Tanker is defined as a ship that is particularly designed and constructed to transport liquid cargoes. Commonly, liquid cargo types that are carried in tankers are:
- Crude oil
- Refined oil products
- Vegetable oils and other food oils
Crude oil and refined oil tankers are significantly bigger than the other segments. Frequently, markets for crude oil and refined products are denoted as the tanker trades. Like other shipping segments, between 2002-2008, tanker markets and tanker freight rates were at their strongest and fastest growing since the beginning of 1970s. Tanker market growth between 2002-2008 has raised the tanker industry to greater prominence within maritime sector. Furthermore, tanker market has risen out of the ruck within the financial community as a sector for possible equity investment. Unfortunately, plethora of new-building tanker deliveries created downward pressure on freight rates after 2008. Tanker market was at the highest point in 2008, the Baltic Clean and Dirty Tanker Indices had almost halved by 2015.
Main reasons to learn more about tanker trades and tanker chartering:
- Tanker specialization has also improved since 1970s, with more specialized tankers have been designed and constructed for oil products.
- Overall size of the tanker fleet has grown enormously, particularly in the 1970s and 2010s.
- Oil trades have grown substantially since 1970s. However, oil trades have also grown extremely disproportionately. Latest accomplishments of the tanker segment cannot be comprehended without some understanding of previous years.
- Like in other segments of shipping industry, quality has become a significant element of the tanker industry. After important oil spills such as MT Exxon Valdez (1989) tragic incident, IMO (International Maritime Organization) interdicted all single-hull tankers in the oceans.
- Politics is a key factor that is affecting tanker sector due to the strategic nature of the cargo. Extreme oil price changes have huge macroeconomic effects upon the world economy. Resulting from drastic political sensitivity, tanker freight rates have demonstrated abruptly evident surges every now and then, mainly correlated with wars. Virtually all commodity prices are sensitive to conflicts, but oil prices and tanker freight rates are unquestionably more sensitive. In all likelihood, 2002-2008 boom period, is the first time in oil trade history, which was sparked without any conflict or war-like activity.
Tanker Market is a very competitive market. Actually, some sub-segments of tanker market are more competitive now than 1970s. In the history, competitive nature of the tanker market when combined with its sensitivity to strategic and political issues, has made tanker market an excessively volatile market.
Seaborne Oil Trade
Conventionally, analysis of oil market is divided into:
- Unrefined Oil (Crude Oil)
- Refined Oil (Oil Products)
When crude oil is refined, different quantities of various oil products are obtained such as:
- Diesel Oil
- Heating Oil
- Fuel oil
- Gasoline (Petrol)
Heavier and lighter oil products are obtained at the refineries. Some of the lighter oil products are more vaporizable and combustible than the original crude oil. Heavier oil products like bitumen must be kept at certain temperature in order to keep as fluid form.
There are two (2) types of tanker trades:
- Transporting the crude oil from its country of production to the international refining industry
- Transporting refined oil products from the refineries to the final consumer
In tanker markets, the location of the refinery is important in determining the relative balance of these two trades. In the 1950s, many refineries in in both North America and Western Europe were constructed nearby final consumer marketplace due to political and economic reasons. Political reason was to maintain refinery in financially stable country. Economic reason was the carriage of crude oil in very large tankers reduced the total shipping costs. Therefore, the crude oil trades developed very quickly and outweighed other oil cargoes by volume. Later on, refineries were built in the Middle East, India and Asia as China became one of the biggest oil consuming country.
Main Developments in Seaborne Oil Trades
Tanker fleet was making up roughly 3% of the world fleet in 1914. In 1938, tanker fleet had increased to 19% of the world fleet. In 1980, tanker fleet had increased to 50% of the world fleet. In DWT (Deadweight Tonnage) terms, tanker fleet boomed from 17 million DWT in 1938 to 338 million DWT in 1980. World oil output is an essential factor in the growth of the oil trades. World oil output surged from 258 million mtons in 1938 to 4,132 million mtons in 2013.
