Dirty-to-clean switch caps high LR2 tanker freight rates as supply widens

Robust earnings on clean LR2 products tankers coupled with tonnage tightness due to the rerouting of ships from the Red Sea have prompted large-scale switching of dirty tankers into trading clean products, according to shipping market sources.

This move has caused considerable pressure on clean tanker freight rates with demand for loading refined products falling in this segment due to the competitiveness of larger-capacity dirty petroleum product, or DPP, tankers, the sources said.

The LR2 Persian Gulf-Japan route has seen a rapid decline in freight to w172 as of July 11 from w272.5 May 24, marking a 37% drop in about a month. The Westbound Persian Gulf to UK-Continent route has followed suit, with freight rates falling to lump sum $5.45 million July 11 from lump sum $7.6 million on May 23, a 28% decrease.

As of July 10, 18 VLCCs, 48 Suezmaxes and 85 Aframaxes have switched from dirty to clean products trading to draw better earnings, compared to 7 VLCCs, 22 Suezmaxes and 58 Aframaxes as of Dec. 31, 2023, with the dirty segment currently experiencing lackluster returns, S&P Global Commodities at Sea data showed.

The time charter equivalent or earnings for non-scrubber/non-eco class VLCCs have almost halved to $15,000/d early July from around $30,000/d in June. In contrast, the clean LR2 tanker segment is still seeing healthy earnings in the range of $40,000s/d, while its dirty counterpart -- Aframax -- is fetching around $30,000/d and a low fleet employment rate.

Also, far fewer newbuild VLCCs and Suezmaxes being delivered from shipyards, which typically would move middle distillates as part of their maiden voyage, is being attributed as one of the reasons for the current cleaning up spree of these classes of tankers.

"One of the key drivers of the trend has been anemic large crude tanker delivery schedule which has led to a dearth of newly delivered Suezmax and VLCC available for lifting clean products on their maiden voyage," shipbroker BRS said in a recent report.

"Notably, 2024 will see only one VLCC delivery (which already hit the water in January), the lowest number since at least 1990 ... it is a similar situation with Suezmaxes with only 6 set to be delivered by end-2024," the report stated.

Clean vs. dirty competition

The cleaning up of VLCCs by trading houses to ship clean cargoes out of the Persian Gulf into Europe has stemmed demand for clean LR2 tankers.

"There are limited cargoes [while] many LR ships [are available] even as some Suezmaxes and VLCCs have cleaned up. So, cargoes are short for LR ships," said an LR shipbroker.

The cost of moving clean petroleum products, or CPPs, on LR2s from the Persian Gulf to the UK Continent has spiked by 42.9% from an average of $52.40/mt in 2023 to $74.89/mt during July 1-11, according to S&P Global Commodity Insights Data.

In comparison, it costs $10.72/mt and $23.14/mt, respectively, for moving these products on VLCCs and Suezmaxes, according to Commodity Insights data.

"It is a good combination for owners, saving the ballast to the West, which is one reason why VLCC rates haven't fallen as much as expected," said a VLCC broker.

Moving clean products on VLCCs help owners reposition their ships in the Atlantic market to load crude from the US Gulf Coast, Brazil or West Africa.

Trading houses are preferring ex-drydock Suezmaxes and VLCCs to carry clean products since this helps minimize the cleanup costs.

Support for moving PG gasoil

The availability of VLCCs could bolster the Persian Gulf gasoil complex in the near term though demand concerns in Europe remain due to a seasonal lull, according to middle distillate trade sources.

"Middle East gasoil is more supported than Asia because of the conversion of dirty tankers to clean but we will need to see if this continues. We will need to see if Europe demand can keep up. It has been quite choppy," a regional middle distillate trader said.

Middle distillate traders are tracking two gasoil laden VLCCs currently heading to Europe. A VLCC can typically load around 280,000 mt or 2.05 million barrels of gasoil.

The Plata Glory will arrive at Le Havre in northern France close to end-July from the Middle East carrying 1.29 million barrels of ULSD. The Nissos Kea is due to arrive in the West of Suez from the Persian Gulf in mid-August with 1.79 million barrels of gasoil, according to sources and CAS data.

"There is some demand for Persian Gulf gasoil cargoes from Europe, so that has helped to divert those barrels away from Asia, but the moment Europe stops buying from them, Asia market will be in oversupply again," a Northeast Asian refinery source said.

Platts, part of Commodity Insights, assessed the key 10 ppm sulfur gasoil FOB Arab Gulf cash differential at an average of $2.20/b over July 1-11, compared with an average of $1.56/b in June. Over the same period, the benchmark FOB Singapore 10 ppm sulfur gasoil cash differential averaged minus 28.4 cents/b, widening from minus 10 cents/b in June.

Switch not sustainable

Market sources confer that it is mainly oil trading houses with their own fleets that are capable of making such conversions seamlessly.

Few independent owners are willing to convert their ships, that too on the condition that charterers would bear the cleanup costs and the associated risks of cargoes getting contaminated.

Also, the duration required for the cleanup process, which can be around one to two weeks, could discourage some owners from making the dirty-to-clean switch.