It’s a black swan on top of a black swan. First, the coronavirus outbreak, and now, the collapse of the production-cut agreement of OPEC+ — the coalition of OPEC and other countries including Russia — after a dispute on how to handle coronavirus-induced demand destruction.
With Saudi Arabia ramping up from production from 9.7 million barrels per day (b/d) to as much as 12 million b/d and offering steep discounts on April cargoes, a full-on price war appears likely.
There are major implications for ocean shipping, varying widely by segment:
Container shipping
On a positive note, the decline in crude prices ultimately flows through to the price of marine fuel.
The IMO 2020 rule requires ships without exhaust-gas scrubbers to switch from 3.5% heavy fuel oil (HFO) to cleaner 0.5% sulfur fuel called very low sulfur fuel oil (VLSFO). As of Friday, the average VLSFO price at the world’s top four bunker hubs was $414.50 per ton, according to data from Ship & Bunker. A year prior, the price of HFO was $427.50.
Given that Brent crude was down by 24% on Monday, VLSFO is likely to fall even further, implying that container lines should actually experience a year-on-year decrease in bunker costs despite IMO 2020, at least temporarily.
But this plus in the cost column will be countered by a minus in the revenue column. The plunge in oil prices will have highly negative economic impacts on oil-producing countries, which would should limit container import demand. And while lower oil prices normally act as a stimulus for consumers, that is not the case if consumer behavior is constrained by virus fears.
Crude-tanker shipping
The most directly exposed segment to the OPEC+ blowup is crude-tanker shipping. The consensus is that the commodity price plunge will be positive for freight rates, although analysts diverge on the extent and duration of the upside.
Clarksons Platou Securities analyst Frode Mørkedal is particularly bullish. As crude pricing induces land-based and floating storage, he sees spot rates for VLCCs (very large crude carriers, which carry 2 million barrels of crude oil) rising from $45,000 per day currently to potentially up to $110,000 per day.
According to Michael Webber, head of Webber Research, “Tanker activity and rates are generally positively levered to production volumes, including overproduction, albeit less sustainably.” He said the OPEC+ dispute would put “additional supply into a market that’s already oversupplied,” and as a result, he expects “floating storage, both structural storage when inventories saturate, as well as contango-driven economic storage.”
Evercore ISI analyst Jon Chappell said that the tanker names “dodged a bullet” when the prior OPEC+ plan for an additional 1.5 million b/d cut was killed. He believes an oil price war and contango “bode very well” for the sector, but that “it’s hard to recommend catching a falling knife in tanker stocks until there’s more clarity on the [coronavirus] impact to oil demand.”
According to Stifel analyst Ben Nolan, “Initially, this [crude-price reduction] would be good for crude tankers, although only moderately. Growth in supply is one thing, but the real problem is a lack of demand. More barrels could lead to floating storage, but ultimately, if people aren’t using the oil, any improvement is temporary. Longer term, an oil war could be negative as it would certainly lead to less activity in places like the U.S., which would shrink ton-mile demand.”
The bearish view for crude tankers is that sustained lower crude pricing will wipe out U.S. shale production, reducing long-haul U.S.-to-Asia VLCC shipments and replacing them with shorter-haul Middle East-to-Asia shipments. Vessel demand is not measured in tons of cargo, it is measured in ton-miles — volume multiplied by distance.
This same point was raised by Mørkedal one week ago, when he wrote: “Bottom line is that even though OPEC cuts are likely negative on the margin [for tanker rates], the potential slowdown in U.S. crude output if prices were to collapse would have been much worse for tankers.” Those prices have indeed collapsed.
The early indications on Monday were that Wall Street investors believe falling crude prices are good for tankers. In the first half of the trading day, as the broader market crashed and system circuit breakers were triggered, sizeable share-price gains were being posted by crude-tanker owners Euronav (NYSE: EURN), Teekay Tankers (NYSE: TNK), Nordic American Tankers (NYSE: NAT), Frontline (NYSE: FRO), International Seaways (NYSE: INSW) and DHT (NYSE: DHT).
Other vessel categories
Product tankers — “Product tankers should be more well-protected [than crude tankers] as there should be some uplift in underlying consumption with lower prices,” said Nolan. “However, falling U.S. production would also be bad for the product-tanker market as the U.S. is the largest exporter of refined products.”
LNG shipping — Spot rates for carriers of liquefied natural gas (LNG) have been in sharp decline and the fall of crude makes prospects even worse.
“Low prices are not good for LNG,” said Nolan. “Cheap crude reduces the motivation to switch to [natural] gas and also the appetite for spending capital by energy companies. Less drilling activity in the U.S. for oil would quickly shrink [natural] gas production, killing off what little interest there may be in signing LNG export contracts from the U.S. This is bad for infrastructure and for ships.”
According to Webber, if coronavirus “brought the near-term prospects for new [U.S. export] LNG business to a particularly slow crawl, we believe the OPEC+ blowup will bring it to a full stop, at least until the dust settles.”
LPG shipping — Liquefied petroleum gas (LPG) carriers primarily transport propane and butane. “The LPG markets would be negatively impacted, as slowing U.S. growth would mean slower U.S. exports, shorter ton-miles, and also, the petchem arbitrage for using LPG versus naphtha would likely not be open,” said Nolan.
Dry bulk — Unlike in tanker segments, the oil-price plummet has no effect on the cargo side for dry bulk shipping. However, as with the container sector, there is an effect on fuel prices. The consequence is different for dry bulk, which has no set schedules, than for container shipping, which does.
“For dry bulk, it is probably slightly negative as higher fuel prices motivate lower ship speeds, so a very low oil price could lead to faster ships and effectively more supply,” said Nolan. More FreightWaves/American Shipper articles by Greg Miller