Overcapacity meets broken promises of soaring demand.
The rates for shipping a tanker-load of crude oil by Very Large Crude Carriers (VLCC) from Rotterdam, Europe’s largest port for the throughput and storage of crude oil, to Singapore, the world’s largest crude oil transshipment center, have dropped another $200,000 since the last assessment, to $2.25 million, according to S&P Global Platts, the lowest level for that route since Platts started tracking VLCC data in 2006.
That’s down by $4.15 million from the $6.4 million price tag in January – a 64% plunge in eight months!
Platts blamed the “large supply of available ships” on the Europe to East route.
Overcapacity in face of lackluster demand is a terrifying condition if it spreads far enough across an industry. As prices get totally crushed, it can lead to bankruptcies and the collapse of entire industries, huge job losses, and massive capital destruction that will spread deeper into the overall economy.
Often, investors aren’t the only ones on the hook. Taxpayers, sitting ducks, savers, and other innocent bystanders are shanghaied into bailing out the industries or at least some major players, either directly via government subsidies and other support or indirectly and less visibly via central bank shenanigans. That includes GM and Chrysler in the US and Canada during the Financial Crisis. It includes the often state-owned steel giants in China via their state-owned banks.
Overcapacity has been ravaging the container carrier industry. Last week, Hanjin, the seventh largest container carrier in the world and a unit of Hanjin Group, Korea’s tenth largest conglomerate, filed for bankruptcy. It has been torpedoing even large shipbuilders, and the entire industry, particularly in China and Korea, is keeling over.
Overcapacity is the result of misallocation of resources by investors and/or governments that have been fooled by their own optimism, twisted policies, and central bank promises that their QE and a flood of cheap money would actually create real-economy demand.
And overcapacity is now also sinking the oil tanker market.
Platts, in observing crude oil “freight rates near historic lows in a variety of regions” across the VLCC spectrum, added:
The main factor behind the dropping rates has been an increase in global VLCC supply, with a large number of newbuilds joining the existing fleet.
During the oil boom – now reduced to fond memory – when WTI was trading above $100 a barrel and when the global economy, driven by central-bank machinations around the world, was expected to accelerate to “escape velocity” and send demand for crude oil surging, during those promising years after the Financial Crisis, when only the sky was the limit to executive imagination, carriers ordered a large number of these mega-tankers to meet that surging demand in the future.
Since years go by between an executive decision and taking delivery of these ships, the new fleet has been entering service with impeccable timing just as the oil price began to crash.
And the deliveries aren’t stopping anytime soon. According to Affinity Research, cited by Platts, 24 new VLCCs have already been delivered in 2016, and 13 more are expected to be delivered during the remainder of the year, for a total of 37. Next year, an additional 39 VLCCs are expected to be delivered.
Tankers categorized as VLCC have a capacity of over 200,000 DWT (deadweight tonnage) and up to 320,000 DWT. Anything larger is an Ultra Large Crude Carrier (ULCC). So one VLCC can carry over 2 million barrels of oil. By comparison, US net imports of crude oil and petroleum products is less than 5 million barrels per day – two tankers. So 70 additional tankers of this size, on top of an already oversupplied market, represents an enormous overcapacity.
And this, according to the report, “is likely to heap further downward pressure on what are already historically low freight rates.”
That’s good for those who pay for oil and petroleum products. Shipping costs are down. They might save a little, or profit margins might edge up.
But overcapacity of this type doesn’t just disappear. It ravages the industry for years. It causes extensive bloodletting. And once it has ravaged enough and enormous amounts of capital have gone up in smoke, some of the dynamics change, prices rise, and survivors emerge. Building and then destroying overcapacity is one of the most wasteful and destructive activities of an economy. And in the era of free money and senseless “stimulus,” we’re seeing more and more of it.
The Hanjin bankruptcy “shatters the complacency” that the largest container carriers, considered too big to fail due to their role in global trade, “are immune to failure.” Read… “Zombie Apocalypse”: The Hanjin Bailout that Didn’t Happen