World oil output growth has not been steady. World oil output:
- 1938-1957 increased fourfold
- 1957-1980 increased three-and-a-half times
- 1980-1989 slowed abruptly
Starting from 1990, world oil production dramatically increased. In 2011, world oil production has continued to rise and surpassed 4,000 million mtons. Main reasons of world oil production:
- Exponential development of China’s economy
- Remarkable demand in America, Middle East, India and other Asian countries
In the long term, oil consumption and production have positive correlation. If an analyst observes annual growth rates of oil consumption over five-year intervals between 1965-2013, analyst realize substantial differences in the growth pattern. Between 1960-1970, oil consumption boomed at 7%-8% every year which is an extraordinary growth rate. Oil consumption slowed down in the 1970s. Between 1980-1985, oil consumption plummeted by 1.1% per year as a result of the second oil price shock. In that period, oil consumption reached its lowest point in 1983.
Since 1993, oil consumption growth has recovered and growth rate return to around 2% per year. In 2004, oil consumption growth reached 4% annual increase due to demand growth from Far East especially China and the United States markets. Between 2008-2009, due to financial recession, oil consumption fell to 2%.
Oil production and consumption are objective indicators of the possible growth in demand for shipping crude oil and oil products. Between 1967-1977, volume of oil shipped was doubled. In 1977, 56% of all oil produced was moved by sea. Between 1967-1977, demand for shipping oil surged faster than the growth in the demand for oil itself. Between 1977-1987, oil shipped by sea plummeted to 45% and oil production remained approximately stable. Stable oil production and consumption express decreasing demand for shipping services in tanker sector.
In 1977, shipping crude oil and oil products decreased from 1,724 million tonnes to 1,343 million tonnes in 1987. Afterwards, tanker markets started to recover. In 1992, total oil cargoes moved by sea exceeded the 1977 level. In 2000, tanker markets continued to recover and with the increase in oil production, substantial recovery in the demand for oil tanker services started.
Oil tonnage transportation increase and decrease explain limited section of the grounds of demand change. Tanker demand can be calculated in terms of tonne-miles and in tonnage terms.
Between 1967-1977, oil cargo shipments doubled but oil tonne-miles transported approximately trebled from 4,130 billion tonne-miles to 11,467 billion, due to the closure of the Suez Canal in 1967. Average length of tanker voyage increased from 4,775 nautical miles in 1967 to 6,651 in 1977.
Suez Canal was reopened in 1975 and till that time tankers were being routed around the Cape of Good Hope (COGH). Therefore, laden distance between the major exporting ports to major importing ports increased enormously. Between 1967-1975, due to the closure of the Suez Canal, ultra large tankers were constructed.
Between 1977-1987, tankers’ average laden leg declined by nearly 50% which corresponds with a decline in the volume of tonnage moved. Overwhelmingly, demand for tanker services tumbled significantly between 1977-1987. This situation created serious difficulties for tanker owners and operators. After 1987, tankers’ average voyage lengths have fluctuated between 4,000 and 4,400 nautical miles. Changes in the balance of long-haul and short-haul oil cargoes have impacts on average voyage lengths.
Oil Consumption and Oil Production
Middle East is the main source of oil exports. Share of Middle East oil production has fluctuated since 1970s.
In 1965, United States leaded for 39% of the world’s oil consumption and 30% of production. Consequently, United States needed to meet its oil consumption needs by importing. On the other hand, in 1965, Western Europe leaded for 25% of world oil consumption and had no oil production. Western Europe was even more dependent on oil imports than United States. Contrarily, Middle East leaded for 2% of the world’s oil consumption and produced 27% of the world’s oil.
In 2013, United States’ share of oil consumption had plunged to 25% while oil production had plunged to 19%. Nevertheless, this exemplifies a rise from a low in 2008 due to shale oil production. According to analysts, United States oil production will soon reach the peak oil production accomplished in 1970. European Union’s oil consumption also plunged to 15% of total world oil consumption.
