The drive to decarbonize shipping looks like it’s about to pay off in a big way — not for the environment, but for the owners of the tankers that carry the carbon: the crude oil, gasoline, diesel and jet fuel the world continues to burn in ever-larger quantities after it’s shipped ever-longer distances across the seas.
To decarbonize shipping, you either need an onboard carbon-capture system (which doesn’t exist yet) or to build new vessels that burn something other than fuel oil.
The regulations on this new fuel haven’t been written yet. So, why would tanker owners in the business of making money accept the residual-value risk of ordering ships that could be prematurely obsolete after the rules are written?
The answer is: They haven’t and they won’t. There is now a historically low number of crude and product tankers on order.
Tanker orderbook dwindles
The numbers are stunning. The ratio of crude tanker capacity on order to crude tanker capacity in service is now down to an all-time low of 2.7%, according to Clarksons Securities.
For very large crude carriers (VLCCs; tankers that carry 2 million barrels of crude), it’s a mere 1.7%. VLCCs are vital for transport of crude exports from the U.S. Gulf and the Middle East. There will be 910 VLCCs of all ages on the water by the end of this year. The number of new VLCCs to be delivered in 2024? Zero. The number to be delivered in 2025? One.
The situation is almost as severe on the product tanker side. The orderbook-to-fleet ratio for product tankers is down to just 6.1%.
How the tanker orderbook dwindled so low — and the profits this implies for owners of existing tankers — was a focal point of speakers at the 17th Annual Capital Link International Shipping Forum in New York on Monday.
“We are now seeing what happens when you go several years without investing [in new capacity],” said Jefferies analyst Omar Nokta.
Owners balk at ordering risk
Uncertainty over future rules on vessel propulsion is one reason more tankers haven’t been ordered. Another is that crude and product tanker owners only recently started making money again; 2020 and 2021 were the two worst years for the industry in three decades.
Yet another reason relates to the cargo itself.
There is a two- to three-year lag between when an order is placed and when a new tanker is delivered. These assets last 20-25 years. Thus, a newbuild ordered today will likely be in service in 2050. If the world is actually decarbonizing and shifting away from consumption of dirty fossil fuels, what are tankers ordered today going to carry in the latter years of their life spans?
“You’re going to be taking a lot of residual value risk. That is usually not a good recipe for long-term success in shipping,” said Ben Nolan, shipping analyst at Stifel. (Residual value risk is the risk that the future resale value will lead to a loss.)
To offset residual value risk, most owners want a shipper of the tanker cargo — a refiner or energy major or trader — to take a portion of that risk themselves by signing a multiyear charter agreement for the newbuilding.
“When you’re ordering a $100 million ship that ordinarily costs $70 million, you’d better be really sure you front-end load your economics,” said Nolan. “If somebody’s willing to give you a time-charter contract to cover your front-end economics, fine. If not, that’s a lot of risk.”
Four years ago, FreightWaves reported on the practical necessity that oil shippers back new tanker orders with long-term charters amid the decarbonization drive. Shippers still haven’t done so and show no signs of changing their strategy.
‘Nothing to do with capital discipline’
“Fundamentally, the lack of tanker orders has nothing to do with capital discipline,” said Bob Burke, CEO of Ridgebury Tankers. “There is no capital discipline in a market like this. It’s just not in our own best interest to order expensive ships with uncertainty over propulsion systems.
“For a ship that will be delivered two and a half years from now, at historically high prices, with a capital drag until delivery and when you don’t know whether the propulsion system is going to last very long, it is really hard for a shipowner to go out and take a flier on something like that without a charter from an oil company,” Burke said.
Maersk Tankers CEO Christian Ingerslev said, “If we look at the orders today, it’s people who have a tax incentive to do so or it’s somebody who gets backing from a longer-term charter, typically for a dual-fuel design. Otherwise, there’s nothing being ordered.”
According to Lois Zabrocky, CEO of International Seaways (NYSE: INSW), “If you order a VLCC in Korea it’s probably $120 million. Then tack on another $15 million to $20 million for dual-fuel LNG capability. That’s a really big number. That’s why you need a partnership to defray some of the risk.”
She said it would take a charter of seven years or more to incentivize a VLCC order. “We haven’t seen that,” Zabrocky said. “Other than the 10 VLCCs in the Shell project, no one else has done it.”
In March 2021, Shell agreed to seven-year charters on 10 dual-fuel VLCC newbuildings. Three were ordered by International Seaways, four by Advantage and three by AET. The first of International Seaways’ dual-fuel VLCC newbuildings, the Seaways Endeavor, was delivered this month.
