A Tanker Tantrum: Post- Hormuz VLCC markets

Altered trade flows, raised supply chain vulnerabilities, new trade terms and pricing frameworks will mould tanker markets for the long term. While Hormuz and Bab al-Mandeb dominate news, a network of narrow waters worldwide is exposed to geopolitical risks.

Which long-term trends will prevail? How will they change freight and asset values? A word to the wise: errors compound in long-range forecasts. All deterministic models suffer from choices we make at breakpoints. Scenarios offer comfort. But a false promise when probabilities are unavailable or unreliable, as they are today.

Arguably, and at the risk of being provocative, we expect:

VLCC ownership to consolidate further, bypass independent owners, and up-rate younger tonnage. 

Major mid-eastern crude producers will control larger fleets than they do now. Those not in the game will get into it. 

Risk mitigation for a future where chokepoints remain contested flashpoints will make a case for itself quite easily. Being able to sell and price cargoes on a delivered basis will also become a competitive advantage until that itself is competed away.

Outright acquisitions must form the backbone of future control. Recently exposed limitations of time charters include having to adopt the risk profile of the head-owner and their insurers. Sovereign cover for owned and controlled fleets offsets some of these.

The demand impulse for tonnage will favour young and modern ships. The older vintage of the tanker fleet throttles supply of such vessels (see chart 1 and 2). The trend vector will therefore provide long-term support for asset values.

In practice, time charters must also play a part in a balanced control portfolio. They need less upfront capital and are quicker to do. That makes a case for a higher floor for long-term time charter rates for younger modern tonnage too.

Large buyers of oil will want to control more moving parts of the oil supply chain in a world where risk likely will remain elevated. 

Independent owners trading their fleet in the spot market want to be rewarded for risk – usually at a multiple to the costs to insure against it. When risk events are episodic, the paying party accepts associated cost as a part of doing business.

But if risks become structural, the marginal cost associated with it will be squeezed out.

Japanese refiners have long held time charter fleets. China’s state-owned companies have de facto control, which will likely morph into more overt control.

India’s refiners, SE Asian and South Korean crude buyers, among others, will be motivated to do the same. Models will differ, but the effect will be the same: upward pressure on time charter rates and asset values for younger tonnage.

Commercial drivers will motivate producer consolidation over and above security of supply. Shipping at scale permits more FOB purchases, aids in price discovery, and enables profits from arbitrage opportunities.

A more inefficient fleet will add another layer to producer consolidation. 

Consolidation alone is unlikely to be a game changer because it will be limited in scale. Merchant tankers are soft targets, notwithstanding ownership. NOCs will likely bias capital allocation for pipelines over ships and hardening and protecting production infrastructure over pipelines.

It will therefore be enough to own tonnage that is sufficient to evacuate oil to safety, not necessarily deliver it to destination.

Safe locations are intermediate onshore storage sites outside of choke points, or even ship-to-ship transfer sites. That will mean additional port and STS days added in double-handling cargo parcels moving across choke points.

Inefficiencies will also show up in the inability of a consolidated fleet to cross-optimize. When ownership is fractured and profit maximizing, the tanker market is highly efficient. Perfectly competitive even. Less so when ‘security of supply’ starts to dominate decisions.

Change in ownership structure will impact spot and futures markets for freight.

Our hypothesis, extended to markets, implies a likely thinner market for spot cargoes. That market will be used mainly to clear the few ‘spillover’ cargoes that remain.

A thin spot market will also be more volatile. While independent owners gained from volatility in the past because they had enough ships in position to ‘ride the wave’, future volatility will be backed by fewer cargoes. That will disadvantage independent owners whose relatively smaller balance sheet needs the outsized impact of long surges to make investments work. That is especially true now when capital required to build a VLCC is a third higher than a decade ago.

As in the oil market, price discovery in VLCCs will need to involve a larger, more liquid futures market. Enablers of that will become more aligned. Independent owners famously do not trade FFAs (Forward Freight Agreements). However, when freight is a cost, not revenue, stakeholders are more likely to hedge their risks. Derivative markets can send powerful signals when deep and liquid.

VLCCs will regain earnings primacy. 

The Russia-Ukraine war transferred earnings power to Mid Sizes over VLCCs. After the outbreak of war, Aframaxes’ Time Charter Equivalents (TCE) averaged at par or above VLCCs (see chart 3). This was a break from the pre-war trend when median Aframax TCE was >40% below that of the VLCC. This crisis will reverse the trend.

3: VLCC VS AFRAMAX TCE ($’000/D)

4: Crude Imports For Stockpiling (Mn B/D)

The broad drivers underpinning the hypothesis are:

– The trivial one is that the risk premium for VLCC freight will sustain for the long term due to contested waterways.

– VLCC voyage lengths will grow; Asian buyers will ease dependence on Middle Eastern crudes, buying more widely.

– Bypasses that avoid the Strait of Hormuz will, on average, take the oil farther away from Asian buyers.

– The salutary driver, however, will be a sustained urgency to refill stockpiles. This will supersede the undercurrent of consolidation for some time.

Onshore stockpiles drew at a rate exceeding 2m b/d between March and June by our estimate. Easing of flows through the Strait of Hormuz will accelerate the draw as demand will surge before supply does.

Not only will draws need to be rebuilt, but future stockpile levels will also be higher. We expect rebuilding flows to translate into a circa >1mn b/d increase in crude trade for three years. The timing is uncertain, though it is certain to follow a resumption of flows from the Middle East.

*Anoop Singh is Global Head of Research at Oil Brokerage Ltd