Asian countries’ oil consumption share has increased swiftly from 21% in 1990 to 34% in 2013. On the other hand, Asian countries’ oil production has remained static at about 10% of world total oil production. Asian countries’ oil consumption has doubled since 1970s. Like United States and European countries, Asian countries have to import oil in order to meet the demand.
Main crude oil exporting countries are in the Middle East and most prominent country is Saudi Arabia. Other major oil exporting countries are former Soviet Union countries, West Africa, South and Central America and Canada. In United States, crude oil exports are prohibited without license. Major crude oil importing countries are Europe, United States, China, India and Japan.
Major oil products exporting countries are from United States, the former Soviet Union countries and the Middle East.
In 2013, Europe and United States leaded for 40% of all oil imports in world total. China leaded for 13% of oil imports. In 2013, major oil exporting countries:
- Middle Eastern countries 35%
- Former Soviet Union countries 15%
- Asia-Pacific countries 12%
- West African countries 8%
Both United States and European countries are major importers and exporters of oil products. As a bunker hub, Singapore is also a major importer of oil products. On the other hand, approximately all of West Africa’s exports are crude oil. Japan and India have no native oil reserves and imported 8% and 10% of the world’s crude oil respectively in 2013. Furthermore, China has no strategic oil reserves and imported 15% of the world’s crude oil in 2013. Europe is a leading importer of both crude oil and oil products.
Crude Oil Price
Between 1975-1985, oil consumption weakened and oil sea transportation plummeted due to the spectacular changes in the price of crude oil.
Price of Arabian Light Oil, after averaging around $2 per barrel in the 1960s, the OPEC (Organization of the Petroleum Exporting Countries) increased Arabian Light Oil price in 1970 to $4 per barrel. In 1973, after Arab-Israeli War, OPEC (Organization of the Petroleum Exporting Countries) raised the price of oil to $9.00 per barrel. By the end of 1973, OPEC (Organization of the Petroleum Exporting Countries) fourfold the price of oil which triggered three (3) imminent results:
- Created an international banking crisis and oil-importing countries had to deal with huge budget deficit problems
- Immense economic recession in many western countries that leaded to lower rates of economic growth
- Abrupt and striking halt in the growth of the tanker market which had experienced two booms in rates in 1970 and in 1973.
Booms in 1970 and in 1973 were generated by the large growth in oil demand volumes that also created an expansion in the tanker fleet. Nominal price of oil steadily surged to $20 per barrel till the end of 1970s.
In 1979, during Iranian revolution, of 1979, OPEC (Organization of the Petroleum Exporting Countries) increased the price of oil at about $40 per barrel. In real terms, $40 per barrel equals to $100 at 2013 prices. OPEC (Organization of the Petroleum Exporting Countries) has been trying to keep the price of oil in real terms. When the US dollar was devalued against other currencies, oil price was increased to compensate OPEC members for the loss of the dollar’s earning power. OPEC’s oil pricing policy might be observed as counterproductive since it supported to create a cycle of low growth. United States tried to counterbalance its deficit and restore the dollar by recessionary policies which triggered low growth, falling demand for oil and stagnation of oil exports.
In 1985, Saudi Arabia and other OPEC members modified oil pricing policy to match that set by Mexico. During mid-1980s, Mexico become a significant oil producer but was not a member of OPEC. OPEC’s oil pricing policy transformation, connected with rising oil production from non-OPEC producers, forced a decline in the oil price. Saudi Arabia introduced net-back oil pricing policy net-back oil pricing policy which was calculated by the selling prices of the refined oil products at the point of final consumption after deducting transportation and refining costs. Saudi Arabia’s highlighted the fact that the crude oil price is driven by consumer demand for the oil products and oil price obtained in the retail market.
In 1990, Iraqi invasion of Kuwait sparked off oil price surge. However, it was short-lived because Saudi Arabia increased oil production to compensate the market.
