Insight

The year 2022 was from the outset seen by many as the year we would finally see the VLCC market recover. After two years marred by Covid restrictions and challenging oil demand, this year started with greater freedom of movement for people across the world and OPEC committing to continuous oil supply increases. As the summer draws to an end, we have a clearer picture of how these changes have directly impacted the VLCC market through the first half of this year.

Looking at our proprietary data, we can compare the average monthly VLCC lifting numbers in the spot market for 2021 and the first half of this year. As oil demand and production have been rising throughout that period, we expect an increase in demand for VLCC tonnage and therefore, an increase in cargo counts in the segment. The data shows a definite boost. Globally we count an additional 27 monthly liftings in the VLCC spot market in the first half of this year compared to the 2021 annual average, and we are very close to reaching pre-Covid fixing volumes.

It is interesting to look at where these changes have occurred in more granularity. Unsurprisingly, the load area with the highest increase in volume has been the Arabian Gulf (AG). Many of the OPEC members that initially responded to the Covid-induced collapse in oil demand by cutting supplies are based in this region. This is also the region now returning oil supplies to the market at a steady pace. We count an additional 26 liftings per month from the Arabian Gulf alone this year. The data also shows a slight increase in volumes loading in the US Gulf with an additional four liftings per month. Much of this has been replacement barrels for Russian oil and has found a home in Europe, a route traditionally covered by smaller tanker segments when traded in lesser volumes. Simultaneously, we see a reduction in cargoes lifted from Europe over the period, as the region has kept supplies internal.

At the same time, Europe is topping the chart of increases in cargo volumes received into an area. This is off the back of a reduction in Russian oil taken following the country’s conflict with Ukraine. Traditionally Europe has not been a big receiver of crude oil in VLCC parcel sizes. However, this year has seen firstly a rise in oil imports into Europe and secondly a freight market that made the VLCC segment competitive relative to the suezmax freight market. We have also seen increased volumes into India, Singapore and other traditional receivers east of Suez. While China remains a significant taker of VLCC cargoes, the data shows an average of 5 cargoes per month fewer this year compared to 2021. This is down to them receiving more crude from Russia via pipeline and smaller tankers and due the country drawing down on inventories during a time of elevated oil prices.

It has been an interesting first half of 2022 in the VLCC market. Our previous blog discussed the change in crude flows into Europe, titled, “Atlantic crude flows drive change in VLCC tradelanes”, however, a positive takeaway from this piece, is that overall cargo counts are up, and not by an insignificant amount. 27 additional cargoes per month would employ more than 30 VLCCs full time if they were all traded between the AG and Singapore. Of course, some travel shorter distances and some travel further, but it is an indication that the market has seen the positive shift we expected at the start of the year, at least in terms of fundamentals. We need this to translate into a more dynamic freight market where tighter fundamentals dictate a sustained uplift in the freight market and a more profitable freight environment for shipowners.

For the past 12 months, we have seen zero new orders for VLCC newbuildings. This has left the orderbook at historically low levels and market fundamentals are pointing to several years of record low fleet growth – or even fleet contraction.

The last recorded order for new VLCC tonnage in the Tankers International Database is dated June 2021. This is more than 12 months ago and this is the result of depressed freight markets combined with booming returns in competing shipping segments. While tanker owners have been struggling with marginal profits since Covid-19 devastated the global demand for oil, shipowners in other segments have experienced golden years, earning healthy returns and leaving them with an appetite for contracting more tonnage. Shipyards have been quick to reach capacity building vessels such as bulk carriers and container ships, and we are currently looking at a delivery timeframe of 2025 or even 2026 to build a large vessel of VLCC dimensions. At the same time, limited yard availability has allowed shipbuilders to push prices up to $120 million to build a new VLCC, and the market has not experienced price levels like this since the tanker ordering boom in 2008.

