ShipBrief  

15 April, 2019 

 

This Edition 

● Shipping Market Updates ● Company Focus: Quarterly Review of Picks ● Macro Focus: Crude Tankers 

 

 

 

 

 

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Market Updates 

Dry Bulk: 

The global iron-ore market is reeling from a late-January dam breakdown at a Vale SA operation that left more than 200 people dead and triggered a sweep of mine closures across Brazil. 

Disruptions will amount to 60 million tons of lost supply this year, according to conservative estimates. 

As a result, a potential shortage looms in the second half, and prices of iron ore are climbing, recently touching a nearly five year high. 

China’s iron ore port stockpiles totaled nearly 150 million tons on April 5, but Wu Wenzhang, founder and president of Shanghai Steelhome Information Technology Co. told Bloomberg that he’d be watching iron-ore stockpiles in China for signs of stress, with a slide below 100 million tons likely to trigger “devastating” price volatility. 

The saving grace here may be low stockpiles of steel in China, which should support steel prices allowing producers to maintain acceptable margins. 

Shipments out of Brazil began showing weakness last month, as March cargoes failed to post a rebound following February’s seasonal weakness. Weakly loadings, which typically come in between the 20 to 30 mark, fell to just 6 for the week of April 1-7, according to VesselsValue data. 

These supply woes come as demand continues to wane in China, which brought in 261 million tonnes of iron ore in the first quarter, down 3.5% from 270.4 million tonnes in the same period last year. 

 

 

 

 

 

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Crude Tankers: 

We were already looking at a busy year for Suezmax deliveries with 31 new vessels expected to hit the water, representing about 5.8% gross fleet growth on the year. But those deliveries came fast and furious during the first quarter of 2019. 

Already 18 of the expected 31 Suezmaxes have hit the water. By contrast, only 18 of 

the expected 77 VLCC's and 13 of 44 Aframaxes have gone live. 

This was one reason why the Suezmax class experienced a larger drop in rates compared to other classes during this seasonal weakness. 

The good news is that deliveries in this class are expected to slow and return to a more normalized pace with several of the remaining vessels scheduled for launch toward the back half of the year. 

But the bad news is that trade dynamics and volumes are constantly changing. Here we'll take a look at a three month period (Thu 27 Dec 2018 - Wed 27 Mar 2019) and compare that to the same 3 month period one year ago (Thu 27 Dec 2017 - Wed 27 Mar 2018). Using VesselsValue tracking data, we observe that the Suezmax class experienced 6.7% reduction in ton miles traveled over that same period. 

The Suezmax class is heavily dependent on Africa and we are seeing Nigerian exports constrained by both infrastructure issues and OPEC cuts. Furthermore, fierce competition from the US for lighter crude has also put a damper on African crude demand as exports out of the US have gained favor as the WTI/Brent spread has strengthened. 

For more on this please see the latest Value Investor’s Edge exclusive on Suezmax prospects and this weeks macro outlook on ShipBrief which focuses more on the VLCC front with an eye on the US. 

 

 

 

 

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Product Tankers: 

 

2018 was one of the worst years for product tankers in recent history. But owners and analysts seem to be in widespread agreement that the end of 2019 will bring a significant market shift thanks to the 2020 Sulfur Cap. 

Paolo d’Amico, Chairman and Chief Executive Officer of 

d’Amico International Shipping, recently noted that the world product seaborne trade is expected to grow by 3% in 2019 while net fleet growth of the MR and LR1 segments is expected to be limited and below 2.0% over the next two years. 

Or course, the 2020 Sulfur Cap will play into heavier than usual demand for product tankers. A popular question is which class of tanker will likely benefit the most? 

Maersk believes that “the trade impact from new sulphur regulations could ultimately benefit the full range of product tankers, as both intra- and interregional trade is stimulated. The larger LR2s and MRs will benefit from growth of inter-regional trade from the Middle East to Europe and Asia, while the smaller Handy and Intermediates will benefit more from the intra-regional trade growth within Asia and Europe. An increase in greenfield refining capacity in the Middle East as Asia will also spur growth of trade in 2019.” 

Of course, they could just be talking their book, but Poten seems to back up this assertion that a fundamental improvement is in the works based on a variety of factors “that will lead to significant additional demand for product tankers, both for trading and floating storage.” 

