pessimistic. But that's really just a matter of opinion. But in our view, we've got to see Opec easing their supply cuts. The next meeting is in April. We'd like to think we'll start seeing some crude coming back into the market from them. But, of course, for that to happen, demand has to meet that. And, of course, the pandemic is not over yet, particularly in Europe right now. So, for us, we really need to see Opec having the confidence to increase supply into the market. We need to see demand continuing to grow and an effective vaccination program to help that. But most of that will come from the Middle East and, of course, the other Opec+ countries contributing as well.

We're hopeful for seeing something like Venezuela, but we think that will be quite a way away, perhaps not even next year, depending on how the politics go. So, yeah, it's not easy to say exactly where it will come from, but Opec Middle East is really where the main expectation is.

Alex: Makes sense. Okay. Let's talk about the other side of this for a second. Where there's demand, there is always the supply. And the supply is always represented by the fleet, the amount of vessels available in shipping. Goes for tankers, too. And what we've seen recently...and this is something which a lot of people in the ship owning community are putting their hopes on is this slowdown in the new building growth. So, there are less new ships being ordered, and that has been going for a while now. And I was wondering if that is still the trend, first of all. And what is it caused by, do you think?

Richard: Sure. Well, there's a few key things to address there. Firstly, we have seen a slowdown over the past few years in new building orders. A large part of that has been driven by the sort of uncertainty as to what to invest in. So, obviously, we know the world is moving towards a greener future. Shipping is not immune to that. And ship owners are uncertain whether it's the right thing to invest in a conventional tanker or go for something like LNG, which still has its own potential climate impacts as well. So, that's probably been the biggest barrier to investment at the moment.

WOF Dirty tanker rates to face painful recovery - Limited Edition graphs 2
But actually, you know, I had a look at the number of VLCCs that have been ordered this year. So, effectively, in the first quarter. And we're already around about 22 VLCCs being ordered in one quarter alone, which is actually a very high number. We'd normally expect to see anywhere between, say, high 30s and maybe an extreme year, high 50s being ordered. So, we're almost halfway to those kind of numbers right now. So, it has been actually a relatively busy start to the year for ordering, particularly on the VLCCs. Although, 10 of those ships alone are for one charterer, in other words, Shell.

Alex: Yeah. And are people...since we're talking about it, I guess I know the answer already. But are people mostly investing in dual-fueled engines when they order new buildings or LNG powered vessels?

Richard: We'd still see the majority as being conventional fuel, but if you look at the order book delivering... So, if you order a ship today, you're really looking at 2023 delivery. And if you look at the deliveries coming in 2023, in some cases, on some sectors, more than half the fleet is at the moment dual-fuel or at least some form of dual-fuel-ready. So, the trend is definitely going that way. But there's still a large section of the industry who doesn't have the confidence or perhaps the expertise in some of these new fuels to make a decision on what to invest in.

Alex: And [inaudible 00:10:46] that's the other part of it and probably is connected to that confidence in the new solutions, among other things. But there has been increased activity in the secondhand market as well. What do you attribute this to? Again, the lack of confidence in the new building and new solutions, the prices for assets or something else?

Richard: Well, the secondhand market, again, is a very interesting one. You have to look at it in two different ways. So, you look at the modern tonnage, which is being sold to, let's say, first class counterparties all trading conventional trade. And modern vessels which have very good fuel consumptions perhaps those that have a scrubber are of course in high demand. You then have the other section of the market where you're talking about VLCCs or, you know, Suezmaxes, Aframaxes, which are over 20 years of age or approaching 20 years of age, and should really be scrapped. But there's also a market for these vessels at the moment for trade which we would call or suspect as illicit.

So, whether this is sailing to Venezuela, whether this is sailing to Iran, there's definitely been an increase in vessels that have been sold seemingly legitimately, perhaps then through several intermediaries, end up trading in sanctioned business. And that actually at the moment is having an impact on scrapping. Because these buyers are willing to pay $2 or $3 million above scrap value for old ships because they know they can trade them in these illicit trades and likely make very good returns.

Alex: Interesting. So, that's one of those cases where the ship suddenly drops off the AIS tracking when arriving to certain places in the world. Right?

Richard: Yeah. I mean, we looked at a vessel yesterday and it was ballasting from [inaudible 00:12:35] southbound Atlantic. And as it rounded the Cape of Good Hope pointing towards the Americas, AIS turned off. [crosstalk 00:12:43]. It doesn't take a detective to have a good guess at where that vessel's probably going.

Alex: Fair enough. Okay. You mentioned scrapping. Again, a lot of the hopes of the decrease of supply go into scrapping. Are we going to see an increase in it in the next 12 to 24 months?

Richard: Well, we hope so. We think that scrapping this year is underperforming. And scrapping should be higher. Some of the reasons behind that of what I just mentioned, you know, companies willing to pay a premium to scrap value for older vessels. But that's probably only a finite market. We think it's going to be harder to sell vessels into those trade and owners having to become more and more diligent in who they sell their vessels to.

