Good news if you're a shipper of coal, grain and iron ore: Ocean transport is once again looking cheap in 2020.
Bad news if you're an owner of a dry bulk carrier: Income at the very start of this year is even weaker for most ships than in early 2019 because fuel costs are much higher in the wake of the IMO 2020 rule.
What's transpiring in the dry bulk sector is important to watch for cargo shippers and vessel owners in all segments — including container shipping — because dry bulk, the largest transport market in the world measured by volume, is now offering a relatively transparent window on what happens if IMO 2020 implementation collides with weak cargo demand.
Scrubber Versus Non-Scrubber Capes
The IMO 2020 rule mandated that all vessels not equipped with exhaust-gas scrubbers burn 0.5% fuel known as very low sulfur fuel oil (VLSFO) or 0.1% sulfur marine gas oil (MGO) as of Jan. 1. Ships with scrubbers can continue to burn cheaper 3.5% sulfur heavy fuel oil (HFO).
Clarksons Platou Securities reported that time-charter equivalent (TCE) spot rates for Capesize bulkers (vessels with a capacity of over 100,000 deadweight tons) averaged $10,800 per day as of Jan. 3, assuming the use of IMO 2020-compliant fuel (i.e., non-scrubber ships).
If a ship had a scrubber and was instead consuming less-expensive HFO, Clarksons estimated that the TCE would be $10,300 per day higher, or $21,100 per day.
In other words, dry bulk spot rates have sunk so low and the HFO-VLSFO spread has risen so high that a scrubber-equipped Capesize should now theoretically be earning twice as much as a non-scrubber Capesize.
To put this in perspective, both scrubber-equipped and non-scrubber bulkers in the spot market obtain the same payment from shippers, calculated in dollars per ton of cargo, with the vessel owner-operator paying voyage expenses including fuel.
When a dollars-per-ton rate is converted into a dollars-per-day TCE rate, the calculation is net of the fuel cost, so ships burning expensive VLSFO will post a lower TCE number than ships using cheaper HFO, despite both receiving the same dollars-per-ton payment from the cargo interest.
It's also important to put the proportion of Capesizes with scrubbers into perspective. Randy Giveans, shipping analyst at Jefferies, told FreightWaves that as of Jan. 6, he believes that "maybe 250-300 Capesizes out of a total of around 1,800 are currently operating with scrubbers, with another 30-50 being completed and entering service over the past week and coming week," equating to a current Capesize scrubber penetration rate of only 15-20%.
What's Fueling The Spread?
According to marine-fuel prices published by Ship & Bunker, the average global cost of HFO on Jan. 3 was $404 per ton, essentially unchanged from the average price one year prior ($402 per ton). The average global price of VLSFO as of Jan. 3 was $674 per ton, a 67% premium to HFO. The spread was much wider in certain key supply hubs. In Singapore, VLSFO cost 97% more than HFO on Jan. 3.
A pivotal question for shipowners is whether the spread is driven by a higher VLSFO price combined with a flat HFO price, a flat VLSFO price combined with a much lower HFO price, or a mix of both.
This issue was addressed on the third-quarter 2019 conference call of crude-tanker owner DHT Holdings (NYSE: DHT). DHT co-CEO Svein Moxnes Harfjeld said, "In terms of the spread, our thesis was never that compliant fuel would be … very expensive. Our thesis was based on a dramatic fall in demand for HFO, thereby making HFO very cheap."
What's happening in the very earliest days of IMO 2020 implementation is the opposite of what Harfjeld predicted. The spread is being driven by the premium of VLSFO over HFO, with the latter unchanged year-on-year. If your ship has a scrubber, you're paying roughly the same as you did a year ago for fuel. If not, you're paying much more.
At least as of today, scrubbers appear to be serving more as a shield against fuel-cost inflation (from VLSFO/MGO) than as a way to reduce year-on-year fuel costs by continuing to burn HFO.
The first half, and the first quarter in particular, is traditionally weak for dry bulk. When this sector hits fresh all-time lows, it's in the first three months of the year. In 2019, Capesize rates fell to under $5,000 per day in late March, compared to a break-even rate in the low teens.
According to Frode Mørkedal, shipping analyst at Clarksons Platou Securities, "The first quarter is always a weak quarter due to weather disruptions and often low demand prior to the Chinese New Year, which is early this year on Jan. 25. FFAs [forward freight agreements; i.e., futures] for first-quarter 2020 are trading at just below $10,000 per day."
Joakim Hannisdahl, head of research at Cleaves Securities, said in a Jan. 6 research report, "As expected, spot rates have tumbled as we near Chinese New Year." He downgraded six of the nine dry bulk stocks under his coverage, citing "falling asset prices and changes in share price."
Hannisdahl warned that the first half of 2020 will be "a challenging time for bulk owners."
Who Pays For IMO 2020 Transition?
Dry bulk's seasonal decline from the fourth to the first quarter has coincided with the transition to more expensive fuel under IMO 2020.
Larger vessel classes doing long-haul voyages, including Capesizes, started buying VLSFO/MGO earlier in fourth-quarter 2019, filling their tanks with compliant fuel while burning off their remaining HFO stored in a separate tank.
The average Capesize TCE rate was $24,900 per day on Sept. 30, 2019, immediately prior to the fourth quarter. Rates have been falling ever since.
Over the period when Capesize owners switched from buying HFO to buying VLSFO, TCE spot rates for non-scrubber ships that switched fuels have fallen 57% (through Jan. 3). The average Capesize spot rate for ships that have continued to burn HFO has fallen 15% in the same timeframe.
Clearly, bulk cargo shippers are not compensating shipowners for IMO 2020-driven fuel hikes as the supply/demand balance in the spot market moves in the shippers' favor. Owners of Capes without scrubbers are covering the higher fuel costs out of their margins. Owners in other vessel categories that face similar supply/demand dynamics may be forced to do the same. More FreightWaves/American Shipper articles by Greg Miller