Marsoft Flash Report – Tanker Market – 18 March 2020

Saudi Arabia's strategy to boost production will support tanker rates in the short-term

The oil and tanker markets have experienced a rollercoaster of events since we published our quarterly report in February. After rocking the Chinese economy in January and February, the COVID-19 virus then spread further west, into Iran, Europe and the US, leading to sharp downward revisions for oil demand in 2020. Furthermore, on 6th March, to everyone's surprise, OPEC+ members failed to come to a new oil production agreement.


Since then, Saudi Arabia and Russia have publicly announced their intentions to reverse their strategy of cutting production to support prices, and instead increase production to regain market share. According to the latest reports, Saudi Arabia has announced the Kingdom will increase production to more than 12 mbd, up from 9.7 mbd in February. Russia and the UAE have also announced plans to increase output. Such an immediate reversal of production
strategy completely changes oil market dynamics and by extension, tanker market dynamics as well.


Demand revisions due to the spread of COVID-19

While the situation still remains highly uncertain due to the rapid spread of COVID-19 in the US and Europe over past three weeks, the International Energy Agency has revised down its estimate for global oil demand, primarily in 20H1. Demand is now expected to decline by 1.3% yoy in 20H1, followed by 1.1% yoy growth in 20H2, as the virus is expected to subside by the middle of the year.

Our base case expectation is that Saudi Arabia and Russia will boost production

OPEC+'s decision to increase production, instead of extending or deepening the existing cuts, sent the oil markets in a tailspin, causing benchmark oil futures prices to fall by more than 30% at the beginning of the next trading day. Brent prices have since fallen to less than $30/bbl. While there is a possibility that Saudi Arabia and Russia, the two key players of OPEC+, will agree on a deal in the coming months, in our base case we assume that production will increase significantly in 20Q2. Both countries have low production costs which we believe will help them adapt to the low-price environment, as they attempt to force high-cost producers, specifically the US shale sector, to reduce production.

Low price environment will likely hamper US shale production and US exports

More specifically, US shale breakeven costs are estimated at an average of about $50/bbl (WTI price) for new wells; while the breakeven, or shut-in, price for existing wells is closer to $30/bbl. Accordingly, drilling activity is likely to dry up in the coming months. We now expect North American production (from the US and Canada) to grow by 0.8 mbd in 2020 (mostly
due to strong gains in 20Q1) and by just 0.3 mbd in 2021, compared to growth of 1.8 mbd in 2019.


On the one hand, slower growth in US production will lead to slower growth in US crude exports, which should have a modest negative impact on the average crude trading distance.But this will be more than offset by the positive impact of increased Middle East supplies on tonne-mile demand.


Inventories and floating storage will increase as a profitable contango develops


In the near-term, the tanker market should benefit from high production levels and rising oil inventories. In addition to increasing trade activity as OPEC boosts output, we also expect floating storage to jump significantly, as an oil price contango has recently developed in the futures market.

Of course, a key question is how long this situation will last. We expect the combination of high OPEC production and high floating storage to persist through 20Q2, but eventually, we think the pain of lower oil prices will bring Russia and OPEC back to the negotiating table.


What happens later in the year will also depend in part on COVID-19 developments. In the event that the virus does indeed subside by 20H2, we should see oil demand recover quickly, especially in China. This will probably allow oil prices to recover with a relatively mild reduction in OPEC output, which will be necessary to eliminate the inventory overhang that will materialize in the coming months. So, it may be somewhat counterintuitive, but we expect tanker rates to fall back modestly in 20H2, even as global oil demand should be recovering then.


In the event that global oil demand continues to weaken during 20H2, OPEC will probably be forced to make even bigger cuts, or else the oil price would probably head towards $20/bbl. And there is a limit to how high inventories can go, so it is unlikely that a stockbuild can continue to support the tanker market if underlying oil demand remains weak. We will discuss our tanker market outlook in more detail in our March eBrief, which should be available before the end of this month.

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