Economic Analysis of Floating Storage
HIDE & SELL
Alec Kyle- Pope gives an economic analysis of floating storage
The practice of chartering vessels to be used as floating storage is not a new or particularly mysterious concept in the tanker business. Most offshore production operations will have one or two FPSOs or FSOs bobbing about and it is certainly not unheard of in conventional trades for a Charterer to ask a laden vessel enroute to a discharge port to drift and await orders whilst the market oscillates and a cargo is sold afloat.
However,it takes a perfect storm of various oil market elements for the practice to become a widespread trend and commercial tonnage to be pulled out from normal circulation to sit fully laden at strategic locations across the globe for months on end.
The purpose of this article is to look at the phenomenon of floating storage, the economics behind it, its affect on conventional tanker markets and pose the question; are all the market ingredients currently present for a return to the floating storage epidemic of 2009?
A brief history lesson
The last great floating storage play was back in 2008-2009. In early 2008, driven more by speculation than market fundamentals, the oil price had been shooting up over the course of the summer when the price per barrel for West Texas Intermediate (WTI), a major pricing benchmark, peaked on 11th July at just over US$147.However, this price bubble was inherently unstable and as the global financial crisis began to take hold demand fell away. Without an adequate correction in supply, the slump remained unchecked and the oil price continued to plummet. By December 2008, the cash price for WTI was below the US$40 per barrel mark.
Such a dramatic price collapse led to a buying spree by those with access to cheap credit. Almost everyone piled in; the oil majors, the banks, and the trading houses. A great scramble ensued to squirrel away physical oil and with land-based storage either 'captive' or filling up fast,a wave of ULCCs, VLCCs and even Suezmaxes were time chartered in, loaded with crude or products and then stationed at places like Scapa Flow and Singapore. Tanker rates, which had been weak, duly rallied and over100 million barrels of oil became stored at sea.
The economic rationale behind this bout of frenzied activity had a name; oil market 'super contango'.
Contango is a condition in a commodity market where the futures price for the commodity is higher than the current spot (or cash) price. One way to capitalise on such a pricing structure is for a market participant to purchase the physical goods today and sell the same goods forward under a futures contract for a specified point in the future at a higher rate. By doing this they can lock in a profit with relatively little risk. However, to pull off this trick they will require the wherewithal to finance,insure and crucially carry the goods until the futures position closes out.
What makes such a tactic viable or not is the scope of the discrepancy, or 'spread', between current spot rates at which the physical purchase is made and the future price at which the onwards sale could potentially be fixed at. A small contango spread of say US$1-2/bbl will not be sufficient to justify the costs involved, but should a spread steepen typically beyond US$8/bbl, particularly over a tighter window of time (a January/August spread versus a January/December spread), the greater the likelihood the numbers will work and the potential for a profit to be made will exist.
How and why the oil price can slip into contango may depend on various sudden or protracted imbalances in real time supply and demand which, if not reflected in near-off or far-off futures pricing, lead to distortions between markets and arbitrage opportunities.
Importantly, once the futures markets for the particular commodity 'catch up' or adopt a similar outlook to what is going on in the spot market and adjust for a new price equilibrium, the game is rumbled and the trade is over.
So how do tanker rates figure in this equation?
On the physical side of the trade, by and large the cost of storage will be the trader's biggest overhead. Whilst land-based storage, being typically cheaper, will be the preferred option once this possibility is exhausted,storing the cargo afloat is the next logical step.
As with the last major contango play, most if not all the main players will have access to cheap lines of credit and will be paying fractionally over LIBOR to finance their oil lots. Cargo insurance will also not be too costly a necessity to procure and items such as bunkers and anchorage dues should only be minor hindrances on their balance sheet.
By way of example, the disbursement account (D/A)for stationing a laden VLCC at Scapa Flow for instance (including anchorage dues, agency fees, inwards and outwards pilotage and tugs) for a 6 month period, at present rates, comes to just under GBP 50,000.
All present and correct so far then.
The biggest stumbling block, however, are tanker rates.Even with 2 million barrel cargoes, there is a huge disparity in the profitability of a floating storage trade between chartering a vessel in on US $40,000 and US $50,000 per day, particularly over a prolonged period. Such a difference can effectively scupper even the most promising contango play and if tanker rates are strong, as is presently the case, any trader will require a much steeper contango spread to develop in order to make the game worth the candle.
A repeat performance on the cards?
In short, not yet.
