LNG Shipping Economics

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Includes: BOIL, DGAZ, DLNG, GAZB, GLOG, GLOP, GMLP, KOLD, TGP, UGAZ, UNG, UNL
by: Tomas Novotny
Summary

Spot prices mania controls the market.

Other important parts of shipping economy are underestimated.

Significant changes in shipping industry already started.

Current spot price of shipping is beginning to limit the US gas.

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Spot Price Bubble?

Spot prices are both skyrocketing and killing stocks of long-term oriented shipping companies. Something seems to be wrong. In this deep dive to shipping economy are discussed most important points - even the damned spot prices.

Overview

The development of the LNG market demonstrates a significant change of perspective on the structure of the global gas trade. The general assessment criteria for LNG shipping are the daily spot prices for hiring the tankers. A closer look at the economy of shipping companies, however, demonstrates that this indicator is not sufficient and many other variables are at play. This article is heavily based on the earnings calls of selected shipping companies.

The issue of maritime transport can be divided into several seemingly contradictory aspects, many of which are economic but some are political. Their combination shows the economy of maritime transport of LNG in a broader spectrum.

We can focus on 1) the cost of transporting a certain amount of LNG from point A to point B, 2) the economics of transport companies, 3) and the influence of propulsion, consumption, ship size, and last but not least, of the volume of engine emissions on the transport economy.

The following table shows the statistics for an average ship during a given period of time. It illustrates not only the increasing transport capacity but also the rapid change in power systems that have been taking place in recent years.

Predominant propulsion type and average capacity of tankers put into operation

Year Propulsion Type Capacity
2004 ST 140,000 m3
2011 DFDE 155,000 m3
2014 TFDE 160,000 m3
2019 ME-GI/XDF 174,000 m3

Source: author

Propulsion Change

The primary cause for replacing the steam turbines (ST) that were used for tankers carrying LNG from the very beginning was, of course, economical. The basic limitation is their low efficiency (<28%) associated with high fuel consumption, all this at a maximum economic speed of 14 knots. For higher speed, natural boil-off LNG is used; to maintain the speed of 17.5 knots, 50 tons of boil-off gas is needed per day.

Only after decades, at the beginning of the new millennium as the oil prices were rising and the volume of transported gas was increasing, did the first change in propulsion technology take place. The DFDE (Dual Fuel Diesel Electric) propulsion increased the maximum economic speed to 19.5 knots and the efficiency to 40%. The daily fuel consumption dropped from 175 to 135 tons of the HFO equivalent.

Today's standard is the TFDE (Tri-Fuel Diesel Electric) propulsion system, which allows the combustion of boil-off LNG, marine diesel oil, and heavy fuel oil (HFO), either alone or in a combination. The efficiency increased to 50% and the daily consumption dropped to 130 tons of the HFO equivalent. This change enabled the introduction of the liquefaction unit - a technological novelty which returns the boil-off gas back to the main tanks and increases the total amount of the transported cargo.

The ongoing economic pressures have been compounded by environmental factors. In recent years, the reduction of shipping emissions, especially of the sulfur oxides, has become a major argument for modernized shipbuilding. The IMO 2020 initiative which allows only 0.5% of SOx has accelerated the development of new ME-GI and XDF propulsions with emissions about 30% lower than steam turbines. The fuel consumption dropped further to 110 tons of HFO equivalent per day, enabling the re-liquefaction of all naturally vaporized gas.

A comparison of fuel consumption by propulsion type and engine mode:

Table 2 Comparison of fuel consumption by propulsion type and engine mode

Source: intertanko.com

The following chart shows the percentage of ships by the current type of propulsion systems and the development of ship orders. Despite the onset of modern propulsions, due to a ship's life of 30 years, the steam turbines constitute the largest group. Propulsion types not listed in the previous enumeration (RHST, UST) represent the Japanese developments which favor modification and modernization of steam turbines.

