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Trading Lessons

Crude Oil’s Piracy Premium

Commodities / Crude Oil Mar 21, 2011 - 01:25 PM GMT

By: Frank_Holmes

Commodities

Best Financial Markets Analysis ArticleHollywood pirates such as Jack Sparrow and Blackbeard are glorified characters among uncivilized peers, stealing from the rich and acquiring bounties of gold. While the adventures of these 19th century caricatures are entertaining, their 21st century descendants are a growing threat to a shipping industry responsible for nearly 80 percent of the world’s trade.


Pirate attacks are on pace to set a nine-year record in 2011, according to data from the International Chamber of Commerce, which tracks global pirate attacks.

Over the past five years, the number of attempted pirate attacks around the world has nearly doubled to 445 in 2010. Pirates successfully boarded the attacked vessels in 50 percent of these attempts. It’s estimated that only 30-40 percent of attacks are reported to international agencies so these are pretty conservative figures. Currently, 750 seafarers on over 30 vessels are held hostage by pirates demanding enormous ransoms.

During that same time period, the average ransom paid to release hostages and vessels has increased dramatically. In 2010, the average ransom for hijacked ships was $5.4 million, including a record $9.5 million paid in November for a South Korean oil tanker. This is up substantially from 2005 when the average ransom paid was about $150,000, according to oil industry analyst PIRA Energy Group.

The largest problem area has been off the coast of Somalia. The country’s history of piracy extends over 20 years since the fall of its government. In an attempt to protect their waters from being overfished, Somali vigilantes began forcing fisherman in the area to pay a tax.

The area Somali pirates controlled was once only along the coast of Somalia to the Gulf of Aden. Now, following a concentrated effort by naval vessels to eradicate piracy in the area, these pirates are extending their destructive efforts to one of the most important shipping areas in the world: the Arabian Sea, Red Sea and Indian Ocean.

Their tactics have become more sophisticated. The revised scheme is to use previously hijacked vessels, called “motherships,” to transport people and supplies as far as 1,500 nautical miles from land, making it much more difficult for naval warships to patrol.

With Somali pirates covering a larger area, there’s an increased risk to energy tankers entering the Indian Ocean headed for key ports in Indonesia, India and China. In 2010, one-third of all pirate attacks were targeting ships carrying chemicals, crude oil and natural gas. This has increased from just 20 percent five years ago.

One country bearing the brunt of Somali piracy is neighboring Kenya. The Kenyan Shippers Council (KSC) estimates that piracy increases the cost of imports by $23.8 million per month, and exports by $9.8 million per month, according to One Earth Future, a global think tank on trade.

Across the continent, Nigeria’s oil industry has been a direct target of pirates. One Earth Future calculated that Nigeria’s oil production has dropped by 20 percent since 2006 as a result of piracy and other attacks. Royal Dutch Shell estimates that approximately 100,000 barrels a day (roughly 10 percent) of Nigeria’s oil production is stolen every day.

To avoid the high-risk areas and protect the workers on the ships and supplies from a pirate attack, these tankers have changed their routes. They now travel farther east toward the coast of India before heading south, adding six days of travel time for a Western destination and increasing travel expenses for the shipper. Energy tankers are also employing armed security guards, paying increased insurance rates and retrofitting their vessels to lessen the chance of a pirate attack.

One Earth Future estimates the global cost of piracy on the economy has grown to approximately $7 to $12 billion a year.

Oil transport is specifically susceptible to piracy because about one-half of total production is moved by tankers on fixed maritime routes, according to the U.S. Energy Information Administration (EIA). This oil flows through chokepoints such as the Strait of Hormuz between Oman and Iran and the Strait of Malacca between Indonesia, Malaysia and Singapore.

PIRA calculated the increased costs related to oil tankers in the table. Considering all factors—vessel diversion costs, additional bunkers, armed guards, hull insurance—the total cost is approximately 40 cents per barrel when transporting oil in and around this area.

When you consider a supertanker can transport up to 2 million barrels a day, it adds up. Under PIRA’s calculations, the piracy surcharge tacks on another $800,000 to the total shipping cost. 

Over the past 30 years, the International Maritime Organization (IMO) has successfully lowered the risk of pirate attacks in other regions around the world. With the recent escalation of piracy around Somalia, governments and worldwide organizations including the United Nations are now working in concert with the IMO to curb these attacks. Their theme for 2011, “Piracy: Orchestrating the Response,” represents an increased awareness of the world-wide political changes required to reverse this trend.

For more updates on global investing from Frank and the rest of the U.S. Global Investors team, follow us on Twitter at www.twitter.com/USFunds or like us on Facebook at www.facebook.com/USFunds. You can also watch exclusive videos on what our research overseas has turned up on our YouTube channel at www.youtube.com/USFunds.

Please consider carefully the fund's investment objectives, risks, charges and expenses. For this and other important information, obtain a fund prospectus by visiting www.usfunds.com or by calling 1-800-US-FUNDS (1-800-873-8637). Read it carefully before investing. Distributed by U.S. Global Brokerage, Inc.

Standard deviation is a measure of the dispersion of a set of data from its mean. The more spread apart the data, the higher the deviation. Standard deviation is also known as historical volatility. All opinions expressed and data provided are subject to change without notice. Some of these opinions may not be appropriate to every investor. The S&P 500 Stock Index is a widely recognized capitalization-weighted index of 500 common stock prices in U.S. companies. The NYSE Arca Gold BUGS (Basket of Unhedged Gold Stocks) Index (HUI) is a modified equal dollar weighted index of companies involved in gold mining. The HUI Index was designed to provide significant exposure to near term movements in gold prices by including companies that do not hedge their gold production beyond 1.5 years. The MSCI Emerging Markets Index is a free float-adjusted market capitalization index that is designed to measure equity market performance in the global emerging markets. The U.S. Trade Weighted Dollar Index provides a general indication of the international value of the U.S. dollar.

Frank Holmes Archive

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