Crude oil balance changes bode well for crude tankers

Iconic Norwegian shipowner, Erling Naess, said in the 1970s: “God must have been a shipowner; he placed natural resources far away from consuming nations and covered two-thirds of the earth  with water.”

At the time, he was primarily referring to the ever-increasing dependence of consumers in Europe and North America on crude oil from the Middle East.

However, more than 50 years later, a shipowner looking at the crude oil tanker market of today may come to the same conclusion, Poten & Partners said in an industry note.

The latest IEA Oil Market Report (Oil 2019), which was published during the middle of March, painted a bullish picture from a shipowner’s perspective.

On the crude oil side, the story is well known - that is - the US is becoming a major player in the global oil trade as a result of the shale revolution. The crude oil export boom is facilitated by growing production capacity in the Permian Basin and to a lesser extent Eagle Ford and other light tight oil (LTO) basins.

At the same time, US midstream companies are working hard to build new and expand existing pipeline capacity to bring the crude to the Gulf Coast. While pipeline capacity is still expected to be a constraint in the first half of this year, there will be ample takeaway capacity by 2020 and beyond. Most of these new pipelines are connected to new or expanded storage and export terminal projects.

In total, the IEA forecasts that the US Gulf will have crude oil export capacity of 5.1 mill barrels per day by 2024. Combining crude oil and refined product exports, this will bring the US on par with Saudi Arabia and Russia as one of the largest oil exporters in the world. Most of the US crude will be destined for Asia.

While the US will bring the biggest volumes to market, it is not the only country (outside OPEC) to ramp up production and exports. Brazil, Norway and Guyana are also worth mentioning.

After a disappointing 2018, Brazil is expected to add 1.2 mill barrels per day oil supply, growing its production from 2.7 mill barrels in 2018 to 3.9 mill barrels per day by 2024. Around 375,000 barrels is expected this year and another 225,000 barrels per day in 2020. Most of Brazil’s production is exported long-haul to China, with lesser quantities going to other Asian countries, Europe and the US.

In Europe, Norway is also on the brink of another expansion. The IEA expects Norwegian output to increase by 600,000 barrels to reach 2.5 mill barrels per day in 2024, the highest production level seen since 2008. Most of this oil comes from the giant Johan Sverdrup field, which operator Equinor expects to produce between two and three billion barrels of oil equivalent and peak production of 660,000 barrels per day.

New player

Guyana is a new player in the crude oil market, but operator ExxonMobil and its partners continue to find new oil off the coast of this Latin American country. Oil will start flowing in 2020 at 120,000 barrels per day and is expected to ramp up to 500,000 barrels by 2024.

These increases in crude oil flows are different for a variety of reasons. First, this production growth is coming from non-OPEC countries and is therefore not subject to the vagaries of output cuts and other production restrictions that are driven by politics (eg sanctions) rather than economics.

Second, most of the additional flows are of the light sweet variety, which are deemed highly attractive in the run-up to implementation of the IMO 2020 sulfur restriction on bunker fuel.

Last, but not least, Asia - in particular China and India - will continue to be the main source of additional crude oil demand. According to the IEA, the East of Suez crude balances (Middle East and Asia combined) show a shortfall of 6 mill barrels per day at the end of its forecast: “This means that even if Middle East producers direct all their exports to Asian refiners, the latter would need to source another 6 mill barrels from other regions,” the organisation said.

Diversification of crude supplies outside the Middle East is no longer a choice, but a necessity to fill the growing Asian need for crude. Since crude oil production in Asia is relatively small and declining, more crude will need to come from long-haul sources in the Atlantic Basin, boosting tonne/mile demand. This growing imbalance will also make triangulation more difficult, reducing the efficiency of the tanker fleet,” the report said.

All this should be music to the ears of the owners of larger crude oil tankers, Poten said.

Tough choices

However, due to regulatory changes, owners will have to make tough choices on how to keep operating older tonnage.

The poor freight market in the first three quarters of last year led to the highest volume of tanker removals for at least 15 years. When freight rates improved in the fourth quarter, the number of ships recycled dried up. At the same time, newbuilding prices were relatively competitive, as shipyards tried to fill their depleted contract portfolios.


How should an owner respond to these contradictory market signals?

Last year, 33 VLCCs with an average age of 20 years and 24 Suezmaxes averaging 22 years old were removed from the fleet. This was a reflection of the poor freight market in 2017 and the first three quarters of 2018, as OPEC production cuts reduced employment opportunities for large tankers.

To put these numbers in context, in the previous 15 years, on average only nine VLCCs and seven Suezmaxes were removed each year. Even though scrapping was very high, the fleet still increased, due to newbuilding deliveries exceeding removals in both segments. For example, in 2018, 42 VLCCs and 33 Suezmaxes were delivered, Poten said.

For 2019, deliveries are still high, as Poten’s orderbook shows 79 VLCCs and 44 Suezmaxes scheduled for delivery this year. However, the delivery schedule will likely change as the year progresses, as typically, about 20-25% of scheduled deliveries at the beginning of the year will be delayed.

The current VLCC fleet, as of the beginning of March, totalled 756 vessels, of which 170 were 16 years or older and 19 were over 20 years of age, while the Suezmax fleet was smaller at 583 vessels, of which 124 were 16 years or older.

Ships older than 15 years are more difficult to employ as some charterers reject older vessels, meaning that the owners of these older vessels will have to make a decision in the coming years.
For example, by September this year, all ships engaged in international trade need to have ballast water treatment systems (BWTS) installed at the first upcoming special survey. For larger tankers, BWTS can cost between $2-$3 mill, depending on the size of the ship and the configuration of the system.

In addition, on 1st January, 2020, new sulfur emission regulations for ships will come into force. After this date, ships will have to switch to more expensive lower sulfur fuel or have exhaust gas cleaning equipment (scrubbers) installed.

Many older tankers have higher fuel consumption than their modern counterparts, so they will become less competitive when they are required to burn more expensive fuel. It is also less likely that these vessels will have scrubbers installed, as their age will make it harder to see a return on investment, compared with younger vessels.

In preparation for the implementation of IMO 2020, owners will attempt to have scrubbers installed and operational by the start of next year, as the fuel cost differential between HFO and low sulfur fuel will most likely be highest early on, while the market adjusts to the new requirements.

If 10% of VLCCs and Suezmaxes install scrubbers and each vessel is out of service for several weeks, the operational fleet will be materially reduced, which will tighten the market and could offset some of the anticipated deliveries, Poten said.

It is likely that the combination of these regulatory requirements will lead to accelerated scrapping of tonnage, but it is impossible to quantify what the exact impact will be.

But by far the most important consideration for an owner deciding whether to scrap a vessel is the expected freight rates. If an owner foresees a healthy market, it is easier to justify the required investment. However, even though the supply side may have a significant impact on freight rates this year and next, tonne/mile demand will remain the key driver.

As they are deciding about how to respond to the new regulations, tanker owners will also need to keep a keen eye on OPEC production and US exports in the context of overall  global oil demand, as mentioned above, Poten concluded.




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