The European Union’s ban on Russian crude imports is now less than five weeks away. As the clock approaches the December 5 deadline, crude tanker owners expect trade disruptions caused by the Russia-Ukraine conflict to worsen, pushing spot rates even higher.
On Thursday’s quarterly call, Brian Gallagher, head of investor relations at crude tanker owner Euronav (NYSE: EURN), said, “A key driver of the oil marketplace over the last six months is about to enter its final — but most impactful — phase.”
During Teekay Tankers’ (NYSE: TNK) earnings call on Thursday, CEO Kevin Mackay stated, “The redrawing of global trade patterns [following Russia’s invasion of Ukraine] is the largest single factor driving current rate strength.” The impending ban is expected to have a significant impact.”
EU substitute for Russian crude
Tanker demand is measured in ton-miles, which are volume times distance. Since the start of the war, demand for crude tankers has increased as the EU has partially replaced imports from Russia with volumes from more distant destinations. To meet the Dec. 5 deadline, the replacement process must be accelerated in the coming weeks.
According to Kpler data, EU imports of Russian crude from Russia fell from 2.6 million barrels per day in January to 1.5 million barrels per day in September. “These volumes are set to fall to zero on December 5,” Mackay said. “So far, imports from the United States Gulf, Latin America, West Africa, and the Middle East have nearly replaced these volumes barrel for barrel.”
The ton-mile demand effect has been extreme due to much longer voyage distances.
According to Kpler data cited by Teekay, reducing Russian short-haul crude flows to the EU between January and September reduced tanker demand by 11 billion ton-miles. During the same period, replacement inflows from other sources increased tanker demand by 35 billion ton-miles, resulting in a net positive effect of 24 billion ton-miles.
Midsized tankers have experienced the most upside in the Aframax (750,000-barrel capacity) and Suezmax (1 million-barrel capacity) categories. Large crude carriers (VLCCs; 2 million barrel capacity) have recently joined the fray.
Gallagher believes that the EU’s substitution of Russian crude for Atlantic Basin and Middle East crude “will benefit VLCCS in particular” and that “this trend has been very pronounced since July.”
There are almost no ports in the United States that can handle VLCCs. Instead, crude is “lightened” by smaller ships like Aframaxes, which perform ship-to-ship transfers to load VLCCs in the United States Gulf.
“We are seeing an increase in lightering exports from the United States Gulf onto VLCCs, some of which will go to Rotterdam,” Mackay said. “We’re seeing heavier volumes come out of the US Gulf, which is why US Gulf Aframax rates have risen to more than $90,000 per day.”
Russian crude exports to the EU have been replaced.
Another significant disruption caused by the war is the rerouting of Russian crude exports from the EU to more distant destinations, primarily India and China.
According to the Kpler data cited by Teekay, this had a positive tanker-demand effect of 41 billion ton-miles between January and September. When combined with the EU import effects, the total net positive of war-related crude dislocations is 65 billion ton-miles.
What happens after December 5th?
So far, Russian crude exports have been unrestricted. However, the impact of the EU ban on tanker insurance, the G-7 price cap, and wider sanctions fears could significantly reduce Russia’s crude exports. This would be detrimental to tanker demand. It would reduce the “tons” in the ton-mile equation, offsetting some of the “miles” gained from EU replacement imports.
According to Argus Media, Chinese refiners “have purchased only a handful of December-arriving cargoes from Russia.” It stated, “China’s large state-owned firms were key intermediaries between Russian producers and Chinese independent refiners until the start of the December trade cycle, but do not appear to be lifting December cargoes.”
Hugo De Stoop, CEO of Euronav, believes Russian crude will eventually find buyers.
“We believe that if [Russian] oil is cheaper than what you can get elsewhere, it will find a buyer.” On the conference call, De Stoop stated, “We have many precedents that demonstrate this.”
Russian exports are subject to operational restrictions.
After December 5, EU sanctions will prohibit EU reinsurance for Russian cargoes sold to non-EU buyers (until EU members approve an exception for those buying under their price cap). The United Kingdom’s Protection & Indemnity (P&I) clubs, which insure most of the world’s tankers, rely on EU reinsurance.
Nonetheless, De Stoop does not expect insurance to have a significant new impact.
“When I look at the P&I with which we are involved, they have already done what many companies and banks have done.” They have self-sanctioned or imposed significant restrictions on their business with Russia,” he said. “So, that is already the case. According to what we’ve heard, [UK P&I] will be replaced by less ‘international’ companies, specifically insurance companies based in places like Dubai and China.
“I believe that physical, operational constraints will dictate whether or not Russia will have to shut down some of its oil fields,” he said.
Russian ports, like US ports, are unable to handle VLCCs. During the winter, the country’s northern ports require ice-class crude tankers, mostly Aframaxes. The number of Aframaxes available to load Russian crude this winter will be limited. Many Aframax owners will choose not to transport Russian cargo due to insurance concerns and the G-7 price cap.
“There will be a two-tier market,” De Stoop predicted. “Because it will be extremely difficult, even if you are based outside of Europe, to have ships that do one cargo out of Russia and the next cargo out of a place that is not restricted.”
It makes no sense from an economic standpoint to load an Aframax with Russian crude and sail it to China or India. It makes even less sense in light of the limited number of ice-class Aframaxes available to Russia. “If those ships are used for a long voyage, they will not be available for the [shorter] icy distance,” De Stoop explained. (An Afraramax traveling from Russia to China or India would return to Russia in the spring.)
According to him, Russia will have to use Aframaxes to transport lighter exports out of icy waters, make ship-to-ship transfers to larger tankers, and then return the Aframaxes to Russia to pick up the next loads. In the winter, Russia will be forced to use lightering operations, and in other seasons, economies of scale will force it to do so. Because ship-to-ship transfers take time, this will further constrict tanker capacity.
“This is a heavier operation than simply picking up the oil in a port and transporting it to a destination without interruption,” De Stoop explained.
Earnings Summary
The wartime rate increase, combined with the post-pandemic oil consumption recovery, has returned tanker companies to profitability after nearly two years of heavy losses. Owners of product tankers and small- to midsize crude tankers were the first to recover, followed by owners of larger tankers.
Euronav reported a net income of $16.4 million for the third quarter of 2022, compared to a net loss of $105.9 million in the third quarter of 2021. Earnings per share of 8 cents were in line with analyst expectations.
Euronav owns VLCCs as well as Suezmaxes. Its spot VLCC rates averaged $22,250 per day, which was more than double the average rate during the same period last year. Rates for VLCCs continue to rise. Euronav has already booked 45% of its spot VLCC days in Q4 2022 at $47,500 per day.
Teekay Tankers, which owns Aframaxes, Suezmaxes, and product tankers, reported a net income of $68.1 million in the third quarter of 2022, compared to a net loss of $52.1 million in the third quarter of 2021. Adjusted earnings per share of $1.68 fell 2 cents short of analysts’ expectations.
Teekay’s spot Aframaxes earned $35,917 per day in the most recent quarter, more than five times the spot rates in the third quarter of 2021. Teekay has booked 38% of its spot Aframax days at $36,600 per day in the fourth quarter.
