The clock is about to strike midnight for ocean shipping. The deadline for IMO 2020 regulation, mandating a game-changing global switch from cheap high-sulfur marine fuel to costly low-sulfur fuel, is now just a few days away – on Jan. 1.
IMO 2020 is shaking up volumes and trade flows for both crude tankers and refined product tankers. International Seaways (NYSE: INSW) owns a large fleet comprised of both tanker types, affording it a bird's-eye view of the shifting landscape. INSW operates 42 vessels (including two floating storage units) totaling 7 million deadweight tons (DWT) and has a current market capitalization of around $880 million.
For the latest on IMO 2020 and other key issues, FreightWaves sat down for an interview with INSW CEO Lois Zabrocky at her company's midtown Manhattan headquarters on Dec. 19. The following is an edited version of that conversation.
IMO 2020 Transition
FreightWaves: After all the hype, IMO 2020 is almost here. I guess I shouldn't be surprised, but a lot of owners seem to be waiting until the very last second to switch from 3.5% sulfur heavy fuel oil (HFO) to 0.5% sulfur very low sulfur fuel oil (VLSFO). How has INSW handled this switch?
Zabrocky: "The ideal is to burn high-sulfur fuel until Dec. 31 and have zero ROBs [remaining on board], and to have other tanks full of low-sulfur fuel that you bought in October or early November before prices rose. You try like heck to burn all your high-sulfur fuel before the end of the year and if you have some ROBs, you can't burn them [as fuel after Jan. 1]; you would lighter them off [unload them]. With our fleet, we were able to take on a lot of low-sulfur bunkers before prices rose. Out of 40 tankers, we're down to watching only about a half dozen [still burning off their high-sulfur fuel]."
One of the big concerns is whether enough VLSFO will actually be available to allow for IMO 2020 compliance. What's the situation as of today?
"I was speaking to our bunker broker this morning and the bunker market is extremely tight. If you have a ship coming in that needs bunkers today, they're stemming for Jan. 7, so they're stemming out two to three weeks. There are bunkers available, but you may have to wait. One of the examples she gave me is that in Fujairah, there's low-sulfur fuel available but there are only one or two suppliers and there's only a certain number of barges and the barges are having to wait to get loaded. The bunker testing labs are also backed up and owners have to wait for the results before burning fresh supplies. Inefficiencies like these are causing a ripple effect throughout the fleet and what this means is that the market goes up."
Everyone is focused on the spread between HFO and VLSFO, but I think it's more important to look at the spread between what HFO cost a year ago and what VLSFO costs today. With ocean shipping switching from HFO to VLSFO, the year-on-year differential equates to the rise in the fuel price. And it looks like it's now up 40-50%. Wouldn't this weigh on the time-charter-equivalent spot rates that will be reported by public shipping companies in the commodity trades?
"It's a negative. When your input costs go higher, that's a challenge. When you start paying $600-$700 per ton for bunkers, that's a big cost input for owners. Particularly so in containers and dry bulk. For tankers, there's more refining [due to IMO 2020] and we're moving the oil, so at least we're getting benefits from that.
"Also, when you look at the fourth quarter, you've been buying low-sulfur fuel but you're not burning it. You're burning the rest of your high-sulfur fuel. But you've got to pay for the low-sulfur fuel in the fourth quarter and the freight is not reflecting that higher price."
Do you think it's possible that spot rates won't recoup the higher fuel costs? This situation already seems to be emerging in dry bulk, with owners having to eat some of the cost.
"The world is facing higher fuel costs [due to IMO 2020] and it's a small price to pay for a cleaner environment, but the transition will not be easy. Trying to pass the cost on through the supply chain is not a foregone conclusion. Every shipowner has to work on that on every fixture and on every trade."