But if you look at the drivers of scrapping, they're all relatively supportive right now. So, we have around about 370 tankers, which are over 20 years of age. That's not an automatic scrapping criteria, but as vessels get past their age, the probability of scrapping increases. We have very high bunker prices now as well, which of course, again, makes an older vessel with high fuel consumption less economic. We talked about stricter regulation, which is coming into play over the coming years. And, of course, freight rates are still very weak and likely to remain challenging this year. So, all of that points towards scrapping being much higher. And as long as we see the disappearance or the reduction in vessels being sold for, let's say, potentially illicit business, then scrapping will pick up as the year progresses. And that will help moderate fleet growth to lower levels, we think, for the next two, perhaps three, years.

Alex: Makes sense. Let's go back to the rates for a second, specific earnings. It's been said quite a bit now in the market that the earnings are quite terrible for dirty tankers, specifically the LCCs, for example. And a lot of talk about the negative earnings, specifically. Could you elaborate a bit more for the audience what negative earnings actually entail? Does it mean that the ship is actually paying for transporting the cargoes? Is it just that it can't cover its operating costs in the voyage? Or does it mean that it's not covering the total costs, including the capital costs for [crosstalk 00:15:02]? When they say negative earnings, what is it?

Richard: Yeah. Exactly. So, it's really associated with the voyage rather than the entire cost of the vessel. So, right now, a VLCC is earning approximately negative $5,000 per day for a non-scrapper vessel of average fuel consumption. And what that effectively means is that the cost of doing that voyage, all of the fuel for the ballast and the laden leg, port costs and any other costs that may be incurred are less than what the owner is effectively being paid to do that voyage. So, you could argue that the vessel is paying to do the voyage. It's not quite that way, but ultimately, when they do, do that.

So, if a VLCC is said to be earning negative $5,000 per day, that's just on the cost of the voyages. What you have to take account is that there's capex involved for paying for the vessel, and there's operating expenses as well. And again, those capex and operating expenses could amount to $25,000 to $35,000 per day, depending on various factors such as how much the ship cost. So, let's just say that the vessel's breakeven capex/opex is $30,000 per day. If you're earning negative $5,000 per day, then you're effectively losing $35,000 per day. So, it's very, very painful right now. And, of course, it's worth bearing in mind that some companies have 10, 20, 30, even more of these vessels that could all be losing money at those kind of multiples.

Alex: So, here's a question both you and I know the answer to that. But, again, to elaborate a bit more, why don't you just idle the vessel, lay it off? If you know you're losing money from moving cargoes, what's the point of moving?

Richard: Well, we will see vessels doing that. And we're hearing increased talk in the market right now of vessels refusing to move at such rates. But at the same time, there's other practical considerations. You know, if you sit the vessel and you don't do any business for a period of time, you might lose some approvals in the oil market for oil majors. And again, you may want to reposition the vessel anyway. So, you may want to take a cargo out of a region which is not paying good money at the moment and go into a region which perhaps is paying better costs.

Alex: [crosstalk 00:17:22] some of the costs for doing that.

Richard: Exactly. Yes.

Alex: Mm-hmm. Okay. So, all considered, considering that we still have recovering demand, considering we're still uncertain on tonnage, it seems, when can we expect tankers to enter a period of sustained growth? Because what we've seen recently and what we've talked about as well is more of the supply squeezes and supplies which are short-term. When are we going to enter in how many months or years the period where the freight rates are likely to be supported long-term?

Richard: Sure. Well, a really simplistic way to look at it is say, well, where were we back in 2019? How big was the fleet back in 2019? And what was the level of ton-mile demands that we were looking at? And the reality is, we're not going to get back to the same supply-demand balance until at some point in 2022 at best. You know, we're not expecting world oil demand to recover fully until 2022 at some point. And, of course, as we just talked about during this podcast, you know, the ton-mile effect will likely be a little bit less because we're going to see less growth coming out of the U.S., for example. So, earliest we think sustainable growth in rates from 2022 onwards. I think as we get towards the end of this year, around about Q4, we're expecting to see most sectors generating returns or earnings which are around about or above those breakeven levels.

But again, we talked about scrapping. We talked about ordering activity. And we do estimate that fleet growth will remain low. And we'll see fleet growth around about 1% to 2% over the next two to three years. So, once we get back above 2019 demand levels, we should be in a position where we can see two, maybe if we're lucky, three years sustainable freight rates.

Alex: Mm-hmm. A quick question just to round this up and hopefully with short reply as well. Since you mentioned there were quite a few VLCCs already ordered in the first quarter, and we both know that sometimes ship owners, again, being eternal optimists, knowing that the market can only go up or is likely to go up in, say, two or three years, can order more vessels. And it takes a few years to build them. So, won't all this new supply arrive just in time for when this demand recovers and it should be sustainable growth just in time to put it back down?

Richard: It's always the way. The industry is incredibly cyclical. There will always be some dislocation between when, say, new build vessels arrive and where the demand is. But that's why we say, "Look. We only really see two or three years of sustainable freight rates." Because anything longer than that, new build vessels will arrive and probably exceed the amount of demand that we see in the market.

Alex: Makes sense. Well, lovely. I think we can round this up here. And thanks for sharing your expertise with us, Richard. That was very informative, as always. And thanks to everyone who listened. If you would like to get more insights into shipping markets, do check out the Argus freight service, which includes prices, news analysis, and a bunch of special bonus content. Also, for more free content like this, visit the "Weight of Freight" page on argusmedia.com where we publish regular podcasts, blogs, and webinars. Till next time, and keep safe, everyone.

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