Soaring shipping costs squeeze US crude arbitrage to Asia

Higher shipping expenses are reducing the price gap that has drawn Asian refiners to US crude, though buyers are still booking shipments to make up for lost Gulf supply. The shutdown of Saudi Arabia's East-West pipeline this month, plus the wider Strait of Hormuz disruptions, has pushed Asian buyers to depend more on non-Middle Eastern barrels such as US grades.

Freight rates for this shipping lane are said to be at or close to all-time highs, mirroring the scarcity of very large crude carriers that has driven up Middle East-Asia shipping costs significantly this year. Japan is particularly vulnerable because it imports nearly all its oil, approximately 95% from the Middle East and about 70% of its total supply transits the Strait of Hormuz.

The Nikkei 225 index has been hit by the disruptions, declining for three consecutive sessions earlier this month amid higher oil prices, a stronger yen, and worries about a near certain Bank of Japan rate hike. Despite the extra freight costs, traders say US crude continues to be price-competitive on a delivered basis in Asia compared with other supplies, but the gap is narrowing as shipping rates climb. A prolonged freight surge, on top of already high crude prices, would increase Japanese import expenses and may further hurt risk appetite in Tokyo if the disruption persists.

All-time high shipping rates are narrowing, but not shutting, the opportunity for US crude exports to Asia.

Main points:

• Shipping costs for US crude to Asia have hit record or near-record levels, according to shipping market data.
• This increase stems from the broader disruption to Middle East oil shipping due to the ongoing conflict and the closure of the Strait of Hormuz.
• Saudi Arabia shut its East-West pipeline earlier this month after it was attacked, heightening worries over alternative export routes.
• Asian refiners are still chartering tankers for US crude despite higher freight costs, aiming to fill the gap from disrupted Gulf supply.
• Traders say US crude remains price-competitive on a delivered basis in Asia even as freight rates rise.

Shipping expenses for US crude to Asia have reached levels that shipping data sources call record or close to record, as continuing disruptions to Middle East supply channels drive Asian refiners to rely more on barrels from outside the Gulf.

Rates on the US Gulf Coast-Asia route have increased consistently this year in line with a wider rise in tanker costs linked to the conflict around the Strait of Hormuz, a key oil transit point. The turmoil has already pushed Middle East-Asia shipping costs up steeply, and the scarcity of very large crude carriers has also affected the lane for US crude shipments eastward.

Saudi Arabia increased the strain on regional supply lanes earlier this month by closing its East-West pipeline, which connects Eastern Province oil fields to the Red Sea terminal at Yanbu, following attacks from Iraq. The pipeline is a key alternative for the kingdom to export crude without using tankers that pass through the Strait of Hormuz. Its shutdown has raised trader worries over how much extra capacity is available to bypass the strait if the disruption continues.

Even with the increased shipping rates, Asian refiners keep chartering tankers for US crude to replace supply that would normally come from the Gulf. Traders note that despite high freight, US grades like West Texas Intermediate have remained competitive on a delivered basis in Asia, a price edge that has supported a flurry of chartering from the US Gulf Coast in recent weeks.

This price edge may not last. If shipping rates continue to rise, the added expense could eventually wipe out the price benefit that has made US crude a viable alternative, possibly reducing the volume of US shipments to Asia and pushing refiners to rely on remaining Gulf or other supplies. For the moment, traders say Asian buyers are focused on securing cargoes at nearly any freight rate, given the unknown duration of the Gulf shipping disruptions.