Outlook is looking pretty bleak for tanker owners across the board, as
tonnage oversupply will continue to dominate market fundamentals for
quite some time, no matter how fast ships are scrapped. In a recent
report, US-based Mcquilling Services noted that matters are only getting worse, as newbuilding tonnage continues to hit the water at a rapid
pace, while the demolition profile has vastly undeperformed
expectations.
As a result, Mcquilling tried to find out what would happen if the market took John Fredriksen's recent advice to scrap large crude tankers of over 15 years of age. According to Mcquilling's analysis, "a look at vessel inventory data through August shows that, only six VLCCs had been removed from the trading fleet, compared to our expectation of ten at this point in the year. For 2013, we projected that 15 VLCCs would be sent to the breakers or purchased for non-oil transporting projects such as conversion to floating storage, ore carrier or heavy lift vessels. However, the market environment indicates that even if this level is reached, fundamentals will not be rebalanced", Mcquilling Services said.
It added that "in the current demand environment, the excess availability of tonnage, stringent vetting requirements and technical restrictions, vessels that are 15 years of age and older are indeed the prime candidates for accelerated conversion or scrapping. A review of vessels that are actively trading shows that 59 VLCCs or 10% of the trading fleet falls into this category.
The removal of these vessels during the balance of 2013, combined with the year-to-date deletions, would reduce the trading fleet by 65 VLCCs. In our annual Tanker Market Outlook, we capture the interaction of tonnage supply and demand by evaluating the effect of influences on freight rates that can be observed in the marketplace. We calculate a surplus or deficit number of vessels for all classes by subtracting the estimated demand from the average annual tanker inventory available. Normalizing this result produces a Capacity Index (CI), a measure of the relative tonnage surplus or deficit of a tanker sector. A higher CI indicates an oversupply of tonnage while a lower shows the opposite. Since 2012, our reading of the VLCC sector has remained one of oversupply", Mcquilling noted.
It went on to add that "if owners heed the call for the 10% solution, the VLCC fleet would be reduced by 65 vessels in 2013 and the capacity index would steadily contract to 31% throughout the forecast period. Although the environment of oil demand has been altered, this move would bring the CI back towards 2008 levels. Our projection is based on the assumption that 15 VLCCs will exit the fleet on an annual basis between 2014 and 2017. Therefore it has the potential to be more pronounced if the trading lives of vessels are shortened", it said.
It continued: "In an effort to observe the impact of the lower capacity index on tanker rates, we put these numbers into our quantitative forecasting model. This uses the relationship between spot rates and the capacity index. The result of this analysis indicates a significant freight rate response to a reduced tonnage supply. This response may provide enough evidence to support the call for scrapping of vessels 15-years of age or older. In the three VLCC trading routes that we forecast AG/West, AG/East and WAF/East, the average increase would be 11 WS points or approximately US $17,000/day. The most significant rise in owners’ earnings would theoretically occur in 2014. The US $5,500/day difference between the required TCE of a VLCC traded for 15 years and one traded for 25 years is immaterial as compared to the expected variation that will be observed in the marketplace over the life of the vessel. The explanation for this lies in the effect of discounting the cash flows over time. The cash flows in the later years of the project make far less contribution that those in the early years.
As a result, the economic impact of shortening the vessel’s life is not as severe as might be expected yet the potential for substantially different TCEs than required during these years is high. Based on current market realities and the theoretical assumptions that illustrate early scrapping could substantially improve market fundamentals at little expected cost to owners, a swift and steady fleet trimming should occur. We are aware that like any business, tanker owners do not operate under an altruistic code so putting theory into practice will not be easy. For years the evidence has been mounting that the market was adopting new operating parameters.
This has been bolstered by vetting and technical requirements combined with swollen inventories from past orderbooks. However, even if these elevated deletions occur, further restraint will still be required. If available tonnage is trimmed and rates rise as forecast, increasing transit speeds will be tempting. Doing this would eliminate a portion of the gains by raising tonnage availability through reduced voyage times. Although the 10% solution will result in dearer transportation costs, charterers should also support this move as it will allay any concerns regarding owners cutting corners to save on OPEX. Sending a 15-year old vessel to the breakers in isolation will accomplish nothing, meaning collective action is required. Coaxing a collective action such as discussed in this note requires true leadership and our industry has a long history of producing leaders. Will anyone step up to the task?", Mcquilling Services concluded.
