Turbulent times for global shipping industry

Regional shipping operations - overview

As the risk of operating in the Black Sea and Sea of Azov has increased, insurance premiums for vessels entering the conflict zone have risen sharply and shipowners are understandably reluctant to deploy their vessels here. As a result, vessels supply in the region will be tight, which in conjunction with a high premium on insurance will push freight rates higher. In the container sector, we expect to see a number of changes to liner service structures by major shipping lines.

In the short term, demand for crude and chemical tankers will increase as importers of Russian crude oil turn to distant suppliers while importers of sunflower oil will switch to soybean oil supplied by countries located further afield than Ukraine and Russia.

While the war could dampen charter rates for dry bulk vessels in the short term by hampering grain and coal exports, in the medium-to-long term, it will negatively impact rates even in the crude and chemical sectors because of the possible contraction in overall crude oil and veg oil trades. 

Our impact assessment of the conflict on the main shipping sectors is provided below:

Dry bulk: War to hamper grain and coal supply from Black Sea

We believe the war will hamper grain and coal trades. Both Russia and Ukraine are major players in the global grain export market, any protracted war will lead to a slump in the grain trade out of the Black Sea region, denting the employment of dry bulk vessels. Russia is also a significant supplier of coal, and supplied 42% of the EU’s total coal imports in 2021 and 16% of the global coal requirements.

Due to the financial sanctions on Russia, arranging necessary finance for importing Russian cargo has become a tedious task for Asian importers. Given the uncertainty on how long sanctions will remain in force and how the war will unfold over the next few months, miners in other coal exporting countries like Australia, the US, Canada and South Africa are also unlikely to lift production to counterbalance Russia’s share in the short term. Consequently, coal prices have started rising, limiting the demand in Asia. Meanwhile, the Nordstream 2 pipeline is now highly unlikely to get EU approval, putting further pressure on coal prices as the EU will be forced to switch to coal-fired power generation. 

Chemical: Trade shift from sunflower oil to soybean oil will support rates in short term

The ongoing war will likely squeeze sunflower oil exports from Russia and Ukraine, forcing their trade partners in Europe and Asia to fill the void created with other distant sources. However, those more distant countries will find it difficult to completely supplement the shortfall as Russia and Ukraine are the largest exporters of the commodity and accounted for 79% of the global trade volume in 2021. The third and fourth biggest exporters of sunflower oil, Argentina and Turkey, account for only 7% and 5% of the global trade, respectively.

Therefore, we believe the demand for sunflower oil will shift towards soybean oil, increasing long-haul vegetable oil exports from South America to India, China and Europe. The resultant higher tonne-mile demand will thus underpin freight rates for IMO-class MR tankers in the short term.

Assuming that the war halts sunflower oil exports from Russia and Ukraine for an extended period, it will be difficult for sunflower oil importers to find an alternative supply of vegetable oil as sunflower oil exports from these two countries contribute about 9% to the global vegetable oil trade. The global vegetable oil trade thus will eventually start declining, hurting tonnage demand and freight rates in the IMO-class MR tanker market.

Crude tanker: Disruption in Russian oil supply provides momentary respite

The ongoing Russia-Ukraine conflict is providing something of a boost to the otherwise weak crude tanker market. Freight rates, which were weak for much of February 2022, surged towards the end of the month on concerns over the possible disruption to Russian oil supply. Although the direct impact of the conflict was initially visible only in the Aframax market in the Black Sea, a surge in overall Aframax rates quickly spread to the bigger vessel segments.

Despite seasonal weakness in demand, tonnage demand in the crude tanker market is expected to increase as financial sanctions on Russia have been compelling buyers of Russian oil to scout for alternative supply. The corresponding change in trade patterns would thus increase the average haul-length of crude tankers in the short term. In addition, the conflict is likely to curb tonnage supply in the market as many countries have announced that they will not be allowing Russian ships, boosting tonnage utilisation in the crude tanker market.

