The Fuse

Oil Tanker Rates Surge as Global Oversupply Drags On

by Nick Cunningham | October 22, 2015

Global oil demand has growth swiftly in 2015, spurred on by low prices. This dynamic has led to a spike in oil tanker traffic, contributing to a corresponding surge in the cost to contract a tanker for crude delivery.

The daily rate for a very large crude carrier (VLCC) traveling to Asia surpassed $100,000 per day in October, the highest level in five years. Tanker rates are extremely volatile, but they have increased sharply from years past, when rates routinely traded below $20,000 per day. VLCCs can carry around 2 million barrels of oil, and they account for the bulk of maritime crude oil trade.

There are a variety of reasons for the sky-high tanker rates, but two stand out. One of them—growing oil demand, punctuated by a flurry of shipments to China—is a bullish sign that oil demand is robust, which may help cut into the supply overhang. But there is another reason for high VLCC rates, one that one doesn’t bode quite as well for oil prices.

China’s SPR boosting global demand

The tightness in the tanker market is in part due to strong demand for crude oil and refined products, as consumers around the world take advantage of cheap fuel. The IEA predicts global crude oil growth could hit 1.8 million barrels per day (mbd) this year, a five-year high.

Nowhere is that demand growth more visible than in China. China this year overtook the United States as the top oil importer in the world as its economy continues to grow briskly, albeit at slower rate than in years past.

But China’s oil demand is exceptionally high because it is building out its strategic petroleum reserve (SPR), a stockpile of crude needed to ensure against supply disruptions. In the first seven months of this year, China has imported 0.5 mbd above what it typically needs to meet domestic demand, with the surplus diverted into storage. China is nearly halfway through a multiyear process of building up 500 million barrels in storage, roughly equivalent to 90 days’ worth of imports. The U.S., in comparison, has stockpiled nearly 700 million barrels in salt caverns along the Gulf Coast.

China’s oil imports surged to a record 7.6 mbd in July as a new storage facility in Huangdao reached completion, adding about 19 million barrels of storage capacity. And China is not done yet. An estimated 50 million barrels of storage is expected to be completed in 2015 at two sites, Huizhou and Jinzhou.

The SPR effort is adding to import demand, although at fluctuating rates. Imports to China can swing by 1 mbd in a given month, depending on current market prices and the filling requirements for SPR storage, according to Colin Fenton, a fellow at Columbia’s Center on Global Energy Policy.

Nevertheless, FGE, an oil consultancy, estimates a 12 percent rise in the level of crude imports into China in the second half of 2015 compared to the same period a year earlier.

Tanker movements to support China’s oil buying spree are having a clear impact on the market for VLCCs, helping to drive up tanker rates and put a floor beneath oil prices. But there is another, more pessimistic case for the recent developments with both China’s SPR and the spike in VLCC prices.

Insufficient storage and the supertanker traffic jam

There’s no question that demand is a key factor underpinning this year’s astronomical rates for VLCCs. But there’s also the fact that the current oil market is characterized by too much supply and not enough storage.

There is evidence that China is struggling to digest such a high volume of shipments, as its new storage facilities are filled immediately after completion.

For example, there is evidence that China is struggling to digest such a high volume of shipments, as its new storage facilities are filled immediately after completion. As a consequence, oil tankers are running into unusually long waiting times to offload their cargo in China, having to sit in long queues. Bloomberg reported that at least 19 VLCCs—each capable of holding two million barrels—waited offshore for two weeks or more in early October. Typically, it only takes one day for a VLCC to unload cargo and depart for its next destination.

The “supertanker traffic jam” could get worse in the coming months: China booked record number of new shipments in early October, all but ensuring greater congestion when they arrive later this year. If that oil does not find a home, it will put downward pressure on oil prices.

The same is true elsewhere in the world. The volume of crude that is sitting on tankers and parked in the Gulf of Mexico awaiting to offload has reached almost 20 million barrels, according to ClipperData, twice as much as usual. ClipperData also says that seven cargoes, accounting for 13 million barrels of oil, is sitting in in the Arab Gulf, suggesting that either storage is short, or there are not enough willing buyers. Either way, the high usage of tankers explains the spiking VLCC rates, but it also points to weakness in oil markets as supply continues to outstrip demand.

Onshore storage is also picking up. Crude inventories in the U.S. jumped by 8 million barrels for the week of October 16, pushing total storage up to 476 million barrels. That is the highest level since May, and close to the 80-year high of 490 million barrels hit in April.

stock surging

The storage pileup is also evident in the oil futures market. As the IEA notes in its October Oil Market Report, all major crude benchmarks remained in a state of “contango,” in which prices for delivery in the future are higher than the present. That creates an incentive for oil traders to store oil now in an attempt to sell at a higher price later. The IEA cautioned that the economics of storing crude to be sold at a later date are not exactly robust, but have improved since the summer.

nymex futures

Economical or not, floating storage is in fact taking place. In Singapore, Reuters reported that oil traders took advantage of contango by contracting out seven VLCCs in September for fuel oil storage, at a time when supply was up and demand was weak.

In the Atlantic Basin, refined products are making their way onto floating storage as onshore facilities in Europe begin to max out. Vitol, the world’s largest oil trader, and Royal Dutch Shell are booking tankers in order to temporarily store surplus diesel, even though the economics are not favorable. Their actions are based on anticipation of a worsening storage situation later in the year.

Glut Persists

Both contango and the shrinking available storage around the world could simply be a reflection of a weak oil market: a glut in supply, and not enough demand to soak it all up.

The contraction in U.S. shale will help to ease the supply overhang, but it doesn’t appear to be enough in the short-term. Vitol’s CEO Ian Taylor sees the downturn in oil prices lasting through next year. “Can I see a big run next year? No. If we are above $60 by the end of 2016 I will be a little bit surprised,” Taylor said at a recent commodities conference put on by Reuters. Even accounting for the decline of U.S. oil production, Taylor argued that the additional 0.5 mbd expected from Iran, coupled with potential production gains from Libya, could more than offset lost output from U.S. shale.

“Once Iranian crude is out in the market, then it might start affecting spot prices for crude oil, which could eventually open up the contango again,” Nikhil Jain, an analyst at Drewry Shipping, told Bloomberg in a September interview.

Refinery Runs

The refining sector traditionally reduces throughput after summer, idling facilities for maintenance. As refineries come back online, some of the downward pressure on crude prices will be removed. Higher refinery runs will burn through more crude oil that is sitting in storage.

The EIA reported that for the week of October 16, refinery utilization increased for the first time in five weeks, perhaps signaling an end to maintenance season.

For oil producers eyeing shrinking storage space and a deepening contango, the end of maintenance season and the expected rise in winter fuel demand can’t come soon enough.