By Henry Curra
Risks to our outlook
We still see ourselves in the midst of a cyclical tanker market upturn that has years to run. But recent revisions to our forecast say more clearly than ever: if you are in the market, enjoy the ride or charter out before term charter rates fall further. If you are out, wait.
But we could be wrong. Here are some common challenges to our key assumptions.
1. Charterers will need to, and will, fix older ships. Taking a dim view on future tanker demand, as we do, our forecast places great emphasis on a slow growth of tanker capacity. We are expecting the modern (<15yr) tanker fleet to shrink much faster than demand over the next 5 years. As the scarcity of modern ships increases, it will cost more to hire them. In some circumstances charterers will take inflation on the chin - particularly where high emission penalties – for instance on most European trades – attract the efficient ships. In others they will simply continue to relax their restrictions on chartering older units. Tighter supply of modern ships will support a high floor on freight prices, and greater tolerance of older ships will provide a ceiling. Within the next couple of years we expect to see a 19 year old ship, for instance, moving around two thirds as much oil as a 13 year old ship. Pre-COVID it would have done less than half the work of the younger ship.
But we could be wrong. An upside risk to our outlook could be that we underestimate the reluctance of risk departments to tolerate older units. If so, freight rates would be governed more by the shortage of younger ships and less by the growing surplus of older units. Equally, an oil spill from an older unit would probably provoke a quick clamp down on substandard shipping . This will (often unfairly) be viewed as a function of a ship’s age. Alternatively, a downside risk could be that today’s users of really old ships - typically exporters subject to trade sanctions - could see exports fall. This might happen because a growing surplus of crude tempts the West to enforce stricter sanctions. Older ships would then be more price competitive, and become better utilised in the international spot market. Many eastern charterers will have already considered fixing ships over 20 years as regulations push efficient ships westward. The less relevance age holds in determining how much cargo a vessel moves, the more quickly we return to long-term oversupply. A well-maintained tanker should, after all, be able to trade well into its 20s without any obvious risk increase to cargo or crew.
2. Recently active tanker newbuilding ordering is calming down. In our modelling of supply and demand, any tanker orders from now on for 2027 delivery will weaken the tail end of our freight outlook. We assume that ordering for 2027 delivery will slow down because owners are growing more concerned about delivering into a weak market. Also because we don’t expect yard prices to fall. As China’s share of global shipbuilding grows, it will gain pricing control. Ordering offshore and container ships should continue to soak up tanker slots in 2027. Steel prices could fall because of weak Chinese demand, but labour cost will continue to rise, frustrating yard’s efforts to reduce costs.
But we could be wrong. The downside risks here would appear to outweigh the upside. Owners are optimists by nature. Their coffers overflow with cash. Given today’s elevated second-hand prices for all but the oldest units, new ships are the best bet for entering (or staying in) the market. Yard capacity, particularly in China, is growing - keeping competition alive. In addition to established yards starting to build tankers, new Chinese builders are emerging every month. Nee yards are unlikely to build tankers for non-Chinese owners from the start, but they could cut their teeth on domestic projects. 2027 still has plenty of slots to be filled. We are perhaps asking too much of other shipping sectors to keep them busy, especially given the poor prospects for containers should the China/US trade spat worsen (perhaps under a new US administration in November) or Red Sea transits become safe. Weak container markets could let tanker orders jump ahead of them in the build queue, potentially raising deliveries in 2026. On the other hand, either US administration could pull something out of the hat to slow Chinese deliveries – something US and Canadian shipbuilding unions have been pushing hard for in recent months. Certainly, some owners have been trying (unsuccessfully so far) to add cancellation clauses in their Chinese newbuilding contracts should the US impose financial sanctions on China. Others are buying insurance to cover it.
3. Scrapping will be largely immaterial over the next five years. For as long as owners are rich and optimistic they will not scrap their ships. Old ships will hang around for several years, if just to see what happens. Most owners are undertaking costly surveys at 20 years and even 25 years. This will allow the global tanker fleet to grow nearly 11% over the next five years. there will be plenty of older units to absorb demand shocks from, say, an expansion of floating storage employment or a blockade of key trade routes.
But we could be wrong. The upside risk is that ships scrap earlier than we think. There is plenty of beach space to absorb vast numbers of tankers, even if containers join the rush to exit. The average tanker scrap age during the last busy scrapping year (2018) was just 19 years old. Today well over 20% of the tanker fleet is over 20 years old. An oil spill on an old substandard ship could produce legislations that forces them out of the picture. An indefinite contraction in demand, coupled with higher environmental penalties, could drive a tanker to the scrap yard even in a strong market (for younger tankers). There is little downside risk to our assumption. Our model ignores vessel scrapping, focusing instead on reducing ‘useful capacity’ as vessels age
4. Geopolitical tensions sustain today’s inefficiencies in tanker trades. Europe’s embargo of Russian oil initially lifted tanker tonne-miles by 7%. It has since given a little ground as Russian oil exports have eased, but Russian trade remains the single most influential inefficiency in today’s tanker market. It will remain that way for the next 5-10 years, we say. In the Middle East, the shipping industry has brushed off the effective closure of the Suez Canal. The longer routing around Africa has added another 2% to tanker tonne-mile demand, we estimate. Tankers will probably be the first to return to the Canal once the Red Sea opens to shipping. But it could be a long wait. We estimate two years at least. Growing political and social unrest in the countries surrounding the Red Sea will sustain the region’s lawlessness.
