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Tanker Shipping & Trade

Tanker Shipping & Trade

The MR2 fleet at a tipping point

Wed 02 May 2018 by Craig Jallal, tankers and markets editor

The MR2 fleet at a tipping point
Poten and Partners head of research Erik Broekhuizen: middle distillates are still the largest export product

The fundamentals are looking good for the MR2 product tanker market, which may achieve supply growth and demand balance this year. But owners and operators must still resolve the 2020 Sulphur Cap and the fitment of ballast water systems in the near future. Tanker Shipping & Trade reviews the latest developments in the MR2 sector.

The 50,000 dwt Medium Range (MR2) is the key vessel in the product tanker fleet, able to call at most petroleum product ports and refineries. The live MR2 fleet currently stands at just under 1,500 vessels, with a total capacity of 72.5M dwt, according to VesselsValue. The MR2 fleet is also relatively young, with an average age of nine years, compared to an average age of 13 years for the tanker fleet as a whole. However, deliveries are now declining: in 2015, 108 MRs entered the fleet; the following year this figure had fallen to 86 and in 2017, just 67 MRs entered the fleet.

Fleet development

So far in 2018, 13 MR2 product tankers of 649,000 dwt have entered the fleet, with another 56 on the schedule for delivery by the end of the year. Compared to the 2000s, the orderbook is very light, with only four vessels scheduled to be delivered in 2021. As it stands, the MR2 orderbook is around 10% of the current fleet and this is unlikely to change in the foreseeable future. According to one MR2 owner Tanker Shipping & Trade spoke to at the Connecticut Maritime Association annual conference and trade show 2018, who did not wish to be named, there are only two shipyards in South Korea currently showing any interest in building MRs. There has been a considerable number of shipyard bankruptcies in South Korea, and the remaining yards are choosing to wait, or already have slots reserved for higher-value vessels.

Catch 22 in the S&P market

Ardmore Shipping Corp founder and chief executive Anthony Gurnee explained that there are now some good value vessels in the market. In his opinion, prices are currently low due to capital constraints. “It’s a Catch 22,” he said, referring to the fact that prices are low because of the lack of funding, but it is difficult to take advantage of the low prices, due to the lack of lenders willing to finance a project.

As a result, just 14 MR2 product tankers have changed hands to date in 2018. If this level of S&P activity is aggregated for the whole of 2018, it implies a modest sum of 56 MR2 product tankers will be sold throughout the year. This would be the lowest level for five years.

Commenting on the situation, AG Shipping & Energy Pte director/freight trader and global head Mangish Kakodkar said: “Asset prices have [bottomed out] in the current cycle [and] that makes it favourable to enter this sector. Furthermore, we feel the Sulphur Cap 2020 will be disruptive for the shipping industry, with only 2% of the world fleet scrubber-ready.”

AG Shipping bought the 2006-built MR2 product tanker Phoenix in April 2018 for a reported US$15M.

Selling to make a point

For some owners, the current situation is an opportunity to sell and realise any increase in the value of their assets. Speaking at the 12th Annual Capital Link International Shipping & Offshore Forum, Scorpio Tankers president Robert Bugbee made no secret of the fact that his company was looking to sell two vessels. These assets had appreciated in value and it was an asset play, fulfilling two purposes. “We are selling two older ships, which will establish a net asset value substantially above our share price, generating liquidity. This will allow us to take advantage of the arbitrage in the share price,” he said.

As the voice of a public company, Mr Bugbee had to choose his words carefully, but this statement may have implied that the company believed its share price was too low (half net asset value), and that by selling two ships and producing a positive yield on the assets, it could signal to investors that the share price was at a discount. At the same time, the company could release funds to buy back its own shares, at a discount.

Demand environment

The general opinion of the product tanker panel at the above-mentioned Capital Link International Shipping & Offshore Forum, held at New York’s Metropolitan Club in March, was that demand for MR2s remains relatively stable compared to other tanker sectors.

During the conference, Navig8 America managing director Jason Kloper noted: “Q4 2017 was the first time we saw tonne-mile demand outstrip supply on the water. That was mostly a factor of export capacity, which has swung export demand sharply upwards from a low basis. The arbitrage opportunities are there, especially from the US to the Far East.”

Mr Kloper felt that naphtha trade in particular had benefited from this situation (naphtha trade increased 13% from the US and 10% from China in 2017. The growth in exports from China was due to a change in local regulations, according to Mr Kloper, but he noted that new refineries in the Middle East are now coming on stream, which will push exports not only to China and the Far East, but also into Europe.

Ardmore’s Mr Gurnee felt that the fundamentals were in place to add up to 4% to 5% underlying demand growth for the product market, but he noted that the most interesting developments were to be found in the small, more complex trades: “North to south trades are interesting, as the volumes aren’t huge, but the distances are long and the delays are significant once you get there,” he told panel host, Deutsche Bank director and senior research analyst Amit Mehrotra.

Concordia Maritime group chief executive Olaf Helgesson observed: “When the drawdown cycle of inventories stops, then the market will pick up; the volatility will kick in and the arbitrage will really start going. We believe it will be in the second half of this year.”

Robert Bugbee pointed to the historical benefits for product tanker trade stemming from the up-scaling of the refinery sector. Whether in Europe or the US, when a large refinery base is created, it stimulates arbitrage and product trading, which in turn stimulates the product tanker market. He pointed to the process now taking place in China, following the lifting of controls on the import of crude oil and the export of products: “We have never seen the LR2 market trading independently from crude oil. The VLCC market fell to US$2,000/day and the LR2 market actually moved up into the mid-teens on a triangulated route.” He pointed that the LR2 and MR2 markets are being supported by strong demand in the East, as outlined above.

