- By Erin Koehler, August 9, 2006

Energy markets received yet another shock early this week, with the announcement that BP is shutting down production at its Alaskan Prudhoe Bay oil field, the largest in the U.S., in order to replace damaged pipelines. Initially, BP announced that the entire oil field would be shut down, cutting U.S. oil production by roughly 0.4 mbd. However, there is now speculation that only half of the field will initially be affected by the pipeline repairs.

In either case, it now seems likely that U.S. production will be significantly lower than we anticipated in our most recent tanker market Base Case forecast, released last week. Specifically, we had expected North American oil output to rise by 0.2 mbd in the second half of this year and by a further 0.3 mbd in the first half of 2007, as new fields come on-stream in both the U.S. and Canada.

But as a result of the Prudhoe Bay closure, we now expect U.S. output to fall by 0.2-0.4 mbd, relative to our Base Case scenario, in the near-term. The duration of the shutdown is highly uncertain, but the U.S. Department of Energy estimates that the field will not return to full production for another six months.

This is good news for tanker owners, at least in the short-term. While some of the offsetting supplies are likely to come from domestic oil inventories (either from commercial supplies or from the Strategic Petroleum Reserve), we expect most of the production shortfall to be met with higher oil imports. This should boost oil trade demand, for both crude oil and refined products, relative to our July forecast.

In addition, most of the incremental crude supplies will likely come from Saudi Arabia, leading to a more significant jump in tonne-mile demand. The Saudis have already agreed to ramp up their production to make up for the lost supplies and their oil is a similar quality to the sour crude produced at Prudhoe Bay, making it a natural replacement. Shorter-haul supplies will be difficult to come by, as roughly 0.8 mbd of output remains offline in Nigeria, while other producers in West Africa and Latin America have very little spare production capacity.

Meanwhile, incremental product imports are likely to be sourced from several regions, including Europe, Asia, and Latin America.

Consequently, if we do see a prolonged disruption, we would expect tanker rates to increase significantly relative to their current levels and to our July forecast.

We will revisit the situation in more detail in our upcoming August eBrief, but a preliminary analysis suggests that a complete shutdown of the Prudhoe Bay oil field would lift VLCC rates on our benchmark AG/East route to an average of $90,000 per day in the second half of this year, up by nearly $20,000 per day from our previous Base Case forecast. Similarly, product tanker rates would average $30,000 per day in the second half of this year, rather than the $25,000 per day predicted in our July scenario.

Alternatively, if only half of the field is shut down, resulting in a loss of roughly 0.2 mbd of output, the impact on tanker rates would be more modest. In this case, we would expect VLCC spot earnings to rise to an average of $79,000 per day during the second half of this year, while product tanker rates would average $27,000 per day over this period.

It is worth mentioning, however, that the potential for further disruptions to U.S. production looms large as we enter the most active phase of the Atlantic hurricane season!

Projected 2006H2 Spot Rates, $/day