Crude tankers come in a variety of sizes and uses, but investors typically talk about three main classes; Aframax, Suezmax, and Very Large Crude Carriers, or VLCCs. Each can carry about 750k, 1m, and 2m bbl of oil, respectively.
These vessels typically deal in a relatively inelastic product making for consistent and predictable demand side gains. But recent Black Swan events (C19 and Saudi Arabia flooding the market with crude before retreating) have made for some very exciting times.
Nevertheless, two things can be certain; demand normalization will occur again and when it does the supply side will dominate the outlook once more.
Before we get started it’s important to review a key concept; the relationship between vessel deliveries and future rates.
Source: Clarksons SIN
Notice the inverse correlation between vessels deliveries and time charter rates – with a bit of a lag time. This proves that supply side adjustments play the primary role for this segment which deals in (typically) inelastic products.
For a thorough academic study on the influence of supply on shipping please see Alexandros M. Goulielmos (2017) The “Kondratieff Cycles” in Shipping Economy since 1741 and till 2016.
As you can see in the chart above we have recently witnessed a lot of tonnage hit the market. But, when it comes to crude tankers, it’s likely that this influx should be perceived as a sort of 2002 type event rather than a 2008 type situation. Again, look at the chart to see the radically different rate outcomes.
The supply side will be a key component in making this determination regarding the expected outcome.
Finally, what shouldn’t be lost is that during both times cited above we were exiting the DotCom Bust and the Great Recession. Again, radically different outcomes based over this period with supply sides holding the greatest weight.
Vessel Orderbook
The orderbook is composed of newbuild vessel contracts which are under construction. In other words, it is the future supply. Given the lengthy nature of shipbuilding, orders placed today may not hit the water until 2023 or later for the larger VLCC class. This provides a great deal of clarity for the most influential aspect of shipping.
Typically an orderbook representing less than 15% of the current trading fleet is a good thing. Less than 10% is bullish given normal trading patterns.
Source: Data Courtesy of VesselsValue – Chart by Value Investor’s Edge
Two exceptionally rare things are happening here; an orderbook if just 8.3% and zero deliveries scheduled for 2023.
In fact, the VLCC orderbook is at its thinnest mark this century.
Source: Clarksons SIN
It’s at this point where I will ask the reader to once again recall the inverse relationship between vessel supply and rates.
Below we see that future deliveries are expected to remain acceptable over the foreseeable future in terms of numbers in the Suezmax class as well.
Source: Data Courtesy of VesselsValue – Chart by Value Investor’s Edge
However, when we break it down by quarters and months we see that 2020 is heavily back weighted while 2021 is heavily front loaded. This means that Q3 of 2020 through Q2 of 2021 will see a greater pace of deliveries. This could prove to be a brief headwind as the market works to absorb this tonnage.
Nevertheless, the orderbook remains at a relatively thin 11.5%. We must use the term relatively as a qualifier as other tanker classes do have significantly better supply side prospects, but for the Suezmax class this anemic orderbook is a rarity.
Source: Clarksons
At first glance all seems well with the Aframax orderbook.
Source: Clarksons SIN
At just 9.2% the orderbook is at one of its lowest points in decades.
However, Aframaxes should be preparing for a bump in the road in 2021 which is when a vast minority of this tonnage is set to hit the water.
Source: Data Courtesy of VesselsValue – Chart by Value Investor’s Edge
This influx of tonnage is coming at a less than ideal time as the world will likely still be engaged in a recovery effort with demand yet to fully recover.
If there is a bright spot it’s that 27 of those expected 38 deliveries in 2021 are taking place in the second half of the year. Not only will seasonal strength help absorb this abrupt influx more smoothly but there also exists the possibility of slight delays (known as “slippage” in shipping circles) pushing some builds out to 2022, painting a far more palatable chart.
Either way, this situation is short term while the set up for the market continues to look fairly promising from that supply side driven cyclical standpoint.
Newbuilds
What’s further reinforcing these longer term bullish expectations is an ongoing aversion to placing newbuild orders.
Source: Data Courtesy of VesselsValue – Chart by Value Investor’s Edge
Given that the recent economic collapse has placed a premium on strong balance sheets (just look at broad market stock price performance for proof), newbuild orders may continue to take a back seat in favor of financial stewardship.
Aside from that we have seen the prospect of IMO 2030 coming into play which will likely address particulate matter and carbon emissions. Without clarity on that front owners may hesitate placing new orders out of the fear they may face expensive retrofits down the road. Retrofits that could have been addressed in the shipyard for much less during the newbuild process had they waited.
Finally, the average age of the tanker fleet continues to climb with Afras and Suezmaxes at 10 years and VLCCs approaching that same mark. This signals a decent number of demolition candidates which should help keep the market tight and also act as a relief valve during times of abnormally low charter rates.
Conclusion
Supply side fluctuations create the most volatility in crude tankers, outside of rare Black Swan events. A return to economic normalization brings with it a return to the supply side dominated outlook for crude tankers.
Currently, the supply side outlook is the best it has been in over two decades. Short term shocks and fluctuations should eventually give way to longer term structural fundamentals. That shift should not only inspire a bit more optimism but also stability.
This tightening supply cannot be solved overnight. Vessels take years to build and require enormous financial commitments. The current environment is not conducive to large scale newbuild ordering which should keep future supply under control for a bit longer.
While the short term outlook is still a bit sketchy due to the dynamic nature of the pandemic, the medium to longer term outlook for tankers presents a very firm case for an improving market through the first part of the decade.