Propulsion of LNG vessel

Source: Dynagas LNG Partners LP

The second graph shows the costs in dollars for 1 transported MMBtu (million British thermal units). Even from this comparison, modern drives are the most advantageous.

Fig. 2 Comparison of unit transportation costs by LNG ship propulsion type

Source: FlexLNG

Spot Prices

Another cost-related variable is the interplay between the lessors and the charterers represented by the daily boat charter price. The type of the ship - its size and type of propulsion - are also an important factor.

An increase in transportation volume enabled the opening of new LNG terminals which, in turn, attracted gas traders like Glencore (OTCPK:GLNCY). Up until recently, the market consisted mainly of companies buying gas for their own use which preferred long-term pricing. However, the above-mentioned new factors resulted in a dramatic change in the ratio between the long-term and the short-term contracts, accompanied by fluctuations in vessel prices.

In recent months, the increasing demand for ships has caused an increase in spot prices, which started half a year before the regular winter price increase. The standard requirement for a smooth shipment from a terminal is 1.2 ships per 1 million tons LNG. For one of the US terminals, Sabine Pass, this was estimated at 1.76 ships. Initially, the analysts expected that, having 6 terminals, Sabine Pass alone would need 47 ships more. However, the completion of the fourth terminal five months ahead of the schedule, along with the decision made by the operator of this terminal to change the number and capacity of the new liquefaction trains from 2 x 4.5 mtpa to 7 x 1.4 mtpa, means that analysts expect the global fleet to increase from 400 to 580 vessels. (Source: Dynagas LNG Partners LP Q1 2018 earnings call, TradeWinds.com - this web is for subscribers only). We assume that most of these contracts would be one way. The development of the contracts' structure is shown in the graph below.

Q3 2018 charters

Source: Dynagas LNG Partners LP Q3 2018 earning call presentation

No wonder that for 174,000 m3 TFDE-driven tankers, the day-to-day (Western) Atlantic spot prices rose to $95,000-100,000 in the summer and - counting the winter growth potential - can reach $140,000-150,000; for (East) Asian markets, the spot price could be over $200,000. Summer prices for ships with ME-GI drives exceed $100,000 for the West and the East alike, whereas for the older steam turbine ships the prices exceed $55,000 on the Western markets and $39,000 on the Eastern markets (Source: TradeWinds, S&P Global Platts). At Dynagas LP Q3 2018 conference call, it was said that spot price for a steam vessel was $100,000 and for TFDE was $200,000 now.

The question is how long will these prices last and would some shipping companies be able to fix them long term - according to unconfirmed reports brought by a reliable source, at least one company (suppose GLOG) was successful. However, this report rather confirms the market expectations, than outlines a new trend. TradeWinds says that the current price of shipping is beginning to limit the US gas traders; it is uneconomical to sell gas on Asian markets (see below). Spot prices were discussed on all earnings calls for Q3. It seems that $60,000-70,000 per day is normal price for long-term contracts now:

The spot rates you're reading about are higher than the rates one could achieve on a 1-year deal, which are higher than could be achieved on a 3-year deal, which are higher than could be achieved on a 5-year deal. Source: GasLog LNG Partners L.P. (NYSE:GLOP)

Teekay LNG (NYSE:TGP) seems to be a bit more successful:

We fixed the Torben Spirit on a multiyear contract at over $100,000 per day. (...) We were able to out-charter the ship from early October on a 3-week voyage for nearly $100,000 per day, and then on a 5-months charter at a rate over $100,000 per day.

There must be said that the multi-year contract seems to include 3x 1-year options, so it is still rather a short-term contract.

Torben contract

Source: Teekay LNG

The current market conditions are the exact opposite of the development that took place during the first months of 2018 when the day-to-day spot prices of those tankers dropped from the January maximum of $85,000 to $65,000 in February, then to $45,000 in April (Source: Golar LNG). For some steamboats, the downturn on the spot market was so brutal that it made sense to temporarily withdraw them - i.e. Golar Mazo owned by Golar LNG Partners (NASDAQ:GMLP).

