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Tanker firms batten down the hatches amid overcapacity

A year of survival and consolidation lies ahead, with over-capacity hanging over the oil-shipping industry

Crude-oil tanker rates may have recovered a little towards the end of 2011, but the market remains depressed and vulnerable to slackening global economic growth. That means 2012 is set to be a year of survival and consolidation rather than recovery.

Overcapacity in the face of slow and patchy global economic growth ensured that 2011 was another year where fleet utilisation remained limited and slow steaming remained commonplace, against the backdrop of rocketing bunker-fuel prices. But the extent to which tanker rates collapsed in 2011 surprised market watchers.

According to the research team at Norway’s Arctic Securities, the day rate for a modern very large crude carrier (VLCC) averaged $20,700 a day in 2011, down by 49% from the previous year; while the Suezmax rate fell by 40%, to $17,600/d. Before the start of 2011, the firm had been forecasting rates more than 50% higher than those that materialised.

“The tanker market witnessed its worst year since 1994 in 2011, as overcapacity became increasingly apparent, despite record-high activity in the Mideast Gulf,” said Erik Stavseth, a shipping analyst at Arctic. He estimates that a modern tanker delivered in 2011 needs a day rate of around $35,000 to break even.

Rising rates towards the end of last year paved the way for some improvement in 2012, but analysts remain cautious. “Profits will be higher in 2012 than 2011, but it’s still going to be a difficult year for owners of large crude tankers,” Steve Christy, director and head of research at shipbrokers EA Gibson, told Petroleum Economist.

Overcapacity dogs market

Christy said underlying demand for tankers is likely to grow as crude-oil trade increases, but that the delivery of new tanker capacity will stunt growth in fleet utilisation.

Shipbroker RS Platou also forecasts a year of market consolidation rather than significant growth. “On balance, the tanker market outlook for 2012 fits the outline of little change,” it said in its December monthly report. “With some 11% of the present fleet to be delivered this year, it will be a very challenging task to push capacity utilisation meaningfully higher.”

There are positive indicators for 2012 and beyond. Platou said one of the biggest potential upsides for the tanker market could be signs that the recent oil destocking cycle – as firms in China and elsewhere sought to reduce oil inventories over the last year-and-a-half – could be ending. That could mean Opec will be able to sustain production of almost 31 million barrels a day (b/d) – a three-year high – as Libyan output recovers.

Platou said tanker demand could grow by as much as 4% if that happened, although a probable decrease in the average distance of voyages, because of the return of short-haul crude deliveries from Libya to Europe, would partly offset the effect of any volume increase on the market as a whole. The shipbroker said demand for floating storage capacity would also be likely grow in this outlook, which, when combined with solid trade growth, could produce a moderate market tightening. But doubts remain whether the market can absorb a sustained increase in crude volumes in today’s fragile economic climate.

Fleet overcapacity issues are likely to persist, however, despite a collapse in new orders, as vessels ordered before tanker rates collapsed take to the oceans. According to Platou, the number of new VLCC orders placed in 2011 fell to just seven – or 37.3 million deadweight tonnes (dwt) – compared with 63 (19.9 million dwt) in 2010. But the overall order book for VLCCs was much higher at the end of 2011, standing at 118 vessels – 37.3 million dwt.

Hayato Mochizuki, general manager at the crude-oil tanker group of Japanese shipping firm Mitsui OSK Lines, said recently he did not expect VLCC rates to be profitable until at least next winter.

That leaves shipowners with the thorny problem of whether to maintain older vessels or send them to the scrap yard. While the market had been hoping the phase-out of single-hull tankers, because of safety concerns, would help take up the slack, the reality has proved rather different. “Much of the optimistic talk in 2010 revolved around the phase-out of single-hull tankers, a phase-out that in hindsight barely budged the market,” said Arctic’s Erik Stavseth. Today, “we count 12 VLCCs [five double hulls and seven single hulls] sent for scrapping in 2011, but we expect this number to surge in 2012, as owners are forced to shed tonnage to restore market balance.”

