Weight of Freight: Red Sea return could mean 15pc diesel freight savings

Freight rates on the key Mideast Gulf to Europe diesel route could drop by as much as 15pc, or around $600,000 ($300,000 each way) on a lump sum basis, as shipowners return to the Suez Canal after the Yemen-based Houthi militant group signaled a de-escalation of their attacks.

The Mideast Gulf is a key source of diesel for Europe and has become increasingly important in recent years as European importers look to replace lost Russian supply. This was one of the first routes to divert around the Cape of Good Hope in December 2023 when the Houthis first ramped up attacks.

But the Houthis have indicated they will solely target Israeli-linked vessels, which could allow many shipowners to return to the Red Sea — although risks remain as Houthi forces do not always conform precisely with announced policy.

A return to the Suez Canal would cut 16 days from a Mideast Gulf to Europe journey, resulting in a fuel saving of around $345,000. In addition, a charterer would not need to pay the hire cost of the vessel, the time charter equivalent (TCE) rate, for those 16 days. The TCE rate on the route is around $32,000/d, equating to a reduction in payment of around $510,000 lump sum. This would be balanced out by the Suez Canal transit fee, which is around $520,000 for a Long Range 2 (LR2) tanker.

The potential lump sum saving would be doubled to around $600,000 for a Ras Tanura, Mideast Gulf to Rotterdam, Europe round voyage.

This potential saving could encourage charterers to push for shipowners to return to the Suez Canal and at lower rates than the current voyage.

A $600,000 drop for a round voyage would bring rates back down towards levels seen on the Mideast Gulf to northwest Europe route in recent years. Between 2019-22, the quarterly average cost of freight on the route for the first three months of the year ranged between $1.6mn-2.6mn. This was $6.2mn in the first quarter of 2023, after Houthi attacks escalated.

But shipowners face a significant revenue fall. The shorter voyage would mean a $500,000 loss in lump sum revenues, along with the added cost of the Suez Canal toll, which would more than counterbalance lower fuel expenditure. This will probably mean shipowners hold out for as long as possible before returning to the canal.

Available fleet numbers to jump

The effect of the Houthi's campaign on freight rates has been greater than can be accounted for just by the extra fuel and TCE costs.

A 16-day extension in the voyage length between the Mideast Gulf and UK Continent keeps tankers occupied on the route for longer and means they are much slower to return to the spot market, reducing vessel supply and driving the spot rate higher.

This rate is typically measured in tonne miles, the equivalent to a tonne of freight moved one mile. Average tonne miles for LR2s on the route surged in 2024 to 16.5 bn/month, from 9.4 bn/month in 2023, as nearly all tankers carrying diesel rerouted around the Cape of Good Hope.

This accounted for the jump in average rates over and above the increased fuel and time charter costs, and the reverse will be true as ships return to the Suez Canal. Rates could drop below $3mn lump sum, back towards levels seen in previous years.

It would also free up tankers to compete on other routes, pressuring rates for these. This would particularly affect the Mideast Gulf to east Asia LR2 naphtha trade.

Additional War Risk Premium costs

A key barrier to ships returning to the Red Sea will be insurance policies and the associated Additional War Risk Premium (AWRP) costs, where shipowners have to pay an additional premium to the insurer when entering waters classified as risky.

As it stands, shipowners entering the Red Sea and Suez Canal have to pay 0.2-0.5pc of a ship's hull and machinery value, which could equate to a cost of as much as $100,000 for an LR2.

Some insurers may refuse to provide coverage to a ship returning to the Red Sea, particularly if there are Houthi attacks against non-Israeli linked ships. Insurers often provide a no claims bonus on AWRP payments of up to 50pc, which would mitigate the cost somewhat.

The continued risk has led at least two large shipowners to indicate they will not return to the Red Sea until there is a proven safety record for ships and crew.

Basrah crude dynamics differ

The dynamics for crude tankers differ from those of clean product tankers. Iraq supplies Basrah crudes — mainly Basrah Medium — to the Mediterranean.

For deliveries through the Suez Canal, this was once principally a Suezmax trade, but is increasingly the province of VLCCs now that most vessels are being diverted away from the canal and around the Cape of Good Hope.

A fully laden VLCC cannot pass through the Suez Canal without lightering and using a pipeline to move part of its cargo to the other end of the canal. And VLCCs offer much greater economies of scale for longer voyages and are the preferred option for most crude deliveries that are routed around the Cape of Good Hope — regardless of origin.

In addition, lower Chinese demand and the reduction in crude exports from Opec+ members freed up a significant number of VLCCs last year, so freight rates did not rise to the extent that might have otherwise been expected, given the number of diversions away from the Red Sea.

The Basrah-Trieste Suezmax rate peaked at an average of $17.45/t in the first quarter of 2024, in the wake of the start of the Houthi attacks on vessels, up from $13.63/t in the first quarter of 2023 and $6.30/t in the first quarter of 2022.

But this rate is deemed a backhaul rate in the freight market and is often favoured by owners that are more focused on repositioning their vessels to Europe rather than making a significant profit. As a result, the voyage is often priced at a rate that covers most of the fuel and port costs but does not generate any revenue for the owner — resulting in a negative time charter equivalent (TCE) rate.

This negative TCE rate will encourage shipowners to return to the Red Sea much more quickly as the shorter journey will limit any overall loss; clean tanker owners will probably be more reluctant, as clean TCEs are not in negative territory and the shorter journey will result in lower overall profits.

Meanwhile, deliveries of Iraq's Basrah crude to the Mediterranean region fell by 27pc to 409,000 b/d in 2024, largely because of the longer journey times around the cape. But there could be more Mediterranean interest this year should Basrah be squeezed out of markets in Asia-Pacific — Canada's Trans Mountain Expansion pipeline has boosted Chinese purchases of Canadian heavy sour

Cold Lake and Access Western Blend crudes, which require lighter grades for blending — particularly if the Suez Canal is reopened.

Russian freight unaffected

The third key Suez route is between the Black Sea and India, which has become a key artery for Russian Urals exports.

Unlike the diesel and Basrah crude deliveries, most Russian Urals cargoes have continued to sail east through the Suez Canal. The Houthis indicated early in 2024 that they would offer free passage to Russian and Chinese ships. Several ships carrying Russian cargoes were still attacked in 2024, but not enough to persuade most tankers carrying Russian cargoes to divert around the Cape of Good Hope.

Given all of the above, the reopening of the Suez Canal is unlikely to have a significant impact on Russian freight — a much more significant factor is the latest wave of US

Author: John Ollett, Editor, Argus Freight