Tanker market rally expands across all segments, with Aframaxes “stealing the show”

The tanker market has been the “darling” of the shipping industry over the past few months, as the dry bulk market recovery story never actually materialized. In an interview with Hellenic Shipping News Worldwide, Mr. George P. Los, Senior Market Analyst / Projects with shipbroker Charles R. Weber noted that tanker market freight rates rose by 68% in terms of average earnings over the course of the fourth quarter of the year, to levels not seen since 2008. He added that “in the Long and Medium range product segments, the quarter marked a return to year-on-year strength with a collective 103% increase of earnings after a number of variances in trade patterns had adversely impacted MR earnings during much of the first half of the year gave way to better overall demand”.

This increase has already fuelled a flurry on newbuilding ordering activity. According to Mr. Los, newbuilding interest has risen markedly for large crude tankers since the start of the year with 16 VLCCs and 17 Suezmaxes having been contracted for. However, he appeared reassuring, estimating that this trend will not continue in the future. Meanwhile, floating storage could come to play about mid-year with increased demand.

Over the course of the past few months, we’ve witnessed the firming up of the tanker freight market? How much have rates risen over this period of time across the main tanker ship classes?

During the final quarter of 2014, the tanker market experienced a broad firming of rates which ultimately extended to all crude and product segments. Among VLCCs, Suezmaxes and Aframaxes, the stronger rate environment translated to a 68% rise in average earnings on a year-on-year basis to levels which were at highs last seen in 2008. In the Long and Medium range product segments, the quarter marked a return to year-on-year strength with a collective 103% increase of earnings after a number of variances in trade patterns had adversely impacted MR earnings during much of the first half of the year gave way to better overall demand. The rallying of rates has in both segments continued through the early weeks of 2015 with crude tankers on course for another incrementally stronger quarter and product tankers extending also their rally, led by a much tighter MR market.

Which have been the main driving forces behind this latest surge of the tanker freight market?

For crude tankers, slowing rates of fleet growth since 2012 and an increasingly diverse geographic distribution of trade routes have largely formed as the basis for tighter supply/demand fundamentals in key markets. For VLCCs, this has helped earnings to overcome what has actually been directionally softer demand as observed from the traditional ton-mile basis as overall availability rates are dragged down by greater competition for units between markets. For example, whereas West Africa VLCC cargoes were traditionally sourced onto units freeing in the US or Europe, these are now almost entirely fixed onto units ballasting from the Far East. In turn, this has reduced the number of units available in the Middle East – to the benefit of rates in both markets. Meanwhile, the size of the Aframax fleet has contracted by about 4% since 2012 while demand rates have risen modestly but with greater diversity as growth in Far East markets and a 33% surge in the Baltic have offset slower demand in the Middle East and steady demand in the Caribbean. For their part, Suezmaxes have found new demand in Aframax markets as alternative tonnage sufficient to offset the earlier strong deceleration of demand on traditional routes linking West African crude with US refining centers. Moreover, when VLCC rates peaked earlier this year, Suezmaxes were able to successfully compete with more attractive dollar-per-ton freights, showing the resilience of the class.

In the products segments, the commencing of substantive exports from the first of three new large refining capacity additions in the Middle East midway through 2014 offered fresh demand to LR2s and LR1 which saw earnings for those classes rise quite strongly during 2H14. MR earnings followed thereafter when lower oil prices boosted European refining margins towards the end of 2014 and have accelerated further more recently thanks to a more even distribution of both intraregional and trans-Atlantic demand between the key European and US Gulf markets. Stronger recent exports from the US Gulf combined with stronger gasoline imports on the US East Coast have kept the Atlantic basin tight while longer-haul exports of diesel from the Baltic to areas further afield than Europe, as well as rare US diesel imports to replenish declining heating oil inventories have further reduced the efficiency of the class by temporarily diversifying trade routes.

Which ship types have benefited the most, in terms of earnings? Is it true that larger tankers have received the “lion’s share” of the market’s rally?

On percentage terms, Suezmaxes observed the strongest year-on-year gains during 2014, followed by Aframaxes and VLCCs. However, when accounting for the lower starting point of Suezmaxes and VLCCs, the upside observed by Aframaxes is perhaps the most impressive. Aframaxes have been in a sustained structural recovery since 2012 while VLCCs and Suezmaxes really only found support from non-structural sources like floating storage and global inventory building during 2010, the run-up to sanctions against Iran during 2012 and a temporary surge in Saudi exports during the latter half of 2014 and otherwise experienced a challenging run between 2009 and last year due oversupply. Nevertheless, VLCC earnings on some trade routes briefly rallied to nearly $90,000/day earlier this year, underscoring long-held conventional wisdom that the largest segments observe the greatest upside. In the products segments, the Long Range classes outperformed MRs during 2014 as these classes benefitted from the demand surge in the Middle East market and the fact that just over half the constructed LR fleet continues to trade within dirty markets.