Arctic expects overall tanker fleet growth of 3.3% in 2012 (4.3% for VLCCs; and 6.1% for Suezmaxes) and growth of 2% in 2013 (3.2% for VLCCs; and 3.7% for Suezmaxes). That growth is held down by scrappage projected by Arctic at 28 million dwt of vessels over the two years. “Although scrapping younger tonnage is a tough decision to make, it is the natural selection in a severely over-tonnaged market,” Stavseth explained.

Some shipping companies struggling to weather the stormy market conditions could go under. Several are already scrabbling for extra funding to tide them over, or have filed for bankruptcy protection. But the market has taken heart that the prospect of one high-profile casualty seems to have been avoided, following the January restructuring of Bermuda-based Frontline, owner of the world’s largest privately owned crude-tanker fleet.

Reflecting poor results in the shipping sector as a whole, Frontline reported an operating loss of $135.8 million in third-quarter 2011, a huge slump on a profit of $48.4 million a year earlier. That, combined with the prospect of refinancing $1 billion of bonds and loans maturing over the next 10 years, put the company on the edge of collapse. In response, Norwegian magnate John Fredriksen, the company’s chairman and largest shareholder, created another company – Frontline 2012 – to acquire assets and debt from the original company, whose tanker fleet has been reduced to 40 vessels from 50 as a result.

The move meant cash-strapped Frontline could avoid making a share offering to cover its obligations, which would have heavily diluted its shares and made it an even less attractive investment proposition. Meanwhile, the more seaworthy Frontline 2012 was able to partly finance the deal through a private share sale that raised $285 million.

Frontline 2012 is buying five VLCC new-build contracts, six modern VLCCs, including one-time charter agreement, and four modern Suezmax tankers at what it calls a “fair market value” of $1.12 billion. Frontline 2012 also took on $666 million in bank debt related to the vessels and new-building contracts, plus $325.5 million in new-building commitments.

“The Frontline restructuring is a positive signal … it will be on a sound footing going forward,” said EA Gibson’s Christy. “Frontline shows the banks have a crucial role to play in the industry when times are tough.”

In today’s tough economic conditions, more firms will likely be forced to endure similar tough restructuring operations, while others try to make the best of things by combining their resources.

Mitsui OSK Lines, AP Moeller-Mærsk, Samco Shipholding, Ocean Tankers and Phoenix Tankers are creating a tanker pool by jointly operating 50 vessels from February 2012. The firms hope the bigger-scale operation will enable them to improve fleet utilisation and make efficiency savings.

Some market observers believe this will do little to stave off the chill wind sweeping through the industry. “While some will seek strength in numbers though pool agreements, attempts to flee from the herd will be futile: 2012 and 2013 will be dog-eat-dog in crude tankers,” Arctic Securities’ Stavseth said.

Shifting patterns of oil trade will also bring a shift in tanker routes. Some are predictable. The return to full oil production from Libya will prompt more short-haul business across the Mediterranean and round the Atlantic coast to serve Europe. That in turn is likely to free up west African crude for longer-haul routes to Asia, rather than serving the European market. The trend towards greater US hydrocarbons exports is also set to grow, as US-produced shale gas and oil production meets a growing proportion of domestic energy consumption.

But some aspects of global trade are less predictable, not least the uncertain situation in the Strait of Hormuz, which Iran has threatened to blockade in retaliation for the threat of sanctions on its oil exports by the US and EU in response to the Islamic republic’s nuclear programme.

Around 20% of global oil trade and 30% of liquefied natural gas (LNG) exports pass through the strait – around 30 miles across – which links the Mideast Gulf with the Arabian Sea. Any blockade could cause a global crisis in energy markets.

It would also have significant implications for the tanker industry, potentially causing a sharp rise in demand on other trade routes, as importers seek alternative supply sources.

The US military says Iran has the capability to blockade the strait for a short time, but that it would be prepared to take action to reopen it – the Gulf state of Bahrain is home to the US Fifth Fleet.