However, in case the Russia-Ukraine war persists for long or the West imposes sanctions on Russian crude exports, it will be difficult for other suppliers to fill the void created by the Russian barrels. Russia accounts for about 11.5% of global supply. Therefore, even if Iranian barrels return to the market after the possible removal of sanctions, it will not be enough to fully replace Russian oil from the market. Any possible disruption to crude supply from Russia in the long term would thus hurt global crude oil trade. Also, prolonged high crude oil prices are likely to adversely affect the global oil demand, further affecting its trade. The charter rates in the crude tanker market in such a case will thus decline after short-term firmness. Moreover, even if the conflict gets resolved quickly, crude oil trade will normalise eventually and overcapacity will see freight rates ease.

LNG: Shift in trade away from US-Asia to US-Europe to hurt vessel demand

We expect European LNG imports to rise in the short term as these countries will reduce Russian gas imports. Even though there are no sanctions on Russian gas, European countries are expected to avoid Russian flows of gas and LNG. Currently, pipeline flows have increased from end February as European buyers look to accumulate lower priced pipeline gas before any serious escalation in the conflict and with that a potential stop to Russian pipeline exports. Some of this pipeline supply will be substituted with higher LNG imports, with the US touted to be the leading supplier as Europe bans Russian vessels from docking at its ports. Nonetheless, LNG shipping rates will remain subdued as the majority of vessels will be headed to Europe since trade will rise on the shorter US-Europe route in lieu of the US Asia route, reducing LNG tonne-mile demand in 2022. However, there will be some re-exports on Asia-Europe while the deferred Russian LNG cargoes will most likely head to Asia through the Northern Sea Route (NSR).

We expect a prolonged conflict would see European countries moving away from Russian energy commodities. The EU sanctions on investments in Russian oil & gas sector would impact the development of LNG liquefaction projects in the country while boosting potential for projects in the US and Africa. LNG supply is expected to remain tight over the next five years that would keep the LNG prices high with increasing possibility of LNG being replaced by coal.

LPG: Rising bunker prices to dampen vessel earnings

The Russia-Ukraine war has led to uncertainty in the market regarding possible sanctions on Russian entities, which could create demand for substitute LPG cargo from the US. While Russia has suspended LPG rail supply to Europe through Ukraine and Belarus, we believe continued suspension could create severe LPG shortages in the region as Russia supplied 3.7 million tonnes of LPG to Europe through rail and sea in 2021.

We estimate that a prolonged suspension of Russian LPG exports due to the conflict would create an additional vessel demand of 7-10 VLGCs to substitute the Russian cargoes.

Meanwhile, supply from alternative LPG sources like Kazakhstan and Algeria will also be impacted in 2022 due to internal protests over domestic LPG prices in the former, and a disaccord between Algeria and Morocco impacting Algerian pipeline supply to Spain. However, LPG supply is expected to improve in the Middle East and the US while a strong possibility of sanctions being lifted from Iran would bring additional volumes to the market which should easily substitute the Russian supply 

Drewry believes the war is partly to blame for the rise in oil prices, which has in turn impacted LPG and bunker prices. While LPG prices have strengthened, the commodity’s discount relative to naphtha has widened, increasing LPG’s demand as a petchem feedstock. However, olefins prices have not increased in-line with other commodities pressurising the petchem margins and in turn the operating rates at the petchem facilities. Meanwhile, higher bunker prices are denting the vessel earnings in the sector which can support an increase in TC rates.

Container: Crisis to change liner shipping structure

The conflict has impacted the container sector in two ways: it has resulted in higher oil prices and has led many countries to impose sanctions on Russia in order to isolate the latter. The increase in bunker prices will likely put further upward pressure on freight rates in an already historically high market.

We also expect a number of changes to liner service structures by major shipping lines which have stopped taking bookings from and to Russian ports in line with sanctions announced by various countries. MSC and Maersk have mentioned that their service suspension will also encompass Russian ports in the Baltic and Far East apart from the Black Sea ports.