Do you expect that the market gains for tankers will spill over to smaller ship types as well?

Just as the largest crude tanker sizes experience the greatest upside, they also experience the greatest volatility. Indeed, while VLCC earnings have softened from their recent highs, Aframaxes have remained elevated as downturns in specific regional markets are more quickly resolved by repositioning of tonnage and/or the return of sporadic delays and demand surges which benefit rates. Nevertheless, in the intermediate and long term I expect that all crude size classes will remain in a sustained directional recovery. As the Aframax fleet continues to contract and rising Middle East exports attract more forward deliveries of LR2s to clean trades, earnings gains will extend to Suezmaxes. And in all crude tanker segments, forward fleet growth appears manageable, once the phasing out of older tonnage is accounted for which should help to maintain the recovery.

In the products space, MRs are presently out-earning their larger counterparts. Structurally, LRs are poised to benefit from a further tightening of supply/demand fundamentals once the final two Middle East refining capacity expansions come on-stream and utilization rates reach normal levels during the second half of 2015. As the products story unfolds, MRs should experience some benefit from a reduction of competition from LR1 units and later potentially from an increase in trader-originated trans-Atlantic diesel trades in the Atlantic basin, assuming that Europe’s refining industry responds to new Middle East product supply with capacity cuts.

Has floating storage made much of an impact on the VLCC market?

Since the start of the year, charterers have taken 36 units on time charters of at least six months but only about four of these units are already actively engaged in floating storage. Of the remainder, the vast majority have either appeared on the spot market as relet units have been temporarily deployed by their charterers into pools for spot trades. As such, the impact on fundamentals in VLCC market has thus far been minimal – and possibly counterproductive since at least two units which had been set to be phased out from the fleet by way of conversion or demolition have returned to active trading. Moreover, as a number of the units recently fixed on time charterers had previously been included in our list of expected 2015 phase outs, we have trimmed our projection of VLCC exits for the year from 20 to 10.

We have maintained a view that the level of time charter activity indicates charterer desire for storage optionality at a lower fixed daily hire rate under a longer term time charter than would be achieved for a short-term, storage-specific charter. Moreover, if floating storage does materialize, charterers who have taken in tonnage have hedged against corresponding rate gains. In terms of timing, crude demand projections show a rise during the second half of the year and the extent of crude price downside which has been observed has only prompted the key forecasting agencies to upwardly revise projections. Once the inflexion point is reached whereby crude demand overtakes crude supply, the excess crude in onshore storage will continue to weigh on spot prices while the contango structure in futures markets may well steepen; this could occur around mid-year and usher in a greater number of storage plays.

In terms of newbuilding ordering activity in the tanker segment – both crude and products – how would you evaluate 2014 and the start of 2015 so far? Do you expect a flurry of new ordering activity, which could perhaps lead to new imbalances in the market?

During 2014, the market observed a shifting of newbuilding interest from MRs to larger crude tanker segments in a trend which has extended through the start of 2015. The shift largely follows performance in the respective markets with the slumping of MR earnings during much of 2014 causing investors to eye more closely the large MR orderbook while the extent of earnings gains in large crude tanker segments prompted investors to look towards those markets for newbuilding opportunities.

Newbuilding interest has risen markedly for large crude tankers since the start of the year with 16 VLCCs and 17 Suezmaxes having been contracted for. While ordering at this scale would be alarming if it prevails, there are some important factors which temper the likelihood thereof. Firstly, as was observed early during 2014, investors’ interest has largely centered on the earliest delivery slots which, at least at key yards, have now largely been filled. Secondly, whereas private equity formed the basis of the MR ordering surge during 2012-2013, private equity firms seeking to invest in the crude tanker space today are more interested in existing tonnage.

Do you think that ECO vessels make sense even in today’s low fuel costs market? Have ship owners kept on investing on these types of vessels during this period of high freight rates?

Essentially all tanker newbuilding designs on offer today have speed and consumption ratings which fit the ECO moniker while existing, non-ECO units have also achieved handsome bunker consumption reductions through various modifications, albeit to a lesser extent. Accordingly, buyers seeking to expand or renew their fleets have essentially been deciding between new or existing units rather than ECO or non-ECO – and the collapse of bunker prices and acceleration of freight rates makes this even more the case.

Nikos Roussanoglou, Hellenic Shipping News Worldwide