Evercore ISI analyst Jon Chappell summed it up the best when he said, “Oil demand is on fire … now if only there weren’t so many ships.” There is nothing wrong with cargo demand. There is just too much new capacity coming onstream.
Investors largely gave up on 2018 before it began: folding their hands, collecting their chips, and leaving the poker table. But markets do not always play out as predicted – particularly in the crude-tanker space – and as last year ended, there was no shortage of geopolitical hotspots with the potential to upend forecasts overnight.
In Asia, there was a risk of war on the Korean Peninsula, where a large number of crude tankers are under construction. In South America, one of the world’s largest crude exporters, Venezuela, was teetering on the verge of a debt default. In the Middle East, tensions were flaring between Saudi Arabia and Iran, while the potential for new US sanctions hung over Iran.
Geopolitical risks coincide with a backdrop of healthy crude cargo demand driven by economic growth. IHS Markit estimates that global petroleum liquids demand will increase by 1.9 million barrels/day (bpd) this year, up from growth of 1.8 million bpd in 2017. The International Energy Agency and OPEC are not as bullish, forecasting gains of 1.3 million bpd and 1.51 million bpd respectively.
On the vessel-supply side of the equation, IHS Markit’s Maritime & Trade (M&T) division is predicting a 4.9% increase in crude-tanker fleet capacity this year, to 429 million dwt from 409 million dwt in 2017. Newbuildings should add 25 million dwt of new capacity, offset by 5 million dwt of demolitions. Of the newbuilding’s capacity, 55% will be in the very large crude carrier (VLCC) category, with the remainder almost equally split between Suezmaxes and Aframaxes.
On a positive note, this marks a slower growth pace than in 2017, when the crude-tanker fleet increased by an estimated 6.2%, with the Suezmax fleet up around 10%, Aframaxes up 7%, and VLCCs up 6.5%.
However, there are significant concerns that recent newbuilding ordering will extend overcapacity pressures into 2019. The pace of ordering was unusually strong last year, with 17 million dwt contracted through November.
Low prices at Asian yards proved tempting for some owners, particularly for VLCCs, which accounted for 75% of last year’s crude tanker orders, with most of those booked at Korean yards. IHS Markit M&T believes this ordering activity, with deliveries extending into 2019, could jeopardise the sector’s rate recovery.
What indicators bear watching this year? In addition to the aforementioned geopolitical wild cards, there are several important bellwethers.
First: the OPEC production cuts and how they play out. As expected, OPEC and non-OPEC partners, including Russia, extended their reductions into this year. And importantly for tanker operators, Nigeria is now included in the cuts; in 2017, long-haul Nigerian exports to India offered support to tanker rates. The question ahead is whether cuts will extend through year-end, or be dropped mid-year.
Another indicator to watch closely is US crude exports. Outbound cargoes from the United States have been much higher than predicted, hitting an all-time peak of 2.1 million barrels/day in November 2017, with most of those cargoes being loaded out of Corpus Christi, Texas. As Saudi Arabia pares back its shipments to Asia as part of the OPEC cuts, longer-haul Asian imports from the United States have filled the gap, which is a positive for tanker tonne-mile demand.
US exports are currently shipped to Asia aboard VLCCs taking the long-haul Cape of Good Hope route. Because of terminal and draught restrictions, the crude is loaded aboard Aframaxes and reverse-lightered onto VLCCs, a costly and inefficient system for exports.
In a recent client note, Evercore ISI energy analyst Timm Schneider estimated that 23% of all US crude exports have been reverse-lightered and of those volumes, 83% have gone to Southeast Asia (largely Malaysia and Singapore) and East Asia (mainly China, with some moving to South Korea).
“The biggest obstacle for US crude oil exports appears to be the draught of US ports,” said Schneider, adding that the cost of reverse-lightering “eats into arbitrage opportunities”.
That could change. The Louisiana Offshore Oil Port (LOOP), which is geared to handle VLCC import cargoes, is reportedly planning to begin serving exports this year. In addition, dredging and terminal work is under way in Corpus Christi to allow the loading of export crude on partially laden VLCCs by the end of this year. “We are increasingly optimistic the LOOP will undergo a reversal,” said Schneider.
Another important tanker indicator to watch in 2018 is Chinese strategic petroleum reserve (SPR) imports. As Chappell pointed out, “Even though its economy has slowed from the breakneck pace of the last decade, China is still the primary driver of incremental oil demand globally. Chinese oil imports are also likely being supported by strategic builds of inventories” and “China’s SPR is opaque at best”. Chappell noted that “if current [SPR] facilities near maximum capacity and/or new sites are further delayed, any meaningful downshift in the pace of SPR builds could reverse the import momentum in China”.
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