So far this year we have regularly seen announcements or media coverage about owners either buying or using own VLCCs for conversion into Very Large Ore Carriers (VLOCs). Lately, we have also observed several smaller vessels (Aframax and Suezmax tankers) being committed for conversion as well. With a booming dry bulk freight market, the final cut-off date for single hull tankers nearing, and generally strong expectations for continued growth in ore imports to (especially) China, this might seem to be a good idea.
As of mid-November we have registered a total of more than 60 tankers that have either arrived at yards for conversion, are committed to conversion, or simply rumoured to be conversion candidates. This activity has implications for both the VLCC market and the VLOC market. In a situation where worries about massive net fleet growth in the VLCC market prevail, such conversions are welcomed. On the other hand, a similar number of vessels will enter the VLOC fleet over a relatively short period of time and have a negative impact on the tonnage balance in this segment.
In the following we will address various aspects of the ongoing conversion spree.
Extent of conversion activity
We have registered a total of 61 named tankers that will be converted into VLOCs. This includes 39 VLCCs, seven Suezmax-, eleven Aframax- and four Panamax tankers. We would like to treat these figures with some caution and most likely our figures will differ from others’, as some rumours are simply not true and some conversion candidates are not known in the public domain.
There is only one such converted VLOC trading currently (Hebei Innovator, converted 2005). Among the vessels we have registered, eight vessels have already arrived yards for conversion.
In the following we will focus on the VLCCs, as most projects are for this size category. For the purpose of this analysis we have based our calculations on all 39 vessels being converted to VLOCs. This represents about eight per cent of the current existing fleet; provided they are converted it will have a significant impact on both the tanker market and the dry bulk market.
Schedule and technical issues
A key question is when these ships will leave active tanker trading and when will they commence dry cargo trading?
In principle, all it takes to convert a VLCC into a VLOC is to convert the centre tanks into dry cargo holds and install cargo hatches. In reality, it of course takes a lot more with respect to selecting the right conversion candidate, design and engineering work which require relatively detailed analysis and, finally, a complete class approval including a global FEM analysis. The actual work by the classification society does not necessarily need to take long time. However, this depends on the quality of the work performed by the engineering company. Based on our investigations, we have been advised that the time required for engineering/class approval is about 5–6 months from start to end.
The actual work in converting the vessel is dependent on several factors. Earlier this year, the stipulated time was indicated to about 5–6 months (from arrival at yard to completed conversion). However, this has been revised upwards recently to about 9/10 months. In addition, shipyard capacity is currently stretched and subsequently one must assume a period of waiting until a slot is available. We observe a number of the vessels that presently are undergoing conversion have been waiting off the yard for about two months.
Finally, the global ship equipment industries are working under pressure due to the strong shipbuilding demand. Hence, one may experience long lead time for delivery of key equipment like hatches. Information about delivery time is varying a lot. A couple of producers maintain “about a year” whereas others maintain this is yard supply and no waiting time should be expected. Assuming that the truth is somewhere in between, one could on average at least expect a 6–8 months wait for hatches.
All in all, we would estimate that the project period – from decision to convert is made until delivery of the VLOC – is about 15 months for the projects launched during the second half of 2007. We observe that all the VLCCs that have not yet arrived conversion yards are trading in oil – some of them are loading right now and several are en route to the MEG to load. For the ships decided to convert during the first half of 2007, we believe they will be completed in a shorter period of time and we could see the first vessels commencing iron trading at the end of the year and beginning of next. Hence, the majority of the conversion candidates will continue to trade in oil during this winter season (at least).
For projects that were decided earlier this year, we estimate time will be shorter and subsequently we have based our exit dates on a scale from 10–14 months for completion of conversion depending on when the projects were announced. There is of course room for errors in such approach; however, it gives a fairly reasonable profile.
As mentioned initially, the 39 vessels correspond to about eight per cent of the VLCC fleet; based on our ‘phase out’ schedule all of these will leave (excluding those already at yard) oil trading between November 2007 and September 2008. Extending the period to the end of 2008, a total of 43 VLCCs are scheduled for delivery.
