Crude Oil Shipping Demand: A Change At The Top

The crude oil shipping sector remains in a state of malaise; the Baltic Dirty Tanker Index (BDTI), the sector's benchmark, remains in its downward trend, afflicted by an overtonnaged fleet and insufficient growth in demand. In the first of a two-part overview of the crude oil shipping sector we examine the changing dynamics surrounding the two largest importers of crude oil in the world - the US and China.

The US is set to concede its position as the world's number-one oil importer to China, as its production of unconventional oil continues to change the dynamics of the global trade. This will have significant repercussions on tanker operators, in particular Suezmaxes, which have been crucial to transporting crude supplies to the US. Meanwhile, continued growth in China's demand is vitally important to operators of very large crude carriers (VLCCs).

Baltic Dirty Tanker Index Struggling To Rise

The BDTI, made up of a number of global crude oil shipping routes for a variety of different vessel classes, stood at 586 on September 27, the index's last close at the time of writing. While this marks something of a recovery from the three-year low in June when the index stood at 577, it is not far off, having climbed by only 1.6% since then.

Choppy Waters
Baltic Dirty Tanker Index

The index does look healthier than it did in the immediate wake of the global economic crisis, when the BDTI reached its nadir, sinking to 453 in April 2009. However, the 1,208 reached in January of 2010, as the BDTI benefited from rising rates and the crude oil tanker sector looked more buoyant, has not been achieved since. While there have been peaks and troughs, the overall trend has been broadly downward. Year-on-year (y-o-y) the BDTI has dropped 9.4%, from 646 to its current level.

We believe that the index will climb over the coming months through the end of 2013 and into 2014. The BDTI traditionally benefits from a pickup in the last months of the year, as the northern hemisphere enters its winter and demand for crude oil climbs. A large number of refineries around the world close for maintenance in the summer months, which further accentuates the benefit to tanker operators when they reopen in the autumn. Japanese shipping firm Mitsui OSK Lines (MOL), one of the world's largest operators of crude oil tankers (it also operates sizeable fleets in the other shipping sectors such as container and LNG vessels), stated in July 2013 that it expected demand for VLCCs - mega-vessels capable of carrying as much as 2mn barrels of oil - to increase by 10.5% sequentially from the second and third quarters of 2013 to the winter months of Q413 and Q114.

Nevertheless, although we expect a slight recovery, in line with the seasonal trend, we do not expect a lasting recovery in the crude oil shipping sector within the next 12 months, or further, because of the fundamental problems still facing the industry.

The overriding cause of the dirty tanker sector's malaise remains overcapacity in the global fleet. A glut of tonnage came online during the pre-downturn boom years and in the aftermath of the crash, coinciding with a drop in demand for seaborne oil. While this demand has recovered, the growth of the fleet, as operators seek cheap deals from slack shipyards, and the cost benefits from buying newly built eco-ships, has outpaced demand growth. The outlook for the global fleet and orderbooks will be examined in more detail in our accompanying piece on supply, but for the purposes of this overview the focus will be primarily on demand.

A Change At The Top
China & Us Total Net Oil Exports (Crude & Products, '000b/d)

The two key markets to look at when examining the demand outlook for global crude oil shipping are the world's two largest economies, the US and China, which, unsurprisingly, are also the two largest importers of crude oil. However, the two countries are following divergent trends with regards to their imports. While China continues to import ever greater quantities of crude oil, in line with its rapid economic growth, the US's demand growth has been negative, with imports into the country falling sharply. This divergence is having considerable effect on the crude oil shipping sector, and is also coming to bear on the oil product and liquefied natural gas (LNG) shipping sectors.

US Oil Imports To Continue To Fall

The fall in US oil imports is not so much a product of its sluggish (especially in contrast to China) economic expansion, but rather of the shale revolution in the US. Since 2009 the US has been in a sedate recovery mode. While growth has remained positive since an economic contraction of 2.8% in 2009, it has not exceeded the 2.8% rise achieved in 2012. We estimate 2013 growth at 1.8%, followed by 2.8% in 2014. From 2014 to 2018 we project that growth will average 2.5%.

