A Quantitative Model of the Oil Tanker Market in the Arabian Gulf.

• Date: 01 September 2023
• Author: Kilian, Lutz

1. INTRODUCTION

   There has been increasing interest in recent years in understanding the market for the shipping vessels used in transporting bulk industrial commodities. (1) Much of this literature has focused on dry-bulk cargo trade, while some studies have specifically focused on modeling the market for oil tankers. It is widely understood that the demand for vessels responds to shifts in the demand and supply of the industrial commodities awaiting transportation. There is also a growing recognition of the importance of accounting for shocks to the cost of shipping (including, most importantly, the cost of the bunker fuel used to operate vessels), shocks to the utilization of the fleet of vessels, and shocks to the fleet size, with new cargo vessels being added in response to higher demand and older cargo vessels being scrapped, as demand subsides.

   Most studies in this literature have examined the theoretical foundations of the shipbuilding and scrapping cycle, the determination of ship charter rates, and the determinants of shipowners' profits. The remainder of this literature has documented lead-lag patterns and correlations of key variables in shipping markets. (2) None of these studies, however, addresses the question of how key variables in this market such as tanker rates, oil exports, bunker fuel prices, and the cyclical component of shipowner profits are determined by shocks to the supply of and demand for oil tankers, tanker cost shocks and shocks to the utilization of the fleet of tankers.

   Our paper develops a structural model of the Very Large Crude Carrier (VLCC) tanker market between the Arabian Gulf and the Far East. (3) About one third of the global trade in crude oil takes place in this region and 70% of this oil is shipped on VLCCs. We use two alternative specifications of a structural vector autoregressive model to quantify the causal effects of shocks to the cost of operating a tanker, the utilization of tankers, tanker supply and tanker demand on the volume of oil exports from the Arabian Gulf, bunker fuel prices, one-year VLCC time charter rates, round-trip VLCC voyage rates from the Arabian Gulf to East Asia, and the profits of the owners of VLCCs chartered for round-trip voyages on this route.

   We show that a positive tanker cost shock has a negligible effect on the real time charter rate, but higher voyage costs are associated with a decline in the demand for time charters because charterers' profits are reduced by higher operating costs. This helps explain the decline in the overall volume of oil exports from the Arabian Gulf. The magnitude of this response is small, consistent with the view that the demand for shipping is fairly inelastic with respect to changes in freight costs (see Stopford 2009). Moreover, real voyage profits decline in response to positive cost shocks, suggesting that cost shocks are only partially passed on to round-trip voyage rates. This finding is consistent with the fact that real roundtrip rates increase in response to positive cost shocks only with a delay. Positive utilization shocks are associated with higher profits, an increase in time charter rates and lower fuel prices and oil export volumes. Tanker supply and tanker demand shocks have persistent effects on time charter rates as well as on the volume of oil exports and the bunker fuel price with the expected sign. Lower tanker supply and higher tanker demand are reflected in persistently higher voyage profits for vessel owners as well as higher round-trip voyage rates.

   Whereas the variability of the real voyage profits of ship owners and round-trip voyage rates depends mainly on utilization shocks and tanker demand shocks, that of time-charter rates depends first and foremost on tanker demand and supply shocks. The variability of bunker fuel prices mainly depends on tanker demand and supply shocks, followed by tanker cost shocks, with utilization shocks playing only a small role. The main determinants of the variability of the volume of oil exports are tanker demand, tanker cost, and utilization shocks.

   Our analysis also allows us to quantify the extent to which the historical evolution of oil exports, bunker fuel prices, time charter rates, round-trip voyage rates and shipowner profits is explained by each of the structural shocks. The results are reasonably robust across model specifications. We find that, until 2008, the volume of oil exports from the Arabian Gulf was largely determined by tanker demand shocks, consistent with conventional wisdom. Since then cost shocks have been the main determinant. Interestingly, there is robust evidence of a tanker-demand driven spike in oil export volumes (as well as in both tanker rates) associated with the temporary detente in U.S. trade policy in 2018/19, confirming that trade disputes have real effects on industrial commodity markets.

