It’s either the calm before the IMO 2020 storm or the calm before a ‘goose egg’ for tanker owners and their investors.
The IMO 2020 rule requires all ships without exhaust gas scrubbers to burn fuel will no more than 0.5 percent sulfur starting January 1, 2020. This change is expected to significantly boost demand for both crude oil and product tankers as more ultra-low-sulfur marine fuel is required around the globe.
Some expected early glimmers of tanker rate upside to be seen by now. Those glimmers have yet to materialize, which is starting to elicit apprehension – particularly given tanker shipping’s long track record of disappointments.
From a timing perspective, larger ships on longer-haul routes are expected to switch to ultra-low-sulfur fuel as early as September or October because vessels have to burn off the high-sulfur fuel in their tanks before the regulatory deadline.
Refineries seeking to quench new ultra-low-sulfur fuel demand were expected to ramp up production starting in the second half of 2019 – a period that began a month ago – translating into more demand for crude oil tankers that provide refinery inputs and more demand for product tankers transporting refined outputs to where they’re needed.
But this refinery and tanker dynamic has still yet to begin.
Two U.S.-listed product tanker owners – Scorpio Tankers (NYSE: STNG) and Ardmore Shipping (NYSE: ASC) – reported quarterly results and held conference calls with analysts on July 31. Their results showed no evidence of higher vessel demand due to IMO 2020, although executives of both companies insisted that evidence could be nigh.
Stifel shipping analyst Ben Nolan noted that with the IMO 2020 deadline just five months away and a tanker rate spike “yet to materialize,” investors “are beginning to become understandably nervous.” He described the market as “waiting on pins and needles for IMO 2020 to kick in.”
Yet he insisted, “It is far too early to throw in the towel” and predicted “the inflection should begin to materialize in the next two months.”
Results down and rates seasonally weak
Scorpio Tankers reported a net loss (with no adjustments) of $29.7 million for the second quarter of 2019, compared to an adjusted net loss of $44.9 million in the second quarter of 2018. Losses per share in the latest period of $0.62 came in better than consensus estimates for a loss of $0.67 per share.
Ardmore Shipping reported an adjusted net loss of $3.4 million for the second quarter of 2019, compared to an adjusted net loss of $8.2 million in the same period of 2018. Ardmore’s adjusted losses per share of $0.10 in the latest period were better than analyst expectations for a loss of $0.12 per share.
Rates improved year-on-year, albeit not enough to reach breakeven levels. Ardmore’s ships in the medium-range 2 (MR2) category, a tanker class with capacity for 40,000-54,999 deadweight tons (DWT), obtained an average rate of $14,892 per day in the second quarter, up 29 percent year-on-year.
Scorpio Tankers’ ships, which span multiple size categories and range in capacity from 38,734 to 113,000 DWT, earned an average of $14,348 per day in the latest period, up 17 percent year-on-year.
The concern is that rates have come down in the third quarter versus the second, at a time when it had been hoped that IMO 2020 preparations would offset seasonal weakness.
Ardmore reported that it has 40 percent of third-quarter revenue days booked for its MR2s at an average rate of $14,000 per day, down 2 percent from second-quarter rates.
Scorpio Tankers reported that rates began falling during the second quarter and were lower in the third quarter in two of its four vessel categories.
When is it time to become worried?
Commenting on Scorpio’s result, Nolan said that Scorpio’s third-quarter rates were “below where we expected,” but added that “in our view, this quarter is the calm before the storm.”
Deutsche Bank shipping analyst Chris Snyder said on the Ardmore conference call that “spot rates have taken a step lower in July, when we were expecting firming rates with refinery throughput starting to outpace normal seasonality.”
The explanation from product tanker executives is that refineries are conducting maintenance and upgrades to prepare for the new demand requirements of IMO 2020, and they front-loaded this work into the beginning of the year. This work has taken longer than expected and has now extended beyond the second quarter into the third quarter, they said.
Ardmore chief executive officer Anthony Gurnee maintained that the IMO 2020 thesis “is unfolding as expected” and that refinery upgrades should be nearing completion. He reemphasized that his company foresees a “meaningful impact on product tanker demand in September.”
On Ardmore’s first-quarter call on May 1, he had stated, “Our assessment is that we will start seeing some signs in July and August and it will kick into full gear by the end of September.”
Asked on the latest call whether he was surprised that July rates were lower, Gurnee responded, “Yeah, I think we were a little disappointed. It’s an extension of what we went through in the second quarter, largely due to refinery turnarounds. But we don’t think it’s of great concern.”
Clarksons Platou Securities said in a research note on July 31 that product tanker rates were falling “across the board,” with MR rates down 26 percent month-on-month, rates for LR1 tankers (long-range 1 tankers with 55,000-79,999 DWT) down 15 percent and LR2 (80,000-119,999 DWT) rates down 19 percent. Clarksons said that its shipping brokers believed rates are declining because “refiners are taking longer than first expected to prepare for the new IMO regulations.”
On the Scorpio Tankers call, Evercore ISI shipping analyst Jonathan Chappell asked executives, “At what point in the second half of the year do you get a bit worried that this [IMO 2020] isn’t going to have as big of an impact as we thought? Is that late in the third quarter and if we’re talking to you in late October [on the third-quarter call] and we’re still in the mid-teens on MRs and high-teens for LR2s, do you start to get worried that this is not going to be as disruptive as you thought?”
In response, Scorpio Tankers president Robert Bugbee argued that there is plenty of underlying fundamental strength in product tanker markets even without IMO 2020, seeming to imply that the regulatory upside is ‘icing on the cake.’
“Let’s take IMO 2020 out of the equation. Right now, the year so far has been much stronger than 2018,” he said. “If that were to continue, we’d see a rally in the product market as we approach Thanksgiving, maybe late October. That’s without IMO 2020.”
Bugbee continued, “You’re not even reliant on IMO 2020. If you’re looking at a normal world economy, if nothing happens, that should lead to an increase in rates from where they were last year. If you add 20-25 percent onto last fourth quarter’s rates, you’re in pretty good shape even without IMO 2020.”
He concluded, “We all share the view, as do our customers, that we’re continuing to see an improvement in the market without the effects of IMO 2020. And at any moment, the IMO switch could be turned on.”