This strengthening economic outlook would in most markets herald an increase in crude oil imports. However, the US is different from most other markets, especially developing ones such as China. From a peak of 12.59mn barrels a day (b/d) in 2005, crude oil imports in the US have declined as the country has introduced more efficient ways of using oil, and increased the use of gas as a result of environmental concerns. We believe that the consumption patterns in the US have gone through a structural shift over the past four years towards much greater fuel economy and efficiency.

This trend has been exacerbated hugely by the emergence of the shale gas and oil industry in recent years.

The number-one crude importer has become steadily less reliant on imports, thanks to advances in technology such as fracking and sideways drilling. Crude oil production in the US has surpassed the 7mn b/d mark, and we estimate that it will have reached 7.2mn b/d in 2013. The structural changes in US oil consumption, combined with rising domestic production - the boom in US unconventional liquids production is set to combine with higher output from the Gulf of Mexico (GoM) to push total liquids supply (crude oil, natural gas liquids, other liquids and refinery gains) to 13.3mn b/d by 2016. US imports of crude oil will continue to decline over the medium-to-long term as a result. In 2014 we forecast a decline of 7.5%, following an estimated drop of 12.1% in 2013. From 2014 to 2018 we project that average annual declines in US crude imports will be 5.2%. This is having a predictable effect on crude oil shipping to the US.

Suezmaxes Hit By US Decline

The US accounts for most Suezmax activity, as the smaller vessel class can dock at more locations compared to VLCCs. One of the key benchmark routes in crude oil shipping is the Suezmax trade route between West Africa (namely Nigeria) and the US Gulf, where the bulk of US refining capacity is located. The decline in imports from Nigeria is readily apparent when looking at figures from the US Energy Information Administration: an 18.3% drop during the economic crisis in 2009 was followed by a rebound of 26.4% in 2010. However, with the rise of the unconventional oil industry in the US the trend has returned to a downwards trajectory: 2011 saw a drop of 20.0%, from 373.30mn barrels to 298.72mn barrels. In 2012 US crude imports from Nigeria fell to 161.43mn barrels, a further drop of 46.0%. This trend was continuing into 2013, though it had slowed slightly on previous years.

US Shale Revolution Impacting Suezmax Rates
Suezmax Rate, US$/Day, West Africa To US Gulf

This decline in imports has hit the Suezmax vessel class hard. According to data from Poten & Partners, the average daily tanker rate for Suezmaxes sailing from West Africa to the US Gulf Coast was US$58,305 in 2008, just as the downturn hit, when crude oil shipping was booming. In 2009 rates fell by a dramatic 59.7%, followed by 4.5% in 2010, and 56.0% in 2011. There was some reprieve in 2012 when rates averaged US$13,875 a day, a gain of 40.4%, though it appears that this was short-lived. Rates so far in 2013 have averaged US$11,356 a day, and if this continues through the year it will mark a decline of 18.2% on those of 2012. Those VLCCs employed on this route have fared little better. The 2013 average rate for these vessels from West Africa to the US Gulf was US$15,480, barely more than the smaller Suezmaxes have been commanding.

Of course the surplus in the Suezmax fleet has as much bearing on rates as the US demand outlook. However, given the rise in domestic oil production identified above, we believe that US imports of oil will continue to decline. This will continue to impact upon the Suezmax trade from West Africa, driving down rates still further. If rates continue around their current level then operators of Suezmaxes will continue to suffer, and we may see tanker operators looking to restructure their debt obligations or even file for Chapter 11 bankruptcy proceedings as they struggle with consecutive quarterly losses. Euronav, the third-largest operator of Suezmax vessels in the world, stated that its break-even operating figure for 2013 was US$23,600 a day, more than twice as much as the current average rate. The company made a loss of US$85.9mn in 2012, and the outlook for 2013 is little brighter.

