Global trade in diesel and other refined petroleum products is evolving exactly as predicted. European Union and G-7 sanctions targeting Russian exports are forcing product tankers to sail longer voyages and sucking more ships into the “shadow fleet,” reducing effective transport supply in Western trades.
What comes next for already tight transport supply is also completely predictable.
The number of new product tankers on order is historically low. Given construction lead times and shipyards chock full of orders for container ships and LNG carriers, the world has no choice but to make due with roughly the same ocean transport capacity for diesel, gasoline and jet fuel until 2026, no matter what happens to global fuel demand.
If demand stagnates, problem solved. If it doesn’t, the world could conceivably face a replay of the supply chain crisis it just went through with containerized goods, only this time, with fuel.
It’s an ominous scenario for those worried about energy security. It’s a potential goldmine for owners of product tankers and investors in their stocks.
Russian invasion fallout ‘center stage’
“Clearly the EU ban on Russian oil products has been the most important driver [of the current market],” said Jacob Meldgaard, CEO of product tanker owner Torm (NASDAQ: TRMD), during a conference call Thursday.
According to Eddie Valentis, CEO of product tanker owner Pyxis Tankers (NASDAQ: PXS), “The Russian invasion of Ukraine continues to take center stage.”
The EU banned imports of Russian petroleum products on Feb. 5. With Russia now finding more distant buyers for its diesel and Europe finding more distant sources to replace Russian diesel, Torm estimates the “trade recalibration” will increase ton-mile demand by 7%. (Ton-mile demand is a measure of volume multiplied by distance.)
“This trade recalibration has already begun,” said Meldgaard.
It’s far from complete. March volumes are deceiving, because the EU prepped for the Feb. 5 ban on Russian imports by loading up on diesel early.
“The EU started to prepare for the ban ahead of the final deadline by importing higher volumes from non-Russian sources, especially the Middle East and India,” explained Meldgaard. ”At the same time, the EU continued to import high volumes from Russia, basically until the very start of the ban.”
Europe topped up its inventories and as a result, “import needs are currently lower,” Meldgaard continued. However, “inventories will need to be rebuilt again, increasing import demand over the coming months.”
Valentis said during a conference call Wednesday, “Inventories have been built up in Europe. This pull-forward of demand is viewed as temporary and high inventories should be unwound in the second quarter.”
Shadow fleet keeps growing
Meanwhile, Russian diesel exports continue to flow. Cargoes are moving on Russian tankers and vessels in the so-called shadow fleet, comprising ships with opaque ownership that operate outside Western financial and insurance regimes.
According to Meldgaard, “Russia has been quite successful in redirecting its clean products to markets in North and West Africa, Turkey, the Middle East, and lately, Asia. Considering that around two-thirds of Russian clean petroleum products originate from Baltic Sea ports, these changes have resulted in solid ton-mile increases.”
The shadow fleet continues to expand as older tonnage is purchased and redirected to the Russian trade. According to Cleaves Securities, “The tanker S&P [sale and purchase] market was dominated by MR [medium-range] product tankers. There were more sales this week than we could count. As usual, mostly older tonnage is being sold.”
With more product tankers pulled into Russian trades, fewer are available to serve non-sanctioned trades, tightening the supply-demand balance in those markets.
Meldgaard pointed to another factor reducing effective ship supply. “Owners that are willing to do Russian trades are also willing to wait for these higher-paying cargoes, which is, again, tightening vessel availability.”
Spot rates high despite EU pause
Product tanker rates are now highly profitable despite the negative effect of high EU inventories. This raises the question: What happens when Europe needs to refill its tanks again?
According to Clarksons Securities, spot rates for modern-built, fuel-efficient LR2 product tankers (with capacity of 80,000-119,999 deadweight tons or DWT) averaged $62,500 per day on Thursday.
Spot rates for LR1 tankers (55,000-79,999 DWT) averaged $46,600 per day. Rates for MRs (40,000-54,000 DWT) averaged $37,800 per day.
Spot rates have not been this high at this time of year for MRs, LR1s and LR2s in the past five years. Current rates are double or more the five-year average.
Historically low orderbook
Looking forward, the product tanker market is in the same situation as the crude tanker market. The orderbook for new vessels is historically low. Stifel analyst Ben Nolan called the tanker orderbook numbers “shockingly small.”
There is no possible way to materially increase the product tanker fleet size until 2026 at the earliest. Yard slots are already full of orders for container ships and LNG carriers.
A side effect of the COVID-era supply chain crisis was that it enriched container shipping lines, which used a portion of their windfall to order a tidal wave of new container ships. That inflated prices for newbuildings in other segments like product tankers and simultaneously soaked up available yard slots in Asia.
Clarksons puts the current ratio of product tanker tonnage on order to tonnage on the water at just 5.9%. Valentis at Pyxis Tankers expects net fleet growth to be under 2% per year for the next two years.
According to Meldgaard, “Very few product tanker positions [yard slots] are available by the end of 2025. And in China, even the 2026 orderbook is being rapidly filled up [with orders for other ship types].
“We have our own view on what the realistic shipyard capacity is in 2025, 2026 and 2027,” he explained. Torm believes that even in the “extreme case,” where product tankers took all the slots available given ordering in other shipping segments, “there would still be a very manageable orderbook.”
“I think it is totally plausible that the additional fleet growth will be subdued up to and including 2026. Then, when you get past that point, the portion of the fleet that needs to go to recycling increases dramatically.”
On Thursday, Torm reported net income of $228.9 million for the fourth quarter of 2022 compared to a net loss of $8.1 million in Q4 2021. Adjusted earnings per share came in at $2.83.
Torm’s LR2s earned an average of $58,889 per day in Q4 2022, with 90% of available LR2 days in Q1 2023 booked at $62,950 per day.
The company’s LR1s earned $48,067 per day in Q4 2022. In the first quarter of this year, 86% of available days are booked at $44,135 per day.
Torm’s MRs earned $45,029 per day in Q4 2022, with 89% of days booked in the current quarter at $37,730 per day.
The historically low orderbook and the potential for future windfall profits is no secret to shipping investors. Shares of Torm and other product tanker owners have performed exceptionally well.
Torm’s stock has more than quadrupled over the past year, surging 336%. The stock closed up 9% on Thursday.
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