Newbuildings And Carbon Questions
After IMO 2020 there's the much bigger issue of IMO 2050, the reduction of greenhouse-gas emissions. So far, this has actually been a positive for shipping fundamentals due to confusion over what type of fuel and ship design will cut carbon emissions enough to meet the 2050 deadline. This has led to a curb in new orders despite high freight rates in the tanker sector, a plus for the future supply/demand balance. How significant is the fear of premature newbuilding obsolescence?
"You build a ship for 25 years. If you place an order today, you get that in 2022, and after 25 years, it's almost 2050. So I think every owner better have some fear when placing an order."
It's widely believed that ships fueled by liquefied natural gas (LNG) or liquefied petroleum gas (LPG) will be approved as transitional designs. Do you expect orders with these fuel systems to start to ramp up?
Zabrocky sees a "tranche" of LNG-powered tanker newbuildings en route. Photo courtesy of John Galayda/CMA
"With a dual-fuel engine, for a VLCC [very large crude carrier, a ship designed to carry 2 million barrels of crude oil], that's an additional $15 million, so if you're paying $90 million, that's more than 15% of the overall cost. Using LNG is a lot better for sulfur and NOx emissions, but it's only marginally better from a CO2 perspective. It doesn't solve the CO2 emission problem. That's going to require using something like hydrogen or ammonia.
"I do think there will be a tranche of dual-fuel-engine newbuildings that will be built, and I think these will be sponsored by oil companies to some degree. They're not going to do 25-year charters; they'll do medium-term charters.
"But I don't think every ship that will be ordered will be dual fuel. I think this is going to be an era of rapid technological improvement. Every owner has to be very alert. You could be allowed [to use dual fuel under new environmental rules] but they may come up with something that's more economical. After all, there are still a bunch of steam-driven LNG carriers out there."
October Tanker Spike And Fundamentals
Let's turn to current tanker market dynamics. We had that crazy rates spike that peaked around Oct. 11, peaking at astronomical levels of around $190,000 per day, then falling back. You were in the middle of all that. What happened there and how do you compare drivers at that time to what's happening now?
"The market really started to improve in September, and that's early – often your seasonal increase in oil demand comes around Thanksgiving. After the attacks on the Saudi infrastructure and the COSCO sanctions, the customers panicked. They just started grabbing ships. What that laid bare was that the market underneath all that was tightening. What I call ‘the defibrillator' went up and down, but the resting rate where it found equilibrium was somewhere around $70,00-$80,000 a day.
"After we had that stampede, we reverted to fundamentals. And now we're definitely seeing more of a seasonal increase. I was talking to our VLCC desk today and they're seeing fixtures into late January at rates approaching $100,000 a day. Let's also remember that we're coming off three years of being at or below cash breakeven levels. In order for an owner to make a living and provide a proper return, you need to have periods like this where you have a high market. It's developing the way we thought it would – which is always reassuring."
Regarding current demand, there has been a lot of focus on both crude and products exports out of the U.S. Gulf. There are some concerns about this, given some signs of weakness and a potential production slowdown in the Permian Basin. What are you seeing?
"For sure, a lot of money invested in the Permian has been lost. It has been challenging, but what's happening is that acreage is being concentrated into bigger hands. Companies like Exxon [NYSE: XOM] are moving in. I meet with a lot of investors and they are worried about U.S. production because the rig count is down, but it still looks like another 900,000 barrels per day [b/d] is coming online next year, and it's getting pushed out [as exports], especially with the debottlenecking from new pipelines.
"Over the last four weeks, crude exports out of the U.S. Gulf have averaged 3.4 million b/d. That's 500,000 b/d more than the first half of the year. If that only went on VLCCs, that's one VLCC every four days. It takes about 115 days to go Gulf-China-Gulf. So that extra 500,000 bpd would require another 30 VLCCs a year. Now, it doesn't all go on VLCCs. Half is going on Aframaxes [tankers with capacity of 750,000 barrels] to Europe and South America. The other half is split between VLCCs and Suezmaxes [tankers with capacity of 1 million barrels]. The Suezmaxes are really flexible and go anywhere, including [the Far] East."