Long-term development of spot rates for standard TFDE vessels and ST vessels:

TFDE spot prices

ST spot prices

Source: Golar LNG Partners LP

On the other chart, we can see the changes to the number of available ships with spot prices. Despite prices were high in past (2012-2013), the LNG boom started in 2015, so the situation is not the same.

Spot prices and number of available vessels:

Spot prices and number of available vessels

Source: Golar LNG

Distances to Ports

Size and propulsion are not the only important factors for the shipping economy. Other variables, such as the distance and the number of days of voyage are significant as well. The more distant the destination, the more significant the price. The transport costs are evident on the next graph which shows how the two types of drives for major transport routes contribute to the price. The graph shows why US gas transportation to Asia is more sensitive to spot prices.

LNG shipping unit transportation costs (U.S. Gulf - China round trip):

Source: FlexLNG

Another interesting example is the Russian Yamal terminal, which uses the ice layer attenuation to transport to Asia via Northern Sea Route, shortening the trip to Japan from 36 to 14 days. On the other hand, this route requires ships capable of crossing the ice; this specialization increases their price. A closer look shows citation from conference call of arctic specialist Dynagas LNG Partners LP (NYSE:DLNG) below.

Comparison of shipping distance (days) from the Yamal LNG Russian terminal to Asia using the summer and winter routes:

Yamal

Source: EIA.gov

Distances between liquefaction and destination terminals, sailing times for 19 knots

Swinoujscie (PL) Zeebruge (BEL) Rotterdam (NLD) Montoir (FRA) Barcelona (ESP) Higashi (JPN) Kochi (IND)
Sabine Pass (USA) 5365nm; 11,8 4908 nm; 10,8 4974 nm; 10,9 4707 nm; 10,3 5205 nm; 11,4 9486 nm; 20,8 9840 nm; 21,6
Cove Point (USA) 3965 nm; 8,7 3481 nm; 7,6 3547 nm; 7,8 3294 nm; 7,2 3877 nm; 8,5 9796 nm; 21,5 8512 nm; 18,7
Mesaieed (QTR) 7042 nm; 15,4 6299 nm; 13,8 6365 nm; 14 5959 nm; 13,1 4679 nm; 10,3 6331 nm; 13,9 1798 nm; 3,9
Port Harcourt (NGA) 5091 nm; 11,2 4348 nm; 9,5 4414 nm; 9,7 4008 nm; 8,8 3852 nm; 8,4 10575 nm; 23,2 6779 nm; 14,9
Skikda (DZA) 2640 nm; 5,8 1897 nm; 4,2 1963 nm; 4,3 1557 nm; 3,4 349 nm; 0,8 9039 nm; 19,8 4561 nm; 10
Barrow Island (AUS) 9979 nm; 21,9 9236 nm; 20,3 9302 nm; 20,4 8896 nm; 19,5 7616 nm; 16,7 3607 nm; 7,9 2974 nm; 6,5
Sabetta (RUS) winter route 11624 nm; 25,5 9785 nm; 21,4
Sabetta (RUS) summer route 2512 nm; 5,5 2505 nm; 5,5 2475 nm; 5,4 3024 nm; 6,6 4352 nm; 9,5 5332 nm; 11,7 9043 nm; 19,8

Source: author, sea-distances.org, marinetraffic.com

Total Cost Comparison

The next table comparing each standard tanker's economy demonstrates the importance of the vessel's age and it highlights the progress that has taken place in shipbuilding. For transporting one MMBtu unit, the modern vessels can charge over 50% more than a 10-year old steam turbine boat. Even though the expenses for a steamship are higher, the price they offer must be lower to remain competitive.

