One industry expert warns that a number of threats could disrupt marine transportation or spark a sharp increase in shipping costs. This warning was issued by Ronald Soffree, business director of Indian Ocean Services at Stolt Tankers BV in an address to the ICIS Base Oil and Lubricants conference in Dubai in October. According to Stolt, with the growing shift in base oil production to the Middle East, producers face severe logistical challenges and exposure to piracy in making shipments to and from the region.

Exports from the Middle East are rising, and this is particularly true of chemical exports. Consequently, base oil producers must increasingly compete with chemicals for shipping space, and this could cause congestion or delays. Soffree drew parallels with the ongoing situation in Southeast Asia, where base oil producers are locked in fierce competition with palm oil and biodiesel exporters.

The Middle East also has a growing import-export trade imbalance that could be significant next year. Trade statistics suggest the gap between imports to and exports from the Middle East will amount to 37 percent in 2012 with 22 million tons of imports and 35 million tons of exports, Soffree told LubesnGreases. The figures exclude crude oil and liquid natural gas shipments but cover exports of chemicals, lubes, vegetable oil, phosphoric acid and petroleum products.

Historically, two types of vessels have been used to ship base oils from the Middle East: product tankers and chemical parcel tankers. The discrepancy in trade supports the increased use of chemical parcel tankers over product tankers, particularly as the region evolves toward higher quality API Group II/III base oils. These technically superior base oils also necessitate the use of parcel tankers due to their better cleaning, segregation, heating and efficient stripping capabilities.

Product tankers typically carry eight to 12 individually coated tanks and are capable of transporting 40,000 tons of deadweight. They generally can handle only one load and thus make a single discharge of one product for a single customer. A typical cargo value is U.S. $38 million. Parcel tankers feature 38 to 52 stainless steel tanks and can bear up to 43,000 tons. They are able to deliver multiple loads and handle multiple discharges, products and customers. Unlike product tankers, chemical tankers require ballast return legs only infrequently. Cargo values of $100 million are typical.

According to Soffree, parcel tankers are necessary for shipment of high-quality products, which supports Stolts investment in a range of Achievement Class diesel-electric propulsion tankers that feature a highly automated bridge, computerized cargo command center, high strength stainless steel tanks as well as a two-meter-thick double hull. Soffree says ship charterers already have stated a preference for stainless steel tankers when transporting more highly refined Group III base oils.

Stolt operates the worlds largest fleet of ISO tank containers, Soffree said. However, despite the seemingly large market for them, he contended that the economics for ship owners continues to be burdensome and to present a cost risk for base oil producers. Although freight rates have increased since the 2008 global financial crisis, tanker owners continue to grapple with falling asset values. Soffree warns that current prices are unsustainable and do not support the building of new tankers or fleet replacement.

He cites as evidence a non-existent order book for chemical tankers over 25,000 dead-weight tonnage (the load a vessel is capable of carrying), a result of new regulations such as the requirement for low-sulfur fuel and ballast water treatment in addition to tanker age restrictions imposed by insurers. Soffree said the current situation has created a perverse incentive structure that is precipitating the building of cheap ships, minimal maintenance, more scrapping and the use of lower technology. In addition, the imposition by insurers of lower age restrictions means that capital costs on a 15-year-old tanker are 45 percent higher than those on an equivalent 30-year-old tanker, according to recent estimates by Stolt.

Freight rates from the Middle East to Europe were around $85 per ton in July, and rates between the Middle East and Asia were around $60 per ton, Soffree said. These represented a moderate recovery since the financial turmoil rocked markets. However, rates are still far off their peaks and below profitable levels for ship operators.

Another pressing challenge is the threat of piracy in the Gulf of Aden and Indian Ocean, which is adding to costs and reducing already thin margins. In its October report, the International Maritime Bureau said figures for piracy and armed robbery at sea in the past nine months are higher than ever recorded with Somali pirates responsible for 56 percent of the 352 reported attacks in 2011. To meet the regional threat, Stolt has employed a three-part strategy of routing ships through low-risk areas, often with accompanying patrol boats and on-board security teams, but this adds to costs. Insurers have reacted to the spate of attacks by increasing premiums for war risk, and ship owners are forced to pay a bonus to crews to maintain morale in the face of potential kidnap and ransom demands. Other costs include hardware installations and the hiring of additional security personnel to fend off increasingly bold attacks by pirates.

Soffree said the convergence of these multiple issues has created an earnings gap for ship owners. He estimated that the industry now faces a 25 percent difference between expenses and revenues based on recent shipyard quotations and a 10 percent rate of return. Ship management costs have also been rising above the rate of inflation, and recent rises in fuel costs can only be partially recovered. However, he acknowledges the gap is not uniform across trade lanes. Closing the difference between revenue and expenses, Soffree said, will require a combination of several factors, including better port efficiency, improved return cargo legs, extending the life of ships and, of course, higher freight rates.

Fuel costs have spiraled in the past few years and continue to have a dramatic impact on profitability. As recently as 2009, fuel cost around $370 per ton, then rose to $465 in 2010 and $640 by October of 2011, an increase of 73 percent.

The combined effect of additional costs could also limit competition as new entrants find it difficult to enter the sector, Soffree warned. Stolt operates in all major base oil trade lanes with a total diversified fleet of 152 ships and DWT of 2,591,401. It has a deep sea fleet of 64 ships and a regional fleet of 88 ships operating in Asia-Pacific, Europe, the Caribbean and U.S. waters, and its 11 terminals have a total of 4.2 million cubic meters of storage capacity.

The tanker supply squeeze will probably intensify, said Soffree, and although orders for parcel tankers have steadily increased from 2004 to 2010, he predicts orders will fall off a cliff this year with the order book forecast to represent just 2.3 percent of the existing fleet in 2012. Scrapping represents 0.4 percent of the existing fleet.

With such a divergence, Soffree said, scrapping is likely to accelerate, and older ships will be dumped on less efficient marginal operators. Nevertheless, he predicts the supply/ demand balance in chemical tankers will be reestablished in 2013 but with limited or no growth in future chemical tanker capacity.

With the growing concentration of base oil production in the Middle East, regional lubricant companies could face mounting pressure on prices, as they feel the effects of increased freight rates and a widening shortage of tanker space. With ship owners battling escalating operating costs, the regions reputation as a re-export hub could be eroded as insurers, worried about the incidence and magnitude of piracy, increase premiums further, particularly in the event of armed naval intervention. In the short term, base oil producers could be faced with less reliable shipment options and a sudden loss of revenues if the threat of piracy and competition for available space both increase.