The Shell deal elicited much fanfare at the time as a potential model for fleet renewal during the energy transition. So far, it has turned out to be a one-off.
LNG, container ship orders backed by charters
Commercial ships are built by yards in China, South Korea and Japan. Shipyards slots through 2025 are already virtually sold out with orders for new container ships and LNG carriers. High ordering in these sectors has jacked up pricing in other sectors such as crude and product tankers.
LNG carriers are ordered by shipowners with the backing of long-term charters from LNG cargo shippers. The duration of those charters is increasing, said Harrys Kosmatos, corporate development officer at Tsakos Energy Navigation (NYSE: TNP).
Charters backing LNG newbuilding orders were down to five to eight years in duration. “Now 10-year contracts are easily on the table,” he said.
Cargo interests in the LNG shipping sector “have realized that for an owner to make an investment in such a high-priced asset, at least a good part of its life needs to be covered by a decent return [through a time charter],” said Kosmatos.
Container-ship newbuildings are either ordered by liner companies or by shipowners. The vast majority of container-ship newbuildings ordered by shipowners are backed by multiyear charters from liners.
For example, the newbuilding program of liner company Zim (NYSE: ZIM) consists of vessels ordered by Seaspan and other shipowners that will be chartered to Zim for up to 12 years.
Tanker shipping used to follow the same model of charter-backed newbuilding orders seen today in LNG shipping and container shipping. It no longer does, leading to the current clash with owners’ newfound insistence on charter-backed orders.
The tanker business in the 1950s through the mid-1970s followed an “industrial shipping” model, author Martin Stopford recounted in “Maritime Economics.” Tankers were either owned by oil shippers or taken on multiyear charters from independent shipowners.
Charters backing newbuilding orders were for five to seven years in duration in the 1950s. In the 1960s “charters of 15 or even 20 years were not uncommon,” wrote Stopford. The widely used charter-backed newbuilding model was known as “shiukumisen” in Japan.
From an industrial shipping to a spot model
That all changed starting in the mid-1970s.
“The transport of oil changed from carefully planned industrial shipping to a market operation” — a spot business. “By the early 1990s over 70% of this [independent owner] fleet was trading on spot, compared with only about 20% in the early 1970s.”
The reason was that “the oil trade changed from the predictable trade for which transport was carefully planned … to a volatile and risky business in which traders played a substantial part. Transport was, to a large extent, left to the marketplace to manage,” explained Stopford.
Burke said during the Capital Link forum, “In the 1960s and 1970s, oil companies had long-term charters. The spot market was on the fringes. Then the oil companies figured out that it was cheaper to get their ships in the spot market. They had other uses for their equity and capital. So, a big spot market developed.”
Oil shippers were no longer there to provide charters to back shipowner newbuilding orders. “They didn’t have to because we always ordered new ships and hoped the market would go up. Then they took advantage of the lower capital costs. We just walked right into it. This time, we can’t.”
For orders to pick up this time, Burke argued, the tanker business “has to go back the other way” — reverting from spot to more industrial shipping.
“If I’m an oil company or trader, I’d be thinking, ‘If these guys [shipowners] aren’t ordering now, when are they going to order?’”
The answer, said Burke, is “we are not going to order.” If oil companies or traders want new ships “they’re going to have to step up and do something.”
‘We will be cash distribution machines’
Because yards are already full of container ship and LNG carrier orders, and because of construction lead times, there’s no way that a material amount of new crude and product tanker capacity can be brought to the market before 2026 at the earliest.
“Even if we deliberately wanted to ruin the market [by overordering], we couldn’t,” said Mikael Skov, CEO of product tanker owner Hafnia (Oslo: HAFNI).
Gross fleet growth percentages from new ships will be in the low single digits in both the crude and product tankers sector in 2024 and 2025. Meanwhile, a large number of older crude and product tankers are being purchased and shifted into the so-called “shadow fleet” for transport of sanctioned Russian oil. These vessels are effectively removed from Western trades.
According to Kosmatos, “New Russian trading patterns will absorb ships into the shadow fleet and we could be facing a situation in Western trades where growth could be negative next year in certain segments.”
Demand growth in both crude and product tanker markets is widely forecast to be positive and to exceed supply growth, leading to high returns for tanker owners, possibly boom-level returns.
“I have never seen it so good. The fundamentals of supply and demand are all in our favor,” said Burke. “There will be a shortage of ships.”
Anthony Gurnee, CEO of product tanker owner Ardmore Shipping (NYSE: ASC), predicted, “We will become cash-distribution machines.”
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