LNG shipping set for more challenges
The sector may have seen a more rational 2020 so far. But that is no guarantee it has learnt its lessons
Some capital discipline appears to have materialised—or perhaps been forced on to ship owners—in the LNG shipping sector in 2020, after several years of subpar returns, deeply depressed share prices and general angst. But there remain significant risks to calling any definitive return to better times.
LNG shipping has over the past 10-15 years transitioned from a floating pipeline market to a more commoditised, increasingly spot-orientated business more similar to the crude tanker market. The combination of an increased number of LNG buyers and sellers and a knife fight to win long-term contracts led to ship owners increasingly being willing to accept:
1) building on a speculative basis in hope of being first in line for contract employment
2) shorter duration term contracts
3) lower returns on those contracts
4) growth in spot employment.
In short, charterers (oil majors, project sponsors and energy traders) had the leverage, and ship owners played right into their hands.
But, while an average of 40 new large LNG carriers per year have been ordered since 2010, so far in 2020, that number is only seven. Lest pessimism begins to creep in, though, there are several outstanding tenders and potential orders against new liquefaction projects such as the Qatari expansion which could drive the number up substantially before year-end.
Depending on the location of the source and destination of LNG cargoes, the number of large carriers relative to production capacity can typically range between 1 ship per 1mn t/yr of LNG on the Australia to Asia route, at the lower end, to 2 ships per 1mn t/yr from the US to Asia. With the US accounting for much of the incremental liquefaction capacity currently under construction, the ratio going forward should be at the higher end of that range.
We estimate that 153 new carriers will be needed through to 2025—although only 22 of those would be needed in 2021 and 2022 combined, as most of the so-called US ‘second wave’ projects are scheduled to start in 2023-25. Demand for shipping could risk outstripping supply by the middle of the decade, based on the current order book.
But, with all 126 vessels currently on order scheduled to be delivered before the end of 2023—combined with a potentially slower pace of scheduled liquefaction startups—we expect the net carrier oversupply to grow by 70 vessels by mid-2023. This is on top of what we estimate to be something in the region of a current 30-vessel oversupply.
These calculations do not account for several items:
- Removal/conversion of existing assets
An average of four LNG carriers per year are removed for either recycling or alternative uses (FSRU, FSU, or FLNG conversion). During periods of market weakness, recycling typically rises and we would expect that to be the case over the next several years. Also, the pace of FSRU/FSU projects is very robust. Collectively we expect as many at 6-8 older vessels per year could leave the fleet—meaning net oversupply could peak at perhaps 40 incremental ships.
- Utilisation discrimination against older equipment
Of the current fleet, c.5pc is in long-term layup. Older steam power ships have much greater boiloff and fuel consumption relative to modern vessels. As legacy contracts roll off, older steam power ships typically move either to lay up or experience much lower utilisation. This could also effectively remove vessels from the fleet.
- Potential for additional ordering
New vessel ordering is likely far from over. While 2024 and 2025 look promising at present for ship owners as demand may exceed supply, new orders could easily offset that undersupply.
There are a few bright spots. The proliferation of smallscale LNG development and LNG bunkering is creating demand for smaller ships—of which there are relatively few in existence or on order.
Seasonal ebbs and flows in LNG shipping rates will also likely continue to be a feature of the market. While it has been a challenging northern hemisphere summer, and could be a rocky next few years in general, we expect that a partial recovery in rates that is already underway could be boosted by a seasonal demand upturn and persist into this winter.
In addition, given the challenging environment, fewer potential participants may enter the market on new tenders, which could cause returns to creep marginally higher. Indeed, it would not be shipping—the ultimate boom-and-bust sector—without hope for silver linings. Those linings do exist, but based on the numbers, we expect they may prove relatively illusive.
Ben Nolan is managing director, maritime and energy infrastructure at Stifel