Welcome to the dark side: The rise of tanker shipping’s ‘shadow fleet’

The European Union and G-7 nations, together with Australia and Japan, implemented sanctions against Russian refined products exports Feb. 5. Restrictions on Russian crude exports began Dec. 5. The system was designed to keep Russian cargo flowing — and it’s definitely still flowing.

“We see no indication that Russia will have to cut back its exports of crude or refined products,” said David Wech, chief economist of Vortexa, during a presentation Thursday.

And despite predictions to the contrary, he believes there will be enough vessels to handle rerouted refined product flows, as has already proven to be the case in crude shipping.

The reason: Russian sanctions spurred a massive increase in the so-called “dark fleet” or “shadow fleet,” older tankers with opaque ownership that operate outside Western insurance, financial and shipping-service circles, and that have a habit of turning off their location beacons.

A representative of Trafigura, one of the world’s largest trading companies, told Bloomberg that the shadow fleet now numbers around 600 vessels, comprising 10% of the world’s crude tankers and 7% of its product tankers.

“Frankly, it is becoming a big deal,” said Svein Moxnes Harfjeld, CEO of crude tanker owner DHT (NYSE: DHT), during a quarterly call on Thursday.

“Maybe the politicians that set up the current sanctions were aware this would happen and it was an acceptable collateral damage … but there is a lot of murky stuff going on.”

Shadow fleet is ‘the new scrapping’

Older tankers that pollute more and are less safe to operate would normally go to the scrapyards for recycling and be replaced by modern, more efficient vessels. But why scrap them when they can earn huge premiums in sanctioned or semi-sanctioned trades?

The shadow fleet first emerged on a smaller scale when the U.S. sanctioned oil exports from Iran and Venezuela. Over the past year, it has ballooned in size as older tankers were acquired to move Russian cargoes.

The shadow fleet “could be viewed as the new scrapping,” said Harfjeld.

“We have seen, in the last six to nine months in particular, a significant amount of funds made available to companies in Dubai that are either owned by Russians or other people,” he explained. 

“We have a sense that a lot of the businesses buying the older ships are funded by Russian capital in some shape or form and they are buying these ships to transport Russian crude oil — and they do that at a significant premium. They make more money than in the ‘complaint’ market.

According to Wech, “We have seen a lot of sales and purchases in different clean [product] tanker sizes over the last year, and most of those are over 15 years old and were probably purchased in preparation for carrying Russian products. 

“There is nothing illegal about a non-EU, non-G-7 country buying Russian diesel without making use of European services. This is perfectly legal and also perfectly legal on the crude side.”

Some freight upside flowing back to Russia

“It’s in the sanctioned or semi-sanctioned environment where freight rates are high, not in the rest of the market,” Wech continued.

On the crude shipping side, Russian Urals-grade crude trades at a significant discount, leaving a large margin to be paid for shipping and logistics, a portion of which likely flows back to Russia, undercutting the Western sanctions’ goal of slashing Russian profits.

“There is no shortage of shipping capacity,” said Wech, citing recent tanker acquisitions. “There are a lot of new players, very nontransparent players, a mix of Russian interests, partly located in the Middle East, and some other trading bodies in the Middle East, and also Indian and Chinese companies.

“The point is that it is difficult to get details on what price is paid by refineries in India and China [for Russian crude], but there’s about a gap [discount] of up to $30 a barrel, so there’s a lot to be made on the logistical side. Who exactly makes that money — some of that may flow to the Russian side — is difficult to tell.”

How trading patterns have changed

Since the EU ban on Russian crude imports began Dec. 5, almost all of Russian crude has gone to India and China, with Turkey, previously a major buyer, pulling out.

“There are essentially only two countries left buying Russian crude,” said Wech. As a result, “they are in an extremely strong position to ask for substantial discounts.”