It is not only the declining US trade that is faring badly for Suezmax operators. In September the cost of sending one of the vessels from West Africa to north-west Europe hit a three-year low, as excess tonnage and little demand as a result of refinery maintenance made themselves felt. The vessel class has been further hit by reduced output from Libya, where protests saw oil terminals closed down for periods in 2013, halting trade and forcing exporters to declare force majeure.

China To Take Number One Spot

With the US the key market for Suezmaxes, China is the main market for VLCCs. These ships were among those ordered most during the pre-downturn years, as they were commanding massive daily rates of over US$200,000. Thankfully for the ships' operators, China's oil imports are set to continue to grow, despite a forecast slowdown in its economic growth. While this might not be quite sufficient to return daily earnings to their previous highs, the hope is that they should now remain positive. Nevertheless, with the prospect of a hard economic landing in China as it goes through painful rebalancing, there is considerable downside risk to our outlook. Any large negative impact on Chinese demand for seaborne crude would be disastrous for VLCC operators.

We believe that China will become the world's largest importer of crude oil in 2015 and overtake the US for the first time. We forecast it will import 6.31mn b/d of crude oil in 2015, compared with US imports of 5.73mn b/d. Growth in Chinese crude imports will average 4.4% per annum from 2014 to 2018, according to our forecasts, in sharp contrast to the falling imports in the US.

The Slowdown
China's Real GDP Growth, % Change, & Averages, 1993-2002, 2003-2012 & 2013-2022

This growth in Chinese imports is markedly less than the rise from 2009 to 2013, which we estimate averaged 11.8% annually. This is in line with our outlook on the Chinese economy, which we believe is entering a period of slowing growth. Following an impressive average real GDP growth rate of 10.3% per annum over the past decade, we forecast growth will average 6.1% between 2013 and 2023. The metal-intensive manufacturing and construction sectors will be especially hit as the economy moves from an investment-driven model to one led by domestic consumption. This will impact the country's commodities imports growth rate. This, in turn, could hit tanker companies counting on stronger growth in China than our forecasts.

China Crucial To VLCCs

Supertankers have been hit most by the overcapacity in crude oil shipping (vessel supply is to be examined in greater detail in our second overview piece for the sector). Rates have fallen dramatically as a result, with daily returns in negative territory for much of the first and second quarters of 2013. The average daily rate in 2008 for VLCCs transporting crude from the Persian Gulf to the Far East was US$96,246, according to Poten & Partners. To mid-July 2013 this figure was just US$10,112, following a 2012 average of US$18,787 - a drop of 46.2%.

Rates Remaining Depressed
VLCC Rate, US$/Day, Persian Gulf To Far East

Unsurprisingly, companies running VLCCs on the spot market have struggled to survive financially as these rates fall well below their required breakeven rates. Frontline, one of the largest VLCC operators in the world, with significant exposure to the spot market, gave its breakeven figure for the supertankers for the remainder of 2013 as US$25,000 in its Q113 results presentation - significantly more than the current daily rates. The company made a first half loss of US$139mn, driven largely by the US$120.3mn loss in the second quarter.

Through the end of 2013 and into 2014 we believe that the rates for VLCCs will pick up, benefitting from the seasonal uptick. As the orderbook for VLCCs comes in line with demand we believe that the sector will also benefit from a more lasting amelioration. One- and three-year time charters for VLCCs are at present considerably more than the current spot rate - around US$22,000-US$24,000 for three-years - indicating that the sector also expects an improvement in the medium term. Not all believe that this will be anything spectacular, however. John Fredriksen, the shipping tycoon controller of Frontline, said in September: 'I do not see any special things before at least another couple of years. At least for the crude oil tankers.'

This article is tagged to:
Sector: Freight Transport, Shipping
Geography: Global

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