After 2002, oil prices increased steadily, driven by demand growth and tight supply. In real terms, 2008 price of crude oil was about the same as it was in 1980. In 2009, oil prices plummeted to $60 per barrel in 2009 due to the economic recession. Afterwards, oil prices reached over $100 per barrel. Slowdown in China’s economic growth rate, sluggish world economic activity in Europe and USA, rising shale oil production in the USA and continued OPEC production output, resulted in a collapse in oil price to $50 per barrel in 2015.
OPEC (Organization of Petroleum Exporting Countries)
At the beginning of 1970s, primary reason for the striking surge in the price of crude was the ability of OPEC (Organization of the Petroleum Exporting Countries) to regulate oil supply. OPEC members were approving to set quotas to limit oil supply and were fixing general oil prices. However, in 1980s, some countries started to break ranks such as Nigeria which consistently exceeded OPEC’s quota. Moreover, increasing oil production from non-OPEC countries helped to undermine OPEC’s monopolistic position. Since 2000, OPEC’s oil production market share increased but OPEC’s oil pricing policy is now very different from that of the 1970s. Subsequently, OPEC’s oil pricing policy may not be such a threat to global macroeconomic stability.
World Tanker Fleet
In 1980, world tanker fleet constituted 50% of world total shipping tonnage. Afterwards, world tanker fleet increase trend was reversed and world tanker fleet share declined steadily. In 2014, world tanker fleet constituted 27% of world total shipping tonnage. In 1984, tanker annual demand in tonnage and tonne-miles reached minimum and stayed at this level until 1989. In 1989, world tanker fleet started growing again. Consequently, stock of tanker tonnage has approximately followed the pattern of tanker demand.
World tanker fleet increased swiftly until the early 1970s. Afterwards, world tanker fleet stalled and declined until 1989. In 1989, world tanker fleet started to grow again. In world tanker history, long-run adjustment of tanker supply to the level of tanker demand has often been a frustrating process. Uneven development of the tanker fleet can be observed in five-year averages. Tanker demand growth leads to tanker supply response which created a difficulty of adjustment in the tanker market. This delayed adjustment problem was only resolved by 1990.
An analyst can compare the changes in world tanker fleet DWT (Deadweight Tonnage) and oil demand in tonne-miles from 1980 to 2014 and index 1980 values. An analyst can observe movement of tanker orders, scrapping and lay-ups plotted against the prevailing level of spot tanker rates. There is close correlation that exists between high tanker freight rate levels, new tanker orders, low tanker lay-ups and tanker scrapping. On the contrary, low tanker freight levels cause few tanker orders and high tanker lay-ups and scrapping. Stock of tanker fleet alters all the time, slowly adjusting to the shifts in tanker demand.
In tanker shipping business, WORLDSCALE (WS) is a convention designed to generate a uniform scale (index) for tanker rates. Each tanker route is calibrated for an assumed ship size and cost structure. Calculated freight rate is set at worldscale (WS) 100 for that route. All tanker fixtures are then quoted relative to this worldscale rate.
Tanker and Dry Cargo Markets
In the short-run period, tanker market is an independent sector. However, in the long-run period, dry cargo and tanker rates tend to move together.
Tanker freight rates are more volatile than dry bulk freight rates. Nevertheless, there is a positive correlation between peaks in dry bulk and tanker sector. In 1980s was an exception to this positive correlation when the dry cargo sector continued to grow while the tanker trade weakened.
Higher the degree of demand substitution between dry bulk (coal) and tanker (oil) sectors, higher the level of supply substitution between these sectors.
Dry bulk and tanker markets share the same key drivers. When world trade boom, it creates good conditions in both dry bulk and tanker markets. Therefore, there is still a long-term positive correlation between dry bulk and tanker markets. China’s economic growth has generated substantial surge in the demand for oil and gas. Simultaneously, China’s demand for iron ore and coal has also increased. This situation has led to record freight rates for both dry bulk carriers and tankers. Theoretically, tanker and dry bulk freight rates are positively correlated by the virtue of ship prices. High freight rates mean high profits, which create high secondhand prices for the ships. When freight rates booms, shipowners rush to order more ships. However, shipyards’ slots are limited therefore one way of building more dry bulk carriers is to build fewer tankers. So, tanker freight rates increase. Therefore, limitation of shipbuilding capacity generates a possible link between freight rates. Here above model assumes that shipbuilding capacity is fully utilized at all times.
