Rescuing the Tanker Business

In late June the media reported that the Commerce Department’s Bureau of Industry and Security (BIS) had granted permits to two Texas oil producers allowing them to ship some of their Eagle Ford light oil output abroad. Industry observers suggest these permits may be the first step in undoing the 1975 ban against exporting American crude oil, put in place in response to the 1973 Arab oil embargo. 

Allowing oil exports has emerged as a key issue shaping the future of the domestic oil business. The industry has always been allowed to export refined products as our refineries produce more heating oil, diesel, and gasoline than we can consume at certain times. Exporting crude oil, however, is another matter. Oil companies and tanker owners would win as a result of new demand, while consumers would lose due to higher prices at home. The stakes are high, and it looks like a drawn-out battle ahead.

The Debate Over Exports

The political debate over oil exports has grown in intensity in recent months due to the success of America’s shale oil boom. Over the past five years shale oil’s growth has lifted America’s production by over three million barrels a day. The Energy Information Administration projects the shale oil revolution will lead to America’s becoming the world’s largest oil producer as early as next year, surpassing Russia and Saudi Arabia, and reaching 9.6 million barrels a day by 2019, of which over 50 percent will come from shale.  

The challenge for domestic producers is too much condensate, classified as light oil, being produced. This oil stream is growing faster than any other segment of domestic production and is overwhelming the refining industry’s capability to process it. As a result, domestic oil prices are trading below where they might otherwise be if the industry were able either to export the unusable supply or refine it. Reconfiguring refineries is physically and financially impossible. Thus, without exports, the growing glut of light oil may force producers to reduce their drilling and, in turn, limit the future supply of domestic oil with all its benefits.  

If the oil industry could export crude, the global tanker industry would benefit. Today, because of the ban on exports, tankers bringing crude oil to the U.S. leave empty. Refined products generally are shipped in smaller tankers because the cargos go directly to consumers rather than refineries. If crude oil could be exported, tankers would be able to haul it to international refining centers, opening up an additional revenue opportunity for their owners.  

The success of the American shale oil revolution has contributed to the pain felt by tanker owners, who have been victimized by lower U.S. imports and reduced consumption in other developed countries. The primary impact of greater U.S. oil self-sufficiency has been reduced imports from North Africa, the Middle East and West Africa, all long-haul tanker routes. Unfortunately, this reduction in long-haul movements came just as the tanker fleet building boom delivered more vessels than could be efficiently, and economically, utilized.  

A History of Volatility

The global tanker business historically has been volatile. The volatility comes from fluctuating demand patterns around the world and the time it takes for the industry to respond. The seeds of the current oversupply were planted in 2003 and 2004. Tanker owners responded to the global explosion in oil demand that appeared to signal a new era for shipping by ordering large numbers of new ships. The oil demand boom was derailed by the 2008 financial crisis and resulting recession. Since then, the industry’s recovery has been hindered by the historically slow economic recovery that has limited growth in oil consumption.  

To understand the extent of the challenge, we need only review the history of the increase in global oil consumption and the growth of the global tanker fleet (see accompanying chart). From the mid-1990s until 2000, global oil demand grew fairly consistently, as did the international tanker fleet, despite the recession due to the 1997 Asian currency crisis. However, in 2000 the world experienced the bursting of the Internet bubble along with a mild recession. The nascent recovery was dashed by the 9/11 attacks and resulting global recession. Annual oil demand growth in 2000-2002 averaged slightly less than 750,000 barrels per day due to the economic and political turmoil. 

In 2003, however, global oil demand more than doubled the average of the prior three years.  After 2003’s rise, consumption growth jumped another 65 percent in 2004 to nearly 2.9 million barrels per day as China transitioned into an importer. The country’s pre-Olympics’ building boom was largely responsible for the demand increase.  

The growth in demand in 2003 and 2004 forced the oil industry to rethink its view about future global oil needs – both where demand would increase and where the supply would come from. Shipowners began recalculating the distance their tankers would need to travel in order to meet the expected future demand. Increased oil volumes traveling longer distances meant the size of the global tanker fleet would need to expand meaningfully, and that is exactly what it did. Shipbuilders quickly filled their order books in response to the need for large new tankers. Freight rates climbed along with tanker demand, which further encouraged more newbuilds.  

In 2005 the euphoria in the tanker industry was untamed even though the increase in global oil demand fell by 50 percent from 2004’s surprising increase. Expectations remained that fundamental changes had occurred in the world’s oil market and those changes would drive the need for more oil, which in turn would have to be transported long distances on tankers. Oil demand growth in 2006 fell another 25 percent, but again tanker owners’ spirits remained high and industry forecasters remained sanguine about the long-term demand outlook. 

As newly built tankers were delivered, shipowners resorted to selling off older tonnage to accommodate the new arrivals. Freight rates softened. But considering how high they had soared in 2004 and immediately afterward, the declines failed to generate much concern.  

The killer for the tanker industry was the onset of the 2008 financial crisis and the subsequent recession. Global oil demand declined in both 2008 and 2009, an historical rarity. Unfortunately, newbuilds continued to be delivered. Oil demand in 2010 reflected a sharp snapback from the prior negative demand years as global economies recovered from the recession, which provided tanker owners with solace about the future, but their financial strength was sapped. The easy availability of capital of pre-crisis days was gone, putting most tanker owners in financial danger.  

Since 2010 the industry has wrestled with continued fleet growth and the lack of older vessels to shed to minimize the impact of low freight rates from too many ships chasing too few cargoes. Annual oil demand growth in the last three years has been better than that experienced during any of the recession years of the prior two decades but nowhere near what was anticipated or the growth experienced during the boom years of 2004 and 2010.  

Where’s the Growth?

More troubling for the industry is that annual oil demand growth remains below that of the 1990s. Given the increase in population and economic output since then, the slowdown in demand suggests fundamental shifts in energy consumption. People moving from the suburbs to the cities, more efficient vehicles, fewer miles driven by car owners, increased use of mass transportation, more Internet shopping, greater numbers of workers operating from home and eliminating the need to commute to work, a growing number of alternatively powered vehicles, and greater use of alternative fuels have all contributed to reduced demand for energy, and for oil in particular. 

There is no indication these trends are weakening.

Whether BIS’s private rulings allowing oil exports mark the opening of the door to a policy change enabling more significant U.S. oil volumes to be shipped abroad remains to be seen. If the policy changes, tanker owners will rejoice as it offers a new revenue source, even though we don’t know where the oil will go. Barring a permanent increase in global oil consumption, tanker owners will be fighting hard over any new exports. 

We doubt the volume of light oil the U.S. will allow to be exported will be very large. Refiners have already begun working on ways to increase their ability to process more of it, and they will fight losing any volumes right after they spent money to upgrade their facilities. Only a full-fledged lifting of the ban will benefit tanker owners to any significant extent.