How Drone Attacks Impact Shipping: Crude Tanker Fallout

The drone attacks on Saudi Arabia's oil facilities could have far-reaching consequences for ocean shipping. There are broader implications for all vessel types – on fuel pricing, chartering sentiment and possibly even trade politics – but crude tankers are most directly in the line of fire.

Financial analysts' views on how crude-tanker companies will be impacted run the gamut from one extreme to the other, with one warning that it is "very negative for tankers" and another arguing that it is "a bullish turn for the tanker market – period." So who's right?

Open vs closed chokepoints

Tanker demand consequences hinge on whether this turns out to be a so-called "open chokepoint" or a "closed chokepoint" for cargo supply.

In an open chokepoint, the temporary closure of one route or cargo source allows for either diversions around that blockage or replacement of the original cargo by another source; in either case, total cargo volume is unchanged but the average distance traveled changes as cargo flows around the obstruction.

This scenario is usually positive for bulk cargo shipping (but not scheduled container shipping). The most famous examples of an open chokepoint were the closures of the Suez Canal in 1956 and 1967-75, which spawned fortunes for tanker owners including Aristotle Onassis. Tankers were required to circumvent Africa, a much longer voyage than the Suez route.

If the same volume of cargo is forced to be carried longer distances due to a sudden geopolitical event, extreme weather or some other reason, it soaks up more vessel capacity, increasing freight rates.

In a closed chokepoint scenario, a source of supply is completely shut off and cannot be immediately replaced through other sources, reducing the total amount of cargo at sea – which is highly negative for ocean shipping. Vessel demand is measured in ton-miles (volume multiplied by distance). In an open chokepoint, the volume is the same and the distance is higher, so ton-mile demand rises. In a closed chokepoint, volume decreases, so ton-miles fall.

A hypothetical example of a closed chokepoint is the closure of the Strait of Hormuz due to a military conflict – a fear that was raised in light of recent tanker attacks in the Gulf of Oman and tanker seizures and boardings by Iran.

An actual example of a closed chokepoint transpired earlier this year in dry bulk shipping. A dam holding back iron-ore residue collapsed in Brazil in January, killing hundreds and forcing the sudden closure of a major mine. A significant portion of Brazil's long-haul iron-ore exports to China were offline for months. Rates for larger bulkers known as Capesizes collapsed. After the mine reopened, Capesize rates surged.

Which chokepoint scenario applies to the attack in Saudi Arabia? At first glance, it would seem a closed chokepoint that temporarily removes 5.7 million barrels per day (b/d) or 5% of the global crude supply. Look more closely, however, and the situation is more of an open-closed hybrid, with a mix of negative and positive impacts for tanker demand.

Ample reserves could fill the gap

The output taken offline by the drone attacks represents around half of Saudi Arabia's production. Stifel analyst Ben Nolan noted that Saudi Arabia is likely to direct its remaining production more towards its domestic refining and petrochemical plants, at the expense of its exports.

Some of that lost export volume will likely be replaced by other OPEC members if recent production cuts are temporarily reversed; Clarksons Platou Securities analyst Frode Mørkedal sees about 500,000 b/d available from other OPEC members on short notice. Another source of replacement supply could be the U.S., which is rapidly increasing its export capacity. 

But a large portion of the replacement is expected to come from storage, a negative for average crude-tanker voyage distance.

Saudi Arabia has cited its ability to open its emergency reserves, while further reserves could be tapped if necessary by member countries of the International Energy Agency (IEA), as well as non-IEA member countries. Saudi Arabia has significant reserves held in its own country as well as in storage in Okinawa, Japan; Rotterdam, Netherlands, and Sidi Kerir, Egypt (on the Mediterranean coast).

When tensions flared near the Strait of Hormuz in late July, the IEA disclosed that its members had 1.55 billion barrels of "public emergency stocks" in hand, with a further 650 million barrels "held by industry under government obligations" that "can be released as needed." The U.S. has 645 million barrels in its Strategic Petroleum Reserve.

Argus reported on Sept. 16 that Asian buyers had "ample strategic and commercial stockpiles": Japan has 300 million barrels of crude in national stockpiles, plus 85 million barrels of commercial stocks; South Korea has 130 million barrels of strategic inventories and 53 million barrels of commercial inventories; and China has 300 million barrels of strategic reserves and 400 million barrels of commercial reserves.

To the extent Saudi Arabian crude stored in Japan is sold to Asian buyers and/or Asian countries consume their own stockpiles, it will be highly negative for tanker demand measured in ton-miles, given the long-haul nature of the Middle East-Asia exports they would replace.

Yet another tanker demand negative involves Iran, and the U.S. claim that Iran is culpable in the drone attacks. Oil market-watchers previously saw an increased possibility of Iran sanctions relief for two reasons: the firing (or resignation) of U.S. national security advisor and Iran policy hawk John Bolton announced Sept. 10, and recent reports that the Trump Administration might be open to renewed negotiations.

Any optimism on the end to Iran sanctions went down in flames on Sept. 14 with the drone attacks. "The incident makes Iranian sanctions less palatable, thereby removing the potential return of over 1.5 million b/d of supply," said Stifel energy analyst Derrick Whitfield.

Inventory building could be a positive

The more optimistic view is that the attacks will actually increase tanker demand, because there will be a rush to buy crude and build up inventories around the globe. Not only will any reserves taken down in the near term need to be replaced, but importers will bolster their reserves further than they had previously due to heightened geopolitical risk, and these shipments will travel longer distances.

"Forget talk of lower Middle East flows depressing tanker demand," said analysts at Norway's Arctic Securities. "We believe refinery purchasing managers now are thinking [about] inventory building and security of supply. Oil will be harder to come by and will have to travel farther – from the U.S., Brazil, Russia and elsewhere. In such a scenario, the opportunity cost of being uncovered on transport is bound to rise, pushing rates higher and available tonnage lower."

"We expect importing nations to build inventories in the medium term as a result of increased tensions in the Middle East," added Randy Giveans, shipping analyst at Jefferies.

Tankers stocks did not collapse

Very large crude carriers (VLCCs) – vessels that carry two million barrels of crude oil each – are the most commonly utilized tankers in the Saudi Arabian and Middle East crude export trade. Given the shock to the system of the drone attacks, one might have expected the stocks of U.S-listed VLCC owners to plunge when they opened for trading on Sept. 16.

They didn't. Declines were minimal. As of the closing bell, the stock of Euronav EURN was up 0.3%; shares of DHT DHT were down 2.5%, Frontline FRO dropped 2% and the stock of International Seaways INSW was down only 0.2%. Volumes were heavier than normal and stock moves were actually positive during certain periods of the trading session, particularly earlier in the day. 

Cleaves Securities analyst Joakim Hannisdahl opined on why at least some tanker stock investors are taking the drone attacks as a plus. "Rather than focusing on the immediate effect of the lost barrels, the market seems more focused on the positive implications," he said, pointing to the potential for inventory builds and longer voyages that may lie ahead.

More FreightWaves/American Shipper articles by Greg Miller

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