However, they caution, and we agree, “Many policy and technical complications, as well as potential market participant responses, are creating numerous interrelated factors that will have a significant influence on the eventual outcome. These factors are highly interdependent on one another, making cause and effect difficult to disentangle.” 

 

 

 

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Containers: 

Yes, charter rates for certain classes continue to hold up, and that is a good thing. 

Unfortunately, we continue to see significant economic trouble in the global market, which inevitably impacts demand for containerized goods as a whole. 

Shipping is like a commodity, and as such it is subject to various price 

distortions between classes over short periods. As arbitrage provides a market solution for most commodities, vessel movements in and out of trade lanes provide a market solution for shipping. Therefore, while it is great to see market strength in a specific class or two, it is likely to succumb to the overall market eventually. 

It is for this reason (and the fact that we have been focused on US/China and Asia/Euro trade in previous reports), that we will focus on some key statistics out of China regarding trade with regions associated with their Belt and Road. 

 

A sharp drop in the cargo volume index came alongside recent weakness out of Europe and slower US trade due to the after-effects of front loading cargoes. 

 

 

A sharp drop in overall cargoes did not spare container volumes at sea which saw significant declines in nearly all major trading regions associated with the B&R. 

 

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LNG & LPG: 

If the past is any indication of the future, ton miles are about to increase significantly along with US LNG availability. 

In 2018, 52% of the LNG exported out of the US went to Asia, 28% to the Americas, 13% to Europe, and 7% to the Middle East. 

This reality is in stark contrast to what some 

analysts suggested as this US capacity was being built - that the Americas would absorb most of the supply and ton mile demand growth would be held in check by this short haul trade. 

However, Asian LNG demand is booming and the US is poised to unleash the next torrent of LNG supply which brings us to a very logical conclusion: LNG ton mile demand is likely to accelerate at a far faster pace going forward. 

In 2018, Asia firmed up its position of leading importing region with a 76% share of global LNG imports, up from 73% in 2017. Asian LNG imports grew by 13% to 238.6 MT 

China, the world’s second largest importer in 2018, posted a 38% rise in imports, following a 42% gain in 2017. The third and fourth largest importers, S. Korea and India, posted a 16.2% and 16.6% rise, respectively. 

Meanwhile, this ever-growing demand will be met with growing U.S. LNG export capacity, which is expected to nearly double by the end of 2019, making it the third largest in the world behind Australia and Qatar. This incoming US supply composes a significant portion of global supply, leaving Asia with few options to satisfy growing demand other than US LNG. 

 

 

 

 

 

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Company Focus: Quarterly Review of Picks For this edition of our newsletter, we’re taking the time to review our picks from the past quarter. After a very difficult end to 2018, the markets have performed well and the broad indexes have also picked up. Although the US-China ‘trade war’ still hasn’t been fully resolved, there has been positive progress and sentiment has clearly improved. Both the 10y Treasury yield and the LIBOR interest rates have slightly declined, sending a positive signal to the overall credit markets.  

The following table lists all of our picks over the past quarter. Every single one has given a positive return, some of which have rallied quickly in just a matter of weeks. The strongest overall return has came from Capital Product Partners (CPLP), which has returned over 30% in around 10 weeks since we last pounded the table. In our last edition, we covered the ‘new CPLP,’ which is focused on fixed charters and income. Those who owned CPLP previously will also have shares in Diamond S Shipping (DSSI), which has put on a remarkable rally, but still remains cheaper than peers.  

 

Over the rest of this iteration, we’ll provide general notes on the specific holdings with updates as relevant. I currently rate five of these as a “Moderate Buy” and three of these as a “Weak Buy.” For income specific holdings, keep in mind that our ratings are based primarily on capital gain potential. These are still excellent income picks, but there’s likely not as much upside for the price itself. 

GasLog Partners Series-C Preferred 

GasLog Partners (GLOP) now has a fleet of 15 LNG carriers, 14 of which are fixed on strongly profitable contracts. I view the common equity itself as a bit expensive and risky compared to peers, but the preferred offers investors a strong yield and a very impressive risk profile. The current yield-to-market is about 8.8% based on a current price of $24.15 versus a yield of 8.5% at the par value of $25.00.  

This is an excellent source of income and can also be tax advantaged for certain investors (qualified dividends versus interest income), but I view it as a “Weak Buy” because there’s not much capital gain upside potential as the ‘fair value’ is likely around the par-level of about $25.00. I highly suggest a review of the full prospectus for more information. I reviewed them in 14 January and again on 18 

 

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March, please also feel free to review those specific newsletters via the Subscriber Portal on ShipBriefs. 

