It was October 2019, just six months ago, but ancient history for tanker trades.
Rates for very large crude carriers (VLCCs, tankers that carry 2 million barrels of crude oil) spiked to $200,000 per day. Tension in the Middle East was a key driver. The threat that military action with Iran could halt tanker transits via the Strait of Hormuz spurred fear that oil prices could skyrocket. This prompted shippers to pull bookings forward, boosting VLCC demand and rates.
The world has turned upside down since then.
Today, low crude prices are driving tanker rates above $200,000 per day. As the coronavirus cripples oil demand, an unprecedented wave of petroleum is going to sea, whether intentionally for storage or unintentionally because cargo owners can’t find anywhere to unload. The more laden tankers on the water, the fewer available to bid on the next spot deal and the higher the spot rate.
If oil prices bounce back up, it would be negative for tanker sentiment — exactly the opposite of what happened in October. A sudden jump in oil price would reduce the attractiveness of traders’ buy-low-sell-high tanker-storage bet by narrowing the contango spread (the premium of the forward commodity price over the spot price).
There’s only one realistic scenario that could push rates much higher very quickly during a global pandemic: a war in the Middle East that closes the Strait of Hormuz.
On Wednesday, President Donald Trump ordered the U.S. Navy to “destroy any and all Iranian gunboats if they harass our ships at sea.” The following day, the head of the Iranian Revolutionary guard threatened to destroy any U.S. ship that threatened an Iranian ship.
The price of Brent oil rose by 30% over those two days. On Thursday, despite historically high freight rates and the broader stock market being up, shares of Euronav (NYSE: EURN) and DHT (NYSE: DHT) fell 5%, with International Seaways (NYSE: INSW) down 4% and Frontline (NYSE: FRO) down 3%.
Jefferies analyst Randy Giveans told FreightWaves, “The fears of a U.S.-Iran conflict and the possible — although unlikely — closure of the Strait of Hormuz is causing investors to pause. Even more so, the market is myopically focused on Brent prices rising and the contango tightening.
“Even with today’s move in Brent, floating storage remains highly profitable even at $115,000-per-day six-month time charters and $75,000-per-day 12-month time charters,” Giveans explained, referring to rates that traders could charter ships for and still profit from selling stored oil.
Analyst J Mintzmyer of Seeking Alpha’s Value Investor’s Edge told FreightWaves, “It has become clear that the current markets are simply trading tankers inverse of daily oil moves, which is ironic since tankers have traded for decades on a tight positive daily correlation with oil. I believe that either knee-jerk correlation is far too simplistic.”
Unprecedented volume of oil at sea
The Iran military scare coincides with a record-setting rise in the amount of oil at sea. “We’ve got massive tailwinds because commercially available land storage in the world is simply not there so the next place to go is ships, so we’re seeing huge effects,” said Frontline CEO Robert Macleod during an online interview with Mintzmyer on Thursday morning.
“A lot of the textbook stuff is totally out the window because these are unprecedented times,” Macleod said, telling Mintzmyer that he has never seen anything like current market conditions in his career, nor has Frontline’s famous founder, shipping magnate John Fredriksen. “I’ve spoken to Mr. Fredriksen as recently as today and he described this as something he has never seen before,” said Macleod.
The key bellwether to watch, he explained, is “oil on the water” data, which is collected by companies including Kpler. This data tracks the volume of oil aboard ships regardless of why it’s there. It could be intentional floating storage on time-charter contracts, ships on normal spot voyages, or the result of slow steaming or port congestion.
Macleod said the Kpler data is showing that oil at sea is growing by 50 million barrels per week, or the equivalent of 25 VLCC cargoes per week.
“One of the reasons why oil on the water is increasing is because there’s no home it,” he continued. “Traders and oil companies have cargoes floating all around the world where there are no buyers. There are a lot of ships off places like Spain, South Africa, Malaysia and Brazil. We’ve got ships off Brazil that have been there for many weeks. I can’t give you an exact percentage, but I’m sure that between 10% and 20% of our ships are currently sitting at a port or anchored and the owner of that oil has no idea where it’s going to go.”
Giveans estimated that the amount of oil now stored at sea is around 250 million barrels, far above the circa-2015 record of 150 million barrels.
“Various brokers and pundits are using different methodologies for how many barrels are classified as floating storage,” he explained. “It’s hard to know exactly how many of the recent time-charter deals are solely for floating storage. Also, there are many fixtures for spot cargoes that are turning into forced floating storage — technically, any vessel sitting idle for more than seven, 14 or 30 days, depending on the methodology. As a result of these factors, you’re seeing a wide range of floating-storage estimates, from 150-300 million barrels, but one thing we know for certain: The number is rising rapidly.”
Fears of future destocking
One of the sentiment headwinds holding back tanker equity valuations is investor concern over what happens after all the world’s storage is filled to the brim and the destocking process begins, during which there will be far less demand for tanker transport.
“This is the trickiest question,” Macleod told Mintzmyer. “It’s the billion-dollar question. I have no idea how long it will last but I do see inventory building through this year. When we come to the period of the inventory draw, freight will go down. There’s no doubt about that, and that’s a time when we need to be well positioned in terms of taking time-charter coverage.
“But I generally think the concern about ‘the other side’ [destocking] is a little bit higher than what we’re going to be faced with. The reason I’m saying that involves the fleet supply side, which is looking very good.
“I expect to start 2021 with a very low orderbook,” said Macleod. “It’s probably going to be historically low, at 2-3% of the world’s fleet, and we’re also going to have a world fleet where one out of four ships will be over 15 years old, so when we do enter the inventory draw, I expect we’ll go into a ship-recycling period, which could be massive.”
In other words, the collapse in demand for tankers during the oil-destocking phase will be partially compensated for by a drop in supply as very few new ships hit the water and as many old ships are scrapped, taking some of the bite out of the future rate slump. Click for more FreightWaves/American Shipper articles by Greg Miller