While the spot market languishes, the timecharter market hints at increased optimism, writes Tim Smith, MSI
The tanker market continues to witness difficult conditions due to the aftermath of the huge drop in oil demand in 2020 and the associated build-up in stocks. Inventory builds have a delayed effect on the tanker sector – initially they are positive but there is often a ‘hangover’ for the market after the inflow from destocking.
As noted in the latest MSI Quarterly Market Report, as stocks are drawn down, they substitute import requirements, effectively removing demand. The reduction in floating storage exacerbates this, re-introducing tonnage into the market.
Chart 1 shows this ‘inventory effect’ in action, comparing movements in total OECD industry stocks (crude and products) with the Aframax 1 Yr T/C rate. We can see that the fluctuations in both variables broadly correspond, stock builds in both 2014/15 and 2020 corresponded with extreme over-supply and declines in the crude price.
Tanker markets responded positively, but it was not a sustainable improvement. In both cases market conditions quickly turned as stocks peaked then reversed. In fact, the declines in tanker market earnings came quickly, once stocks had stopped building.
Stock levels, or more specifically flows, are not the only factor driving tanker market earnings. However, they do illustrate the intertwined nature of the oil market – draws and builds reflect and react to refiner, producer and consumer behaviour and dynamics. High oil prices in Q2 are related to improving oil demand and OPEC+ production restraint. These are both supporting stock draws and restricting oil trade flows.
One feature of Chart 1 is that, despite the continued bleak conditions in the spot market, tanker 1 Yr T/C rates have arrested their decline, and even started to increase in Q2. We have seen deals concluded on significantly improved terms for owners in recent months. Clearly these rates are reflecting the market sentiment that conditions are going to improve, and that the second half of 2021 could look markedly different to the first.
The period market has stabilised and posted some modest upward momentum in Q2. This is at a higher level than the previous trough in 2018. Comparing 1 Yr T/C rates for crude and product tankers in May 2021 versus May 2018, they are approximately 24% and 17% higher respectively.
For the tanker sector, high oil prices have not been positive. As predicted last year, the drawdown in stocks associated with a demand recovery (and restricted production) is proving negative for the market.
Chart 2 compares our forecast for VLCC 1 Yr T/C rates from the same time last year with our current outlook.
Overall, our track record over the last 12 months has been very good, accurately predicting both the timing and magnitude of the downturn.
2021 is expected to be a year of extreme ‘internal’ dynamics, like 2020, but reversed. We are potentially going to witness some of the strongest oil demand growth ever seen in the modern era during H2 21, as the world (hopefully) transitions towards more normal conditions.
Annual average data and forecasts mask some of the impact of this, but beyond 2021 we see the sustained improvement in the market more clearly. Next year an acceleration in annual average demand growth combines with much more manageable supply-side dynamics. Assuming our scrapping assumptions are correct, fleet growth will start to contract further out, allowing for continued improvement in the tanker market despite limited demand growth.
For 1 Yr T/C rates this translates into continued increases in earnings. From a demand-side perspective, we are now in the COVID recovery phase where we expect strong demand growth to be tempered by available fleet growth in 2021 and 2022.
The market will see fundamentals change direction and over the longer-term we enter a demand-side environment shaped by the energy transition. Oil demand growth will decelerate, resulting in lower tanker demand growth. However, we continue to expect the supply-side to be very constructive, with high tonnage removals supporting improving market utilisation, and ultimately driving annual average earnings higher across the forecast.