Tanker shipping equities: State of the market and rising asset prices
Global oil demand surpassed 100 mbpd in 2H19 before plunging by 9% to an annual average of 90.80 mbpd in 2020 due to the pandemic-linked demand destruction in 2Q20. OPEC’s latest report forecasts demand growth of 5.95 mbpd for 2021 followed by another 3.28 mbpd next year, effectively restoring the lost demand by 4Q22. For its part, the IEA sees global oil demand recovering from 90.80 mbpd on average in 2020 to 96.20 mbpd in 2021 and 99.30 mbpd in 2022, slightly more bearish than OPEC.
Be that as it may, a production cut of ~10 mbpd by OPEC+ in May 2020 coupled with well shut-ins by several oil majors continue to have cascading effects on the tanker shipping industry.
Crude tanker earnings are under pressure across vessel classes, driven by ample availability of tonnage at key loading ports which increased the bargaining power of charterers. At USD 1,000pd, average VLCC spot earnings on the AG-Japan route hit a historical low in the past 20 years in the 1Q21 peak season, in contrast to USD 30,500pd average earnings for VLCCs in the first quarter of every year for the past 11 years. The story remained the same in 2Q21 as well since demand remained muted. Recently, Euronav a major tanker owner, posted a net loss of USD 89.7mn in 2Q21 after registering a record profit of USD 259.6mn during the same period of last year, as its VLCC spot earnings averaged USD 11,250pd in 2Q21 versus USD 81,500pd in 2Q20.
There was some positive development when crude oil prices hit a 30-month high in the last week of July this year but demand concerns due to the rising Delta variant Covid infections in China and increased OPEC+ output from 1 August took the prices down. Nevertheless, on a YTD basis, crude oil prices have jumped by 29%, partially driven by an increase in crude oil consumption as well as its trade over the past 16 months.
Key market indices were largely on an uptrend since the beginning of 2021 with S&P 500, Dow Jones Industrial Average (DJIA) and Nasdaq Composite gaining 17%, 14% and 13% YTD (as of 19 August) respectively while Drewry crude tanker index was relatively more volatile. Tanker equities also surged in the first six months on the back of demand optimism before they slid in July and August on concerns of more contagious Delta variant of the virus amid seasonal weakness. Accordingly, Drewry crude tanker index plunged by 21% in the past two month which offset the gains realised in 1H21 as weak vessel earnings across vessel classes put pressure on stock prices.
Meanwhile, tanker shipping continues to suffer from the 9% plunge in global oil demand in 2020 and persistent oversupply as vessel owners preferred to delay scrapping of older tonnage expecting a recovery. With the surge in steel prices due to strong steel demand, average demolition prices jumped by 36% in the past seven months to USD 560 per ldt (light displacement tonnage), ensuring that second-hand oil tankers command a premium over scrap prices and taking asset prices higher since the beginning of 2021.
Second-hand prices of crude carriers are primarily influenced by prevailing vessel earnings and provide a better assessment of the existing supply-demand situation in the market. During extended periods of high charter rates, vessel values tend to appreciate and vice versa. Historical data suggests that second-hand values (5-year-old vessels) have occasionally surpassed newbuilding prices when vessel earnings are high; for instance in 2007-08 second-hand values were occasionally higher than newbuilding prices. More recently, asset prices were on the rise in March and April 2020 due to the sudden surge in vessel earnings because of increased demand of oil carriers to store excess crude oil supply. A reversal was soon witnessed when asset prices declined from May to December 2020 as the spot TCE rates plunged across vessel classes because of limited demand and ample tonnage availability.
In 2021, crude tanker spot TCE rates have been declining so far with vessel day rates falling even below the rates seen during the tanker market downcycle in 2018. Yet, asset prices have been trending upwards since the beginning of 2021.
So, what is driving tanker asset prices when the market is subdued?
1. Increased bargaining power of shipyards:
VLCC newbuild prices moved up by 16% between December 2020 and July 2021 to USD 100mn whereas Suezmax newbuild prices increased by ~20% to USD 67mn over the same period. We believe the uptrend in newbuild prices despite weak vessel earnings has been fuelled by the increased bargaining power of shipyards that have emerged as price setters with yards flushed with excess ordering, albeit from other shipping sectors, and are hence hard pressed for time for any new orders. Tanker shipowners are also willing to pay extra sums in anticipation of improved market at the time of delivery of the vessels.
2. Uptrend in newbuild and demolition prices is pushing second-hand asset prices:
We have also witnessed limited scrapping this year despite weak vessel day rates. Part of the problem also lies with the higher steel prices that led to a 36% increase in demolition prices to USD 560 per ldt between December 2020 and July 2021. The uptrend in newbuild tanker prices coupled with higher demolition prices has pushed up second-hand vessel prices across vessel classes. For example, asset prices of a five-year-old VLCC and Suezmax moved up by 12.5% and 11.4% to USD 72mn and USD 49mn respectively over the same period.
3. Expectations of demand recovery is supporting asset prices:
In July 2021, global crude oil consumption jumped by 22% to 98.10 mbpd from the record low of 80.35 mbpd in April 2020 with easing lockdown restrictions and opening up of several economies in 2H20. This is a positive development despite the negative news of Covid and its variants which is leading to lockdowns in many countries. But what is encouraging is the rollout of several vaccines and an increased vaccination drive that can sustain the uptrend in global oil consumption and trade. While the demand for gasoline, gasoil and naphtha is already close to the pre-pandemic levels, that of jet kerosene is still nearly 32% lower because of restrictions on international travel. We expect demand and trade of refined products including jet kerosene to recover over the next 18 months due to the vaccination drives and overall recovery in the global economy which could further support the recent uptrend in crude tanker asset prices.
4. Expectation of return of Iranian crude:
Ongoing negotiations between P5+1 and Iran in Vienna to revive the 2015 nuclear deal have seen many ups and downs since April 2021, but both the US and Iran are hopeful of reaching an agreement by ironing out their differences. Anticipating the resolution, Iran is all prepared to ramp up oil output to restore production to 3.38 mbpd within a month of removal of sanctions. We do not expect Iran to be part of the OPEC+ production cut, and therefore believe that the return of Iranian crude to the international oil market will lower the crude oil prices, a move that is expected to support the demand and trade once sanctions are lifted. Moreover, lower crude prices could encourage major importers like China and India to increase their stockpiling activities to build strategic petroleum reserves (SPRs) that would also support the asset prices of crude carriers. Although the market expects an upside from a potential return of Iranian crude, the return of Iranian crude is subject to high uncertainty with the potential of bringing in additional effective capacity to the current global tanker fleet.
How does this impact tanker shipping equities?
Although tanker shipping companies are expected to report net losses in the near term, we believe the tanker shipping market has bottomed out and losses will shrink further over the next one year with companies’ earnings turning to the black from 2H22. Rising asset prices and shrinking losses are expected to support the uptrend in crude tanker shipping stocks over the next two years, but a minor correction cannot be ruled out during the weak seasonal demand in the summer of 2021 and 2022.
Conclusion: Newbuild as well as second-hand crude tanker prices were on the rise across vessel classes since the beginning of 2021 despite weak vessel earnings. Increased bargaining power of shipyards and rising steel prices played crucial roles in driving the asset prices over the past seven months. We expect crude tanker asset prices to continue to grow over the next six month albeit at a slower pace as steel prices are higher and market optimism has increased the bargaining power of shipyards.