Tsakos Energy Navigation Series-C Preferred 

Tsakos Energy Navigation (TNP) is a highly levered play on crude and product tankers. It is a moderate risk, high reward type play on the common, but the preferred equity offers an improved margin of safety while still paying a large yield. The Series-B and Series-C are less risky because they contain a Fail-to-Redeem (“FTR”) provision, which means the company pays a huge penalty in the form of higher dividends if these shares are not redeemed by Fall 2020 (Summer 2019 for the TNP-B). 

This provision turns the TNP-C into a quasi-bond type instrument as those dates are likely to be similar to maturities. It’s not a guarantee that the TNP-C will be redeemed of course, but it's far more likely than the non-FTR cousins like the TNP-D/E/F. Tanker markets have improved markedly over the past six months and we were riding a wave of improvement when we covered them in our 14 January report. The price has since appreciated markedly. There’s no real capital gains left, in fact there is likely to be a slight loss as they trade at $25.42 and we expect them to be redeemed in about a year and a half at $25.00, but the dividends themselves are likely very safe. This remains a top-notch income idea. 

Tsakos Energy Navigation Series-E/F Preferred 

We covered the TNP-E/F in our 18 February report where we highlighted a huge buying opportunity due to an index rebalancing dislocation. Sure enough, investors were able to log a rapid 15-20% gain in just a couple weeks without taking much risk. Once the big gains were logged, there seemed to be less upside in these names (remember the Series E/F are riskier than the B/C), so in our 18 March report, we took a sort of ‘victory lap’ and suggested the GLOP-C was now a better income idea. This remains true today as I would like to see a larger discount to get involved with these again.  

Capital Product Partners (CPLP) 

CPLP has been a major winner for us on a YTD basis and definitely since we’ve discussed and recommended the name here on ShipBrief. The new version of CPLP is covered extensively in our last update and we covered the overall spin-off mechanics in our 4 February report. Both of these are readily available via the Subscriber Portal on ShipBrief. 

For those who are trying to make sense of the performance of units, keep in mind that ‘new CPLP’ was a 7-1 reverse split and that CPLP unitholders also received one share of Diamond S Shipping (DSSI) for every 10.19 units of CPLP. The quick way to calculate performance is to quote CPLP, divide by 7, then quote DSSI, divide by 10.19, and add the two parts. For example, as of Friday’s close (12 April), CPLP is worth $2.92 ($11.19 CPLP/7 + $13.44 DSSI/10.19), if you owned it YTD, then also remember the $0.045 dividend! Odds are this is a very profitable position, it certainly has been for me, and I expect both parts to continue to do well. 

 

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Golar LNG Partners (GMLP) 

We’ve discussed GMLP in several reports and it remains one of my favorite income names. Their Q4-18 results were solid, but they cautioned for lower coverage for Q1-19 before seeing a normalization in Q2 as their major 15-year FSRU contract in Jamaica kicks off. This cautionary note seems to have weighed on pricing as it trades well underneath what I believe is a fair range of about $15-$16. 

The biggest factor for GMLP’s future performance is whether or not they can secure new contracts for the “Golar Spirit” FSRU (currently in lay-up) and the “Golar Igloo” FSRU, which has one more year of contract remaining. If the answer is ‘yes,’ then GMLP will easily cover their distribution and we might even return to payout growth. Such a scenario could push us back to the high-teens, maybe even $20.00 range. If both of these ships remain without a new contract, then we’re likely to stay in the 10-12% yield range and coverage will remain tighter. Their backlog is shown below, taken from the Q4-18 results presentation (slide 9). 

 

They have a small bit of LNG spot market exposure via the “Mazo” and “Maria,” but this is a rather small factor. There is growth opportunities either via more of the “Hilli Episeyo” FLNG or via the “Golar Nanook” FSRU, which begins its contract in Q1-2020. Golar Partners will need to complete their refinancing of 2020 debt prior to pursuing more growth.  

Conclusion: Helpful Market, Excellent Results 

 

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We’ve had an enjoyable market session this past quarter and I hope our research has been helpful for both income and capital gains perspectives. For those interested in more coverage and deeper dives into the upcoming earnings season, we are currently offering a two week free trial to Value Investor’s Edge, which is our premier research platform for shipping, MLPs, energy, and income. 

