TradeWinds: Do not burn fingers in today’s red-hot LNG shipping market

1 November 2018: 

Since May, the LNG shipping market has tightened considerably. Our assessment for spot rates for a 160,000-cbm, tri-fuel vessel increased from $40,000 per day to about $140,000 per day. A modern ship with XDF or MEGI engines, if available, is achieving even higher rates. Additionally, all vessels are spending less time off hire, resulting in the best returns since 2013.

New entrants

But as with previous shipping booms, today’s favourable LNG market and its current positive prognosis is attracting new entrants to the sector. This year alone, at least 44 firm vessels have been ordered with a nearly equal number of options. About one-third do not have charter commitments.

While there may be some sound fundamental reasons for existing and new owners to order now, they should be careful before proceeding too aggressively. LNG shipping is becoming increasingly risky.

Why? To begin with, because of increasingly complex trading patterns, spot market rates are becoming more and more volatile. They can vary dramatically depending on the location and availability of the vessel. There can also be significant differential between ships trading in the Atlantic and Pacific basins.

Reletting vessels

And, interestingly, owners face competition from their own charterers that consider high freight rates as an opportunity to relet the ships that they chartered-in earlier at much lower rates.

Plus, a two-tiered market is emerging with owners having to choose between competing in the spot market or participating in tenders for long-term charters — now defined as five to seven years — at significantly lower rates.

The latter is driven by portfolio players balancing cost minimisation and the risk of technological obsolescence. Assuming a vessel has a 35-year life, this means that more than 80% of a ship’s useful life still remains at the end of the initial charter period. Although the vessel may be entering a more liquid spot market, owners are assuming more residual value risk than ever before.

And, although there is growing liquidity in the spot charter market, it remains almost non-existent in sale and purchase. It makes it extremely difficult for owners to exit the sector.

Finally, the current shipping market tightness is essentially the result of the LNG trade growing faster than the fleet.

This year, supply capacity expanded rapidly to more than 50 million tonnes, a large portion being US exports to Asia — far more than expected because of strong demand.

However, as more projects come online, it is doubtful that US exporters will keep sending cargoes to Asia at these levels. Price arbitrage between Europe and Asia has closed for the moment, resulting in fewer long-distance voyages.

Tipping point

If owners keep ordering vessels, the LNG shipping market may quickly approach a tipping point. By 2022, there may be more ships than supply unless additional supply projects come on stream. Given the required time to construct and commission these projects, and the continuing delays in start-ups, especially in the US, that appears unlikely.

What we can expect over the long-term is a highly volatile LNG market going through the same boom and bust cycles as other shipping sectors.

However, a major difference is that the cost of transporting LNG is extremely high compared with the price of the commodity. For long-term supply contracts with strict lifting or delivery obligations, charterers may be unwilling to rely on the spot or medium-term markets to cover their shipping needs. This will result in more new orders leaving owners stuck with expensive assets with limited options, at least until the next wave of new supply.

Published by TradeWinds