Crude from Russia’s European ports is loaded on Aframaxes (tankers with 750,000-barrel capacity) and Suezmaxes (1 million-barrel capacity), then moved onto very large crude carriers (VLCCS; 2 million-barrel capacity) via ship-to-ship (STS) transfers, largely off Ceuta, Spain and Kalamata, Greece, then shipped to India or China.

The product tanker scenario is different. “There are many more markets to place Russian diesel than Russian crude,” noted Vortexa senior analyst Pamela Munger. 

Turkey is continuing to buy Russian diesel and Morocco has dramatically increased its imports, replacing cargoes from Saudi Arabia.

Wech noted that media attention is squarely focused on Russian crude flows. “From the amount of media requests we are getting, I have the feeling that every single journalist out there is currently tracking Russian oil on VLCCs,” he said.

Diesel moves on a larger number of smaller product tankers that are harder to follow, with STS operations much easier to hide. “If the vessel is at port where there’s a refinery, it’s harder to track because you’re not sure if it’s refined product from that refinery. The origin [of diesel] becomes very mixed very quickly,” noted Munger.

With less of a “spotlight” on diesel flows, and “more players out there that need Russian diesel than Russian crude,” Wech said there should be more interest among buying countries. He believes that “the transparency” of the crude shipments “is one the key reasons keeping most countries in the world from buying Russian crude.”

Ongoing challenges with price cap

While most Russian crude and products are moved by the shadow fleet, sanctions allow mainstream tankers to carry cargoes under a price cap set by the EU and G-7. Western shipping services providers can participate if they have a written attestation that the cargo is priced under the cap.

Wech predicted that “it is more likely that European services and shipping companies and insurance will stay involved on the clean product side than on the crude side.”

Russia has said no cargoes will move under any of the caps. But Wech said Russia makes twice as much exporting diesel than crude, so it could look the other way. “I think they will somehow not see it or not document it internally.”

Nevertheless, Western insurers — the Protection & Indemnity (P&I) clubs that cover tankers — continue to face sanctions challenges, which has kept most Russian flows on shadow tankers.

At the Hellenic-American/Norwegian-American Chambers of Commerce shipping conference in New York on Tuesday, Nik Ivanos of Skuld P&I explained, “There needs to be some form of protection for a P&I club that receives an attestation and isn’t able to verify the price cap. The approach taken by the U.S. is what’s called ‘safe harbor.’ If you’ve exercised good faith and complied with the documentary requirements, you’re given a level of protection.

“But no safe harbor exists in the EU implementation. In fact, they require due diligence, which is a moveable feast,” said Ivanos.

Asked by American Shipper whether Skuld had provided cover for any cargoes moving under the price-cap mechanism, Ivanos said he wasn’t aware of any.

But at least some cargoes have moved with Western shipping services. Dan Tadros, COO of American Club P&I, confirmed his company had covered at least one cargo and would cover more if the system was improved.

Safety risk of shadow fleet

Tankers operate under international laws promulgated by the International Maritime Organization and policed by individual nations. The concern is that the rise of the shadow fleet will ultimately lead to a catastrophic maritime casualty.

“When we talk about the growth of the dark fleet, that’s not quality shipping,” said Ivanov. “These are ships that have transferred ownership that are insured by questionable internal Russian insurers. Who knows what’s going to happen if there’s a major maritime casualty?”

During the Vortexa presentation, Henning Gloystein, director of energy at Eurasia Group, said, “The EU authorities and NATO are extremely worried about the STS activity in the Mediterranean. I’m fairly certain there will be pressure to clamp down on STS activity off Spain and in Greek-Cypriot waters.”

According to Harfjeld, “I question whether some of these ships are complying with laws and regulations. I wonder what would happen if we suddenly had a big oil tanker with 2 million barrels aboard [have an accident] close to where people live, in the Singapore Straits or the West Indian coast or the middle of the Arabian Gulf. Sadly, maybe that is what it will take for this to get the attention of the politicians.”

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