Although it is certainly true that the recent drop in oil prices mirrors in many respects the beginning of the last 'super contango' this in itself is not enough to suggest a spate of lengthy period charters with storage options are on the immediate horizon.
The issue is twofold; the required spread is not yet there and current VLCC rates are too high.
Oil market fundamentals have significantly changed in the last 6 years. The shale revolution in the US has dramatically altered market dynamics and trade flows.Whilst Saudi Arabia still retains the whip hand, OPEC would appear to no longer wield the power it once did and also has the competing interests of the likes of Russia and Mexico to worry about, as well as its own internal politics.
What this means in basic terms is that the current supply glut the major producers find themselves confronted with would not appear to be a temporary or fleeting dilemma.
Crucially, given the overwhelming level of supply and with the Saudis' continuing reluctance to cede market share, present market fundamentals do not inspire an aura of volatility sufficient to dramatically offset current and future pricing. Longer term contango spreads would not therefore seem presently wide enough to encourage putting barrels into floating storage unless tanker rates were to substantially fall.
This is of course until one, or a group, of the major producers acts decisively to rein in exports and counterbalance supply with existing levels of demand.For many however, particularly the likes of Venezuela and Nigeria, such a step would be almost unthinkable given the level of dependency their economies have exports and would likely pave the way for political and economic turmoil.
With the two 'swing' voters, Saudi Arabia and Russia, both unwilling to back down from their present position sit seems unlikely much will change for the time being.
It is also important to note that, this time around, tanker rates are in rude health.
Along with increased seasonal demand over recent winter months and a more general uplift in ton-mile demand as more West African cargoes make their way to the Far East (another legacy of the shale revolution), since the recent slump in oil prices, both India and China have been ramping up crude imports to fill their respective Strategic Petroleum Reserve (SPR) inventories. China, notoriously coy about disclosing details regarding her energy stockpiles, now has significant SPR storage capacity up and running, and according to various media sources including the Financial Times, increased daily crude imports to over7 million barrels a day by the end of 2014.
This increased market activity, along with similar type demand from commercial refiners, helped push up an already rising market, particularly for VLCCs, and this was reflected in spot rates over the winter period.Whilst some of this demand has tailed off in the last few weeks, with a finite amount of supertankers in circulation and stronger rates forecasted for 2015, it would seem present tanker rates, relative to current oil market contango spreads, are yet to be conducive enough to make floating storage an attractive option right now.
Has the game therefore changed?
It is probably a bit premature to write off the chances of a repeat of 2008-09 as some of the key ingredients would seem to be present once more but certain parameters have now evolved.
Whilst the underlying rules remain the same, this time around, the players in the game have changed.Along with the ever present oil majors, today the markets are dealing with a much more sophisticated level of trader.
Due to regulatory pressure in the US the 'Wall Street Refiners' have over the last few years stepped back from front line physical oil trading and the trading houses that remain are now far more vertically integrated,with significantly enhanced storage assets and access,than previously.
For these entities the game has been afoot for sometime but much of it has been conducted quietly, with oil shipments being funnelled into land based storage hubs such as Jurong Island, Saldanha Bay and Fujairah.
As a consequence, the presence of these highly equipped independent trading houses and their heavy duty state backed Far Eastern competitors has meant the scope for ad hoc highly responsive floating storage plays has diminished from what it once was.
However some 40 million barrels of tanker capacity,comprising various ULCC and VLCC units, was apparently booked as floating storage at the turn of the year according to Reuters, but the reported period rates agreed bore no resemblance to spot market levels at the time. Whether these fixtures were a preemptive strike remains to be seen but since this flurry there has been little further similar chartering activity.
In the absence of significant contango spreads therefore,which previously peaked above US$17 for Brent and US$23 for WTI respectively during the 'super con tango' epoch, there is far less impetus or frenzy within the market to opt for floating storage at present.
For tanker Owners understandably keen to make the most of buoyant spot market rates the corresponding level of attraction is likewise absent for now. Looking ahead, much though may depend on whether Chinese demand for crude oil imports slows down in the near future or the degree to which tanker rates may soften as summer approaches and refineries go off-line for planned maintenance work.For tanker Owners understandably keen to make the most of buoyant spot market rates the corresponding level of attraction is likewise absent for now. Looking ahead, much though may depend on whether Chinese demand for crude oil imports slows down in the near future or the degree to which tanker rates may soften as summer approaches and refineries go offline for planned maintenance work.
However, with all the above in mind and OPEC yet to get its house in order, the rush to store large quantities of oil at sea is yet to fully take off.