Structure of Tanker Markets
In 1960s, oil industry was dominated by gigantic oil companies such as Exxon, Gulf, Shell, Chevron, Texaco, BP and Mobil. At that time, these gigantic oil companies owned one-third (1/3) of the world’s tanker ships and chartered-in another one-third (1/3) of the world’s tanker ships on long-term time charters. Only one-third (1/3) of the world’s tanker ships were trading in the rest of the tanker market. When gigantic oil companies controlled up to 70% of the tanker fleet, shipping market seemed like an oligopoly rather than a perfectly competitive market. However, this appearance can be deceptive, tanker market is a highly competitive market. Furthermore, latest trends made the tanker market more competitive than it used to be, particularly in the crude oil sector.
Some sub-segments of tanker market, specialist ships like LNG and chemical carriers, may be less competitive than when tanker market was less fragmented. Many academic studies showed that tanker market is a perfectly competitive market.
Fundamental characteristics of a competitive market:
- Large number of buyers
- Large number of sellers
- All market participants struggle to maximize profits
- Neither buyers nor sellers are not large enough to influence price
- Product is homogeneous
- Freedom of entry to and exit from the market
- Full information is available to all market participants
Number of Shipowners and Charterers
In 1960s, when giant oil companies only dominated substantial part of the word’s tanker tonnage (2/3), there were still many independent oil companies that needed tankers to ship oil (1/3).
After 1970s, share of giant oil companies diminished noticeably for a few reasons:
- Surge of state-owned oil companies which diminished the share of giant oil companies
- Establishment of a large spot oil market meant that oil cargo may go through many traders before it arrives its final discharging port. Increase in number of the oil traders has triggered an increase in the number of independent charterers of ships
In 1970s, surge of the Rotterdam spot oil market overlapped with the loss of market control by giant oil companies. During the 1970s and 1980s, independent oil traders established new distribution channels. Consequently, giant oil companies reduced the tanker tonnage held on long-term charter, in response to the oversupply situation of the mid-970s. Furthermore, giant oil companies reduced direct ownership of tanker tonnage, partly in response to the introduction of the Oil Pollution Act 1990 (OPA90). Oil Pollution Act 1990 (OPA90) impose a penalty on the shipowner of any ship that pollutes the United States coasts will be fully liable for unlimited damages.
Transformation in tanker ownership have led to a significant decrease in the giant oil companies’ total tanker tonnage. In 2015, independent tanker owners and stock market companies accounted for 79% of world tanker tonnage.
In 2015, total giant oil company tanker tonnage amounts only to 9.4% of the world fleet. As of 2015, there are about 2,100 tanker companies which are operating tanker fleet about 5,000 tankers. In other words, this situation creates a fragmented and competitive tanker market. In tanker market, top five (5) tanker companies own around 10 million DWT which merely represents 12.5% of the world fleet. In other words, each top five (5) giant tanker company owns only around 2.5% of world tanker fleet. These are very low figures for industrial concentration.
Oil might seem to be a homogeneous product, however oil vary in terms of its sulphur content and viscosity Some of the trade involves the movement of different qualities of oil to be blended at refineries, as different blends meet different market needs. Practically, the main characteristic lies in the nature of the transportation of oil, not oil itself. Oil transportation is very homogeneous. Tanker shipping service supplied by one tanker is significantly identical to that supplied by another tanker owner, assuming that cargo delivery times, tanker reliability, quality and so on are similar. Therefore, economic assumption that the product is homogeneous can therefore be maintained.
Free Entry and Exit
Essential element determining ease of entry to the shipping market is access to capital to pay for a new or secondhand ship. After 2008 financial crisis, it is harder than before to get the funds from a bank or other financial institution.
