Tankers steered back from the brink
A recent spike in rates has rescued tanker owners, but the reprieve could be short-lived
Crude and product tanker owners hemorrhaged cash in the first three quarters of 2018, then pulled out of their slump in the fourth as spot freight rates surged. Any threat that oil shippers' tanker counterparties could go bankrupt and default on their obligations has been alleviated—at least for now.
Crude tanker owners' reserves were fattened by very strong years in 2015-16, but excessive newbuild orders caused freight pricing to fall much more steeply than expected in 2018. Jonathan Chappell, a shipping analyst at investment bank Evercore ISI, described 2018 in a year-end client note as having "the worst three-quarter start to any year in many decades". At an investor event in New York in December, Lois Zabrocky, CEO of ship owner International Seaways, dubbed the summer of 2018 "the worst summer we have seen for tanker rates in the last 10 years".
Pain for product tanker owners has stemmed from the duration of the lows even more than the severity of the drop. Spot rates had been mired near or below breakeven for most of the past decade as a result of bloated land-based inventories and other factors.
Nonetheless, 2018's second and third quarters still marked "all-time lows" for product-carrier rates, Scorpio Tankers commercial director Lars Denker Nielsen told an investor forum in New York in December. At the same event, Scorpio Tankers president Robert Bugbee said of the third quarter, "All had become really dark for those who remained. It was a matter of survival, just doing whatever you could to get though."
Everything abruptly changed for the better in the fourth quarter. Very large crude carriers (VLCCs), which earned as little as $4,000/d in June, took in over $60,000/d in late November and early December. Suezmax crude tanker spot rates reached $44,000/d in early December, up from $8,000/d in the third quarter. For product carriers, medium-range (MR) tanker spot rates rose to almost $30,000/d, up from $6,000/d; long-range 1 (LR1) rates increased to over $20,000/d, up from $8,000/d; and LR2 rates reached around $30,000/d, five times higher than their $6,000/d third-quarter nadir.
This late 2018 rebound could mark nothing more than a brief, much-needed cash infusion for beleaguered ship owners. Alternatively, it could be the start of a sustained recovery. The outcome hinges on how vessel supply and cargo demand play out in 2019.
For the supply side of the equation, Petroleum Economist obtained net fleet growth projections from VesselsValue (VV), a sister company of UK-based SeaSure Shipbroking. According to VV estimates, this year's supply outlook is considerably more favorable for product tanker rates than for crude tankers.
The product tanker fleet experienced high levels of incremental capacity growth in 2015 and 2016, 6.6pc and 6.1pc respectively, moderating to 4.2pc in 2017 and just 1.5pc last year, according to VV data. The higher freight pricing in the fourth quarter suggests that previous years' fleet growth had been absorbed and that the market was generally balanced. VV believes the product-tanker fleet will grow by only 0.4pc this year, implying that even a small increase in cargo demand should strengthen rates.
VV data reveals that crude tanker capacity growth intensified in 2016 and 2017, increasing by 6pc and 6.5pc respectively. Fleet growth was only 0.2pc for 2018. The historic lows in rates across the first nine months, despite minimal new capacity in 2018, implies that the market had struggled to absorb the 2016-17 fleet additions that had not been absorbed and tanker supply was outstripping cargo demand.
VV projects 3.4pc crude tanker fleet growth this year, below 2016-17 levels, but still considerably higher than 2018's pace. Also problematic for rates is the concentration of new capacity in the workhorse VLCC segment. According to VV, the number of VLCCs on the water was essentially flat last year versus 2017, but this year is set to rise by 5.6pc, from 736 to 777. VLCC growth rates were similarly high in 2016 (6.8pc) and 2017 (6.2pc).
On the cargo demand side of the equation, 2019 began with an immediate headwind for freight rates. Opec members and participating non-Opec members cut production by 1.2mn bl/d from October levels starting January 1, including 800,000bl/d from Opec, primarily Saudi Arabia, and 400,000bl/d from non-Opec, largely Russia.
Reports suggest that Saudi Arabia's cut of around 500,000bl/d would specifically target the long-haul Arabian Gulf-to-US Gulf route "to more directly influence the closely watched [US] weekly inventory data", a move that Evercore's Chappell believes would be particularly negative for VLCC rates. "The Opec cut is like a stick in the eye for crude tankers," added Stifel analyst Ben Nolan in December client note.
"We may see some volatility at the beginning of the year [due to the production cuts], but we're still set for a stronger market in 2019," maintains Internal Seaways' Zabrocky, who believes that production growth of almost 2mn bl/d in non-Opec countries, as well as rising demand, should ultimately offset the negative impact of production cuts.
US-based tanker consultancy Poten & Partners sees a potential silver lining for VLCC rates as a result of the Opec-driven cuts. If US crude exports to Asia aboard VLCCs remain strong, and Saudi Arabia pares its VLCC voyages to the US, then empty VLCCs in ballast will have to reposition to the US Gulf to pick up outbound cargoes. Paring the percentage of laden voyages renders the overall fleet less efficient and reduces effective vessel supply, a plus for rates.
From a global perspective, the demand outlook for crude and product tankers hinges on refinery capacity growth-where new capacity is being built, how far it is from its crude sources, and how close it is to consumers of refined products. The further refineries are from crude fields, the better for crude tanker demand because voyages are longer and more tanker capacity is absorbed. The further refineries are from consumers, the better for product tankers.
During the Scorpio Tankers event, the firm's senior analyst James Doyle asserted that this 'refinery location' indicator had swung to product tankers' favour over the past decade. He noted that, between 2011 and 2017, the US, Saudi Arabia and Russia accounted for 76pc of incremental refining capacity, 78pc of incremental crude production, but only 21pc of added consumption, meaning that "incremental refining capacity is moving closer to the wellhead and places with access to cheap feedstock, while consumption is moving farther away".
Future refinery capacity expansions offer a mixed bag for tanker demand. On one hand, Saudi Arabia's 400,000bl/d Jazan refinery scheduled to come on line this year, as well as the 615,000bl/d Al Zour refinery in Kuwait and 500,000bl/d Dangote refinery in Nigeria, both set to enter service in 2021, should be negative for crude tankers-they are very close to their crude source-and positive for product tankers, to the extent refined products are exported and not consumed locally.
On the other hand, refinery capacity growth in Asia, particularly in China, should boost voyage length for crude tankers and slash demand for product carriers. This year alone, according to the International Energy Agency, 300,000bl/d in capacity is set to come on stream in Malaysia, and 1m bl/d in China (200,000bl/d in Zhanjiang and 400,000bl/d each in Dalian and Zhoushan). These Asian refining projects could offset some of the crude tanker rate fallout from Opec cuts and rebalance some of the relative optimism among product tanker owners.