   Cost shocks have only minor effects on the evolution of real time charter rates. The demand-driven cycle in time charter rates largely mirrors that found in oil export volumes and voyage profits. Between 2010 and 2015 (and again between 2016 and 2019), there is evidence of a trough in real time charter rates caused by the cumulative effects of tanker supply shocks, consistent with the delivery of many newly built vessels during this period. Finally, the results for the real round-trip voyage rate from the Arabian Gulf to East Asia and for the real vessel owners' profits from these round-trip voyages are qualitatively similar. The historical evolution of these variables is more sensitive to utilization and tanker demand shocks than tanker supply or cost shocks.

   The remainder of the paper is organized as follows. In section 2, we review the institutional details of the tanker market and the construction of the data. Section 3 describes the structural model and the econometric methodology. Section 4 discusses the impulse responses and variance decompositions for real time charter rates, oil export volumes and real profits in the baseline model. Section 5 presents an alternative model specification that allows us to assess the determination of real round-trip voyage rates and discusses the corresponding empirical results. In section 6, we draw on both models to examine the historical evolution of the model variables. The concluding remarks are in section 7.

2. INSTITUTIONAL BACKGROUND

   Our analysis focuses on the market for VLCCs which refers to oil tankers with a capacity of between 200,000 and 325,000 dwt. These vessels are the backbone of long-distance oil shipping from the Arabian Gulf to East Asia. (4) This industry is competitive with the largest company owning only 6.3% of the VLCC fleet. By construction, oil tankers can only be used to transport crude oil, so the market for oil tankers can be viewed in isolation from the market for other vessels.

   VLCCs may be chartered for transporting crude oil by entering into a voyage charter contract or a time charter contract. A voyage charter involves a payment to the ship owner for a voyage from one port to another port. The shipowner is responsible for all voyage costs, including fuel costs, cargo loading and discharge costs, port charges, as well as the costs associated with the up-keep and maintenance of the vessel such as maintenance fees, insurance premia and crew wages. Voyage charter spot rates are available for the most commonly used routes. These quotes serve as a reference price for transactions.

   Short-term voyage contracts account for the bulk of crude oil cargoes due to their flexibility and convenience. Voyage contracts can be executed on short notice and rates reflect the all-inclusive cost of seaborne transportation. These contracts are also amenable to the practices of physical crude oil trading, as cargoes of crude oil are traded whilst in transit and the final ownership and/or final destination of the cargo may change many times during a voyage.

   A smaller segment of the oil shipping market involves time charters. A time charter involves leasing the vessel for a specific period, which may range from a few months to several years. A typical lease would be for one year. The lessee pays the shipowner a daily fee during this year. The lessee is responsible for paying all voyage costs associated with the operation of the vessel. Although time charters only account for about 5% of the VLCC market, the inclusion of time charter rates in the structural model facilitates the identification of cost shocks. Our analysis exploits the fact that time charter rates by definition are not directly affected by fluctuations in bunker fuel prices and related voyage costs because the shipowner is not responsible for these costs (see Stopford 2009; Kilian and Zhou 2018; Nomikos and Regli 2019).

   One advantage of focusing on oil exported from the Arabian Gulf to East Asia is that this route is representative for the VLCC market. About one third of the global trade in crude oil originates in this region and more than 70% of this oil is shipped on VLCCs, the majority of which is destined for East Asia. Another advantage is that virtually all trade on this route relies on VLCCs. This allows us to abstract from the existence of smaller tankers. A third advantage is that the focus on one regional market helps address the concern that equilibrium outcomes depend on the demand for oil cargoes in each load area market and the availability of ships within proximity to the market (see Parker 2014).

   Our data set is monthly. The estimation period is 1991.1 through 2019.10. There are no data available prior to January 1991. Our analysis utilizes a novel data set consisting of the volume of seaborne crude oil exports from the Arabian Gulf (in mb/d); the price of bunker fuel in Fujairah (in U.S. $/ton); the one-year time-charter rate for VLCCs (in U.S. $/day); the round-trip voyage rate on the benchmark Ras Tanura-Chiba route (in U.S. $/mt); and the corresponding profits earned by owners...