 

 

 

 

 

 

 

 

 

 

 

 

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Macro Focus: Crude Tanker Update  

Overview 

Just after summer ended in a Value Investor’s Edge exclusive report, James Catlin projected that the "spring and summer of 2018 marks the bottom" for this current rate cycle. The downturn, as many might recall, began at the start of 2016, which also coincided with a bearish forecast made correctly on VIE. 

As 2019 progresses, even with the latest dip in rates, it looks like the 2018 bottom may hold for the overall market. This long awaited reversal comes as the market shows structural improvement, trade dynamics are shifting favorably, and an unprecedented mandate is expected to give rise to tanker demand. 

Here we'll discuss some of the more influential factors that will continue to shape the market through 2020. 

Supply 

Shipping is notorious for peak to trough cycles, with supply side often playing the most influential role. In a business that would benefit from counter-cyclical action, shipping often suffers from reactionary owners behaving in a collective manner, causing market swings to become more profound. 

2016's downturn was rooted in the supply side, as new tonnage outpaced demand growth, leading to declining rates. Much of this new tonnage was ordered during 2014 and 2015 when an attractive market beckoned owners to the shipyards. Too many orders were placed and owners became the instrument of their own misfortune. 

It often takes 18 to 36 months to build a crude vessel depending on size and other factors. Therefore, as time moves on with few orders placed, the thin orderbook that we have been looking at in a speculative manner for so many months is moving ever closer to becoming a reality in the coming years. This is particularly pronounced in the Suezmax and Aframax classes. 

 

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Source: Data Courtesy VesselsValue - Chart by ShipBrief 

 

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2017 saw peak deliveries in this latest cycle for the Suezmax classes with Aframaxes peaking this year. VLCCs are expected to peak this year as well with a total of 77, representing over 10% gross cargo capacity growth for this class. 

With a recent VIE exclusive out on Suezmaxes, let's take this opportunity to focus on the VLCC class. 

While VLCC deliveries are high, the good news is that a sizable portion of that will probably be delayed as 2019's delivery schedule is heavily weighted toward the back half of the year, with 25 scheduled in the final quarter and 17 in December alone. 

Normally some slippage is to be expected but Charles R. Weber estimates that just 51 VLCCs will actually be delivered this year, implying an approximate 33% slippage rate. 

But 51 is still a large number and for comparison remember that 2018 saw just 39 deliveries while witnessing an unprecedented level of demolition resulting in no net growth for the fleet. 2019 likely won't see that happen, especially since no VLCCs have been reported as scrapped so far this year, which stands in stark contrast to a busy Q1 of 2018. 

In fact, if anything owners are likely to test the second hand market given the recent strength. Vintage tonnage has been en vogue and fetching prices much higher than expected. 

Source: VesselsValue 

The only reason to pay handsomely for tonnage which in a few years will inevitably be valued as scrap is a bet on near term charter rates. The purchase of these vessels likely represents an optimistic view on crude tanker demand centered around the 2020 Sulfur Cap. 

 

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The latest sale of the C. Dream for $21.75 million, well above the $17.97 million VesselsValue market valuation (which was also the projected scrap price), led Splash247 to declare that millennial VLCCs are in vogue. 

Although it is interesting that one of these sales is actually to bunker supplier, Equatorial Marine Fuel Management Services, which intends to use the vessel as floating storage. 

While the acquisition of a vintage VLCC is indeed a play on the short term market, one other observation should be made with regard to demolitions. With vintage tonnage now fetching a premium over demolition value, owners wishing to dispose of older ships may test the second hand market. If enough buyers are bullish on these short term forecasts it may keep the S&P market active at the expense of the demolition market. 

Additionally, we should consider that owners now see forward expectations of higher rates emerging from these buyers of older tonnage. That may keep these owners from even wanting to part with their aging vessels and instead try to maintain as much tonnage on the water to capitalize on a bullish uptick. 

If these short term higher rates do emerge as we make our way into 2020 the big question becomes what will bunker prices for LSFO be and how well will these increased prices be covered by hopefully higher charter rates? If we see rates able to cover the added OPEX for an older vessel, we may not see scrapping materialize to the extreme that many predicted. Remember, some analysts suggested that anything older than 15 years would be scrapped in the VLCC class, now we see money being placed against that notion. 

