North or South?

Oil price has big implications for shipping; whether it goes up as it has done so relentlessly for many years or heads south as rapidly as it has for the last six months. Where exactly it is headed remains to be seen leaving ship operators needing to weigh up a lot of options.

Nobody really knows where the oil price is going. The fall wasn’t something that most experts predicted nor was the slight revival in February. On 25 February Francisco Blanch, head of commodity research at Bank of America-Merrill Lynch, speaking on CNBC noted that global supply is running around 1.4 million barrels a day above demand. “If you run out of space, prices tend to react a lot more violently to adjust that supply and demand imbalance and that’s what we expect over the next few weeks,” he said, forecasting both WTI and Brent will fall toward $30 a barrel.

Two days later the same channel featured Neil Beveridge, a senior oil analyst at Sanford C. Bernstein, in Hong Kong saying “We’ve seen the bottom of the current cycle and prices should go higher through the year and in the short term. We still have an excess of oil supply but that will slow during the year. Also we’re starting to see the green shoots of recovery, with stronger demand in China.” Beveridge predicted Brent crude should end the year at over $70 a barrel.

If the economic experts cannot agree on what will happen even a few months hence then what chance has an owner or operator? Shipping has seen its economics and strategies turned on their heads several times since the oil crisis of the 1970s. Usually it is rising prices that create the biggest headache, so a fall of the magnitude that has taken place since late summer last year would ordinarily be seen as a fillip for the shipping industry but this time around it is causing a little bit of chaos and confusion. It is also impacting on various sectors differently — positively for some and very negatively for others.

Clearly the most negative impact is upon sectors that are connected with the offshore industry which is having to adjust to a price for crude oil that has made oil from large numbers of fields marginal or uneconomic. Baker Hughes and Schlumberger, two of the largest oil service companies in the world have announced lay-offs of 7,000 and 9,000 workers respectively. 10,000 jobs have gone in Mexico and reports from the UK and Norway predict job losses in oil production of 35,000 and 40,000 respectively over the next few years. The Dallas Federal Reserve estimates that in Texas alone 128,000 jobs will be lost by this summer if prices remain around $50 a barrel.

These are not necessarily shipping jobs but there are impacts for shipping connected to them. Rigs that are mothballed or reduced to skeleton crews and known reserves left untapped means that demand for PSVs and standby vessels reduces hitting crews and shipyard jobs in turn. The other knock on will be to equipment companies as the reduced number of ships needed filters through to order books. In Norway, one in nine jobs in the country has some connection with oil and gas.

Globally there will be several yards that fear for the future not least because for the years following the 2008 crash, offshore was seen as the only growing sector and the saviour of marginal yards. Orders in offshore cover ships as well as rigs and FPSOs and all are being affected. New drilling has dramatically slowed, with the current oil rig count at a five-year low and falling.

One sector that does look to profit is the tanker sector. While spot oil prices are lower than future contracts, the chance to fill up inventories is one that cannot be missed. Some US storage will be filled by US shale oil which is now marginal but most will be from the Middle East. That brings a demand for tanker space to move the oil and for floating storage. As crude storage fills so the need to shift it to make way for more grows pushing the benefits into the products sector.

The tanker sector has been over-tonnaged for some time meaning an ordering spree would be somewhat speculative — not that that has ever been an obstacle — and responsible owners may prefer to see how the oil price moves before committing. A sign that some may be tempted was the addition of 12 new VLCCs to the order book in January this year — a big contrast to the total of 38 ordered throughout 2013.

All ship types and sectors will of course benefit from lower bunker costs and that can take effect in different operating strategies. Slow steaming which reduces fuel costs and takes up slack capacity has been with the industry since before 2008. Ships in the spot market may be obliged to restrict slow steaming to ballast legs as charterers have the right to expect ships to progress with due despatch. In the liner sector, schedules allow operators to determine their own speed.

Cheaper fuel could mean an increase in speed although so far leading players have resisted the temptation to do so leaving that strategy to minor operators. There are good reasons, even though on time arrivals are only reaching a best of around 75% increasing speed brings costs but no additional revenue when ships are still running less than full.

A point acknowledged by Maersk CEO Nils Smedegaard Andersen when presenting Q4 figures for the Danish operator in February. Announcing higher profits resulting from higher volumes and lower fuel prices and discussing future ship purchases Andersen said “The lower the oil price gets, the less benefit the larger ships offer.” Andersen has not written off buying more large ships but has said that smaller vessels will feature in their considerations. The company expects to invest about $3 billion a year through to 2019 on new vessels and containers and on retro-fitting current ships. There are 449 boxships on order for a combined total of over 3.4Mn teus including 44 ships of the Triple-E generation for a variety of owners. Once, ships of this type were seen as the future of Asia-Europe trade, but if oil prices continue to fall and trade volumes do not grow, then their future must have a very big question mark hanging over it. A falling oil price will of course translate into lower costs and savings for consumers so it may be that they will have more disposable income that will help boost trade but there is no guarantee that the desire to spend on trinkets from the east will be as strong as it once was.

For all ship types, the effect of the EEDI rules is something that must be frustrating for operators at a time of falling oil prices. The EEDI formula would actually favour faster vessels if the extra speed could be achieved without higher fuel consumption but it is a recognised fact that the result of EEDI is inevitably slower ships.

What is to be expected is that operators with a feel for their customers’ demands will opt to order vessels between now and 31 December 2019 — unless they have already committed to vessels prior to 1 January this year. That will allow them to take advantage of a more lenient Phase of the rules timetable and invest in a vessel with more options as regards service speed. A long period of low oil prices if combined with high or growing cargo volumes will likely lead to operators hanging on to older tonnage as the potential to perform more voyages annually will offset the cost of extra fuel used. Lower bunker costs could also have an effect upon the prospects for LNG and also for scrubber sales. It is likely that the differential between distillates and residuals will remain similar in percentage terms but drop in hard cash. Since the cost of scrubbers will not alter, the payback time of installing a scrubber may increase beyond what an operator sees as being of value. As for the prospects of LNG, one advantage claimed for it has been a likely lower cost in the long term. That will only remain true if LNG prices come down as fast and as far as oil. There has been some reduction but not of the magnitude needed.

As a consequence, LNG’s attraction as a fuel is not as great as it was just a year ago. Ship operators have spent the best part of a decade knowing that fuel efficiency and its environmental impact was something they may not have full control over in an age of mandatory rules. They have planned their strategies and in many cases begun putting them into effect. Perhaps for now the best strategy would be to enjoy the lower price while they can, consider again where prices might go and then decide for the longer term.