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Note: This report was originally published on May, 13, 2022, on Value Investor’s Edge, a Seeking Alpha Marketplace service.
Ever since hitting an anticipated cyclical bottom back in 2018, the LPG shipping market has witnessed consistent progress highlighted by steady market demand which has slightly outpaced new vessel capacity.
But last year, that consistency was called into question – in a good way. As some might recall, my 2021 LPG Shipping Outlook, published December 10, 2020, had what I thought was one of the bolder predictions in the series of forecasts for that year, projecting 10%-12% demand side growth while most were forecasting around the 5% mark, or even less. Those double-digit demand side projections, as we now know, nearly came to fruition with approximately 9.78% cargo mile demand growth for the VLGC class according to my data, with Clarksons estimating 11.8% for the entire LPG segment.
My 2022 forecast witnessed slightly more subdued expectations, with 7%-9% cargo mile demand gains expected, against the consensus of approximately 5%, yet again.
This discrepancy is a big deal, as it not only informs us of the ongoing and sustainable nature of these demand side gains but it also determines the degree of market tightening as we head into an expected influx of vessel deliveries in 2023.
As of May 12, 2022, VesselsValue estimates a YTD cargo mile demand gain for VLGCs of 9.64%, with the entire LPG segment registering an 8.55% gain, putting our forecast right on track.
These are not only impressive numbers for the segment, but LPG is currently experiencing the most cargo mile demand growth of any shipping segment so far in 2022.
While these figures were anticipated, it’s always wise to take a deep dive and make sure the market is functioning as projected. Therefore, my attention turned to the notion that perhaps short-term factors may be at work, bolstering these figures.
Given the price action for energy lately, which increases arbitrage opportunities, and in the case of LPG (ethane) can increase substitution to and from naphtha, this was a legitimate point to explore. Therefore, it became important to determine just how much of this growth is actually sticky organic demand compared to short-term fleeting market responses.
This led me down a rabbit hole where I continued to look for anything which would support the notion of these knee-jerk market responses having a meaningful impact.
In the end, I was wrong about one thing, these aren’t knee-jerk or short-term market responses. In fact, for 9 out of 12 months in 2021, LPG (ethane) was more expensive than naphtha, which decimated the argument of ethane substitution having a bullish impact – in fact it was bearish for most of the year which weighed against cargo mile demand gains.
It will be interesting to see what happens since that bearish dynamic is reversing as we move through 2022 with most months to come projected to favor ethane substitution. As of May 10, swaps market indications show European propane averaging an around $120/t discount to naphtha out to the year-end, while Asia-Pacific propane is averaging a slimmer $70/t discount. Both spreads are larger and longer in duration than those witnessed in 2021 and should theoretically inspire substantial propane feedstock substitution at naphtha’s expense.
All of this suggests that over the course of 2021 and 2022, the greatest potential for this substitution dynamic to influence the market in a bullish manner will happen in the back half of this year.
This is being met with another potentially bullish development, the elimination of Russian LPG cargoes to Europe with replacements coming from the US Gulf.
Russia did export approximately 40,000 b/d of short haul seaborne LPG to the global markets, and about a 100,000 b/d via overland markets, representing 140,000 b/d or around 1% of total global LPG demand, with much of that going to Europe.
As Europe seeks to replace that supply, they are looking toward the United States. Those 140,000 b/d are roughly equivalent (depending on speed traveled, port efficiency, etc.) to five extra VLGCs per month out of the US Gulf. Looking at 2021’s full numbers, this represents a possible 2.1% increase in journeys traveled based on this dynamic alone. The impact of this should also become more prevalent in the second half of this year.
Now, let’s put those last two topics together for another twist. If we look at naphtha coming out of Russia, exports total approximately 500,000 b/d, or nearly 4 times more than LPG.
Consider that the global Naphtha market volume in 2020 came in at 313.1 million tons while the global LPG market attained a volume of about 325.44 million tons in 2020. Both are relatively similar in size, so the cuts out of Russia will have different impacts on global prices. What that means indirectly for LPG is that the spread between propane and naphtha will widen in favor of propane being the preferred feedstock for flexible ethylene steam crackers.
This is likely some of what is being priced into those forward (ethane/naphtha) curves discussed earlier and therefore proper considerations should be factored into LPG carrier demand as well.
Since we are on the topic of price, Europe, and Russia, let’s quickly discuss the ongoing propensity for arbitrage trades to play a role in seaborne LPG demand.
Disruptions due to Covid, high energy prices, record energy demand, the Russia/Ukraine war, and an uncertain economic backdrop all impacted trade flows around the world, which have consequently impacted LPG inventories/availability and therefore prices.
These higher prices have even started to carry over to the US.
Source: Clarksons SIN
However, it is still exporting at positive arbitrage values to Europe and Asia prices in several key areas remain well above the USA.
Given the United States’ increasing daily production, export capacity, and relatively flat domestic demand over the same time period, it is expected that low inventory levels will be less of a concern than they were a decade ago while prices remain relatively subdued compared to international markets.
This would indicate an ongoing focus on exports over stockpiling on the part of the US, allowing that the arbitrage window to remain open for an extended period of time.
Finally, before we leave the demand side section, it seems relevant to mention that during this latest examination of the LPG market a thorough review of trade routes was conducted. This was to determine if any outliers had emerged (other than the Russia/Ukraine situation) and to ensure that this latest round of impressive cargo mile demand gains was actually rooted in organic demand growth in key nations.
