How crude oil inventories impact freight rates

What is the relationship between crude oil inventories and tanker freight rates? If inventories drop, do oil shipments follow, causing freight rates on that route to increase? 

We worked with Nikos Nomikos, one of the world’s top experts on shipping finance and professor at the Cass Business School, to answer these questions. 

Supplied with Ursa oil inventory data, Nikos recently finished his research into the topic. The result is an exciting new paper, titled, “Impact of Crude Oil Inventories on Tanker Freight Rates: Using Satellite Technology to Predict Freight Rates.”

The paper focuses on the most important oil shipping route, linking the Middle East and China. 

The round-trip voyage from Ras Tanura, Saudi Arabia to Ningbo, China takes 45 days, plus another four days for loading and off-loading. The route involves a class of tankers known as Very Large Crude Carriers (VLCCs), which can carry up to 2 million barrels of crude oil.

The period examined was November 2016 to March 2020. The locations were Dalian, Lanshan, Ningbo, Tianjin and Zhoushan. 

The main conclusions were:

  • Dalian showed the most significant results. Following a 5% reduction in total inventories (equivalent to the cargo load of 2 VLCCs), the cumulative change in freight rates in the following 4 weeks will be a 7.27% increase.

  • The next most significant change involved Ningo. Following a 5% reduction in total inventories, the cumulative change in freight rates in the following 4 weeks will be a 4.3% increase.

  • The impact of the Strategic Petroleum Reserve on freight rates was less significant, with the exception of Zhoushan, though the implied change in freight rates was small.

Earlier this week, I spoke with Nikos about his research and career. Below is a transcript of the interview, edited and condensed. 

Tell us a little bit about yourself

I’m originally from Greece. That’s where I grew up and did my undergraduate studies. My interest in shipping came early on. My father was a captain and ran his own shipping company.

I came to London for a Master’s degree in Shipping Trade and Finance. I found it extremely exciting and then completed a PhD. 

What is your area of expertise? 

My field of research is the combination of financial economics and shipping. This involves the valuation of shipping assets, shipping risk management and the ways shipping companies can hedge their freight risk using futures and options.

I also like to examine the links between shipping freight rates and the global economy. What are the factors that determine freight rates? How does shipping facilitate trade? 

It’s difficult to overstate the importance of shipping

The headline figure is that more than 80% of world trade by volume is carried by sea. That includes raw materials, like coal and oil, agricultural commodities, like wheat and soybeans, finished and semi-finished goods, or the components of an iPhone or PC. A ship was involved somewhere in the process.

It’s apparent to me how the global economy impacts shipping. The better the economy is doing, the more trading there is. What are some ways the shipping industry shapes the global economy?  

One of the biggest contributions of the shipping industry is helping emerging economies develop. Think of the mining sector in Sub-Saharan Africa. All these commodities are destined to far away places separated by oceans.

Shipping creates economies of scale that are essential for the transportation of the commodities in large quantities which leads to export growth that helps those countries develop and grow.

In your paper, you explore the link between crude oil inventories and freight rates. How did this come about? 

Most research up to now has analyzed the freight market at an aggregate level. I was interested in what drives the market at a more granular level.

I also wanted to focus on the trading route from the Middle East to China because there’s a single commodity -- oil -- that moves with regularity. 

There are 815 VLCCs in operation, and 60% of that capacity is on route from the Middle East to Asia. 

The thought was looking at inventories could be interesting because they could act as a leading indicator of freight rates. The reduction of inventories means they eventually need to be replenished.

Why does this matter? 

Anything that helps explain the direction of the market can be translated into better trading performance and strengthen the bottom line. 

If there’s a connection, then the level of inventories should be more closely followed by the shipping community.

Zhoushan, China

Zhoushan, China

That’s not currently the case? The shipping industry isn’t paying much attention to oil inventories?

The vast majority in the industry think of the balance between supply and demand at a high level. The advantage of the crude inventory data [provided by Ursa] is its granularity and timeliness. It’s in real-time. 

People look at customs data, but this is very coarse and lagged. It’s good for analyzing how the freight market responded over the previous six months, but less useful for what is happening right now.

What other factors influence freight rates? 

At an aggregate level, freight rates reflect the balance between supply and demand: i.e. the utilization of the existing shipping fleet relative to the ton-mile demand for seaborne trade.

At the more granular level examined in this paper, financial factors such as the basis in the Forward market for freight as well as the Brent crude oil forward curve also play an important role. 

For instance, a strong contango in the crude oil market is a good sign there will be a surge in demand for VLCCs [Very Large Crude Containers] for floating storage. 

Also, the number of VLCCs due in the Arabian Gulf in the next four weeks. If there is a reduction, that can mean a shortage of tonnage and I’d expect freight rates to pick up. 

You need to take into account the big picture when building a model, so even after accounting for these other factors, you can say inventories are still important. 

Tell me about the results. Were you surprised? 

I expected a negative relationship, and that is what I found. A reduction in inventories caused higher freight rates.

The strongest relationship was in Dalian. There I was surprised about the magnitude of the relationship: A 5% reduction in inventories leads to a 7% increase in freight rates, which is quite large in magnitude.

Zhoushan was the largest site examined, but the relationship between inventories and freight rates wasn’t as important as the other locations. That was also a surprise.

What will come next? Do you plan on doing any follow-up research? 

One idea is trying to identify the economic benefits. How can someone take advantage of this relationship by trading the forward market, for example. 

The second item is tracking the impact of inventories on freight rates and cargo flows. I began to combine the information with vessel movements using satellite data, but that’s at an early design stage.

You can also view a summary of Nikos’ paper as a Story Map contained on our Capabilities Dashboard.
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Geoffrey Craig