Back in my SIMON SAYS blog on 8th March, I had asked the question, “are VLGC owners about to lose control”. It might have taken over a couple of months to evolve, but I think today we are seeing the answer. As Simon Cowell, the infamous X Factor panel critic on both sides of the pond would say, “and it’s a yes from me”. It just took a little longer than I expected, and the terms of engagement have maybe changed a little from what I had originally expected. Of course it’s all tied up with the issues associated with coronavirus, and its impact on the economy, the energy and LPG markets. I think ship owners can only hope there is going to be some sort of dramatic change, that again brings Middle East and U.S. LPG volumes flowing, albeit some ship owners, such as BW Gas, are trying to take more of their fate into their own hands, however it remains to be seen whether this drop in freight levels continues to reflect on the name of one of Simon Cowell’s greatest boy band discoveries - One Direction!
To understand more of what is happening today we need to rewind a little, and explain how the structure of the LPG shipping sector has developed in recent years. A key change in the shipping market was the booming demand for shipping space driven by the Chinese appetite for raw materials in the early 2000s, which not only helped to line the pockets of many a ship owner, but also brought interest from the Wall Street money men, looking to make a cut on investor’s cash, who were desperately looking to find higher yields than just sat in the bank. This led to a number of ship owners accessing the required debt funding for new buildings from the bond market, LPG was no exception. One important factor was that the money men needed to assess performance, with quarterly figures the ultimate measure of success or failure. The traditional ship owning model in LPG was to build vessels on the back of long term time charters, and then be left to only concentrate on the operational requirements of the vessels, and the monthly invoicing. Now the shipowners were being asked to answer for the weekly and monthly movements in the LPG shipping market, the whole emphasis had changed.
This caused the VLGC owners to shift away from the time charter market, moving significantly into fixing on a short-term spot basis, not just caused by the influence of the financial reporting obligations, where having rates that could be measured against the current market would make life a lot easier, but also by the oversupply of tonnage in the market at the time, and the feeling that ships being time-chartered to traders were undercutting attempts by the traditional ship owners to keep rates under a degree of control. Traders were re-letting in weaker markets just to keep ships moving, not to keep freight levels maintained or higher.
History is important because ship-owners today have ultimately to live and die by the sword of the spot market, but let’s not forget freight levels are dominated by the swings in LPG product prices, as well as physical supply and demand issues, the supply of ships is only one element. With the 2019 market overrun by increased U.S. exports, trade war logistics, IMO uncertainties and delays caused by fog in Houston, water issues in Panama, or Indian discharge bottlenecks, and with the supply of new-buildings a relative trickle, the ship owners found a market they could only dream of. But as we know nothing remains that good for that long, and the grip of the ARB is going to take control, both as it widens and especially as it starts to narrow.
So guess what, we are back to talking about the ARB, and there are three of them impacting the LPG world, the sometimes illogical (some say always illogical) CP/FEI spread, the more market related MB/FEI ARB, and the smaller volume relation, MB/NWE differential. Middle East cargoes are the bread and butter to the less adventurous ship owners, as they move on contract and are geared to the timing around nomination acceptances. The Baltic rate, that covers the freight element that accompanies the movement of LPG from the Middle East to Asia (Ras Tanura to Chiba), has collapsed by over $20/ Mt in the last couple of weeks, to a level just below $35/ Mt. The spot ARB has very little to do with this, except that the argument goes as follows: if supply in Saudi Arabia is cut-back, CP will get pushed-up in short-term market plays, which on occasions are likely to catapult the newly set monthly CP FOB price above the delivered FEI levels, meaning freight should theoretically be negative, and therefore spot cargoes will become more difficult to fix. The more relevant indicator are the number of cargoes programmed for export, and this week the June acceptances showed nine cargoes either deferred or cancelled. The paradox being that Qatar, whose LPG is a by-product of non-associated gas, had three spot cargoes for sale, showing that the current market is still being dominated more by very thin demand than supply issues. Anyway the flurry of post acceptance activity, however small, did put a brake on the drop in freight levels, but for how long?
The U.S. export market is throwing up all sorts of conundrums when it comes to the invisible hand of the ARB. Although June ARB levels have been relatively stable in the mid $80s/ Mt, cancellations have not appeared, although a couple have recently been rumoured, as freight levels have dropped in an attempt to keep the ARB open, and ships moving. The problem is we’re not seeing the cargoes. I said previously that the terminal operators rarely enter the spot sale/re-sale market, as they have contractual commitments covering the majority of their slots, but it appears that with a few contracts having come to an end, notably Shell with Energy Transfer in Nederland, the contractual slate isn’t what it used to be, or what some export terminals would have you believe. So we’ve had the unusual occurrence of cargoes being offered by the likes of Energy Transfer, Enterprise, P66 and Targa on the spot market, and some say there could be potentially more. The problem is that demand for U.S. cargoes is currently pretty sketchy, and whereas sellers aspire to 5 or even 6 cents/ gallon, they’ll be lucky to see much above 4 cents/ gallon. The EIA export figures back up the lack of export volumes, with levels of barely 850 M Bbls/d of propane reported in both of the last two weeks, amounting to a drop of nearly a third from the levels seen earlier in the year. There’s probably more butane being nominated, but the trend has been set. Again it’s not good news for the ship-owner, as rates drop, and charterers prefer to fix on floating Baltic rates than levels in the low to mid $60s/ Mt.
With ship owners now looking at sub $800,000 time charter equivalents on most of the ARB routes, it’s still just about keeping their vessels in the black, but with bunker prices strongly influenced by the renaissance in the crude oil price, this might not last for too long. The supply news is not good for the ship owner, but the demand news is not good either. China appears to have imported 2 million plus Mt of cargo in May, but June buying appears to be already at an end. India is still clearing the excess volumes it bought after the announcement of lockdown, and with less than rosy news coming out of China regarding GDP goals, it’s difficult to see demand easing the pressures on producers, exporters and therefore ship owners. Maybe one piece of good news for ship owners, but maybe not for the financial health of the world in general, is that the tensions between the U.S. and China are escalating, on such areas as Hong Kong, the potential delisting of Chinese firms on the U.S. exchanges, and of course the source of the coronavirus. There might be help for LPG ship owners if we see a set-back on tariff realignment between the U.S. and China, but the overwhelming concern will increasingly be focused on demand, and the effect that will have on already worrying LPG production levels. Whatever the “V” shaped economic forecast curves are saying, the near future still looks as if it’s heading in one direction.