The "Freddy Krueger" scenario for the crude oil and product tanker owners has always been lower global demand growth, whether via some worldwide economic collapse or a game-changing cost breakthrough for non-fossil fuels.
The investor pitch for tanker equities in 2019 is that capacity growth is slowing just as the IMO 2020 rule – which will cap marine fuel and emission sulfur content – is nigh.
The regulation is expected to raise fuel costs, lower average ship speed, reduce effective vessel supply and increase demand for both crude and product transport – all else being equal.
But that ‘all else being equal' caveat is looming larger after a string of bearish reports on oil demand over the past week.
Barrage of warnings
On July 9, the U.S. Energy Information Administration (EIA) cut its estimate for 2019 global oil consumption for the sixth month in a row, and emphasized that demand growth in China is increasingly shifting towards natural gas liquids (NGLs), which are carried on liquefied petroleum gas tankers, and "away from transportation fuels such as gasoline and diesel," which are carried on conventional tankers.
If not for new NGL flowing to petrochemical plants, the EIA said China's liquid fuel demand growth in 2019 would be at low levels not seen since 2008.
On July 11, OPEC released its 2020 outlook, projecting that demand for OPEC crude would fall by 1.3 million barrels per day (b/d) or 4 percent year-on-year. It said that an extension of production cuts until March 31, 2020 was necessary to "avoid a destabilizing build-up of oil inventories."
On July 12, the International Energy Agency (IEA) dubbed demand growth in the first half of this year "exceptionally weak." It predicted that demand for OPEC crude oil in the first quarter of next year would "plunge" to a level not seen in 17 years.
Importantly for tanker markets, the IEA said that weak demand has pushed inventory stockpiles above the five-year average, implying that "any rebalancing [of supply and demand] seems to have moved further in the future." Stockpiles are the bane of tanker demand; if there's crude or products in storage, you don't need to ship as much in by sea.
Peak oil demand
In a new research note to clients, Stifel shipping analyst Ben Nolan warned, "There should be some help from IMO 2020 related to consumption growth, but beyond this one-time event, it does appear as though there may be structural issues with consumption growth."
One of those structural issues, he said, "is natural gas, which is eating into oil demand in developing economies and Europe. Should natural gas and NGLs remain inexpensive, the pace of fuel switching could accelerate."
Nolan cited the once popular idea of ‘peak oil,' which originally referred to the supply-side theory that the world would soon run out of oil. Peak oil supply is not happening anytime in the near or medium term given resources tapped with new technologies in countries such as the U.S., but the idea of peak oil demand is still very much alive.
"While the market is still at least several years away from peak oil demand, and markets like China continue to grow at more than 300,000 b/d, the idea of oil consumption falling is certainly on the horizon, and we suspect sooner rather than later," said Nolan, who added, "Peak oil lurks like a monster in the shadows."
"Longer term, this is likely to have a negative impact on the tanker markets," he cautioned. "If absolute consumption is falling, the constant growth of the fleet size is no longer needed, particularly in the crude tanker business, which is also subject to cannibalization by product tankers.
"While longer-term issues have little near-term bearing on equity markets, should oil consumption in 2020 grow by only 1 million b/d instead of 1.4 million b/d, it could mean only 1 to 2 percent tanker demand growth instead of 2 percent to 3 percent, against what is likely to be 2 to 4 percent supply growth," said Nolan.
As previously reported by FreightWaves, data from VesselsValue indicates that a significant amount of newbuilding supply remains to be delivered during the second half of this year, particularly in the category known as very large crude carriers, vessels designed to carry two million barrels of crude oil each. For there to be a sustained recovery in tanker rates, cargo demand needs to keep pace with these newbuilding deliveries.
Second half still positive
On a positive note, the recent oil sector reports did offer some upside perspectives on the second half of 2019, implying potential for near-term strength in freight rates.
According to Randy Giveans, shipping analyst at Jefferies, "The IEA expects refinery throughput to increase to 84 million b/d in the third quarter [from 80.9 million b/d in the second quarter]. As such, we expect tanker rates to strengthen into the second half of 2019 and 2020 as refinery maintenance ends and new refining capacity is added."
U.K.-based brokerage Gibson Shipbrokers acknowledged the "dark clouds" inherent in the recent IEA statements, but pointed out that the same report "indicates global refining runs could rise by over 3 million b/d in the third quarter versus the previous quarter, with Europe and Asia alone needing an extra 800,000 b/d each. Where will this crude come from? Some of the additional demand is likely to be met out of stocks, but mostly refineries will need to rely on increases in crude production and imports."
Given production cuts by OPEC and non-OPEC partners (OPEC+), Gibson believes "the obvious place to fill the net deficit is the U.S. Plenty of new pipeline capacity to the U.S. Gulf is expected to come online in the second half of the year, enabling further growth in exports. Incremental volumes are likely to flow to Europe and long-haul to Asia, more than offsetting ongoing restraint out of the Middle East. If that is the case, then OPEC+ production cuts could actually be good for [the tanker] business."
This argument echoes the one recently voiced by Petter Haugen, equity research analyst at Paris-headquartered Kepler Cheuvreux, who maintained that OPEC+ cuts merely subsidize U.S. exports, which travel two to three times the distance as Middle East exports and soak up two to three times the ship capacity. He further claimed that both OPEC+ cuts and IMO 2020 will raise the price of oil and refined products, which will provide more "headroom" for traders to buy and sell these commodities around the globe, a plus for shipping volumes.
Oil price casts shadow
Tanker equity investors do not yet appear to be entirely convinced of this argument, perhaps in part because the price of oil hasn't yet risen.
Even before the EIA, OPEC and IEA reports came out last week, there were ample concerns on demand, as seen in the downward pressure on oil pricing despite geopolitical tensions – such as the tanker attacks in the Gulf of Oman – that would have otherwise pushed pricing much higher.
The price of crude rose between January and April, and the stock prices of most listed tanker companies concurrently rose during the same period.
Between January 2 and April 24, the share price of Ardmore Shipping (NYSE: ASC) rose by 54 percent, Frontline (NYSE: FRO) by 43 percent, Scorpio Tankers (NYSE: STNG) by 36 percent, Euronav (NYSE: EURN) and Torm (NASDAQ: TRMD) by 31 percent each, and DHT (NYSE: DHT) by 30 percent. The stock of Diamond S Shipping (NYSE: DSSI) rose 20 percent between the date of its direct listing on March 28 and market close on April 24.
In April, it was speculated by some analysts that the tanker stock rise signaled an inflection point, driven by improved supply-demand fundamentals and the IMO 2020 catalyst.
But since April, the price of crude has pulled back despite a continuation of OPEC+ cuts and despite geopolitical tensions. Some of the tanker stocks, most notably that of Euronav
(NYSE: EURN) – the largest public tanker company in the world measured by market capitalization – have come down from recent highs as well.
The correlation between Euronav stock's pricing and crude oil pricing begs the question: If some tanker stock investors are using the crude price as a signal on future global demand concerns, will tanker stocks rise if and when IMO 2020, geopolitics or some other factor eventually pushes crude price back up? Or to put it another way: If fears on future global demand continue to put a cap on oil pricing, will that also cap tanker stocks?
Image sourced from Pixabay
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