Removing tonnage in the form of demolitions would curtail overall net fleet growth for the year, which would be beneficial considering the VLCC class will see gross fleet growth of 6.8% in 2019 with the delivery of just 50 vessels. 

This is why the recent sale of this older tonnage is a double edged sword. On one side you are glad owners are making the bet on a better market, but by doing so they may impact the demolition market which needs to be healthy to achieve a balance between supply and demand. 

Either way, with the lack of demolitions so far this year and incoming tonnage, the new capacity coming in looks troubling on the surface. But fortunately this year looks to provide some interesting developments that will likely see 2019 and 2020 go down as above average ton mile demand growth years. 

US Exports 

The United States became the world’s biggest oil producer in 2018, and over the next five years, the nation will take aim at becoming the top oil exporter. 

 

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US crude oil exports will nearly double to 9 million barrels per day by 2024, the International Energy Agency forecasts. At that level, the U.S. will surpass Russia’s shipments and threaten to unseat Saudi Arabia, the current top exporter. 

In fact, IEA Executive Director Fatih Birol said in a statement. “It will see the United States account for 70 percent of the rise in global oil production and some 75 percent of the expansion in LNG trade over the next five years. This will shake up international oil and gas trade flows, with profound implications for the geopolitics of energy.” 

Over the same time, the IEA says global oil demand will grow by an average 1.2 million barrels per day per year through 2024. Much of that new demand will be in Asia, which is heavily import dependent. Since Faith Birol included LNG in her previous statement, it's worth noting that concentrated demand side growth in Asia holds true for LNG as well. 

This burgeoning trade route also represents one of the longest hauls in shipping and will likely influence ton mile demand. 

The difference in voyage time for China bound cargoes out of the USA vs. that of Saudi Arabia is significant. 

At 12.2 knots, China bound cargoes originating out of the U.S. Gulf take approximately 48 days via the Suez Canal and 51 days via the Cape of Good Hope. Compare that with a direct voyage out of Saudi Arabia to China which takes approximately 20 days at the same speed. 

Now consider that four of the top five importers of crude reside in that general region; China, Japan, India, and S. Korea. What's more important is that US crude is finding a market in several other far off countries. 

Year to date, total ton miles originating from the US for Aframax, Suezmax, and VLCC's comes in at 266.35 bn DWT NM. But in 2018 that figure stood at just 185.64 bn DWT NM. Approximately 95% of the recent growth in US ton mile demand can be attributed to international demand with just 5% being domestic. 

YTD, we see that the top importers in terms of cargo tons, S. Korea, Taiwan, Netherlands, India, Singapore, Thailand, and the UK are also many of the top contributors to ton mile demand. Over the past year we have seen S. Korea rocket to the top spot in both ton miles and cargo tons going from 6.52 bn DWT NM for 2018 YTD to 53.65 in 2019. 

In fact, with the exception of China, all major importers have continued to increase imports of US crude over the past year, more than negating any impact the trade war has had on this issue. 

Evidence of that can be seen below with the first chart showing ton mile demand between the US and China with the second depicting total ton mile demand out of the US. 

 

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Source: VesselsValue 

Even as China's imports of US crude dropped, total ton miles showed relatively little weakness as a result. 

Of course, an end to the trade war would bring the US-China route back to life as commodity purchases are increasingly likely to be part of an overall deal. 

A resolution couldn't come at a better time for either country as China's thirst for crude is about to intensify, courtesy of massive new refining capacity coming online, while the US looks to clear up infrastructure bottlenecks that have constrained export volumes. 

That bottleneck, which is most critical at the Permian Basin, is close to being resolved, and a new network of pipelines will help U.S. producers bring more crude into the Gulf Coast and consequently the global market. 

Citigroup energy analyst Eric Lee told CNBC, "Once you get to the first quarter of 2020, almost certainly the Permian will be fully de-bottlenecked for now." 

 

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This takeaway capacity is coming at the right time as drillers expect to double their output from the Permian over the next four years, to 8 million barrels a day. 

All of this comes as the demand for lighter sweeter crude will likely rise, thanks to the 2020 Sulfur Cap, as the market focuses more on middle distillate output.   

With volumes and consequently ton mile demand set to rise thanks to US output, which class will benefit the most? 

The answer is VLCCs. 

Due to infrastructure constraints, US exports of crude on VLCCs are challenging, but are being done. 

