VL-exit?

 

The current weakness has been essentially driven by the build-up of available tonnage, leaving charterers with healthy numbers to choose from.

 

However, is this a temporary blip or are there more fundamental forces at play? Perhaps, the best way to understand the current situation would be to examine the main drivers of the VLCC market both last year and so far in 2016 to see what has changed.

 

Back in 2015, the spectacular strength in all crude tanker markets (not just VLCCs) was underpinned by very limited growth in supply coupled with major gains in demand. Demand was supported by notable gains in Middle East crude exports and strong refining margins, which stimulated trade to existing and new markets, as well as commercial and strategic storage. 

 

At the same time, the overhang of crude oil production over demand not only “pushed” surplus barrels into floating storage but also resulted in sizable delays/inefficiencies in tanker transportation.

 

In the 1st half of this year crude tanker demand benefitted from a major increase in Iranian crude exports. In addition, floating storage continued to rise. At the end of May, the number of non-trading VLCCs (including tankers employed in storage of Iranian crude/condensate) reached 9.5% of the existing fleet. 

 

However, at the same time we are also starting to see stronger growth in tanker supply. The VLCC market has witnessed 20 new additions so far in 2016, the same as for the whole of 2015. Deliveries in the Suezmax segment have been more restricted, yet the Aframax fleet has seen the biggest growth, both in terms of new deliveries and “migrants” from the clean segment. 

 

Furthermore, the Suezmax and Aframax markets have “underperformed” so far this year relative to VLCCs, capping the earnings’ potential for VLCCs. 

 

Crude oil production disruptions in Nigeria have caused the most damage to Suezmax demand, but long haul crude trade WAF/East has also somewhat eased. Finally, tight tanker supply/demand fundamentals back in 2015 enabled owners to take advantage of falling bunker prices; this year charterers are gaining an upper hand and rising bunker prices are gradually eroding owners’ profitability.

 

What should we expect in the second half of this year? The pace of deliveries is expected to accelerate. Between July and December 35 VLCCs are scheduled for delivery, although some slippage is anticipated, taking into consideration the turmoil in the shipbuilding industry. 

 

Furthermore, the market may see NITC tonnage starting to compete for spot VLCC cargoes in the latter stages of 2016. 

 

On the demand side, any further increases in crude exports out of the Middle East will be supportive to trading demand; however, at the moment the scope for further increases appears to be limited. This coupled with the anticipated strong seasonal increase in oil demand, continued decline in US shale and ongoing production outages in a number of countries around and the world suggest that oil markets are likely to move to much closer balance in the 2nd half of this year. 

 

Although, inefficiencies in transportation and tanker storage are unlikely to disappear overnight; nonetheless, storage demand is expected to wane. 

 

All of the above indicate that VLCCs could face rough seas ahead. However, as with any forecast (including UK opinion polls), there is a degree of sensitivity. The actual decline in US crude production could be smaller than currently expected. 

 

The situation in Nigeria may improve, following the recent announcement of ceasefire with militants. Alternatively, Iran could beat market expectations once again and the country’s crude exports may register further strong gains. 

 

Any of these scenarios will help to maintain the overhang of crude production over demand, offering further support to forced and operational tanker storage and/or tanker trading demand. In addition, the presence of a mild contango structure in oil futures could at least provide a floor to short term VLCC rates. And last but certainly not the least is the prevailing owners’ sentiment, which can at any moment override any fundamental developments.