Products sector improves

 

There are better prospects for the non-crude oil segments of the shipping sector. The refined-products tanker market is set for a better year, if only because the number of new vessel deliveries in 2012 is likely to be relatively low. “With continued growth in oil demand and trade and a slowdown in the fleet expansion for products tankers, a continued upturn in products-tanker earnings can be expected in 2012,” said EA Gibson’s Christy.

And there is a completely different picture emerging for the LNG-carrier market, which is benefiting from rising demand growth in Asia markets and an increase in planned exports from Australia and elsewhere.

Growth in upstream activity could also feed into greater demand and tighter rates in the oil and gas tanker markets. Christian Lefevre, chief executive of Bourbon, which owns one of the largest industry supply fleets, said recently he expects greater demand and increased rates in 2012 and 2013, as investment in west African and Asian offshore projects picks up. “Vessel utilisation rates in 2013 could reach levels last seen in 2007,” he said in January.

Bourbon’s average vessel utilisation rate was 83.8% in the first nine months of 2011, up from 79.5% in 2010, but still lower than the 89% recorded in 2009. Lefevre said deep-water vessel utilisation rates would “easily rise by 5%”

Slow steam ahead

Sky-high bunker prices, low freight rates and fleet overcapacity mean there is little incentive for tankers to hurry to their destinations, if they can save on fuel costs. That means slow steaming is set to remain a significant feature in the oil-shipping industry.

Slow steaming, the practice of cutting speed on voyages, is tempting because it reduces the amount of bunker fuel consumed, which can result in significant savings for the shipping company at times when charter rates are low and there is limited demand for vessels. Consequently, slow steaming has become an increasingly common method of reducing losses in a difficult market.

"Slow steaming is a natural result of market conditions, when rates are so weak and bunker prices are up at around $700 a tonne," says Steve Christy, a director at shipbroker EA Gibson. That compares with bunker prices closer to $500-600/t a few months ago, when slow steaming was already a widespread practice.

While accurate data is hard to come by, analysts say the figures that are available suggest slow steaming, first evident in the oil tanker and container sectors, is becoming more widespread across the shipping industry. Besides improving earnings on longer routes, the increased voyage time also helps to support flagging fleet-capacity utilisation.

Easing the pressure

 "The slow steaming of any tanker would ease the pressure from the supply side, as it remains the least bad option for cash-strapped owners attempting to maintain cash flow," says the Baltic and International Maritime Council, the world’s largest international shipping association, in its Reflections 2012 outlook, published in early January.

And the practice is likely to remain a feature of the industry in coming months. "Slow steaming is here to stay for the year to come at least, creating a glass ceiling for freight rates," said Erik Stavseth, an analyst at Arctic Securities.

LNG shipping: a different story

The crude-tanker market may be stuck in the doldrums, but those chartering liquefied natural gas (LNG) carriers are benefitting from a strong following wind, as rates rise to new heights, driven by spiralling Asian demand.

By the end of last year, brokers were quoting one-year time-charter rates above $150,000 a day, up by more than 10% on prices just a few weeks earlier, while spot rates for shorter periods also surged to around $145,000/d. Lloyds List recently reported rumours that a vessel had been chartered for a short voyage within Asia for the equivalent of $200,000/d.

"We were bullish on LNG for 2011, but the strength has exceeded expectations by a wide margin," said Arctic Securities’ shipping analyst Erik Stavseth.

A $200,000/d rate may be the exception at the moment, but analysts suggest it could become the norm in the near future, as rising LNG demand continues to soak up increasing production. While there is a healthy orderbook for new LNG tankers, much of the fleet expansion will not become operational until late next year, maintaining upward pressure on rates in the shorter term.

In 2011, 50 LNG carriers were ordered, the highest number in a single year since 2004, when Qatar first became a player in the sector. Stavseth said the orderbook represents 17% of the existing fleet, but that most of those vessels would not affect the market until late 2013. He described this as a crucial reason why his firm is "so comfortable with LNG in 2012".