Most of the maritime nations offer tax relief for investing in shipping. Commonly, shipping investments are made at the top of the shipping business cycle. In other words, investments are made when freight rates and time charter fixtures are comparatively high. At this situation, shipowners invest in more ships and financial institutions lend more funds in the expectation that freight rates will be high in the future. Contrarily, when spot and time charter rates are low, financial institutions are reluctant to offer funds. Furthermore, there are fewer shipowners willing to risk the acquisition of a new ship.
A shipowner may exit the shipping market by scrapping the ship or by selling to another shipowner. However, the latter does not decrease the tonnage supply overall. In some industries, exiting the market is very difficult when the company has been committed for a long-term project and could not convert the capital into cash. Assets might have to be sold below the initial cost of constructing the project. Company might find it very hard to leave the industry. Exiting the tanker market is relatively easy because there are many buyers and sellers on the second hand market except extraordinarily bad market conditions.
Huge proportion of capital invested in shipping is literally mobile. In other words, any geographical demand imbalances might be swiftly altered by a shifting the position of the ship. However, Very Large Crude Carriers (VLCCs) and some other sub-segments of the shipping market are less elastic than others. Very Large Crude Carriers (VLCCs) are restricted from some routes by draught restrictions. Additionally, Very Large Crude Carriers (VLCCs) cannot enter the Suez Canal when laden due the draught restrictions.
Replacement of one tanker for another on most trade routes means that all tanker sectors tend to move together. Tanker supply can be very elastic in the short run. Fleet of laid-up tankers are used when there is a sharp increase in demand. When tanker lay-ups are fallen to 1%, such a input would not be available and only new building capacity would increase supply in such a situation. Practically, tanker inspection and approvals regime does not encourage tanker owners to lay up tankers unless market outlook is desperately poor.
The market is extremely well served by the specialized shipbroking companies which keep in constant contact with both owners and charterers on a 24-hour basis all around the world. Many shipbroking companies have offices at strategic points around the globe to offer this service. London plays a crucial role, because it is located in a time zone which can trade with the Far East on the same day as trading with New York.
All this activity means that charterers and owners are continuously informed of current events and prices. Many fixtures are publicly reported, with all salient details available. This makes the provision of market information relatively cheap and very efficient and it provides a bench-marked market.
The emergence of publicly quoted tanker companies, whose shares are traded on the world’s stock exchanges, also means that information becomes more readily available as these companies must file accounts and provide information to shareholders.
Overall, it would appear that all the fundamental properties of a perfectly competitive market are fulfilled when the tanker market is examined. This means that modelling its behaviour using demand and supply analysis can be justified.
Different tanker sizes have different own-price and cross-price elasticity of demand with respect to freight rates. Gross profit margins varied broadly between tanker sizes. Very Large Crude Carriers (VLCCs) have noticeably large variability in those margins. If tankers were all in the same segment, the variability should have been the same. As a result, conditional volatility of tanker freight rates differed across tanker sizes. Although tanker sub-segments may have become more distinct in the short run, it does not follow that tanker sub-segments are unrelated in the long run because shipowners have the choice of investing in all sub-segments. Free entry and exit is available in all sub-segment, so that market imbalances may exist for a few years. However, all tanker market will be self-corrected by different rates of entry and exit in the sub-segments. If Very Large Crude Carriers (VLCCs) is severely low, Very Large Crude Carriers (VLCCs) segment will have very high lay-ups, higher than average scrapping rates and few new building orders. Tanker owners will be focusing on other sub-segments that are comparatively more lucrative, until the excess supply problem in Very Large Crude Carriers (VLCCs) segment is resolved. However, in the long run, same common factors driving each of these sub-segments and common trends emerging.
Modelling Tanker Demand
Demand for oil shipping is potentially to be excessively price inelastic. Oil shipping is a derived demand and the freight rate elasticity of derived demand depends on:
- Final product’s own-price elasticity of demand
- Cross Price Elasticity: can be substituted by other modes of transportation
- Share of freight costs
- Elasticity of supply of tanker supply
Lower the price elasticity of demand for the final product:
- Harder shipping can be substituted
- Larger the share of the freight costs in the final delivered cost to consumers
Tanker freight’s price elasticity of demand is very inelastic due to:
- Products derived from crude oil has very low elasticity, because of limited technical substitution and limited substitution for oil as an energy source in the long run. Oil elasticity is -0.17 in other words oil is very inelastic.
