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Low Bunker Prices Benefit Ship Owners in 2015

Maritime Activity Reports, Inc.

January 4, 2016

 As 2015 draws to a close and the Worldscale Organisation published the new 2016 Flat Rates, Poten and Partners goes through the annual exercise of updating Flat Rates in its systems. 

This highlighted once again the significant changes in bunker prices that occurred over the last 2 years. The Worldscale Organisation calculates Flat Rates based on average bunker prices over the period from October 1 of the prior year to September 30. 
The 2015 Flat Rates were based on Heavy Fuel Oil (HFO) prices of $614.81/metric tonne (MT) while the 2016 Flat Rates use prices of $367.55/MT, a reduction of 40%. Currently, HFO bunker prices are significantly lower again, at around $150/MT. The last time bunker prices were at such levels was in 2004.
As most readers know, the freight cost (or revenue, dependent on your point of view) of a voyage is calculated by multiplying the cargo size by an annually adjusted Flat Rate and a market driven Worldscale rate. The concept of Flat Rates and Worldscale attempts to compensate for different voyage costs (bunkers, port expenses, etc.) and voyage durations between various tanker routes. 
In theory, an owner should be indifferent between carrying a cargo from port A to port B or from port A to port C if the Worldscale rate for the two voyages is the same. Bunker prices are the primary variable component in the annual Flat Rate calculations. As a result, Flat Rates for many routes have declined between 20% and 30% for 2016. 
The Flat Rates for 2016 include one additional change compared to 2015: The higher bunker costs incurred in Emission Control Area (ECA) zones are now included in the base Flat Rate rather than as an additional fixed differential per steaming mile in an ECA zone. This causes Flat Rates for voyages that pass through ECA zones to decrease less than they would have otherwise. For example, the Flat Rate for the Ras Tanura - Chiba route declined by 28%, while the Flat Rate for the Rotterdam – New York route only declined by 13%.
 Bunker prices are mainly driven by crude oil prices, but fuel oil supply and demand dynamics will also affect the spreads to some degree. The general market sentiment at this moment seems to be that oil prices stay under pressure for at least the first half of 2016 when additional Iranian barrels are forecast to enter the market.
Expectations are that starting in the second half of the year, the oil supply / demand balance will gradually be restored as demand increases due to improving economic performance and continued low prices and as steep cuts in capital investments by oil producers affect oil production growth.
Owners have largely been in a position to hold on to the benefits of lower bunker prices and in many cases they even managed to increase total freight rates. In 2015, tankers had on average the highest Time Charter Equivalent (TCE) earnings since the peak year of 2008. 
According to the IEA, global oil demand increased by about 1.8 million barrel per day (Mb/d) in 2015 compared to 0.9 Mb/d in 2014 and 1.2 Mb/d in 2013; resulting in strong tanker demand growth. Fleet growth was limited in 2015 as owners held off in ordering new tonnage during the prior years when freight rates were significantly below breakeven levels and the financial markets limited the availability of debt capital for shipping investments.
The current futures forward curve for HFO in Rotterdam reaches $200/ton only by the 1st quarter of 2017. If these prices actually materialize, this should help the tanker market in 2016 as well. However, the dynamics of bunker prices will change in the coming years as exhaust gas emission standards are tightened in 2020 or in 2025, depending on a fuel availability study to be performed by the IMO. Europe has already indicated that they will adapt the standards by 2020, regardless of the outcome of the study.
This will require ships to install exhaust gas scrubbers or to burn more expensive Marine Diesel Oil (MDO). Currently, MDO is selling for about $320/MT, but the spread could widen significantly once a large percentage of the fleet is required to use MDO.
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