The data shows that the main drivers of this growth continue to be nations which were anticipated to register the highest uptake of organic and sustainable (long-term oriented) demand growth.
All of this, when taken together implies that these cargo mile demand gains are very sticky for the foreseeable future.
The main concern heading into 2023 will be an exorbitant amount of vessel deliveries which have been threatening to derail this consistent market.
Source: Data Courtesy of VesselsValue – Chart by VIE
This came from a very brief ordering binge in during the first half of 2021, where owners locked in contracts for newbuilds as yard space was becoming a bit scarce while newbuild prices were on the rise.
Source: Clarksons SIN
When these orders first started accumulating in 2021, it looked to be the beginning of another round of ordering akin to 2013-2014, which had a detrimental impact on the market less than two years later.
But 2021’s ordering spurt had a much shorter life span, which left fewer orders that are concentrated in a single year, as opposed to the three-year supply glut (2015-2017 deliveries) that the orders in 2013-2014 spawned.
Additionally, these deliveries come as the EEXI is set to impact the market which promises to carry with it an outsized burden on gas carriers. This will likely result in some of the fleet slowing, vessels docked to undertake retrofits, or even being scrapped.
Finally, in April’s LPG report, Clarksons estimated that 2023 LPG cargo mile demand growth will only total 3.3% while net fleet growth will come in at a whopping 8.6%. This paints a picture of a massive upheaval in the market with a 5.3% market disconnect that would soften rates. While I don’t disagree with the supply outlook, I must again respectfully disagree with this demand side assessment, offering up a conservative 6%-7% cargo mile demand growth estimate that could be even higher if we begin to see margins improve for petrochemicals.
This latter scenario would imply a somewhat negligible difference between supply additions and cargo mile demand gains, which would only detract a very minor amount from the market tightening we witnessed in 2021 and continue to witness in 2022.
So, while I was initially concerned about those newbuild orders in early 2021 and their consequent impact on the market, it now appears that due to the very limited window over which they took place, the radical drop in orders after that window closed, the recent cargo mile demand gains as of late which are projected to continue, and the impact of the EEXI, this vessel influx is likely to register more as a brief headwind than a full blown issue for the markets.
With just one order for a VLGC so far in 2022, it appears the ordering binge has not only ceased, but an eerie calm has fallen over the market. That lone VLGC was ordered in April with delivery scheduled for late 2024, which also implies that the 2024 window is closing for large LPG vessel deliveries – and likely already closed for the VLEC class which saw their latest orders scheduled for 2025.
This highlights 2024’s upcoming deliveries which could end up being the smallest capacity additions, as percent of current fleet capacity, we have witnessed in over a decade.
Therefore, not only is it looking like 2023’s delivery schedule is a manageable chore for the market, but it will also be followed by a potentially very potent tailwind. This implies that even if there is a dip in the market due to these deliveries, it will be rectified almost as quickly as it formed.
Before Covid-19 I had opined that diversified, growing, retail oriented, predictable demand was a major attraction to LPG shipping, thus providing a solid base to achieve stable cargo mile demand gains.
In the foreseeable future, this should be complimented by growing substitution opportunities, a healthy arbitrage trade, and increasing long-haul exports out of the USA.
In fact, in terms of trade routes, the single greatest contributor to cargo mile demand since the start of the year has been the USA to China route, something that was absent from the market just two-years ago and still gaining momentum as relations return to normal.
Let’s also consider that LPG demand in China has been stymied a bit due to poor petrochemical margins in the region, with the new PDH plants operating at far less than full utilization. Reports suggest about 2/3 of new capacity is being utilized and one new plant has even suspended operations. These bearish developments have indeed played a role in LPG demand, but the bulls are just trampling over the bad news.
If we want to talk about one more apparent bearish development as of late, we should discuss the very brief dip in Indian imports, which surfaced largely because of climbing import prices which inspired domestic destocking. That dip has now abated according to recent loading (declared destination) data, as their market is heavily reliant on the fuel with minimal substitution opportunities for households, which are a primary consumer.
It’s worth pointing out that consumer sales of LPG in India only dipped in February, with January posting strong numbers and March showing a return to previous trends. Meaning that dip in seaborne Indian imports had more to do with commodities markets operating in their expected manner rather than consumers shunning the fuel due to price.
Getting back on track, all these demand side factors taken together would indicate that not only is the market still poised for growth, but bullish developments are potentially waiting in the wings. The only thing we need to be a bit wary of is LPG prices getting too hot and impacting demand or arbitrage opportunities.
Over on the supply side we are bracing for a bit of an influx of vessels which could prove to be a headwind even if these strong demand side conditions persist, which some suggest won’t. This discrepancy between future demand assessments is a key issue, as demand side growth in 2023 will play a key role in determining the deviation between supply/demand and therefore the degree of market dislocation.
But, if we can manage 2023’s challenges, which I now believe is the probable scenario, the market appears poised to pick up right where it left off in a very big way with minimal vessel introductions. This could become a 2025 issue as well since many shipyards are reporting minimal space for larger and/or more technologically advanced vessels. Remember, we have yet to see a single VLGC set for delivery in 2025 – and both time and capacity are running tight to make that cut.