The first method is through reverse lightering; a process where crude is loaded onto smaller vessels then loaded onto a larger vessel outside of the port. VLCCs take on as much as they can at the port, sail out to deeper water, then top off through reverse lightering. Yes, it adds an additional cost, but attractive WTI pricing coupled with the economies of scale presented by these larger ships more than makes up for it. 

Second is through the Louisiana Offshore Oil Port or LOOP. Originally designed for oil imports LOOP, which is only facility in the US that can directly load a VLCC without using ship-to-ship transfers, first started exporting crude on VLCCs in February 2018. The facility averaged loading about one tanker a month for the remainder of the year and has loaded three so far this year. 

Currently, Texas ports are making plans for more and larger ships to carry oil exports from the U.S. to customers in Asia and elsewhere. With Harbor Island scheduled to come on-line in 2020 and the deepening and widening of the main channel to follow within the following two years, the completion of the Port of Corpus Christi's projects will go a long ways towards alleviating any potentially developing export bottlenecks, just in time to accommodate this increasing takeaway capacity. 

We have also seen a solid preference by key importers of US crude for VLCC vessels. For example, of the 52 voyages from the US to South Korea over the past year, 34 were VLCCs, 13 of the Suezmax class, and just 5 were Aframaxes. Taiwan utilizes only VLCCs while a majority of voyages into India, Japan, and China use these larger vessels as well. 

If a trade deal is reached between the US and China, VLCC tonnage would be the likely beneficiary, as shown in the following chart depicting the types of vessels undertaking the US-China route over the past year. 

 

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Source: VesselsValue 

That's not to say that smaller vessels won't see some action though. In terms of vessel visits, key growing importers like Singapore, the Netherlands, and the UK all utilize smaller tonnage over that of VLCCs. 

China 

China's increasing reliance on crude imports will only grow more pronounced as growing organic demand and a wave of refinery capacity will come online while domestic crude output continues to decline. 

Imports are growing at a very fast pace. 

Source: Banchero Costa 

 

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In February 2019, crude oil imports rose 21.6% year-on-year to reach 39.2 mln tonnes marking the fourth month in a row of crude oil imports into the country exceeding the 10-million-bpd mark. 

According to customs data, Chinese refineries processed 102.49 million tons of crude oil during the first two months of the year, up 6.1% on the year, which was the highest on record, according to calculations made by Reuters. 

Globally, in 2019 refining processing capacity is set to increase by 2.6 million bpd, the most growth in four decades and China is a big part of that. Some 890,000 barrels a day of new refining capacity is due to open this year in China, with another 1.08 million barrels coming online in 2020 and 1.12 million barrels in 2021. 

This will add to import demand for crude tankers but may also have another important result for product tankers. 

China’s refining additions are expected to far outpace its own domestic demand growth and, as a result, product exports are forecast to grow rapidly. 

All of China’s new capacity will be located in the coastal provinces. China’s Bohai Bay is starting to resemble the US Gulf Coast with a stretch of 1,300 km housing 43% of China’s refining capacity, but only 17% of its population. 

The infrastructure is in place to facilitate both crude oil imports as well as product exports. Most of these exports are destined for other Asian countries and will likely benefit the Handysize/MR trades. 

China is expected to account for 40% of the world's refinery expansions through 2024 and the flood of new product out of China over the coming years is a major reason why analysts largely foresee global supply outpacing demand. Export quotas granted to major oil companies are already up 13% from a year earlier and it is likely that these new Chinese refineries will be given more access to global markets. 

Remember, these new refineries were fueled through enormous debt and with the world now keeping an eye on China's debt woes these refiners will likely be prompted to produce at all costs in order to service that debt properly. 

This brings about some interesting results. Refining margins on a global scale will likely remain under pressure. If this goes on long enough it may bring forward some refinery closures in other regions. Additionally, demand for product tankers should increase especially in the intra-Asia trade lane. Furthermore, if a significant product glut leads to depressed pricing inventory builds could resume as opportunistic stockpiling takes place. Once again, this would benefit product tanker demand. 

Finally, it's worth observing that product tankers are poised to be the star beneficiaries of the 2020 Sulfur Cap, so demolition expectations here are perhaps the most conservative of all classes. 

 

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Sulfur Cap 2020 

The IEA estimates that demand for high sulfur fuel oil (HSFO), the main vessel fuel since the 1960s, will plunge to 1.4 million bpd from 3.5 million bpd in just one year, with middle distillates taking its place. 

