Shutting down the Suez Canal

By now I assume everyone knows that the Suez Canal is closed because of the container ship Ever Given ran aground while transiting:
 

Yep, it is blocked all right!

(The ship is operated by by the Taiwanese shipping line Evergreen, but the vessel is owned by a Japanese company, Shoei Kisen.)  

But the canal's operations were slowed (though not stopped) 10 years ago because the service workers linked to the waterway went on strike. At the time, about 2.1 million barrels per day (MBD) of oil and oil products were trans-shipped through the Canal in both directions. There is also the Sumed pipeline, running from the Red Sea to the Mediterranean coast, that has a capacity of about the same (crude only, though) which can easily pump 1 MBD.

Market speculators say that the canal's closure will cause the spot price of crude oil to rise. That is very possible, and near-certain if the closure lasts more than the two weeks initially estimated. Suez-transit costs are far below costs of sailing all the way around Africa's Cape of Good Hope, but this is mainly because ships' fuel oil ("bunker oil") is priced so high right now.

In 2011, shippers said that bunker fuel oil prices would need to fall to $370 per tonne to make the Africa Cape route economically attractive. It was priced about $100 more. Today, EMEA (Europe, Middle East and Africa) fuel oil prices are ranging between $454-485. 
 

Adding to total costs of Suez transit is the added costs of sailing the piracy waters off Somalia, although these risk costs are much lower now than in years past. At present, cost about $10 million more per year for a single Very Large Crude Carrier (VLCC, the second-largest crude-oil tanker afloat) to sail around the Cape rather than the Canal. "Need for rethinking about when to sail around the Cape of Good Hope?" explains the implication of routing through the Canal compared to sailing around Africa. A summary:

1. "... a fully laden VLCC cannot go through the Suez Canal without a partial discharging of cargo to the Sumed Pipeline at Ain Sukhna Terminal in the Rea Sea before picking up an equivalent shipment at Sidi Kerir Terminal on the Mediterranean Coast." The reason for the stop is that the Canal has a maximum depth of 66 feet; VLCCs cannot transit the Canal fully laden. And the offload/onload stops costs money.

2. "One important issue that has changed the picture dramatically is the potential repercussions for ship owners of the executive order issued by US President Obama." The order is still in effect. It is called, "Executive Order Blocking Property of Certain Persons Contributing to the Conflict in Somalia." For shippers, the order lay additional compliance requirements before they can deal with pirates who capture a vessel and/or crew. For example,

... the shipping company whose vessel is captured off of the coast of Somalia, in addition to determining whether to negotiate with the pirates, will also have to determine whether any sanctioned pirates are involved anywhere in the chain of events. Out of an abundance of caution, one would expect that a U.S.-based shipping company would presume an SDN is involved and would work with his insurance company and its financial institution to obtain the necessary authorization from OFAC before dealing with the pirates. One also would expect that OFAC will institute expedited licensing procedures to reflect the danger and urgency of pirate hostage-taking situations. Where a non-U.S. shipper is a victim of piracy but a U.S. insurer, reinsurer or financial institution is involved, the compliance burden is likely to shift to those parties.

Passage into out out of the Suez Canal in the south unavoidably entails sailing through piracy waters. The executive order raises compliance costs of the risk, though in a rather fuzzy way. However, these costs are part of the total costs of Canal passage, which are also affected by:

3. Bunker fuel oil prices, as discussed, plus daily charter rates and ship values for container vessels in relation to totals shipping costs of Suez transit.  

What matters the most in the cost calculations?

For a liner company it is primarily a question of higher bunker expenses due to the large consumption of fuel oil for the very powerful engine, while a tanker company primarily is concerned with the added capacity costs even though the fuel consumption also plays a significant part.

4. Comparing costs of the Canal versus around Africa:

The costs incurred from going round the Cape is related to the extra fuel consumption but also to the extra capacity required and related insurance premium increase in order to lift the same quantum of cargo in the same amount of time. Conversely, the costs incurred in going through the Suez Canal consist of canal tolls, extra insurance risk premium and the use of services such as tugs, pilotage and mooring. 

Bunker fuel today is about the same price as 10 years ago. But freight markets are low because of the pandemic. This makes the Canal option much less costly than sailing around the Cape. If bunker fuel's price drops below $370 per tonne, the Cape route becomes more economical even though much longer. But no one is forecasting that. 

The bottom line is, well, the bottom line. Costs of Canal transit would have to increase very sharply to make the Cape route more economical for crude and container ships. For example, piracy insurance premiums would have to more than quadruple.

One month ago, before the Ever Given problem, container ship charter prices reached a 13-year high of more than $21,000 per day for a one-year term, reaching into the $30s for a three-year term. There was already a shortage of shipping containers driving costs up, and now the Ever Given's capacity of 20,000 twenty-foot equivalent units (TEUs) is stuck going nowhere. However, there are a large number of other container vessels sitting dead in the water in Suez approaches on both ends of the canal. They and their container capacities are off the market also. 

The depressed oil markets because of Covid drove down VLCC charters costs to about that of container ships. However, VLCCs are much more fuel efficient than container ships, so total daily costs from all sources have to be compared. Dry bulk vessels have an altogether different calculation since they are chartered for each voyage, so total revenue weighs more heavily than costs, per se.

Here is a handy Excel calculator of comparative costs of sailing the Cape or the Canal that informs just how complex and assumptive the decision can be - click here.

My assessment:

Oil spot market prices will rise not long from now (they are up today) because of the blockage. Even when the blockage occurred, oil prices fell, but that was because EU countries had just announced stricter pandemic-lockdown-type measures, depressing economic activity forecasts. 

For those who are adventurous enough, buying "long" oil ETFs such as USO may pay off. (I am not so buying, however.) 

Related:

-- a primer on the world's oil-transit choke points.