The push to decarbonize shipping appears to be paying off handsomely — not for the environment, but for the owners of the tankers that transport the carbon: the crude oil, gasoline, diesel, and jet fuel that the world continues to burn in ever-increasing quantities after being transported ever-longer distances across the seas.
To decarbonize shipping, either an onboard carbon-capture system (which does not yet exist) or new vessels that burn something other than fuel oil are required.
The regulations for this new fuel have yet to be written. So, why would tanker owners in the business of profit accept the residual-value risk of ordering ships that may become obsolete before the rules are written?
The answer is no, and they will not. The number of crude and product tankers on order is now at an all-time low.
The tanker orderbook is shrinking.
The figures are astounding. According to Clarksons Securities, the ratio of crude tanker capacity on order to crude tanker capacity in service has reached an all-time low of 2.7%.
It is only 1.7% for very large crude carriers (VLCCs; tankers carrying 2 million barrels of crude). VLCCs are critical for transporting crude exports from the Gulf of Mexico and the Middle East. By the end of the year, there will be 910 VLCCs of various ages on the water. How many new VLCCs will be delivered in 2024? Zero. In 2025, only one will be delivered.
On the product tanker side, the situation is nearly as bad. For product tankers, the orderbook-to-fleet ratio has dropped to 6.1%.
The 17th Annual Capital Link International Shipping Forum in New York on Monday focused on how the tanker orderbook dwindled so low — and the profits this implies for owners of existing tankers.
“We’re now seeing what happens when you don’t invest [in new capacity] for several years,” said Jefferies analyst Omar Nokta.
Owners are wary of ordering risk.
Uncertainty about future vessel propulsion rules is one reason more tankers haven’t been ordered. Another factor is that crude and product tanker owners have only recently begun to make money again; 2020 and 2021 were the industry’s two worst years in three decades.
Another reason has to do with the cargo itself.
There is a two- to three-year lag between placing an order and receiving a new tanker. These assets have a lifespan of 20 to 25 years. As a result, a newbuild ordered today will most likely be in service by 2050. If the world is truly decarbonizing and shifting away from the use of dirty fossil fuels, what will tankers ordered today carry in their final years of service?
“You’ll be taking a lot of residual value risk.” “That is rarely a recipe for long-term success in shipping,” said Ben Nolan, a Stifel shipping analyst. (Residual value risk is the possibility that future resale value will result in a loss.)
Most people agree on one thing when they sign a contract for a new car or a new house: they agree on one thing when they sign a contract for a new car or a new house.
“When you order a $100 million ship that normally costs $70 million, you better make sure you front-end load your economics,” Nolan said. “Fine, if you can get a time-charter contract to cover your front-end economics. If not, that is a significant risk.”
In the midst of the decarbonization drive, FreightWaves reported four years ago on the practical necessity for oil shippers to back new tanker orders with long-term charters. Shippers have yet to comply and show no signs of changing their strategy.
‘It has nothing to do with financial discipline.’
“Fundamentally, the lack of tanker orders has nothing to do with capital discipline,” said Ridgebury Tankers CEO Bob Burke. “In a market like this, there is no capital discipline.” It’s simply not in our best interests to order expensive ships with unknown propulsion systems.
“It’s really difficult for a shipowner to go out and take a flier on something like that without a charter from an oil company for a ship that will be delivered two and a half years from now, at historically high prices, with a capital drag until delivery, and when you don’t know whether the propulsion system is going to last very long,” Burke said.
Tax Incentives and Long-term Charters Drive Current Orders
According to Christian Ingerslev, CEO of Maersk Tankers, “If we look at the orders today, it’s people who have a tax incentive to do so or people who get backing from a longer-term charter, typically for a dual-fuel design.” Otherwise, nothing is being ordered.”
“If you order a VLCC in Korea, it’s probably $120 million,” says Lois Zabrocky, CEO of International Seaways (NYSE: INSW). Add an additional $15 million to $20 million for dual-fuel LNG capability. That is a huge number. That is why you require a partnership to mitigate some of the risk.”
She stated that a charter of seven years or more would be required to incentivize a VLCC order. “That’s something we haven’t seen,” Zabrocky said. “No one else has done it except the 10 VLCCs in the Shell project.”
Shell agreed to seven-year charters on ten new dual-fuel VLCCs in March 2021. International Seaways ordered three, Advantage ordered four, and AET ordered three. The Seaways Endeavor, the first of International Seaways’ dual-fuel VLCC newbuilds, was delivered this month.
The Shell deal was heralded at the time as a possible model for fleet renewal during the energy transition. So far, it appears to be a one-time occurrence.