A common misconception of the sulfur regulations is that they will cause vessels to consume 2.1 million barrels of diesel fuel daily to replace the high-sulfur fuel oil that is consumed today. 

While it is perhaps possible for vessels to run on actual ultra-low-sulfur diesel, it is much more likely they will be consuming low-sulfur fuel that, like diesel, exists within a class of refined products known as middle distillates. Refiners will likely blend very-low-sulfur feedstocks with high-sulfur residual fuel oil to produce the new IMO compliant bunker fuel. 

Nevertheless, this furthers the rise of petrochemicals over the next few years at the expense of fuel oil, bringing with it winners and losers. The losers will likely be producers of heavier crude, while U.S. oil producers whose typical crude products are lighter, will benefit from growing demand. Furthermore, shale oil will also help meet the new IMO requirements and provide the quantities of naphtha required for the petrochemicals industry. West Africa is another popular producer of lighter grades and could also see increasing demand as a result. 

Another interesting point about the upcoming 2020 Sulfur Cap is that while 3% of the crude tanker fleet (in terms of dwt) is fitted with scrubbers, 16% of the crude tanker fleet is pending retrofit which will take tonnage out of the market. Drewry estimates the vessel supply could be reduced by 2.0-2.5% over the next year as retrofitting takes place. They conclude that the retrofitting phase will improve the supply-demand balance in the market, especially in 2H19 when demand will be seasonally firm. 

Once again though, let's call attention to that last sentence regarding expected strength in the short run, which is what led to the purchases of vintage tankers. This expectation is why we won't see demolitions materialize to the degree that many once anticipated. 

Remember, there is a direct correlation between demolition activity and charter rates. When times are good we see owners extend the life of vessels well beyond what was originally intended. When things are bad we see more and younger ships head to the beach. Rates will be the deciding factor in this equation and until owners have better information it seems likely that the demo market will stay a bit subdued. 

Conclusion 

The supply side for crude tankers is clearing up with the Suezmax and Aframax classes having downright thin orderbooks. The VLCC class is still a bit concerning with quite a few vessels still in the pipeline, however a high degree of slippage and growing ton miles out of the US should provide a counterweight. Furthermore, it's a positive sign that interest in vintage VLCC's is growing as owners are optimistically placing bets in the near term prospects for these ships. Finally, it is noteworthy that 

 

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while spot rates have suffered a sizable dip in recent months, time charter rates have held up strong, indicating confidence in the market further ahead. 

Scrapping of vessels will be largely dependent on charter rates as we move into and through the implementation of the 2020 Sulfur Cap. If rates spike again in the back half of the year, as many are predicting, this would play into an ongoing weak demolition market. 

The US is poised to unleash a torrent of crude as infrastructure woes are remedied. Long hauls from the US Gulf headed toward Europe or Asia will contribute handsomely to ton mile demand, with VLCCs being the main beneficiary. Cleaves Securities is forecasting US crude oil production to rise 11% year-on-year in 2019 with a corresponding 45% increase in US crude exports. 

China will be playing an important role in the crude and product trade development as new refinery capacity is supplied through imported feedstock with products increasingly finding a home in overseas markets. 

Finally, it was no accident that we discussed Chinese refining capacity prior to our discussion on the 2020 Sulfur Cap. The fact is that as we near the implementation date, we are seeing talk of catastrophic consequences die down and more moderate rhetoric take its place. There most likely will not be a total breakdown in supply chains brought on by fuel shortages. Crude oil shortages are not in the cards, with OPEC actually restraining supply while prices are still relatively acceptable. Refining capacity additions, the greatest in four decades, have come at a fortuitous time and major suppliers have voiced their confidence in the ability to deal with the shift. Bunker suppliers have already started to carry out preparations. There will not be panic, chaos, and shock. Instead it looks like a very organized shift is taking place and knee-jerk reactionary behavior, like scrapping everything over 15 years old, is being cast aside. 

 

 

 

 

All information copyright by ShipBrief 2019 

www.shipbrief.com 

Note: This material is for informational purposes only. It does not constitute investment advice and is not intended as an endorsement of any specific investment. While ShipBrief believes the information to be accurate and reliable, we do not claim or have responsibility for its completeness, accuracy, or reliability. Statements of future expectations, estimates, projections, and other forward-looking statements are based on available information and ShipBrief’s views as of the time of these statements. Readers should consult with appropriate tax and investment advisors as applicable before making any investment decisions. 

 

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