Oil (Crude Oil) as a Commodity

Crude Oil is one of the most important and sort after commodities. Oil powers most modes of transportation as well as power plants and makes up the backbone of global economy. Variation in price of this commodity impacts the world economies like no other. As the oil prices rise, the costs go up for transportation companies and they are forced to squeeze their profit. Marine transport industry is no exception and follows the same trend. The figure below shows the volatility in oil price since 1970; it is clear from the chart that as the world economies grew, fueling demand for oil, oil prices steadily increased 1970 onwards. However the growth pattern has been disturbed on many ocassions due to major socio-political events such as wars, shift in political scenarios, etc.

Oil Trade Demand for Marine Transportation Services

The demand for marine transportation is a derived one and is directly dependent on trade of the commodity to be shipped. So, if there is no demand for oil, the demand for oil tankers will not exist. Therefore, any fluctuation in the volumes of Oil trade would have a direct impact on the oil tanker markets. The demand for oil trade is created due to the fact that some nations (The Exporters) have a massive comparative advantage for production of crude oil while other nations (The Importers) are unable to manage their high consumption levels solely with their domestic production. This situation creates the basis for oil trade thereby creating a demand for shipping oil. Major exporters and importers of Crude Oil: Exporters Saudi Arabia (OPEC) Russia Norway Iran (OPEC) UAE (OPEC) Venezuela (OPEC) Importers USA Japan China Germany South Korea France

Kuwait (OPEC) Nigeria (OPEC) Algeria (OPEC) Iraq (OPEC) Angola (OPEC)

Italy Spain Taiwan India

As per the UNCTAD Review of maritime transport, trade in oil volumes has grown from 9,499 billion ton miles (or 2,163 million tons) in 2000 to 11,292 billion ton miles (or 2,749 million tons) in 2008. This shows a significant increase of about 19% in terms of ton miles and about 27% in terms of tons in the traded volumes of oil (crude and products) in the last 10 years. The notable difference in the growth percentage when expressed in terms of tons and ton miles is due to the shift in location and capacities of production sources. Correct expression of the demand for marine services is in terms of ton-miles as the demand for ships will not only depend on the volumes being shipped but also on the distances the goods are to travel. In other words, assuming the volume traded remains same, if the supplier and consumer location of oil are farther apart geographically, the demand for shipping will be more. Development of petroleum pipeline systems has a direct impact on the world shipping demand. A case in point is installation of petroleum pipeline between Iran and India. Although presently the project is on hold due to political unrest in Pakistan, once the project takes off, the demand for oil tankers hauling cude from Arabian Gulf to Indian subcontinent will be severely affected. Another case in point is the ESPO (East Siberia Pacific Ocean) oil pipeline system. This pipeline system brings major oil reserves of landlocked eastern Siberia to the western Russian port of Kozmino (near Nakhodka) and from there is shipped to China, Korea, Japan and even the pacific coast of US. This development has actually increased the demand for shipping in the region. Figure 1 World Crude Oil movement

Chart below shows the trends in the of world trade for the period from 2000 to 2010. Analyzing Chart 2, it is clear that from 2002 onwards there was a steady increase in world trade which in turn led to higher energy demand and consequentially pushing up the crude prices.

The figure also shows that there has been a sharp fall in the oil trade commencing at the end of 2008 caused by the global economic crisis. The crisis caused the demand for oil to tumble and following the trend, crude oil prices followed suit. Chart 2 World Trade

Chart 3 Crude oil price

Tonnage Supply of Marine Transportation Services

37% of the 1.1 billion DWT tonnage of the world fleet comprises of oil tankers. Oil Tankers are mainly classified by their size which is expressed in Deadweight (DWT) tones. This is a shipping term which plainly means the maximum capacity of the tanker expressed in terms of metric tones. ULCC Ultra Large Crude Carriers - these are vessels with DWT of 320,000 to up to 550,000 mt, mainly employed in the carriage of crude oil as the name suggests. VLCC Very large Crude Carriers these are vessels with DWT of 200,000 to 320,000 mt, mainly employed in the carriage of crude oil. Main trading patterns of ULCC and VLCC are: o Middle East to Asia Pacific, Europe, USG, Indian subcontinent o West Africa to Asia Pacific, Europe, USG, Indian subcontinent

Suezmax Tankers these are vessel of DWT between 120,000 and 200,000 mt employed in carriage of crude oil and sometimes DPP (dirty petroleum products such as fuel oil, etc). The name has originated from the fact that this is the maximum size of the vessel tht can transit though the Suez Canal due to depth restrictions. Main trading patterns of ULCC and VLCC are: o Middle East to Asia Pacific, Europe, Mediterranean, Indian subcontinent o West Africa to Europe, USG, USAC, Indian subcontinent o Across North Sea o Across Mediterranean

Aframax Tankers the DWT of these tankers is between 80,000 and 120,000. The vessels of this category are equally employed in the carriage of crude oils and DPP. Due to the shallow drafts and relatively smaller size, Aframax tankers provide the owners with a lot of flexibility in terms of ports that can accept this size. Main trading patterns of ULCC and VLCC are: o Middle East to Asia Pacific o Indonesia to Japan o Across North Sea o North Sea / Mediterranean / Black Sea to USG, USAC o Across Mediterranean and Black Sea

Panamax Tankers - these are vessels of DWT between 60,000 and 800,000 mt, mainly employed in carriage of DPP and clean petroleum products (CPP). As the name suggests, this size is the largest that can transit through the Panama Canal. Main trading patterns of ULCC and VLCC are: o Middle East to Asia Pacific, Indian Subcontinent and East Africa o Singapore to China, Japan and Korea

o o o

North Africa to Mediterranean Europe Across Baltic and North Sea North Europe to USAC and USG

For the past 10 years the world tanker tonnage in terms of DWT has grown from 283,066 thousand tons to 450,053 thousand tones. This is mainly due to the growth in trade of crude oil which led to and increased demand.

