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Spotlight: Freight rates spike to record highs, but likely to cool off quickly

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Spotlight: Freight rates spike to record highs, but likely to cool off quickly

Highlights

Freight rates eat into or shut long-haul arbitrage incentives globally

Spike due to confluence of mostly temporary factors

Platts Analytics sees freight rates easing quickly

VLCC rates have spiked to all-time highs as a number of factors -- from US sanctions on a Chinese shipping giant to ships going into dry dock for scrubber installations -- combined to reduce dramatically the effective VLCC fleet capacity. Rates for other vessel classes followed suit as charterers sought out alternatives.

The Arab Gulf-Far East VLCC rate was assessed at a record $65.53/mt (Worldscale 327.5) on October 14, while the WAF-Far East Suezmax rate hit a record $88.80/mt.

On September 25, the Trump administration sanctioned six Chinese companies for trading with Iran, including two affiliates of COSCO Shipping Co., setting off a frenzy as charterers that had booked tankers with COSCO looked to secure alternate tonnage. The Chinese shipping giant owns 42 VLCCs, representing 5% of the global fleet, in addition to dozens of smaller vessels.

The sanctions on COSCO follow the re-imposition of US sanctions on Iran and the discontinuation of waivers, which have left much of the fleet of Iran's shipping company, NITC, idle. NITC owns 38 VLCCs, some of which have been used by China for its purchases of Iranian oil despite the sanctions.

More recently, an oil major requested guarantees from shipowners that their vessels hadn't called on Venezuela in the past 12 months. While the US has not announced secondary sanctions (forbidding all business with actors who had done business with Venezuela previously), there is some concern that sanctions could be applied. If such sanctions were imposed, it would affect another 65-75 VLCCs, excluding the VLCCs already affected by the COSCO and NITC sanctions, or those owned by PDVSA.

Route Rate as of October 14 ($/MT) 1Q-3Q Avg. ($/MT) % Difference
Arab Gulf-Far East VLCC 65.53 9.73 673%
West Africa-Far East Suezmax 88.8 23.73 374%
Indonesia-Japan Aframax 28.18 11.68 241%
Arab Gulf-Japan LR2 44.48 22.15 201%
Arab Gulf-Japan LR1 41.94 23.96 175%
Arab Gulf-Japan MR 36.01 26.72 135%

Source: S&P Global Platts

Additionally, Platts Analytics expects approximately 60 VLCCs to head for dry docks in the fourth quarter ahead of the implementation of IMO 2020 regulations, taking more tonnage off the market. Each scrubber installation takes roughly one month. Finally, we estimate that 26 VLCCs are being used for discretionary floating storage, though many are older vessels and would likely be avoided by certain operators.

The factors affecting the global VLCC market also extend into other vessel classes. While COSCO only owns three Suezmaxes and 12 Aframaxes, rates for these have also rallied as charterers looked for cheaper alternatives using vessels in other size groups. VLCCs represent 42% of the total carrying capacity of the global tanker fleet, meaning large movements in rates trickle down quickly to other vessel classes.

Looking at clean tankers, COSCO's sizeable LR1 fleet caused rates for that size class to increase, and some clean LR2 vessels switched to carrying dirty products to capture the ensuing run-up in Aframax rates, reducing the effective LR2 fleet capacity in the process.

Marginalized Vessels Have Reduced Effective Fleet Capacity

VLCC Suezmax Aframax Panamax MR Product
COSCO 42 3 12 28 34
PDVSA 0 4 13 0 4
Iranian Tanker Company 38 8 5 0 0
Floating Storage 24 4
Venezuela Trading History ? ? ? ? ?
Planned Scrubber Installation in 4Q* 60 (20) 43 (13.3) 50 (16.7) 1 (0.3) 32 (10.7)
Total* 144 48 63 28 59
Total Fleet 792 586 1041 464 2027
% of Total Fleet* 18.2% 8.1% 6.1% 6.0% 2.9%

Source: S&P Global Platts Analytics.

*Scrubber installations take one month; one third of planned scrubber installation count used for calculations

Platts Analytics sees signs that the spike will come off quickly, even as freight rates remain elevated with significant tonnage still marginalized. First, the same oil major is reported to have fixed a Suezmax that called at Venezuelan ports over the last year. The market is likely to view that decision as a sign that restrictions on vessels with Venezuela trading history are unlikely in the near term.

Second, the higher freight rates are likely to make shipowners think twice about sending their vessels to dry docks to be fitted with scrubbers. That would ease tonnage constraints in the short term but further pressure high sulfur fuel oil cracks in 2020. Also, shipowners will increase their speeds in the hope of getting more fixtures at these elevated rates, which ultimately add tonnage to the market and reposition ships.

The rally in freight rates has eaten into or shut arbitrage incentives to ship crude to Asia, and while we expect the spike to be short-lived, we still expect FOB crude pricing to respond to lingering strength in freight rates. For example, India Oil Corp. said it was reducing its spot purchases following the increase in freight rates. Differentials for West African crude grades were assessed sharply lower last Monday (down 65-85 cents/b), offsetting some of the spike in freight rates.

For more Spotlight research published by S&P Global Platts Analytics go to http://plts.co/O3Xs50wHo6j

-- Jack Laursen, jack.laursen@spglobal.com

-- Ken Bogden, kenneth.bogden@spglobal.com

-- Sergio Baron, sergio.baron@spglobal.com

-- Edited by Jonathan Fox, jonathan.fox@spglobal.com

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