- Carriage of oil on seas is highly specialized. In some parts of the world, oil pipelines seem as substitutes for seagoing tankers, but oil pipelines are not practicable alternative to tankers.
- Share of freight costs in the retail price of gas is about 2%. Because, oil products are extremely taxed at the retail end because of the low elasticity.
- Tanker supply elasticity is usually quite high. Tanker supply elasticity can fall to zero in extreme booms.
Tanker price elasticity is the responsiveness of demand to changes in freight rates. Tanker price elasticity can be regarded as close to zero. In other words, tanker price elasticity is extremely inelastic.
Tanker demand is very inelastic with respect to the current freight rate. However, tanker demand it is very sensitive to the level of economic activity. Tanker demand might be drawn on schedule as more or less vertical when drawing the quantity demanded in tonne-miles or tonnes of cargo, against the freight rate, for a given level of economic activity. If rate of economic activity surges, entire tanker demand schedule can shift very rapidly. Tanker demand schedule shift to the right in booms and to the left in recessions.
Modelling Tanker Supply
Tanker supply schedule for the market as a whole is very similar to the dry cargo market. Tanker supply schedule will be elastic when there are significant amounts of tanker tonnage laid up, as laid up tanker tonnage is readily usable to increase the size of the active tanker fleet. Tanker owners must be very careful before lay-up decision due to oil company tanker approval regime. When laid-up tanker proportion plunge, sources of additional short-run tanker supply become more limited, so that the elasticity declines.
All variations that are observed in the tanker market are observed when the utilization of the fleet is reached to 80%. It becomes less and less elastic until full capacity utilization is achieved. This is tanker supply model is for the short-run supply. Assumption is being made that the tanker tonnage supply is unchanged, with variations in tonne miles produced generated by variations in lay-ups, storage, ship speed and delivery.
Tanker Market Model
Tankers very inelastic demand schedule together with the varying elasticity supply schedule generates a model of the equilibrium spot freight rate for tanker services.
Tanker market model is consistent with:
- At the higher tanker demand, there is great rate volatility
- Freight rate increases do not increase the short-run tanker supply at all, once full utilization of the existing tanker fleet is achieved. Tanker market model is very similar to the dry cargo market model. As a result, tanker and dry bulk markets are very competitive sectors.
Dry Cargo and Tanker Market Rate Volatility
Tanker markets higher rate volatility compared with dry bulk markets can be explained by:
- Dry cargo market comprise various major bulk cargoes, sub-sectors and tramp shipping. In other words, dry bulk tonnage can be shifted from the declining sub-sector to the growing sub-sector. However, this process keeps rate volatility under control in the sub-sectors
- Average size of dry bulk carrier is smaller than a crude tanker. There is positive correlation between freight rate volatility and ship size. Freight rate volatility might be higher due to the variation in average ship size between dry bulk and tanker sectors
- Oil is vital for the transportation and chemical industry. Additionally, oil is a crucial energy source for factory power. Plastics industry is based on oil-derived products. Main export region of oil is the Middle East. Historically, every substantial spike in tanker freight rates has been affiliated with political event in the Middle East such as:
- 1956 Suez Canal closed
- 1967 Six-Day War
- 1973 Yom Kippur War
- 1979-1984 Iran-Iraq war
- 1990 Iraq-Kuwait war
Tanker growth in the period 2002-2007 has been driven by market fundamentals. Middle East will be a significant oil supplier in near future. Thus, further oil price fluctuations due to political instability in the Middle East is quite high.
Reason for the early tanker freight rate spikes is easy to observe. Giant oil companies ordered as much as oil potential from the Middle East as soon as tensions flared but this was not coincided with extra tanker supply. Therefore, tanker freight rates skyrocketed.