But we could be wrong. Europe is understandably reluctant to return to heavy reliance on a single energy supplier, friendly or otherwise. But oil traders have other ideas. They will continue to exploit legal loopholes to maximise returns. Moreover, once peace returns to Ukraine, Europe will have a moral responsibility to channel Russian oil revenue into reconstruction projects. The more Russian oil moves to Europe, the more control Europe will have over the process. Trump says he can settle the conflict within 24 hours if elected in November. Though improbable, it is a downside risk. Similarly, a surprise breakthrough in the Israel/Gaza peace process could in theory (but again likely not in practice) spell an early end to Houthi attacks on Red Sea shipping.
5. No new geopolitical events are identified that will interfere with tanker trades during the forecast period. Unforeseen events are, as one might expect, tricky to foresee. There is little doubt that a more assertive China, the de-globalisation of world trade, climate change, and a tendency to elect populist governments bode ill for international relations. But as we don’t know what will happen when, we don’t make any allowance for black swan events in our forecast.
But we could be (and almost certainly will be) wrong. Perhaps the biggest upside risk to both the demand and supply side of our forecasting is an escalation of events in existing, or new, trouble spots. While missiles fly into and out of Israel, the risk of escalation remains high. Dragging Iran into open conflict would impact both oil production and exports. Iran could attempt to blockade the Hormuz Straits. The US could tightening sanctions (or maybe just enforced them) on Iranian exports. And that assumes any escalation does not spill into neighbouring oil producers. Looking East; an escalation of skirmishes over disputed territories in the South China sea, or Taiwan, is more a case of when than if. Generally, but not always, these conflicts create panic buying and extend trade inefficiencies. In the longer run, loss of oil production would likely cause oil prices to spike. This would dampen tanker demand by accelerating the energy transition, or applying a brake to economic growth.
6. The outcome of US elections will have little impact on our tanker market outlook. US protectionism is inevitable no matter who is at the helm. Neither Trump nor Harris will be able to bring overnight peace to the Middle East or Russia / Ukraine. Much of what Trump promises for the international stage can be dismissed as campaign bluster.
But we could be wrong. While neither administration are friends of China, we suspect Trump would take more action, more quickly, to obstruct Chinese trade. This could include the re-imposition of sanctions on Chinese-owned or built ships (which caused the freight market to spike in 2019). Trump would undoubtedly act more favourably towards the US oil industry – a lighter touch on regulation; easier leasing of land and waters; a reversal of climate-focused policy – though this would probably be more meaningful for US LNG exports than oil. Oil production grew by 2m b/d under Biden, after all. Trump’s resistance to EVs and a tendency to support fossil fuel-based initiatives, such as power generation, could grow US oil and gas consumptions faster than it would under Harris. As the US Gulf prefers heavier sour crudes to optimise refineries, higher US consumption could lift US crude imports without eating into its lighter, sweater crude exports.
7. China’s demand for transport fuels will peak by 2025, and by 2030 for all oil products. Assumptions on Chinese demand growth matter both because of China’s outsized influence on tanker flows, and because a paucity of reliable economic data heightens the risk - for foreign economists like us at least - of reading China wrong. We believe that rapid EV penetration and demographic shifts are being aggravated this year by reduced property investment, an industrial slowdown and low consumer confidence. A Chinese economic recovery in 2025 is unlikely, and would in any case do little to change oil demand. China has been critical to the growth of tanker demand post financial crisis. Now the focus for demand growth shifts to India. This is bearish VLCCs, which rely heavily on long-haul Chinese crude oil trade. It is also bearish global refinery margins as China adds more refining capacity over the next few years.
But we could be wrong. An upside risk emerges from our tendency to underestimate China’s ability to stimulate its way back to demand growth. If this is a crisis of Chinese confidence, not deep set problem with the Chinese economy, the country could rebound quickly. A downside risk for oil demand, however, is that outsiders have also tended to underestimate the pace of China’s energy transition. Trucks have moved over to LNG and cars to electricity much faster than expected. Over half of all new cars sold in China are now EVs.
8. We will see a seasonal recovery in tanker freight markets in Q4. Oil demand tends to peak in q3 these days. But crude exports typically rise between q3 and q4. CPP exports are highest in q3 and q4, while DPP exports tend to be highest in q3. The q4 jump in tanker demand is typically exaggerated by weather delays, leading to an even more pronounced jump in q4 ‘oil on the water’. This jump will be repeated this year.
But we could be wrong. There is nothing ‘typical’ about today’s market, or any quarter since COVID for that matter. Demand worries are currently weighing down on the oil price. Brent has hit year-to-date lows despite a likely delay, communicated last week, in reversing voluntary OPEC cuts. The 2.2m b/d voluntary output cuts were made last November. The return of lost production was expected to start next month. This has now been pushed back to December, amid weak economic news from the US and China, and signs of an early resolution to the Libyan crisis. Oil trade will continue to be supported by production growth in the Atlantic basin. Bit recent Chinese PMI readings suggest Chinese oil demand could struggle to repeat traditional growth patterns this winter. This would affect the VLCC market more than most. The growth in Canadian (mostly Aframax) exports to China from the recently expanded Transmountain pipeline has already dampened Middle Eastern VLCC flows to China.
While we still expect markets to remain well above historical averages, over summer our forward view (along that of most oil demand forecasters, tanker time charter rates and FFA forward curves) has darkened slightly. We now expect VLCCs to slide steadily from around $52k/day this year to $32k/day by 2028. Suezmaxes should slip from $50k/day this year to 35k/day in 2028. Our outlook for tankers smaller than Suezmaxes has dropped around $3k-5k/day from our June outlook from 2025 onwards, dropping from $44k/day for Afras and $48k/day for LR2s (both basis non-Russia trading) to $33k/day in 2027/28. LR1s slide from $45k/day this year to $31k/day in 2027, while MRs ease from $35k/day this year to $25k/day in 2028.
But we could be wrong.