Sanctions Are Cleaving The Global Shipping Fleet In Two

Five days after the Trump administration slapped sanctions on China's COSCO (Dalian) – a subsidiary of the largest vessel-owning group on the planet – shockwaves continue to reverberate across ocean shipping.

Not only does the U.S. decision create immediate rate upside for tanker trades, it has two broader impacts.

First, it will likely be a major point of contention in the upcoming U.S.-China trade negotiations, talks that will affect all ocean shipping sectors and listed shipping stocks. Second, the global fleet is becoming increasingly split between vessel interests willing to abide by U.S. sanctions and those that profit by filling the gap.

The sanctions announced Sept. 25, enacted in response to alleged carriage of Iranian crude, are still sowing confusion vis-à-vis which ships are blacklisted, given that the U.S. Office of Foreign Assets Control (OFAC) has yet to designate specific vessels. Charterers are erring on the side of caution and reportedly avoiding any ship that might conceivably be on the target list.

As a result, tanker rates that were already elevated in the wake of the attacks on Saudi oil facilities are rising further still.

One of the questions in shipping circles is: Did the U.S. government realize the significance and potential side effects of sanctioning a subsidiary of a Chinese company the size of COSCO?

Jonathan Epstein, a partner with law firm Holland & Knight, said in an interview with FreightWaves, "The big question in my mind is whether they meant to throw a hand grenade into the water and cause a big splash and create a lot of disruption or whether this is more like when they designated [Russian aluminum company] Rusal, and nobody anticipated what the effect of that would be."

Short-term tanker rate boost

Rates for very large crude carriers (VLCCs), vessels that carry 2 million barrels of crude oil each, rose to $55,200 per day as of Friday, Sept. 27, up 33% week-on-week, according to Clarksons Platou Securities. Rates for Suezmax tankers, which carry 1 million barrels of crude each, reached $30,700 per day, up 7% week-on-week. Baltic Exchange indices indicate that tanker rates rose even further on Sept. 30.

Shares of U.S.-listed tanker owners have responded in heavier-than-normal trading volume. Between market close on Sept. 24 and Sept. 30, shares of Euronav EURN increased by 9%, International Seaways INSW by 7.4% and DHT DHT and Frontline FRO by 4%.

Sanctions have forced charterers that had previously scheduled cargoes aboard COSCO (Dalian)-owned vessels to rebook them on short notice at much higher rates. When a replacement VLCC cannot be found, charterers have booked two Suezmaxes instead, leading to positive momentum in that sector as well.

"Tonnage availability is becoming scarcer with charterers seeking to replace vessels owned by COSCO," said Clarksons Platou Securities analyst Frode Mørkedal. Jefferies analyst Randy Giveans added that charterers were "scrambling for tonnage."

OFAC specifically stated that the sanctions apply only to COSCO Shipping Tanker (Dalian) Co. and its management company, not other companies under the vast China COSCO Shipping Corp umbrella – the largest ship-owning entity in the world with a fleet spanning the tanker, dry bulk, gas and container arenas.

According to data from ship brokerage Clarksons, COSCO (Dalian) has 26 VLCCs and other COSCO companies own a further 17 VLCCs, while COSCO (Dalian) also owns three Suezmaxes and 23 smaller tankers.

The numbers from U.K.-based VesselsValue for COSCO (Dalian) are different: four VLCCs, three Suezmaxes and 10 smaller tankers. The variety of estimates on the COSCO (Dalian) fleet size depending upon the data source is an important part of the story because it underscores the uncertainty in the charter market on which tankers are affected.

According to Argus Media, "The [COSCO] group's opaque ownership structure has caused confusion among charterers as to which of COSCO's tankers were under sanctions."

Sam Tucker of VesselsValue told FreightWaves, "The ownership structure of these vessels is notoriously murky and until the U.S. publishes a definitive list of the affected vessels, charterers are avoiding fixing any vessel that could be linked."

That uncertainty is effectively rendering the U.S. decision to sanction COSCO (Dalian) as the practical equivalent of sanctioning the entire COSCO Group's tanker fleet, at least until OFAC provides more clarity. According to VesselsValue, the overall COSCO Group has 138 tankers; Argus puts the total at 151.

"In practical terms, the sanctions mean that most Western charterers will probably avoid chartering COSCO vessels," said Mørkedal.

Sanctions divide the global fleet

As the U.S. sanctions regime continues to expand – restricting trade with Iran, Syria, Russia (on a limited basis), Venezuela, North Korea and Cuba – the global shipping industry is becoming more splintered between fleets that are exposed to the U.S. financial system (and thus the risk of sanction violations to their dollar-denominated transactions) and those that aren't.

While the charter-rate and stock-market effects of the COSCO (Dalian) decision may be relatively short-lived, this bifurcation of shipping tonnage is increasingly the "new normal" for the long term.

The result is structural market inefficiency, a positive for freight rates and a negative for bulk cargo shippers. If only certain vessels can handle certain markets, they will be positioned less efficiently to serve customers than in a perfectly open global system, and it will take more ships to move the same worldwide cargo volume. In a fully open system, ships can better triangulate (i.e., move cargo from A to B, then B to C, then C to A) and thus better optimize utilization by reducing ballast (empty) time.

The split between those on the safe side of U.S. sanctions and those that aren't is far from even; the former far outweighs the latter. But to the extent the second category grows, market inefficiencies will escalate – and putting even part of a giant like COSCO into that second basket could materially move the needle.

According to Stifel analyst Ben Nolan, this separation effect will play out with the COSCO sanctions. After the current scramble to replace COSCO ships with new charter vessels, "over the course of the next month, this should normalize, with COSCO ships gravitating toward new nonrestrictive markets and other ships being paid more to move to COSCO-restricted markets," he said.

Nolan believes the absence of COSCO ships in the U.S. Gulf should be a "windfall" for international tanker companies, given that U.S. crude exports have been averaging 3 million barrels per day (b/d) and new pipelines to the coast with an additional 1 million b/d of capacity have come online within the past month.

Bruce Paulsen, a partner with New York law firm Seward & Kissel, told FreightWaves, "What we've seen is that the Iranian sanctions regime wound up, then wound back down, then wound up again substantially, so First World operators are very cautious about this. We've also seen that there are a host of operators who could care less. Iran is a big market and if they think the U.S. government is not a threat and they can do business in some other currency, they will dodge the raindrops."

Epstein at Holland & Knight likewise believes sanctions could bifurcate the global fleet. "In the short term, it could be tactically sound [for the U.S.], but in the long term, this could create an alternative [shipping system], where the Chinese realize they need their own P&I [property & indemnity insurance coverage] and so on. I have the same concern with the U.S. banking system, where it has become so difficult to do legal trade that it's sort of forcing a move away from dollars." More FreightWaves/American Shipper articles by Greg Miller

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