Therefore, we have a clear view of any new tonnage that will join the VLCC fleet over the medium term. Compared to historical data, the numbers are very low. By our estimation, we expect a further 20 new VLCCs to join the fleet this year, followed by another 15-20 during the whole of 2023. And that is it. No VLCC deliveries are scheduled beyond 2023.

On the flip side, the VLCC fleet is ageing, and there is scope for a significant removal programme. 20% of the current fleet is aged 15 years and older, with 10% of vessels falling into the 18+ years age category. Even if a fraction of this pool of ships is sold for removal, we will see the VLCC fleet reducing in size over the coming years. For comparison, over the last 20 years, an average of 4% of the VLCC fleet has been removed per year. A fleet contraction will be welcomed by tankers owners in a market that has been dominated by tonnage overcapacity for a number of years.

While tanker demand is rising, as Covid-constricted oil demand is in recovery mode, there is still a way to go before there is total balance in the VLCC market. A reduction in fleet supply would get us to a fundamental equilibrium between demand and supply just a little bit quicker.

The Atlantic basin has not traditionally been a place where VLCCs pick up crude cargoes destined for Europe. These relatively short haul routes load in North and South America, West Africa and the Mediterranean for discharge in Northern Europe and are usually serviced by smaller oil tankers. This year we have seen VLCCs increasingly competing for this business resulting in a change to trade patterns for the segment. There are a number of factors that help to explain this situation.

Firstly, oil flows from Atlantic basin producers to Europe has increased. Crude flow data from KPLER clearly shows an increase this year, especially as we move into the second quarter. This of course is on the back of reduced crude flows into Europe from Russia. If we overlay this with Tankers International fixture data we note a sharp rise in VLCC liftings over the same period. In the second quarter of this year, we have counted an average of 13 inter-Atlantic VLCC liftings per month compared to historic figures of just 1-3 monthly liftings.

However, the increase in crude flows does not fully explain what has happened here, as this could have simply translated into a boom in the Suezmax and Aframax segments. This did occur to some extent. As Europe began to replace Russian crude with similar grades from suppliers in the Atlantic basin, freight rates for the smaller tankers spiked as demand went up. A relatively weak VLCC freight market meant that this segment became more competitive, even on these shorter routes, and VLCC fixing activity started to take off.

One question that arises is whether this represents a fundamental change to VLCC trade patterns going forward. The answer to this is not straightforward. If the crude flows into Europe from Atlantic basin suppliers remain at elevated levels, they will certainly provide a baseline for keeping a certain level of localised VLCC activity within the region. The swing factor is likely to be freight markets and the correlation between Suezmax and VLCC freight. Charterers will consider all options and, all other things being equal, choose the cheaper vessel.

The VLCC orderbook is at a historically low level, with the segment making up just 8% of the global trading fleet. This metric supports our positive freight market outlook for 2022. With many shipyards reporting limited availability in the next couple of years, it is unlikely that many new VLCC orders will be placed for delivery in 2022-2024. This means we have a good grasp of expected fleet additions for this time frame.

The VLCC orderbook is shrinking on the back of a slowdown in tanker contracting. This is driven by several factors. The oil tanker sector has gone through a period of very low earnings. Most VLCC owners have been far from breaking even on most of their vessels, making it difficult to justify investing in new tonnage. Secondly, the shortage of large vessel slots in reputable yards has pushed prices up. An earnings boom in the container and dry bulk sectors has encouraged contracting in these segments, filling up yard capacity fast. Another driving force is the uncertainty around the longevity of any engine design decisions made today and how to ensure newbuilt vessels will successfully navigate a low-carbon future.

With low fleet growth expected over the next few years the VLCC market is moving closer to an equilibrium between vessel supply and demand. Vessel demand has already started to see signs of a sustained recovery. The demand for oil is picking up across the world and OPEC and its allies are determined to maintain their original schedule of incremental monthly oil production increases.

As more oil is moved around the globe, the demand for oil tankers will benefit. We are optimistic about 2022 and believe that this is the year we will see a positive shift in the VLCC freight market.