Occam’s Razor Revisited

The greatest number of mistakes in shipping are committed at the top of the cycle.  It is just that the realization of these errors take place at the bottom.  Flush with cash in 2020 and 2021, liner owners clearly ordered too many new vessels.  In many cases, for propulsion they chose dual fuel LNG vessels, which make no sense in 2022 in a world in which natural gas outside of the US and the Middle East is in short supply.   These ships will likely burn VLSFO instead of LNG for the next four years, with the additional cost of dual fuel engines a waste of cash.  As well, as the supply chain normalizes, less capacity is needed. According to the Wall Street Journal (Saturday, October 22, 2022), with demand slipping, shipping lines have canceled between 26% to 31% of their transpacific schedules in the coming weeks.  Many of the publicly traded shipowners used demand in 2020 and 2021 to sign long-term charters, so are likely fine until the new capacity is digested.  On the other hand, the correct decision for liner companies, which few made at the time, would have been to return cash to shareholders or to delever.

Right now, LNG shipping rates are at historical highs and clean and dirty tanker rates have risen to levels not seen since 2020. As noted in the October 21, 2022 Poten Tanker Opinion, “Without restrictions, commodity flows are optimized based on relative prices and shipping distances.  Once restrictions such as sanctions or complex regulations are factored in, the free flow of commodities will be compromised, and friction is introduced into the system.” Ton miles increase, and effective capacity declines.  If China is reselling US LNG to Europe, shipment distances increase and vessel availability shrinks.  There are low order books in both the product and crude tankers, mainly because rates since 2020 have been abysmal. Currently we are worried about the large LNG orderbook.  Ships are ordered in anticipation of new plants going into service.  The vessels are delivered on time, while the plants can be delayed for years. We won’t know if that will be the case until much later.

In the meantime, we are investing in fog for the next few months.  European oil sanctions are scheduled to go into effect December 5th and February 5th.  The G7 price cap will be introduced at the same time.  The Biden administration is in a difficult position.  If they introduce export restrictions on distillates, they will undermine Europe and South America security, since these countries currently purchase American products.  Shipping usually develops along the lines of Occam’s Razor, i.e., moving goods in the shortest distances.  When the goods must travel much farther or the disrupted time periods are too brief as in 2020, investors must be alert to the opportunities and dangers. Uncertainty, as we see daily in the news, is not disappearing any time soon.