Crude Oil Tanker Owners See Dollar Signs As Russia Ban Approaches

The European Union import ban on Russian crude is now less than five weeks away. As the clock approaches December 5, crude oil tanker owners expect the Russia-Ukraine war to exacerbate trade disruptions, which will push spot prices even higher.

“A key driver of the oil market over the past six months is about to enter its final — but most impactful — phase,” Brian Gallagher, head of investor relations at crude oil tanker Euronav (NYSE: EURN), said on a quarterly conference call Thursday.

Teekay Tankers (NYSE: TNK) CEO Kevin Mackay said during his company’s call Thursday, “The reshaping of global trading patterns [following Russia’s invasion of Ukraine] is the largest single factor behind current interest rate strength. The impending ban will significantly increase that impact.”

EU substitute for Russian crude oil

Tanker demand is measured in ton-miles: volume times distance. Demand for crude oil tankers has increased since the beginning of the war as the EU partially replaced imports from Russia with volumes from more distant destinations. In order to comply with the December 5 ban, this exchange process must be accelerated quickly in the coming weeks.

Mackay cited data from Kpler showing that EU imports of Russian crude fell to 1.5 million barrels a day in September from 2.6 million barrels a day in January. “Starting December 5, those volumes are expected to drop to zero,” Mackay said. “So far, these volumes have been replaced almost barrel by barrel with imports from the US Gulf, Latin America, West Africa and the Middle East.”

(Chart: Teekay Tankers Q3 2022 earnings presentation. Data: Kpler)

Due to much longer travel distances, the ton-mile demand effect was extreme.

The drop in Russian short-haul crude flows to the EU between January and September reduced tanker demand by 11 billion tonne miles, according to Kpler data cited by Teekay. Replacement inflows from other sources over the same period added 35 billion tonne miles to tanker demand – a net positive effect of 24 billion tonne miles.

Mid-size tankers in the Aframax (capacity 750,000 barrels) and Suezmax (capacity 1 million barrels) categories have enjoyed the greatest upside potential. More recently, very large crude oil tankers (VLCCs; capacity of 2 million barrels) have joined the party.

According to Gallagher, the EU substitution of Atlantic Basin and Middle East crude for Russian crude “will benefit VLCCS in particular,” he said, adding that “this trend has been very pronounced since July.”

There are almost no US ports that can handle VLCCs. Instead, crude is “lightened” with smaller vessels like Aframaxes that make ship-to-ship transfers to load VLCCs in the US Gulf.

“We are seeing an increase in lighter exports to the US Gulf on VLCCs, some of which will go to Rotterdam,” Mackay said. “We’re seeing larger volumes coming out of the US Gulf, which is why you’re seeing Aframax rates on the US Gulf going above $90,000 per day.”

Russian substitute for crude oil exports to the EU

The other major disruption caused by the war is the diversion of Russian crude oil exports that used to go to the EU to more distant destinations, mainly India and China.

The Kpler data cited by Teekay shows that this had a positive effect on tanker demand of 41 billion ton miles between January and September. This, combined with EU import effects, brings the total net gain from war-related crude oil warpage to 65 billion ton-miles.

But what happens after December 5th?

So far, Russian crude oil exports have flowed unhindered. However, the combination of the impact of the EU ban on tanker insurance, the G-7 price cap and broader fears of sanctions could significantly reduce Russia’s crude oil exports. This would have a negative impact on tanker demand. It would reduce the “tons” in the ton-miles equation and partially offset the “miles” upside of EU substitute imports.

Argus Media reported on Wednesday that Chinese refiners “have so far bought only a handful of shipments arriving in December from Russia.” It said that “China’s major state-owned companies 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 loads.”

Euronav CEO Hugo De Stoop claimed that Russian crude will eventually find buyers.

“We believe that if the [Russian] Oil is cheaper than what you can get elsewhere, it will find a home. We have a lot of precedents showing this,” De Stoop said on the conference call.

Operating Restrictions on Russian Exports

EU sanctions will ban EU reinsurance for Russian cargo to non-EU buyers after December 5 (until EU members approve an exemption for those buying below their own price cap). The UK’s Protection & Indemnity (P&I) clubs, which provide insurance cover for most of the world’s tankers, rely on EU reinsurance.

However, De Stoop does not see any major new impact from insurance.

“If I look at the P&I in which we have a stake, they have already done what many companies and banks have done. They have sanctioned themselves or put many restrictions on the deals they do with Russia,” he said. “So that’s the situation. That’s what we heard [U.K. P&I] simply being replaced by less “international” companies, namely insurance companies based in places like Dubai and China.

“I think it will be more the physical operational constraints that will determine whether or not Russia has to close some of its oil fields,” he said.

Russian ports, like US ports, cannot process VLCCs. In winter, the country’s northern ports require the use of ice-class crude oil tankers, mainly Aframaxes. The number of Aframaxes available to load Russian crude this winter will be limited as many Aframax owners will choose not to carry Russian cargo due to the insurance issue and the G-7 price cap.

“There will be a two-tier market,” said De Stoop. “Because it’s going to be very difficult to have ships carrying one cargo out of Russia and the next out of a place that isn’t under restrictions, even if you’re based outside of Europe.”

From a economies of scale perspective, there is no point in loading an Aframax with Russian crude and sailing it all the way to China or India. It makes even less sense considering the number of ice-class Aframaxes available for Russia is limited. “If you use these ships for a long voyage, they will not be available for the voyage [shorter] Distance that is icy,” explained De Stoop. (An Aframax going all the way from Russia to China or India would not return to Russia until spring.)

He said Russia must use Aframaxe for lighter exports from frigid waters, ship-to-ship transfers to larger tankers, and then bring the Aframaxe back to Russia to pick up the next cargoes. Russia will be forced to conduct lighter operations in winter and will be forced by economies of scale at other times of the year. This will further tie up tanker capacities because transhipments from ship to ship are time-consuming.

“Obviously this is a heavier operation than if you can just pick up the oil at a port and transport it to a destination non-stop,” De Stoop said.

profit summary

The rate boost from the war, coupled with the post-pandemic recovery in oil consumption, has pushed tanker companies back to profitability after nearly two years of heavy losses. Owners of product tankers and small to medium sized crude oil tankers recovered first and, more recently, owners of larger tankers.

On Thursday, Euronav reported net income of $16.4 million for the third quarter of 2022, compared to a net loss of $105.9 million for the third quarter of 2021. Earnings of 8 cents per share were in line with analyst consensus.

Euronav owns VLCCs and Suezmaxes. Spot VLCC rates averaged $22,250 per day, more than double the average rates for the same period last year. VLCC rates continue to rise. So far in Q4 2022, Euronav has booked 45% of its spot VLCC days at $47,500 per day.

Chart showing crude oil tanker owner Euronav's earnings

Teekay Tankers — which owns Aframaxes, Suezmaxes and product tankers — reported net income of $68.1 million in Q3 2022 compared to a net loss of $52.1 million in Q3 2021. Adjusted earnings of $1.68 a share was 2 cents below analyst consensus.

Teekay’s spot Aframaxes earned $35,917 per day last quarter, more than five times spot prices in Q3 2021. So far in Q4, Teekay has booked 38% of its spot Aframax days at $36,600 per day.

Chart showing Teekay Tankers revenue

Click here to view more articles by Greg Miller

Leave a Comment