VLCCs might play spoilsport in the LR market

July 8, 2024

Skyrocketing freight rates in the product tanker market, especially in the LR segment, are luring some charterers to use VLCCs for the CPP trade after tank cleaning. As most LRs carrying Middle Eastern diesel to Europe are passing through the Cape of Good Hope, the stretched voyages have not only increased the cost of transportation but also tightened tonnage supply, underpinning LR rates.

While LR rates are soaring due to tight supply, VLCC earnings are low amid subdued Chinese demand and production cuts by Middle Eastern producers. In June, the average TCE for LR1 plying on the AG-NW Europe route was about $55,000pd compared to the average TCE of $29,000pd for the VLCCs employed on the AG-China (TD3C) route. Higher charter rates in the LR market are inducing charterers to use VLCCs in the CPP trade. For instance, Trafigura – one of the major commodity traders – chartered a VLCC (Plata Glory) to transport diesel from the Arabian Gulf to Europe.

TCE – VLCC vs LR1

Usually, crude tankers carry CPP from the Far East to Europe on their maiden voyage as the tanks of a new tanker are clean. However, a limited delivery schedule for crude tankers (five Suezmaxes and one VLCC) in 2H24 will give little respite to the compressed product tanker market.

Once a crude tanker starts carrying dirty cargo such as crude and fuel oil, they cannot be employed directly in the CPP trade as their tanks are not clean enough to carry clean products. Although crude oil washing (COW) is done to clean out the tanks between voyages, it is inadequate to make tanks clean enough to carry clean products.

The process of tank cleaning to make a crude tanker capable of carrying CPP is lengthy and expensive. According to our estimates, the cost of tank cleaning for a VLCC, including fuel cost, chemical cost, staging cost, de-slopping charges, manpower cost, shipyard cost, off-hire cost, etc., will be roughly in the range of $1.1-1.3 million. Additionally, VLCC employment will have many operational limitations. For instance, many export/import ports are not capable to handle VLCCs. The CPP parcel size for VLCC (280k tonnes) will be significantly higher than the standard parcel size of LRs (55-80k), so tankage at many load and discharge ports might also be a constraint. Moreover, the possibility of cargo contamination cannot be completely ruled out.

To assess the attractiveness of employing VLCCs in the CPP trade, we considered a hypothetical case where a charterer takes a non-eco VLCC on a 1-year time charter and employs it in AG-NW Europe diesel trade after cleaning tanks. We assume all contractual obligations are in place, and there is no port limitation for VLLCs to load/discharge CPP.

In such a case, as per our estimate, the freight cost of carrying 280,000 tonnes of diesel from the Arabian Gulf to Rotterdam via the Cape of Good Hope will be $25 per tonne as compared to the spot rate of $75 per tonne for LR carrying 65,000 tonnes of diesel on the same route. A massive $50 per tonne freight cost difference will not only recover the cost of tank cleaning in a single voyage, but it will also save huge shipping costs for the charterer. For oil traders owning crude tankers, the decision to move to VLCCs/Suezmaxes from crude to CPP trade after tank cleaning will be easier as it will minimise most of the risks related to employability, parcel size, cargo quality etc.

Crude tanker employment might rise in the CPP trade as the gap in freight rates in the product and dirty tankers is wide enough to justify the switch. However, any influx of big crude tankers in the CPP trade will cool off the rates in the LR market as one VLCC will displace at least four LR1 tankers.