A Balancing Act

The current tanker market cycle peaked in 2004 with the highest tanker rates seen in a generation.  Since this high point, rates have been gradually moving downwards, and the recent acceleration in the decline can be, at least partially, attributed to the steady stream of newbuildings entering the tanker market.  At the same time, scrapping has not been a significant factor in reducing the size of the fleet with only seven crude oil tankers reported sold for scrap so far this year.  Far more impressive perhaps are the thirty or so vessels tied up for conversion projects.  Nonetheless, the situation is such that, at least for now, crude oil tanker spot rates are in the doldrums, and the fear is that this is not a mere passing summer fancy but that it may be the shape of things to come for the next couple of years.  Even the most optimistic of the large owners are realistic when it comes to the future, and although they hope for another boom, they are prepared for things being pretty slow.

The question remains, however, why are time charter rates and tanker prices so high during a period when spot rate time charter equivalents are so low?  If we look at the  Suezmax market as an example, we will see that a 2001 Suezmax was recently reported sold at just below usd 93 million, and most analysts are estimating the rate for a one year time charter on a modern Suezmax to be around usd 45.000 per day.  In the midst of all of this, the present time charter equivalent rate for a Suezmax trading in West Africa is about usd 23.500 per day.  So far this year, the average time charter equivalent rate on this route has been around usd 34.000.  In order to amortize an investment in a five year old Suezmax vessel, one would need close to usd 38.000 per day given today´s prices in the low to mid usd 90 million range.  If this situation continues, warning bells will have to start ringing.  Even the most reckless of prospective buyers will have to eventually be put off if he begins to see that the potential earnings curve is below what is needed to service his debt, and certainly, prudent charterers will not continue to pay time charter rates far in excess of what they can expect to be charged in the spot market. 

The current situation in the tanker market is reminiscent of the famous quote from Abraham Lincoln which I have transcribed by substituting the word ‘market´ for the word ‘people´: ‘You can fool some of the market all of the time, and all of the market some of the time, but you can´t fool all of the market all of the time.´  Certainly, the incongruity of the present (im)balance between price and time charter rates compared to spot rate time charter equivalents cannot be sustained in the long run.  The nature of markets is that they find equilibrium by correcting themselves so that all essential elements are in sync with each other.  It is also important to point out that spot rates are the prime mover in the tanker market and the whole character of the market is derived from them.  In the end, both tanker prices and time charter rates are a function of what is being earned by vessels in the day-to-day market.  What we are seeing today cannot continue, and eventually the three factors of price, time charter rates and spot rates will have to fall in line with each other.  Unfortunately, there appears to be little chance of spot rates climbing in order to come into balance with tanker prices and time charter rates.  It is far more likely that if the spot market remains weak for a prolonged period, both time charter rates and second hand prices will eventually have to come down.  The fact that prices have remained so high in the face of a withering decline in spot rates is probably just a reflection of the ready availability of capital and the need to invest it.  If the spot market continues to be weak, investors will get the message and either find other objects in which to invest their ready cash or more likely hold out for prices that more realistically represent the earnings potential of the vessels they intend to purchase. The same will probably be the case for time charterers as well.  In the meantime, it will be interesting to see how long it will take before equilibrium returns.