Q&A: Seaborne US crude market is just beginning
Houston, 19 January (Argus) — Vivek Srivastava, the director of tanker research at SSY Consultancy & Research, spoke with Argus on the sidelines of the Argus Americas Crude Summit in Houston, Texas, about global freight rates and shipping economics for US oil exports. Edited highlights follow:
Your presentation focused on Very Large Crude Carriers (VLCCs) — especially heading to Asia. Europe has been emerging as another key destination lately, but primarily for smaller tankers. Can you talk to me about what you are seeing with that?
US crude exports are really at the beginning of their story, and the infrastructure is developing as we begin. Most of it is sold on a spot basis because, for longer term contracts to be put in place, we need a few more certainties like pipeline costs. None of that has been built yet. So, it is pretty much all spot at the moment, and it is being driven by opportune traders.
A lot of (last year's) exports were going to Asia, and refining margins out there were strong. Demand from refiners for US crude was strong. We've seen refining margins in Asia come down a bit since the start of this year, so Asian refiners aren't that desperate to pull a lot of crude at the moment. Chinese state refiners at the end of last year got new product export quotas, and they've — I wouldn't say they have flooded the market — but they have oversupplied the region with cheap gasoline. That has brought down refining margins for other Asian refiners, so the economics don't work at the moment.
In contrast, because of the cold weather you've been having in Houston and a few weeks ago on the US east coast, European refiners have been experiencing high demand for heating oil and middle distillates. European refiners have been shipping a lot of middle distillates to the US east coast, and refining economics in Europe have been good. And European refiners want crude oil right now, so they have had an incentive to import.
The thing about shipping oil over long distances is that it is an economies of scale game. The longer distance you transport the oil, the more cost effective it is to use a larger tanker. So if the oil is going all the way to Asia — across two oceans — it makes a lot more sense to use a VLCC. If it is only going to Europe — only across one ocean — you don't necessarily need a VLCC. You can go on a Suezmax or even Aframax.
VLCCs at the US Gulf coast headed to Asia, particularly to Japan and South Korea, are increasingly being co-loaded with Mexican crude. This wasn't really the case when exports first ramped up out of the US. Are economics better now to co-load at both locations compared to loading via ship-to-ship (STS) transfers at the US Gulf coast?
The economics are in flux at the moment. When VLCC exports first started (truly) emerging, it was in the wake of the hurricanes that started around September. I think at that time, it was very cheap to charter a bunch of Aframaxes to do STS transfers in the US Gulf. As the year progressed, it became (more expensive). People started experimenting with co-loading at the east coast of Mexico; some of them found they could make the economics on that work.
I can't tell you off of the top of my head which gives you better economics, but the first of those is definitely dependent on Aframax rates as well as VLCC rates. And the two of those trend together — if crude is expected to load onto a VLCC, it is expected to do so via STS transfers.
With all of the expansions to current infrastructure at the US Gulf coast, do you think any VLCCs would be ballasted back to the Middle East without crude aboard?
That would only happen if the market were really bad. The Middle East can't get cargoes from the US Gulf; they can't get cargoes from Venezuela, Mexico, or anywhere in this region. They'd be very loathe to do that because they are paying all the costs of that voyage, but they wouldn't be earning any revenue at the same time.
It does happen in very bad markets, but — given all the predictions we have seen over the course of this conference for US cargo growth — I think there is going to be enough supply for US cargoes. East coast Mexico and Venezuelan cargoes are a bit more problematic.
The only thing I think that could possibly interrupt the US story is if demand from US Gulf refiners surprises to the upside and they bid up the price of WTI Houston and Light Louisiana Sweet (LLS), tugging at the arbitrage.
Roughly what ballpark would you say the WTI/Brent spread needs to be in for VLCC exports to work?
$4/bl. That's down. It's cheaper to charter a VLCC than it was two years ago.
How have rising US crude exports have affected tanker markets out of places like west Africa or Latin America?
The two biggest west African producers, Nigeria and Angola, have had problems outside of the Opec and non-Opec agreement. Nigeria has had massive civil unrest, which has interrupted its crude loading. Angola has had a few years of under-investments in the previous regime. Production is now starting to suffer, even without the Opec and non-Opec agreement. Cargo volumes from west Africa dropped off because of those two big producers.
The overall total production and total exports have fallen off, but they have kind of prioritized exports to the east — to Chinese refiners and South Korean refiners, even Indian, Taiwanese and Japanese refiners. They have maintained exports at a level to those destinations, and flows on those routes actually recovered a bit in 2017 versus 2016.
It is the westbound routes that have taken the big hit. They are sending very little crude to Europe, particularly, at the moment. I think west Africa to the US as a route was very popular in the early 2000s. It died a bit shortly after the financial crisis and dwindled to nothing at one point. It has come back slightly, but it is still not that voluminous or relevant.