As a result, Mcquilling tried to find out what would happen if the market took John Fredriksen's recent advice to scrap large crude tankers of over 15 years of age. According to Mcquilling's analysis, "a look at vessel inventory data through August shows that, only six VLCCs had been removed from the trading fleet, compared to our expectation of ten at this point in the year. For 2013, we projected that 15 VLCCs would be sent to the breakers or purchased for non-oil transporting projects such as conversion to floating storage, ore carrier or heavy lift vessels. However, the market environment indicates that even if this level is reached, fundamentals will not be rebalanced", Mcquilling Services said.
It added that "in the current demand environment, the excess availability of tonnage, stringent vetting requirements and technical restrictions, vessels that are 15 years of age and older are indeed the prime candidates for accelerated conversion or scrapping. A review of vessels that are actively trading shows that 59 VLCCs or 10% of the trading fleet falls into this category.
The removal of these vessels during the balance of 2013, combined with the year-to-date deletions, would reduce the trading fleet by 65 VLCCs. In our annual Tanker Market Outlook, we capture the interaction of tonnage supply and demand by evaluating the effect of influences on freight rates that can be observed in the marketplace. We calculate a surplus or deficit number of vessels for all classes by subtracting the estimated demand from the average annual tanker inventory available. Normalizing this result produces a Capacity Index (CI), a measure of the relative tonnage surplus or deficit of a tanker sector. A higher CI indicates an oversupply of tonnage while a lower shows the opposite. Since 2012, our reading of the VLCC sector has remained one of oversupply", Mcquilling noted.
It went on to add that "if owners heed the call for the 10% solution, the VLCC fleet would be reduced by 65 vessels in 2013 and the capacity index would steadily contract to 31% throughout the forecast period. Although the environment of oil demand has been altered, this move would bring the CI back towards 2008 levels. Our projection is based on the assumption that 15 VLCCs will exit the fleet on an annual basis between 2014 and 2017. Therefore it has the potential to be more pronounced if the trading lives of vessels are shortened", it said.
It continued: "In an effort to observe the impact of the lower capacity index on tanker rates, we put these numbers into our quantitative forecasting model. This uses the relationship between spot rates and the capacity index. The result of this analysis indicates a significant freight rate response to a reduced tonnage supply. This response may provide enough evidence to support the call for scrapping of vessels 15-years of age or older. In the three VLCC trading routes that we forecast AG/West, AG/East and WAF/East, the average increase would be 11 WS points or approximately US $17,000/day. The most significant rise in owners’ earnings would theoretically occur in 2014. The US $5,500/day difference between the required TCE of a VLCC traded for 15 years and one traded for 25 years is immaterial as compared to the expected variation that will be observed in the marketplace over the life of the vessel. The explanation for this lies in the effect of discounting the cash flows over time. The cash flows in the later years of the project make far less contribution that those in the early years.
As a result, the economic impact of shortening the vessel’s life is not as severe as might be expected yet the potential for substantially different TCEs than required during these years is high. Based on current market realities and the theoretical assumptions that illustrate early scrapping could substantially improve market fundamentals at little expected cost to owners, a swift and steady fleet trimming should occur. We are aware that like any business, tanker owners do not operate under an altruistic code so putting theory into practice will not be easy. For years the evidence has been mounting that the market was adopting new operating parameters.
This has been bolstered by vetting and technical requirements combined with swollen inventories from past orderbooks. However, even if these elevated deletions occur, further restraint will still be required. If available tonnage is trimmed and rates rise as forecast, increasing transit speeds will be tempting. Doing this would eliminate a portion of the gains by raising tonnage availability through reduced voyage times. Although the 10% solution will result in dearer transportation costs, charterers should also support this move as it will allay any concerns regarding owners cutting corners to save on OPEX. Sending a 15-year old vessel to the breakers in isolation will accomplish nothing, meaning collective action is required. Coaxing a collective action such as discussed in this note requires true leadership and our industry has a long history of producing leaders. Will anyone step up to the task?", Mcquilling Services concluded.