Skipping the light contango

The word contango encapsulates a specific situation on the commodity markets where the future price of a given commodity is above the expected future spot price. It arises where buyers are willing to pay more for a commodity, in the future, than the actual expected price. A driving factor may be due to a willingness to pay a premium for the commodity in the future, without incurring the storage and transportation costs of buying it today.

The last time oil prices fell dramatically was during the financial crisis of 2008, when they dropped from a record $145 per barrel to under $40. While this led to a lot of financial losses, enterprising parties seized the opportunity to buy cheap oil and given the shortage of land based storage they used tankers as floating tank farms. When the price rebounded, the oil was likely sold at a profit.

Oil prices fell significantly at the end of last year and at present they remain very low. The impact of this is felt across the world particularly when a number of oil economies as well as development projects work towards a price of $100. The current price of below $50 per barrel puts them under pressure while providing a boost to intensive oil consumers.

This market situation has again given rise to contango, and this meant that tankers found themselves in great demand towards the end of last year. At first this was due to the rush to buy perceived cheap oil, but as shore side storages started to fill up, increasingly tankers were hired to act as floating storage facilities. Both ways, these were welcome developments for tanker owners and long term period charterers who saw their vessels fetch a solidly improved rate in the spot market.

But how long will this period of low oil prices last? That is a question on which a lot of money will turn. Not least because buying and storing oil now is based on the goal of being able to sell it at a profit in the future, but that requires oil prices to rise by more than the cost of shore or ship storage and subsequent transport to the actual receiver.

Storage considerations

The starting point for consideration of long term storage will be an assessment of the vessel’s suitability for this purpose. An important factor will be whether the vessel will be at sea or anchorage or otherwise operating. The state of the tanks will also be key, as the long term storage of cargo may put strains on the coating and lead to deterioration and corrosion.

There are also a number of issues that must be considered with any STS operation. Ensuring that it can done safely is paramount and factors here include weather, sea states, fendering, the compatibility between vessels, and so on.

If a number of STS operations are envisaged, with cargo being parcelled out, then there is an added risk of shortage issues, as it may not be easy to ensure that ullages are accurate and that only the correct amount is transferred. Paying extra attention to this issue will be important.

An additional factor is that in some locations smuggling or sanctions breaches may occur. Members should at all times ensure that the cargo they are taking is legitimate and fully documented.

If members are asked to engage in the blending of cargo, it is important to remember that this is not permitted under SOLAS for any time the vessel is on a sea voyage. Blending can also be an issue for P&I cover, as a new product is created (as opposed to co-mingling the same cargo/grade from different sources), and may also pose bill of lading challenges. It may be necessary to have a laboratory set up on the vessel with a suitable expert in attendance to ensure that repeat operations result in the desired outcome, or risk possible contamination claims.

Even if the vessel does not engage in frequent STS operations, it will be necessary to monitor the volume of the cargo on board with periodic dipping and ROB calculations. If the cargo is of the kind that can lose significant volume over time then this must be understood as an on-going issue.

Shelf life

While some cargo types are stable and not easily affected by long term storage at sea, others may be very sensitive or otherwise suffer deterioration over time. The properties of the particular cargo to be loaded and stored must be properly understood, as well as the time frame for the proposed storage. Should storage exceed the safe ‘shelf life’ of the cargo, then action may be necessary to ensure it does not deteriorate significantly or risk potentially dramatic claims from the ultimate cargo receivers.

On a contractual front, owners and charterers should ensure that before fixing, all parties work out the full range of risk scenarios that come with the use of the vessel as a floating storage facility and make sure these are addressed appropriately in the final fixed charterparty. That includes apportionment of risks, extra costs, hull and tank cleaning as well as insurance coverage issues, otherwise these are likely to be fertile ground for disputes. Failing to contract carefully can be financially devastating.

Using a vessel as a long term oil storage facility may also impact insurance coverage, as this may not be the trade for which the ship is normally insured, and indeed this operation is not like a hot or cold lay-up situation. It would be prudent to consult with underwriters about the potential impact before fixing the vessel for this purpose.

This article is published for The Baltic Exchange members by kind permission of Skuld. Skuld thanks London Offshore Consultants and Andrew Moore & Associates for providing input towards this advisory.