Orders for LNG and container ships are backed up by charters.
LNG and Container Ship Orders Secure Shipyard Slots Until 2025
Shipyards in China, South Korea, and Japan construct commercial ships. Orders for new container ships and LNG carriers have virtually sold out shipyard slots through 2025. Due to high demand in these sectors, pricing in other sectors such as crude and product tankers has risen.
Shipowners order LNG carriers with the support of long-term charters from LNG cargo shippers. According to Harrys Kosmatos, corporate development officer at Tsakos Energy Navigation, the duration of these charters is increasing (NYSE: TNP).
Charters supporting LNG newbuilding orders were reduced to five to eight years in length. “Nowadays, 10-year contracts are easily available,” he said. “Cargo interests in the LNG shipping sector have realized that for an owner to make an investment in such a high-priced asset, at least a good part of its life needs to be covered by a decent return [via a time charter],” according to the report.
Liner companies or shipowners place orders for new container ships. The vast majority of newbuilding container ships ordered by shipowners are backed by multiyear charters from liners.
Container Ships Follow Charter-Backed Newbuilding Model
For example, liner company Zim’s (NYSE: ZIM) newbuilding program consists of vessels ordered by Seaspan and other shipowners and chartered to Zim for up to 12 years.
Tanker shipping used to follow the same model of charter-backed newbuilding orders as LNG and container shipping do today. It no longer does, resulting in the current conflict with owners’ newly discovered insistence on charter-backed orders.
According to author Martin Stopford’s book “Maritime Economics,” the tanker business followed a “industrial shipping” model from the 1950s to the mid-1970s. Tankers were either owned by oil shippers or leased from independent shipowners for long periods of time.
In the 1950s, charters backed up newbuilding orders for five to seven years. “Charters of 15 or even 20 years were not uncommon in the 1960s,” Stopford wrote. In Japan, the widely used charter-backed newbuilding model was known as “shikumisen.”
From a spot model to an industrial shipping model
That began to change in the mid-1970s.
“Oil transportation transitioned from meticulously planned industrial shipping to a market operation” — a spot business. “By the early 1990s, more than 70% of this [independent owner] fleet was trading on spot, up from about 20% in the early 1970s.”
The reason for this was that “the oil trade evolved from a predictable trade for which transportation was meticulously planned… to a volatile and risky business in which traders played a significant role.” “To a large extent, transportation was left to the marketplace to manage,” Stopford explained.
“In the 1960s and 1970s, oil companies had long-term charters,” Burke said at the Capital Link forum. The spot market was on the outskirts. The oil companies then discovered that it was cheaper to get their ships on the spot market. They had other plans for their capital and equity. As a result, a large spot market developed.”
Oil shippers were no longer available to back up shipowner newbuilding orders with charters. “They didn’t have to because we always ordered new ships, hoping the market would improve.” “They then took advantage of the lower capital costs,” Burke explained. “We simply walked right into it.” We can’t do it this time.”
Burke argued that for orders to pick up this time, the tanker industry “has to go back the other way” — from spot to more industrial shipping.
“If I were an oil company or trader, I’d be wondering, ‘If these guys [shipowners] aren’t ordering now, when will they order?'”
Burke responded, “We are not going to order.” “They’re going to have to step up and do something” if oil companies or traders want new ships.
‘We will be cash distribution machines,’ says one.
Because yards are already full of container ship and LNG carrier orders, as well as construction lead times, a significant amount of new crude and product tanker capacity will not be available to the market before 2026 at the earliest.
“Even if we wanted to deliberately ruin the market [by overordering], we couldn’t,” said Mikael Skov, CEO of Hafnia, a product tanker owner (Oslo: HAFNI).
In both the crude and product tanker sectors, gross fleet growth percentages from new ships will be in the low single digits in 2024 and 2025. Meanwhile, a large number of older crude and product tankers are being purchased and repurposed as part of the so-called “shadow fleet” for the transportation of sanctioned Russian oil. These ships have effectively been removed from Western trade.
“New Russian trading patterns will absorb ships into the shadow fleet,” says Kosmatos, “and we may be facing a situation in Western trades where growth could be negative next year in certain segments.”
Demand growth in both the crude and product tanker markets is widely expected to be positive and to outpace supply growth, resulting in high returns for tanker owners, possibly at boom-level levels.
“I’ve never seen anything like it. “All of the fundamentals of supply and demand are in our favor,” Burke said. “There will be a ship shortage.”
“We will become cash-distribution machines,” said Anthony Gurnee, CEO of product tanker owner Ardmore Shipping (NYSE: ASC).