Based on our delivery schedule and our estimated phase out schedule for conversion to VLOCs we arrive at the graph above. On a cumulative basis we arrive at the graph on page 25.
According our schedule, the last of the known/rumoured conversion candidates will leave oil trading in September 2008. This will reduce the net fleet growth during the coming 14 months (to end 2008) from 13.2 mdwt to 4.4 mdwt. In relative terms, the growth rate is reduced from 8.0 to 3.0 per cent. We are entering a period of strong fleet expansion due to the bulging VLCC order books; hence, conversion activity must be considered is a welcome contribution amongst VLCC owners.
Impact on the VLOC fleet
Going back a couple of years, VLOCs were considered to be a sort of odd size used for very long term business by Japanese and European steel mills. As the Chinese steel industry expansion gathered speed and imports of iron ore showed double-digit growth rates, it became apparent that larger vessels would be beneficial as freight rates in the spot markets soared. Furthermore, Brazil has increased its importance as a source for Chinese iron ore imports and subsequently VLOCs has become more popular. This has resulted in the current order book of 105 (28.2 mdwt) vessels larger than 200,000 dwt (the corresponding figure in August was 73/19.4 mdwt).
In comparison, the current existing fleet of bulk carriers and ore carriers larger than 200,000 dwt counts 91 vessels (20.4 mdwt). Thus, if we consider the conversion projects as part of the ‘order book’ there is a total of 144 VLOC/bulk carries (38.6 mdwt) on order.
Considering pure VLOCs/bulk carriers (larger than 250,000 dwt), the comparable figures are:
Existing 15 (4.4 mdwt)
On order 59 (18.1 mdwt)
Conversions 39 (10.5 mdwt)
Total order 98 (28.6 mdwt)
Thus, for ships larger than 250,000 dwt, the current ‘order book’ is 550 per cent of the existing fleet!
Most of the newbuildings, if not all, are already committed on long term charters, and several of the announced conversions are also committed. But the majority of the conversions are unfixed and converted on speculation.
Currently there are about 10–12 iron ore loading terminals worldwide that can accommodate vessels of this size. Some of these ports have a relatively small throughput and are restricted with respect to both beam and LoA. Furthermore, there are only four terminals that can accept a vessel with a beam larger than 55m. None of the conversion candidates have a beam less than 56m. Having said this, a terminal may be modified to accept larger beam vessels, but this of course calls for investments by the terminal companies.
An early 1990 built single-hull VLCC can in today’s market fetch around 55 MUSD. On top of this we understand the conversion cost – at least for the latest projects – is estimated to around 30 MUSD. In addition, cost of engineering, loss of earnings during conversion, interest, and inspection costs easily bring the price to around 90 MUSD. Still far below the current newbuilding price, but assuming a ten residual trading period (before scrapping) the break even rate is around USD 45,000 per day in order to get a reasonable return on investment. In today’s market this must be considered ‘dirt cheap’!
Conclusion
Provided that all 39 conversion candidates are converted, it will have a very positive impact on the supply side of VLCCs. Still, the VLCC segment cannot be considered isolated from the rest of the crude tanker market, and the order books for Aframax and Suezmax tankers for the rest of 2007 and 2008 are substantial. Still, the contribution is quite positive.
For the VLOC fleet this is definitely bad news. With an already large order book the addition of another 39 vessels is not very positive. Furthermore, we question the commercial soundness of converting a VLCC into a VLOC as we believe they will have trouble in securing steady business. As a result, time will be lost in waiting. The flexibility, not only on the loading side, of these vessels is simply not good enough.
We believe this fact will dawn upon owners considering converting VLCCs to VLOCs and eventually the number of converted ships will be far below the 39 known candidates. The result will be increased net VLCC growth and decreased net VLOC growth.
Text: Sverre Bjørn Svenning, Fearnley Consultants AS
Date: 30 January 2008