Viewpoint: Opec cuts, new ships to weigh on VLCC market

  • : Crude oil
  • 18/12/28

Mideast Gulf very large crude carrier (VLCC) freight rates are likely to retreat in 2019, as Opec production cuts and sustained high delivery levels of new-build tankers erode recent strength.

Rates on the key eastbound routes have been particularly strong in the fourth quarter. The Mideast Gulf-east Asia VLCC assessment averaged $14.71/t, compared with just $8.76/t over the same period in 2017. The rate averaged $15.45/t in November, the most for any month since December 2015, and the December average is on pace to be $15.26/t.

Rates benefited from the US' reimposition of sanctions on Iran, which encouraged Asia-Pacific refiners to source alternatives from other Mideast Gulf nations. That in turn caused regional producers — particularly, but not only, Saudi Arabia — to raise production. This all fuelled demand for tankers to load spot cargoes in the Mideast Gulf.

But sensitivity to gasoline prices tempered the US' desire to reduce Iranian exports to zero, and Washington granted eight countries six-month waivers on purchases of Iranian crude.

The additional demand for VLCCs is likely to fade in January, with a knock-on effect on freight rates. Opec and its non-Opec allies have agreed to cut production by a combined 1.2mn b/d in the first six months of 2019, from an October baseline, with the bulk of those cuts concentrated in the Mideast Gulf and especially in Saudi Arabia.

Opec and its partners will meet again in April to determine strategy for the second half of next year, so the longer term outlook for tanker demand is unclear.

Nor is it clear if and to what extent all eight countries will exercise their waivers — although it is likely that some will not. How much Iranian crude China and India will continue to take after the end of the six months remains is also an unknown.

India has already put in place insurance and banking mechanisms — such as recognising Iranian insurers and paying in rupees — to maintain Iranian crude imports and the use of Iranian tankers. Aside from serving India and China, the sizeable Iranian tanker fleet — at 42 VLCCs the second largest state-owned VLCC fleet in the world — is unlikely to resume voyages to other countries any time soon.

Following official US guidance, marine liability insurance providers have advised countries with waivers to employ only Iranian ships, or to use domestically-registered ships with government-backed insurance. Concerns about the potential for breaching US secondary sanctions on insurance provision might dissuade some importers from exercising their waiver rights.

Burgeoning US Gulf crude exports helped buoy VLCC freight rates this past year, and these flows are likely to grow in 2019 as export infrastructure expands. A typical voyage from the Mideast Gulf to north China takes around 21 days and the journey from the US Gulf can take more than 50 days, so the impact on tonne-mile demand for tankers is significant. While there is still a risk of renewed tariff tension between the US and China, that would not bar US crude from other markets in east Asia.

Crude from the US will more than offset falling production and exports from two other key Atlantic basin exporters Angola and Venezuela. Exports from the former are still a significant influence on VLCC freight rates, since much of it goes to China and a journey from Cabinda to Qingdao occupies a tanker for almost 34 days.

Scheduled Angolan loadings in January will match August's multi-year low of 1.33mn b/d.

By contrast, much Venezuelan crude makes short voyages to the US Gulf — longer-distance shipments are typically to cover debt. Nigerian crude exports are more of a factor for the Suezmax tanker sector.

On the supply side of the VLCC market, the tonnage glut is likely to persist after years of rapid new-build deliveries and a full order book for 2019. Around 10 VLCCs are still due for delivery in 2018, most of which now look destined to roll over into 2019. That will add to the just under 70 new-build VLCCs scheduled to hit the water next year, enough to accommodate 134mn bl of crude.

The net gain will be lower, because of scrapping. The pace of demolitions quickened in 2018, but there will be muted scrapping rates in early 2019 as owner earnings improved greatly in the fourth quarter.

Around 25 VLCCs are aged 20 years or more and are likely scrapping candidates, with perhaps another 14 to reach that milestone in 2019. That means strong net fleet growth is still likely in 2019, maintaining the supply-side pressure on freight rates.

The pace of scrapping could accelerate in the longer term as, by some estimates, around 20pc of the VLCC fleet could be 15 years or more in 2019.

The approach of the International Maritime Organisation (IMO) 2020 sulphur limits might constrain VLCC tonnage in 2019. Exhaust scrubber uptake is higher among VLCCs than among other classes of tanker because of relative installation costs and potential bunker fuel cost savings. So more VLCCs could making dry dock visits later in 2019 for retrofitting, temporarily removing some tonnage from the market.

Retrofitting may take place on up to 100 VLCCs, most likely before the end of 2019 or in early 2020. There is unlikely to be sufficient dry dock capacity for shipowners to make significant new orders ahead of the IMO sulphur limit coming into force.

Demand to use VLCCs as floating storage has been very limited in recent years, but could again be a significant factor affecting tonnage availability. Aside from NITC vessels, VLCC floating storage demand remains highly dependent upon whether the crude forward curve is sufficiently in contango.

The Bab el-Mandeb strait remains a source of risk while the conflict in Yemen drags on. Any disruption to tanker traffic through that or any other chokepoint, particularly the straits of Hormuz, could have a significant and rapid effect on VLCC freight rates.

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