Pyxis Tankers is an MR2 tanker company quoted on NASDAQ  and its chief executive Valentios “Eddie” Valentis said that growing independence from the crude oil sector and the current relative stabilitywas one of the reasons the company entered the sector. “This year (2018), the fundamentals are pointing towards a better market. It is pure supply and demand. We project supply (growth) of 2.8% annually and demand growth of 3% annually,” he told BDP1 Consulting chief executive Barry Parker in a post-Capital Link online interview.

In the shorter term, product tanker companies like Pyxis are looking to take advantage of the short-term market driving arbitrage opportunities. These can be seasonal, such as gasoline flows changing direction across the Atlantic, due to refinery maintenance and/or weather conditions.

“This is not something we can predict,” said Mr Valentis. “Maybe others can. We just react.” These short-term changes can move day rates into the US$20,000/day or US$21,000/day category, and time charter rates toward the US$18,000/day level. Pyxis has several product tankers coming off charter in the middle of 2018 and it will be interesting to see if they re-fix on the short-term charters to oil majors, or play the spot market.

Aarbitrage is also being driven by the level of inventories, which have been declining. “We believe this will make the market a little volatile,” said Mr Valentis.

US oil product exports

The lack of growth in US refining capacity is one of the factors driving the arbitrage that supports the MR2 tanker fleet. US refining capacity in 2017 grew by only 2.3%, to just under 20M barrels per day (b/d), but utilisation grew to 91%. However, domestic demand has remained stable and the additional production has been exported, according to US broker Poten and Partners head of research Erik Broekhuizen.

The increase in refined exports commenced 10 years ago and middle distillates remain the largest export product. In 2017, the US exported 1.4M b/d according to the US Energy Information Administration, 17% more than 2016 volumes.

Gasoline is the second largest commodity, with average daily exports of 747,000 b/d in 2017, 18% higher than in 2016. Other export products include jet fuel and residual fuel oil. LPG is the fastest growing export and in the last five years, LPG exports increased more than six-fold, from 196,000 b/d in 2012 to 1,225,000 b/d in 2017.

European demand for US exports has fallen from almost 20% in 2012, to a little more than 12% last year. The uptake has been in Asia and the near Americas. In 2017, 21% of US product exports went to Asia and more than 50% to nearby countries in the Caribbean, Latin America and Central America.

Ballast water viewpoint

A pressing issue in the MR2 market remains the fitment of ballast water treatment systems. “About 10% of the fleet in 2019/20 will be 20 years old,” says Mr Valentis. “Owners will be considering whether to take the vessel through a fourth survey and add the ballast water system; for an MR, the cost [of doing so] is in the region of US$750,000.”

By 2019, there will be no more extensions from the US Coast Guard for vessels not fitted with ballast water treatment systems. Will the market at that time support the capex necessary to fit ballast water treatment systems, plus the expense of dry docking for the fourth survey and the loss of earnings?

2020 sulphur fuel

With the 2020 Sulphur Cap looming ever larger on the horizon, the requirements for compliance are now a very pressing concern. Pyxis Tankers believes that fitting a scrubber is not an option, as there is not the available space in the engine room of a MR2 tanker and the cost/payback ratio is not economical. In Mr Valentis’ opinion, the solution will fall on the refineries to supply a fuel product that complies and is cheap enough. He felt that most product tankers will switch to marine gasoil in the short term, until the new fuel is available and predicts that most owners and charterers will switch to slow steaming to lower consumption, which will benefit the market.

“If the fleet decreases speed by 10%-15%, there will be an additional demand for between 60 to 80 MR2 vessels approximately,” said Mr Valentis. He pointed out that moving the fuel from the refineries to the ports where it is required will increase tonne-mile demand, a hidden benefit to the MR market.

AG Shipping’s Mr Kakodkar took a different view: “We will be looking to retrofit scrubbers on existing second hand MR. A pre-sale survey will be able to determine that,” he said. He also felt that charterers will pay a premium.

“We see a differential of about US$450 tonne between high-sulphur fuel and low-sulphur fuel. A measure of that difference will have to be built in to the timecharter rates for vessels fitted with scrubbers. This premium will even out as more vessels get fitted with scrubbers,” said Mr Kakodkar.

Consolidation and pools

A significant portion of the MR2 fleet operates in pools, the purpose of which is to derive commercial and marketing efficiencies. Scorpio Tankers’ Mr Bugbee said that his company had seen efficiencies following the merger of the Scorpio Tankers and the Navig8 product tanker LR fleets: “We are [now] able to negotiate better with charterers and put together triangulations that could not have been done for the fleet we had before. This is a clear benefit of size and consolidation in a relatively small (LR2) market.”

In the MR2 market, the situation is different, according to Mr Bugbee. “You need a certain critical mass to (gather market) information and win charters,” he said. He also warned that the MR2 market is more consolidated that it appears, with a number of companies that operate MR2 also running pools. The inference is that this gives them crucial assess to market data, more so than if they were independent of pools.

Citing his own company as an example, he said: “Scorpio Tankers may own 109 product tankers, but we run around 180 product tankers in pools. While the product tanker market appeared weak in the last quarter, none of the companies earned an income below their operating costs. Every single day the product tanker market has been contributing to capital, unlike what we have been seeing in the dry market and the crude oil market.”

His point was that there are far more product tankers behaving in concert, due to the pool system, than is apparent and when the upturn in the market comes, the product tanker companies should be well placed to reap the benefits, due their positive position on earnings at the low point in the cycle. Indeed, according to VesselsValue data, 325 MR2 product tankers are operated in pools, which equates to around 20% of the live fleet. This appears to confirm Mr Bugbee’s point concerning the opaque nature of consolidation in the MR2 market.

 

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