There has been so much focus on crude exports out of the U.S. Gulf that people have sort of lost sight of what's going on with products exports.
"The product exports are bigger in volume than the crude. The U.S. Gulf is now the largest loading area in the world for MRs [medium-range product tankers, with capacity of 25,000-54,999 DWT]. U.S. Gulf refineries are operating at about 92% [utilization] and the East Coast refineries are in the 60s. For product tankers, that's ideal, because you're bringing in gasoline to the East Coast [from Europe] and your exporting diesel out of the Gulf Coast [to Europe]."
Capital Allocation And Fleet Renewal
INSW has been very focused on reducing debt, after which attention could turn to other capital-allocation options to the benefit of shareholders. Investors are very focused on the potential for dividends and would like more color on the timetable.
"If you look at the actions we've taken since we became independent, the markets in 2017 and 2018 were terrible, and that actually worked well for us because we needed to renew the fleet. We bought nine tankers and spent $650 million if you include the scrubber investment [exhaust-gas scrubber installations to allow continued use of HFO after Jan. 1]. The way we think about that is: our depreciation and amortization is about $80 million a year, so we essentially concentrated eight years' worth of fleet renewal into the downturn, when prices were lower.
"The next critical strategic move was the sale of our LNG joint venture in October. We were not getting credit for the LNG investment from our shareholders and analysts and it was noncore, and [with sale proceeds] we paid down $110 million in debt. In essence, that's the deleveraging we had planned to do.
"What we'll do next is refinance – remove some of the higher-cost debt used to buy the ships from our balance sheet. We're going to streamline and simplify the balance sheet and bring down the interest expense. Our fleet is now young enough that we can refinance our debt through traditional banks at a much more competitive interest rate. We were not able to do that before.
"Once we've executed on the refinancing, we'll be in a position to give serious consideration to returning cash to shareholders in our capital allocation. We have not decided as a board exactly how we're going to return cash to shareholders, but it is on the docket for discussion."
Through no fault of its own, INSW missed out on the last wave of newbuildings, negatively affecting average fleet age. Overseas Shipholding Group (OSG) ran into financial difficulties and ultimately filed for Chapter 11 bankruptcy protection in 2012. It emerged in 2014. The initial post-bankruptcy plan was to sell OSG's international fleet, and when that didn't work, the non-U.S.-flagged vessels were spun off as International Seaways in December 2016. You're now completely separate from that legacy, but the fact remains, the earlier situation precluded ship orders. Going forward, how can you reward shareholders, through dividends for example, and at the same time continue the fleet-renewal process?
"In addition to buying nine modern ships, we've also sold 16 older vessels. We'll still be looking at pruning other older vessels if their discounted cash flow doesn't support keeping them, but actually, the ships we've selectively kept that are older than 15 years are making a much higher return on investment in this cycle than the modern ships. Earnings of older ships are now much closer to earnings of modern ships. It's when you're in a downturn when the inefficiencies of an older ship are really revealed.
"[In terms of adding tonnage] you should also expect us to opportunistically add in ships if we have a premium pool to put them in, in addition to returning cash to shareholders as we go.
"We think we're in the early part of this cycle right now and asset values have not gone up inordinately. When we do feel we're far enough into the cycle that values are toppish, we may sell ships and we may have to get smaller for a while. We're going to be very disciplined in how we spend our money. We don't want to splash out money on ships to have it be dilutive. You won't see us buying ships at the top of the market."
So, you may get smaller before you get bigger, but is the whole point to ultimately be younger?
"You can't just say you want to be younger. That's part of it, but the whole point is to provide the best value to shareholders.
"I think we're in a great spot. But nothing is ever enough. It's not like you can ever say, ‘We're done.' That doesn't work. There's always something more to do. And what we want to do next is to be a leading tanker company, run the best company we can and put up the best returns. That's our goal."