Many investors are asking questions about the dynamics of the tanker market and asked us to confirm their views on vessel utilisation across the tanker market.
This answer is very much linked to how supply and demand balance one another in a bulk tramping market. Whilst there is no precise correlation between earnings and supply, it is critically important to understand that small changes can have major impact on the market as a whole. When the market is undersupplied with tankers, there is little or no resistance to pricing and when the market is oversupplied with just a few tankers, the market has no support and indeed owners have been known to even transport cargo at a negative gross cash flow!
The speed of the vessel is one of those changes that can have an impact on the market. But what is it that ship owners want to gain by speeding up their vessels?
The choice of the speed is more complex than it appears
The single largest variable cost of a voyage is the bunkers and this varies in direct relationship to the speed at which the voyage is performed. The speed of the laden part of the voyage is agreed with the charterer when the voyage charter is negotiated. The ship owner or, if there is one, the time charterer chooses the speed of the vessel for the ballast voyage (when the ship is empty of cargo) sailing the ship to a position where it can load a cargo for the Voyage Charter. In both cases the slower the ship, the lower the fuel cost as consumption will be lower and the faster the ship, then the higher the fuel consumption and therefore the cost.
The slower a ship sails, the longer the voyage (more days) but the less fuel it consumes. So the calculation of the TCE will be affected in two ways (as the Freight lump sum remains the same). The Net Freight will go up because of the savings made on the fuel but at the same time it will be divided by more days taking the TCE down.
Therefore a ship should only go slower if the cost of fuel, saved by slower sailing, offsets the reduction of the TCE caused by the increase in the number of days the voyage lasted. Finally, if the fuel cost saving justifies slower sailing then the owner will look to the lost opportunity of the days that could have been spent on the next voyage compared with the improvement in TCE from slower steaming on the current voyage. This is a very important point but the decision must be taken at the start of a voyage (the start of the ballast passage – see Voyage Accounting below) but this is done on the basis of unpredictable assumption regarding the next voyage. At that moment, the current Voyage Charter may not already have been fixed let alone the one after.
Consequently, it is good practice upon discharge to sail at the most economical speed away from the discharge port to a way point (the last point at which the ship has full optionality as to its destination). As an example, on leaving China, this might be Singapore for orders.
During this period the vessel is being marketed for its next Voyage Charter. Once the Voyage Charter is contracted, the vessel should proceed at such a speed so as to arrive at the port just in time to load the contracted cargo.
It serves no purpose to arrive earlier as waiting adds additional costs against which there is no certain additional income. So in this example arriving early worsens the voyage TCE Earnings.
More fuel is consumed going faster and if the ship arrives too early fuel is consumed waiting (to provide minimum energy to run the ship) and there is no additional income. If an earlier cargo lifting date could be contracted then the issue is whether it would add sufficient additional income to offset the additional cost of fuel for sailing faster. Still, if it does not, then arguably, the days gained may translate into more value in the subsequent voyage but with a high degree of uncertainty which will be lifted only two or more months away and in a market subject to huge volatility.
In addition, speeding up means that the global supply of ships is also going up and that, in itself, is likely to reduce the freight market. There is therefore more chance that the value burned in speeding up will NOT be recuperated in the subsequent voyage as there is more chance that the market will be lower by then.
In this context it is also important to note that the consumption of fuel, relative to speed, is not uniform and at the top speeds ships consume exponentially more fuel. For VLCC vessels, there is an inflection point above 13 knots and steaming above this speed, to save a few days, will disproportionately increase the voyage expense compared to the number of days saved.
It’s a Commodity Stupid!
The owner or time charterer of a vessel should always manage bunker costs, as described above, by sailing as slowly as the pattern of trade it is involved in allows. When deciding the speed, at which to sail from a discharge port, the market environment is very important.
The world VLCC fleet is small, only around 630 vessels, and each ship will lift somewhere around 5 to 6 cargoes per year depending on the trade and move those cargoes over long distances. So for any cargo movement the number of ships available to load the cargo due to location and timing may vary considerably. This is very different from even other tanker trades that are short haul such as the product trades or localized dirty trades in smaller ships.
Many participants and investors follow the global supply of ships and try to present the market as a bull or bear market depending on the overall supply of ships compared to the overall demand for ships. They are often confounded by a precipitous fall in rates in what they have characterized as a bull market; equally they are often denying the possibility of high fixtures in what they have characterized as a bear market. Yet when one reviews past fixtures it is apparent that the market can have very large swings within both peak and trough periods.
Average earnings between 2004 and 2008 (inclusive) for VLCCs were USD 70,000 per day yet within that period voyages were done at USD 300,000 and USD 20,000 and within days, swings could make a difference of tens of thousands of dollars.