The surplus tonnage fell sharply in the beginning of the decade keeping is always below 2% of the fleet until 2008, when the surplus tonnage started to rise again and making it extremely difficult for the Owners to find employment for their vessels, especially the older and single hull tonnage. The table below gives the figures for tonnage surplus for the period: 1990 266.2 40.9 15.4 2000 279.4 13.5 4.8 2004 298.3 3.4 1.1 2005 312.9 4.5 1.4 2006 367.4 6.1 1.7 2007 393.5 7.8 2.0 2008 414.0 14.4 3.5 2009 426.4 17.2 4.0

World Tanker Fleet (DWT) Tanker Fleet Surplus (DWT) Share of Surplus fleet in Tanker fleet

Encouraged by the constant growth in demand the new built prices of oil tankers kept rising and Owners places record orders for new vessels. The chart below shows the trends of new built tanker prices from 1976 to 2009. The sharp rise in the prices from 2002 to 2008 is apparent. The trend was followed by the crash in demand and price of new built in 2008 end due to the crisis.

The freight rates for oil tankers were on an upward trend between the periods 2002 to 2008 due to growing world demand for oil tanker tonnage. The ship owners were in the commanding position and made huge profits during this period with their daily earnings for a VLCC hovering between 50K and 100K per day. However, in the last semester of 2008, owing to global crisis, the freight rates for tankers came tumbling down and even after the marginal recovery in 2010, have remained subdued to mid/low twenties.

Characteristics of Oil Tanker Market

In the yester years the tanker market was dominated by the major oil companies, such as BP, Exxon, Mobil, Shell, etc. The Oil majors owned or chartered in most of the tanker tonnage. However, in the past 25-30 years the Oil majors have slowly got rid of their own tonnage and even shied away from chartering in tonnage for long term. This has given rise to independent tanker owners slowly taking over the market. As a result, the market which was an oligopoly has taken form of a highly competitive one. What makes Oil Tanker Market a competitive market? Once the share of oil majors declined, there emerged many independent charterers in the market such as the state owned companies; oil traders, etc however, none had a major dominance in the market, making it competitive. The tanker fleet is also distributed among many independent tanker owners thereby ruling out any dominance or monopoly. The service provided by various ship owners is very homogenous due to its nature and therefore, it is vey difficult for any one owner to have an edge over the other. Comparing to other industries, it is relatively easier to enter and leave the Oil tanker market in terms of capital investment. This freedom to enter and exit the industry further adds to the competitive nature of the market. The spot market provides a full disclosure of the demand and supply situation to the charterers and ship owners, through a highly skilled network of brokers. This provides a platform for the parties involved to freely compete with each other.

Modeling Demand and Supply of Oil Tankers: Following facts form the basis of demand and supply of oil tanker market: The demand for oil is very inelastic to its price, making demand for transport service also inelastic. Oil Tanker market has virtually no substitution making the demand inelastic to the freight rates. Except for some pipeline projects, there is no other alternative available to transport crude oil. The freights form a very small fraction of the final price of crude. Therefore demand does not get much affected with change in freight rates.

All the above indicate that demand is inelastic to the freight. However, with increase in economic activity, the demand will shift. Demand shifts to right in booms and shift to left in recessionary times.

When the demand curve shifts to the right (D1 D2), the laid up or idle tonnage and the surplus tonnage starts to get employed thereby minimizing impact on the freight rates (P1 P2). Once the idle tonnage is all employed, there is a sharp rise in the freight rates (P2 P3) as the demand curve further shifts to the right (D2 to D3). Any further shift of the demand curve to the right (D3 D4) makes the supply curve very inelastic and a large rise in freights only yield in a minor increase in supply. This phenomenon happens due to the fact that once all idle tonnage is employed; new tonnage cannot be available in the short span in time. The Ship Owners can only temporarily increase supply to some extent by; Increasing the speed of the vessels, for faster turn arounds Taking shorter routes, even if it involves paying higher canal dues, etc Loading vessels to maximum capacities, thereby increasing supply in terms of ton-miles.

However, these are temporary measures with limited effect on the supply of tonnage.

Freight Rates ($/mt) D1 P4 P4 P2 P1 D2

D3

D4

Q1

Tonnage (ton-mile)

Q2

Q3

Q4

Similarly, when the Seaborne trade volumes are low shifting the demand curve to the left, Ship Owners take the following actions to reduce the supply of tonnage: Slow steaming: Ship owners resort to slow steaming the vessels. This helps to create a temporary reduction in the supply, which is measured in ton miles. Taking longer but less expensive routes: Ship owners tend to take longer routes e.g. choosing to route via the Cape of Good Hope instead of the Suez Canal to avoid expensive canal dues. Removing vessels from service (Lay Up): if the demand stays subdued, Owners opt to lay up the vessel, by taking her out of service, temporarily. Demolition of fleet: If however, the short term measures described above do not have the desired effect or are not sufficient to create the necessary demand, the owners have no choice but to scrap the old tonnage. In year 2009, we have seen a massive increase in the demolition numbers of the vessels due to global recession.