By Ira Breskin – Moderate production cuts announced Sunday by the world’s major crude oil producers should reduce what has been the critical need for floating storage used to warehouse excess production, and ease charter rates for storage vessels.
On Sunday, Saudi Arabia, Russia, and 21 other oil producing nations agreed to reduce production by 9.7 million barrels per day starting in May. That will be followed by smaller, scheduled production cuts running through April 2022.
One apparent goal of the planned production cuts is to better match reduced output to predicted demand, ideally minimizing the need for crude oil storage.
That immediate production cut in May should help reduce the 15 million barrels per day of surplus output that strained oil storage capacity, both afloat and ashore, during the last few months, according to experts from Marsoft Inc. of Boston last week. Marsoft evaluates ship finance risk
Marsoft analysts offered insight into the floating storage market during an April 8 webcast entitled Oil and Tanker Outlook: Key Issues and Opportunities. Marine Money hosted the webcast.
The current large surplus and resultant storage capacity squeeze is due to increased production tied to the month-long, spirited Saudi Arabia-Russia price war. It came amidst the sharp Covid-19 induced drop in usage of refined petroleum products.
Planned production cuts will likely reduce the need for floating storage provided primarily by Very Large Crude Carriers, should demand for crude oil increase.
The announcement of the production cuts come as the VLCC spot charter market has been experiencing extraordinary volatility, driven by increased demand for floating storage, Marsoft analysts said.
Oil producers and middlemen use VLCC higher-cost floating warehousing as a last alternative when cheaper land-based storage is unavailable. Afloat storage is almost twice as expensive as warehousing crude at a tank farm.
An oil owner’s storage strategy is simple. Hold distressed-priced oil and sell it later, in a stronger market, at a significant premium, including the $0.50 to $1 monthly per barrel floating storage charge.
Land-based storage facilities now are filled close to capacity, and floating storage (usage) is at levels never seen before, said Aditya Trivedi, a Marsoft analyst.
Moreover, worldwide oil storage afloat could be maxed out if producers fail to better match supply and demand, according to Marsoft.
Only a portion of the world’s 750 or so VLCCs — which each can store about 2 million barrels — are available for immediate storage duty, under terms of a spot charter contract; many are operating under longer-term time charters that generally lock in capacity at lower rates.
And given recent restraint by tanker owners in placing orders for new ships, there is no immediate prospect of, or incentive for, adding significant floating storage capacity to relieve what could be a medium-term supply crunch.
Introducing incremental capacity would lower charter rates.
“Tanker (storage) supply is very positive (for owners)” because the newbuilding order book is at a 25-year-low, Trivedi said.
In fact, the order book-to-fleet ratio is less than 10 percent, he added.
Stated another way, that ratio means that new capacity would increase by 10 percent several years out, minus any tonnage withdrawn from service because it is being scrapped.
Storage has become a popular option for oil producers and traders because, at current prices, crude oil is selling below break-even for many of the oil majors, said Melanie Lovatt, an analyst with Poten & Partners. She spoke during a separate webcast last week sponsored by Poten, a New York-based ship broker and energy consultancy.
Given recent oil market uncertainty, VLCC daily spot charter rates have swung between $15,000 to $250,000 in the past six months or so, said Arlie Sterling, Marsoft co-founder and president, during the webcast he moderated.
Rather than play the more volatile spot market, some oil principals and traders are signing time charters that generally feature cheaper storage rates, but higher market risk attached to longer-term storage commitments.
However, the time charter market also is in flux. For example, when low crude oil prices at March 31 drove six-month VLCC time charters rates to $120,000 per day, ship owners locked in significant profit, Trivedi said
Conversely, a sharp drop in crude production (and modest uptick in demand) could result in six-month VLCC time charters falling to $40,000 per day; ship owners then would be leasing their vessels at or near break-even, he added.
“This quickly becomes less profitable or unprofitable” for the carrier, Trivedi said.
Business of Shipping is a column from Ira Breskin, a senior lecturer at State University of New York Maritime College in the Bronx, NY and author of The Business of Shipping (9th edition, 2018), a primer that explains shipping economics, operations and regulations.