Effect of tanker types and spot charter rates on LNG shipping:

Table 4 Effect of tanker types and spot charter rates on LNG shipping

Source: FlexLNG

The Economy of Transport Companies

The frequently quoted daily spot prices (that is the costs of the journey) are only one part of the shipping companies' economy. A quotation from Dynagas LNG Partners LP conference call shows another important variable, the number of days a ship is contracted for: with utilization at 100%, the vessel's daily operating expenses were at $11,741 per day; while the average rental price per day was $66,300, the break-even was $59,000 per day.

These figures put the economy in a completely new perspective and show how tight the transport market is, despite seemingly large amounts in play. Every day when a ship is not contracted means not only lost income but mainly worsening of the overall economic situation due to regular expenses. It is necessary to take into consideration the installments of loans, leases, dividends, and other expenses, as well as the periodic works on a dry dock which are required every five years. The dry-dock works usually last for thirty days and the companies spend approximately $270,000 on them (Source: GasLog Partners LP). Therefore, the percentage of days the vessel is in use is the most closely monitored economic indicator.

The UP LNG Shipping Indices Family which is posted on my SA blog can be used as a guide to the condition of LNG shipping industry. Here is how it looks now.

Comparison of UP LNG shipping indices:

Comparison of UP LNG Shipping Indices

Source: author

Because of the necessary regular expenses, most shipping companies prefer stable long-term contracts over higher spot prices. There is also evidence that such leases are beneficial to large fleet companies, preferring cash flow, which, to some extent, may miss the short-term growth in prices. Let's say the average price of a new tanker was roughly $180 million in 2017 (Source: FlexLNG, Marine Money Week 2017) and that tanker operates on a permanent contract with 100% days utilized (or one dry-dock periodic inspection), for $70,000 a day, with $12,000 per day of operating costs. In order to simply repay the purchase price - excluding interest and other expenses - it must operate for 3,138 days.

Significant LNG Market Changes

Finally, a brief mention of the important factors that will affect the economy of LNG shipping in the future. Firstly, the US exports will grow:

1. From July this year, the Panama Canal can be navigated by LNG tankers at night as well.

2. Since traders entered the market (who can buy loaded cargo without a final customer), the vessel destination became flexible, but at the moment, only American producers allow to do so. The increased interest in ad hoc purchases is also demonstrated by the above-mentioned change of capacity and number of Sabina Pass terminals.

All these changes are likely to be reflected in the renaissance of smaller tankers of 100,000-120,000 m3 that are more suitable for such trades.

Future Prices

Every investor is interested in the present spot prices becoming fixed for at least mid-term contracts. However, the shipping companies argue that the spot prices can still go up before that happens. They are expected to reach their peak in 2021:

Continued strong demand from Asia underpins a forecast 10% year-on-year growth and production to some 388 million tons per annum by 2020. Growing 10 miles from an increase component of U.S. based deliveries, confirms that the market appears to be short some 30 to 40 vessels over the next two to three years. And the inability to get new orders delivered before 2021 indicates higher rates over the coming years.

Source: Golar LNG

LNG vessel fleet and order book by propulsion type:

Order book

Source: FlexLNG

Constructing a new LNG vessel takes 2.5 years and here we can once more quote from the conference call of GasLog LNG Partners:

Looking out to 2022, we estimate that the market may require between 35 and 63 incremental ships, but we would note there is more than sufficient time and yard capacity for these vessels to be delivered in time to meet this demand.

Conclusion

It is certain that LNG shipping is a rapidly growing industry with an interesting future not only for large investors. Present stock prices are downed by overheated spot prices, whole stock market sentiment, and debt refinance questions. During Q1 earnings calls, which was just six months ago, management of many companies was asked when will they come with any long-term contract and leave the spot market. Now the situation is completely opposite. But it is long-term contracts what allows these shipping companies to pay attractive and sustainable distribution.

Disclosure: I am/we are long DLNG, GMLP. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.