1990 tanker freight rates spiked due to Iraq’s regimes Kuwait invasion. This oil crise was short-lived because Saudi Arabia purposefully increased its own oil production to compensate for the loss of Kuwaiti production.
In 1990s, Middle East was no longer as dominant in export shares as it had been in the early 1980s. Furthermore, giant oil companies are not so vertically integrated.
Till the end of 1996, price of crude oil plummeted around $20-25 per barrel. Therefore, tanker freight rates also declined. After 2000s, high oil prices were observed due to Far East demand levels that reached refinery capacity levels, rather than due to political events. Currently, developed western economies has a declined share of manufacturing and energy price changes have less impact on domestic inflation than 1970s.
- Future freight expectations. Tanker freight rates were affected by what was called price elastic expectations. In other words, higher the freight rate, more sensitive the market became to rates themselves and the market raised its expectations about future rates by more than was warranted. However, this new level of future freight expectations would cause a shift in the current demand curve, which would raise prices, until unsustainable levels were reached. This situation resembles a speculative bubble occurring in stock market, where all stock traders know the price is not related to economic fundamentals, but everyone is making so much money out of the constant rise in prices that no one really asks whether the process can be sustainable. Every market player knows that this situation cannot be sustainable and this idea is called rational expectations in market behavior. Future tanker prices are driven as much by what we expect to happen to future tanker freight rates and future tanker profitability. If tanker market is efficient, then all known information about such a market is argued to be captured in its present market price, freight rates or secondhand tanker prices. Transformation in future expectations will then spontaneously alter current market prices. For example, a war in the Arabian Gulf will send both oil prices, tanker freight rates and secondhand tanker prices up immediately because the likelihood of greater profitability is a consequence. These market models assume that every player in the markets had identical future expectations and in fact this is not true.
Tanker Freight Rate Fluctuations
Tanker freight rates peaked in 1967, 1970, 1973 and 1979. All these years are associated with wars and political turmoils in the Arabian Gulf and Middle East.
When we examine tanker freight rates over monthly or bi-weekly time periods, we would observe that tanker freight rates reflect the seasonal surges in tanker demand generated in the developed economies for oil in the winter months.
After 2000s, due to the huge oil demand from China and Far East countries, world tanker fleet was completely employed up to the financial crisis in 2008. 2008 mortgage crises can apparently be observed in the plunge in the tanker freight rates post-2008.
After 2008, tankers used as floating oil storage which has provided some employment till 2010. Tanker owners prefer slow steaming instead of laying up tankers in times of oversupply in order to maintain oil company charter approvals.
In recent years, oil refineries are closed in Europe and Australia. New refineries are opened in the Arabian Gulf (AG) and India. Therefore, oil products tonne-miles are increased. Furthermore, United States became an exporter of oil products due to shale gas production. Thus, crude oil shipments from West Africa to the US Gulf have diminished noticeably.
Oil Pollution Act 1990
In United States, Oil Pollution Act 1990 was enacted due to the United States reaction to the Exxon Valdez pollution incident in Alaska in 1989. Under Oil Pollution Act 1990, doubled-hull tankers were to become mandatory for tankers trading to United States waters. led the way at the IMO (International Maritime Organization) and the phasing in of double-hulled tankers for all operators by 2015 was agreed. However, after the incidents of the Erika in 1999, the European Union (EU) proposed an accelerated phased withdrawal of single-hull tankers by 2010. Tanker sector was transformed by the tanker renewal programme. Consequently, phasing out single-hull tankers created more efficient and safer oil transportation. Currently, oil pollution from tanker accidents or operations is substantially lower than it was in the 1980s. Furthermore, the introduction of the International Safety Management Code (ISM Code) in 1998 has radically changed attitudes to safety in the shipping industry. Port state inspections increased operational quality. International Convention on Standards of Training, Certification and Watchkeeping for Seafarers (STCW) has increased the standard of training of ship crew. STCW became mandatory in 2001. These procedures have significantly increased the standard of shipping quality and reduced pollution.