This apparent super volatility comes about through the structure of the market. As described above, the earnings of ships come from the movement of cargoes. So when transport is required for a cargo, the cargo owner will instruct the internal shipping department of the cargo owner, who will in turn approach several brokers and sometimes owners directly and will seek to auction the cargo move. The lowest bidder will win the contract, or at least, set the contract rate that clears the market for the other bidders. Each broker hoping to make a commission on the contract conclusion will encourage his owner to be low enough to win the auction.
The owners will be guided as to who else is bidding and how low they have to bid to succeed. The owners must have good information to know who is a real competitor and who is not. To be a real competitor a ship must be of the right age, type and class and be acceptable for the customer under the tanker vetting regime. It should also be reliable and so only those ships which are free of cargo and close enough to reach the load port at which the cargo is being prepared on the dates that the cargo owner has specified can realistically compete.
This creates a mini market for each and every cargo, which comprises those ships that can work that cargo. This mini market is defined by time and distance. If many ships are truly available for the cargo, the mini market auction will take the current market level down, if the number of ships truly available is limited or only one, then provided the owner is aware of this, the market level will go up. This is regardless of the global supply of tankers.
The owner is at a disadvantage as the auction is controlled by the cargo owner and because of that, the cargo owner has all the bids. The cargo owner also knows which ships are cleared for him to use and what other cargoes also need to be moved. There is no uniformity of information relating to bids or availability. The owner must have a view on that balance if the true value of the ships position, the commodity, is to be discovered particularly when the market is set so that it could go up. This is the true added value of a pool as it increases market visibility through better information and broadens market knowledge improving pricing.
Speed is critical in the management of the spot market, as speeding up (and remember this worsens voyage economics) serves a negative purpose if it accumulates the number of ships bidding on a cargo (increase the supply). It worsens the economics of the voyage that is about to be done and takes the whole market level down. So ship owners and time charterers need to focus on bunker cost management and only speed up when a voyage has been fixed and then only sufficiently to arrive just in time for the cargo loading dates.
The ship owner dilemma
Too many ship owners focus on their relative outperformance; whether they do better than other ship owners. Often this leads them to undersell their services in the hope of perceived marginal gains (making sure they get a cargo sooner than later) over the other ship owners. But giving a discount to their services is detrimental because each Voyage Charter is a separate commodity negotiation which needs to be priced, as precisely as possible, to gain real absolute value giving good return to capital. By underselling their services, they may cut waiting time but often the discount is greater than the cost of waiting for the next cargo priced at a higher market. In the long run, the reason why relative value is irrelevant is simply that weak performance does not cause ships to leave the market as demonstrated over the last cyclical downturn. Relative outperformance will almost never deliver appropriate reward to capital… it just lowers the market for all.
The only way to resolve this dilemma is to be part of a large platform such as a pool which is actively marketing available tonnage every day.
As Euronav transitions to greater public ownership, it will continue to attempt to lead the market in focusing on the requirement for a good return on capital. Shipping is a capital intensive business and if the right returns are not given to capital then the industry will struggle to find access to capital whilst providing the necessary stability in the industry to bring security of supply, increasing environmental awareness, safe and rewarding conditions for employment, in short all of the things that the world expects.
Time Charter
A time charter is a lease of a ship by an owner to a lessee (known as a charterer) for a period of time (rather than the performance of a voyage) and paid for by a daily rate of hire usually an agreed dollar amount for each day and pro rata for each part of a day. The time charter daily hire covers the cost of the ship and its crew together with all cost and expenses for the ship to operate. The service provided is to operate the ship to steam the ship between ports, load, store, transport and deliver the cargo under the orders of the time charterer. The costs specifically related to the charterers orders in steaming between ports, loading, storing, transporting and discharging the cargo are known as the voyage related costs and are consequently for the account of the time charterer.
Voyage Charter
The carriage of a specific cargo from a load port (typically a terminal at an oil field) to the discharge port (typically a terminal at a refinery) is called a voyage or spot charter for which the cargo owner pays a lump sum usually denominated in US Dollars (it is calculated usually using a system called world scale). The voyage related costs comprise primarily bunker fuel but also port costs, tugs, pilots and any other thing incidental to the cargo carriage. The ship owner, or if there is a time charter, the time charterer will seek to recuperate these costs from the freight paid by the cargo owner but these costs are not a pass through and do not form part of the negotiation.
Voyage Accounting
The cargo owner is only interested in the movement of the cargo but the ship owner must reposition the ship after discharging one cargo and before loading another cargo. The costs for this repositioning must be taken into account in the costs of performing the cargo transportation. In most cases it is elected to apply the repositioning costs to the cargo transport just about to be done. In other words a complete accounting voyage is, in most cases, from discharge port to discharge port. The ‘actual’ voyage commences after leaving the last discharge port sailing unladen to a load port, entering that port, loading the cargo and sailing to the discharge port, entering that port and discharging the cargo. The process then starts again.
Special Report: SPEED UP FOR WHAT?
Source: Euronav