In the meantime, rampant gas demand in China, and Japan’s need to meet its energy needs with LNG to replace nuclear-power capacity hit by the effects of last year’s earthquake and tsunami will ensure the existing LNG fleet remains busy. Global LNG demand could grow by around 7.5%, to 258 million tonnes in 2012, according to US research firm Sandford C Bernstein – trade in 2010 was 213 million tonnes, according to Cedigaz.

With more LNG coming on tap from projects in Angola and Australia, such as Pluto, there should be enough supply to meet this extra demand. And with buyers more concerned about simply securing volumes, rather than worrying so much about the shipping cost, average voyage distances are likely to grow. That trend could be exacerbated by the development of a US LNG export market.

Vibrant LNG demand also makes for added buoyancy in the market for floating storage and regasification units (FSRUs) to handle imports. Arctic says five FSRU projects were awarded last year, compared with two in 2010. It says around 30 more developments have been proposed, some with near-term start-up schedules, suggesting several further contracts could be awarded this year.

Busy builders

And Asian shipbuilders are being kept busy catering for the development of the floating-LNG (FLNG) production sector. The latest firm to unveil an FLNG vessel design is Hyundai Heavy Industries. Front-end engineering and design work on the vessel, designed in conjunction with Germany’s Linde, is now complete. The ship-shaped unit has production capacity of 2.5 million tonnes a year with storage capacity of 193,800 cubic metres. Hyundai said in January the unit would take 45 months to build, 25% faster than building an equivalent LNG-export plant onshore.

Maritime emissions: still on the agenda

The thorny issue of how to tackle carbon emissions from shipping was effectively put on the "too difficult" pile at December’s global climate change talks in Durban, South Africa. But this is a problem that the industry must confront sooner rather than later.

A proposal to place a carbon tax on global shipping was slated for discussion in Durban, but was dropped from the agenda, in part because of the slim likelihood of making progress on the issue. But with aviation emissions already destined to be taxed within the EU Emissions Trading Scheme (ETS), despite the complexities involved, it is unlikely that shipping will remain free of emissions regulation for long.

Maritime emissions were not included in national commitments under the 1997 Kyoto climate-change protocol, which instead handed responsibility to the UN’s International Maritime Organization (IMO). Bogged down by squabbles among member states over how the cost of emissions should be distributed between rich and poor countries, the IMO has made little progress in limiting or costing emissions from the sector.

But the more positive mood among participants at Durban regarding co-operation between developed and developing countries over emissions in general could provide a path for maritime emissions to be included in a future global agreement, which could be signed in 2020.

The move could be hastened by the establishment of a Global Climate Fund, the basis for which was agreed at Durban. The fund would provide up to $100 billion a year by 2020 to compensate poorer states for any short-term hardship under such a global agreement, if countries can agree on how to fund it.

That could help alleviate the financial blow to the maritime sector in some parts of the world. But that is not the only reason it’s attractive to policymakers at climate-change talks – income from shipping emissions levies, along with those from aviation, could provide valuable finance for the fund itself, easing the burden on state coffers. The idea has government support in several western countries. During the Durban talks, Chris Huhne, the UK’s climate minister, described a tax on maritime bunker fuel and aviation emissions as a more preferable option than proposals such as raising a tax on financial deals.

The global shipping industry is still digesting the possible ramifications, but is broadly supportive of the idea. The International Chamber of Shipping (ICS), which represents over 80% of the world’s merchant fleet, has said that if governments decide that shipping should contribute to the Green Climate Fund, the industry would probably support the idea – as long as the details were agreed at the IMO. The ICS says it would prefer the charge to be a levy on ships’ fuel consumption, rather than through an emissions-trading scheme.

Before any global agreement is in place, the EU may decide to push for the inclusion of international shipping in its ETS. But the controversy over the inclusion of aviation emissions in the EU ETS since the start of the year, suggests a similar plan for the maritime sector could be prove difficult to implement: the move has drawn protests and threats of retaliatory action from the US, China and elsewhere.

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