Tanker TCEs During #IMO2020 Switch Demystified

If you’ve been following the maritime industry’s #IMO2020 fuel transition to lower sulphur fuels, you know that some vessels who have installed “scrubbers” can still burn high sulphur fuel oil (HSFO), while others have to burn low sulphur fuel oil (LSFO) or Marine Gas Oil (MGO), fuels which are much more expensive. As you can see from the chart below, the price differential between low and high sulphur fuels is hovering near 80%. Given that fuel is the largest cost of operating a large ship, this is a big deal.

This has caused some confusion among industry participants as to how much boats are actually earning. Journalist Greg Miller recently pointed out:

To all #shipping investors who’ve drunk the #IMO2020 Kool-Aid, don’t be surprised to read in future quarterlies: “Our average TCE rates are lower year-on-year as a result of higher fuel costs due to IMO 2020.” See cautionary reminder on reg headwind here:

He is referring of course to the fact that despite freight and shipping rates going up, fuel costs are as well, and for the 94% of the maritime fleet that has not installed scrubbers, higher day rates will be impaired by higher fuel costs.

However, not all vessels or asset classes are equal. There are three main distinctions:

Non-Eco: Standard ship design.

Eco: Modified engines, propulsion, and exhaust systems, resulting in ~15% higher fuel efficiency.

Scrubber: Cleaning system which removes sulphur from high sulphur fuel exhaust.

Eco and Scrubber retrofits cost millions of dollars and require months of downtime, and so few owners (only about 6% as of Dec 27) have opted to install scrubbers. Very few boats feature eco design.

Ship earnings are reported as TCE (time charter equivalent). As you can see from the table below showing VLCC rates from various routes, there are some large spreads between the earnings of ships based on permutations of the above options:

Eco ships with scrubbers are earning far more per day than their non-eco, no scrubber counterparts. This is interesting when forecasting company earnings, as they should outperform rate expectations.

Many brokers are reporting their rates as a single average for each route. Investors are extrapolating expected earnings for their favorite tanker play based on those averages. When Fearnleys or Riverlake put out numbers, it’s an average of all of the above configurations. For instance, check out the chart below of Suezmax earnings from Riverlake:

The rates given are an average of all charters. Going forward, brokers will be factoring in the higher cost of low sulphur fuel in their route TCE calculations (and some already are for Q1 bookings). As far more tonnage does not have scrubbers or eco design, average earnings will be skewed lower. This is simple to illustrate using elementary math and 10 imaginary ships:

((8*50k)+(2*65k))/10 = 53k

As we have more data points on the low side, we have lower expectations. Still relatively few ships have installed scrubbers. Those ships will earn far more than industry participants are expecting when simply looking at average earnings out of context.

Splitting hairs over good versus great earnings

As Mr. Miller pointed out in his post:

The difference between the tanker sector and the dry bulk sector is that the fundamentals in dry bulk appear weak and the fundamentals for tankers are strong.

In a weak market, the negotiating power in the spot voyage negotiation goes to the cargo interest, meaning that the vessel interest is less likely to recoup its higher fuel cost. The situation reverses when vessel supply is tight, as is the case with tankers.

But even so, higher year-on-year fuel costs for tanker owners with a high percentage of their fleets in the spot market are inherently bad for those vessel interests.

Whichever way you cut it, oil tankers are earning more money than they have in more than a decade, scrubber or no scrubber. While $10–20k per day is a huge difference in the level of profitability, it’s a difference between very profitable and obscenely profitable. It doesn’t matter very much. Most tanker companies are going to earn more in 2 quarters (Q4 and Q1) than they’ve earned in the last several years.

It may be better to earn 100k per day than 80k per day, but in the grand scheme of things, it’s all very profitable to tanker operators, and those without eco or scrubber ships are getting those earnings without the capex and associated debt impairing the balance sheet and depreciation impairing the income statement.

Scrubber installs will support rates

Early estimates were that a much larger portion of the global fleet would have installed scrubbers. Due to delays, cost, and uncertainties, fewer ships than expected have installed scrubbers. As non-scrubber companies see their peers outperforming due to lower fuel costs, they will rush to yards when availability opens up, putting a floor under rates as scrubber installs take supply out of the market.

Eventually, the market should reach some sort of equilibrium and the LSFO / HSFO spread should narrow, but for now, scrubbers have introduced a very interesting pricing dynamic into shipping.

So who has scrubbers?

DHT, Frontline, and Scorpio Tankers are the most well known scrubber plays, and I believe all have 50% or more of their vessels equipped with them.

Diamond S Shipping and International Seaways also have some vessels equipped with scrubbers.

Euronav also bunkered six months worth of compliant fuel ahead of time, at some 40% lower than current prices, and was able to enjoy high rates while some peers were installing scrubbers.

Conclusion

Tanker rates are amazing. All tankers should outperform, especially the most beleaguered and undervalued. However, as long as fuel price spreads are wide, the economics favor ships with scrubbers.

Software developer, investor, energy markets analyst.

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