Trading Tankers
The tanker industry is absolutely vital to global oil supply. Tankers account for the vast majority of oil trade and 90 percent of all oil shipped out the Middle East.
Thanks to growth in oil trade and global oil demand, investing in tanker stocks can be extraordinarily rewarding. Better still, tanker firms earn huge free cash flow when tanker freight rates are healthy; many return this cash to shareholders as dividends. The result: Some of the firms I outline in today’s issue generate dividend yields of 12 to 17 percent.
As demand for energy imports increases, tankers will be an increasingly valuable sector. The key to profiting from this industry is understanding what it entails and what separates the winners from the losers. See Tanker Trade.
Oil inventories play a significant role in tanker rates, depending on the time of year. And adverse weather can also impact rates as well. See Tanker Rates.
As oil inventories continue to tighten, imports will be in higher demand. Tankers are the only real solution, and with nearly all ships currently providing service already under contract, demand for tankers will only increase as well, spelling bigger profits for tanker operators. See The Current Outlook.
I’ve had exposure to this market through several Portfolio and How They Rate recommendations. But I see value in others in well. Here’s an update. See How to Play It.
Check on how several Portfolio companies are holding up here. See Portfolio Update.
I’m recommending or reiterating my recommendation in the following stocks:
Source: BP Statistical Review of World Energy 2008
Total global oil exports have risen 34 percent over the past decade, compared to a rise of just less than 16 percent in total global crude consumption. Trade is growing at more than twice the pace of demand.
It’s also important to note the source of global oil exports. Check out the chart below for a closer look.
Source: BP Statistical Review of World Energy 2008
The largest oil exporters are the Middle East, the former Soviet Union (FSU) and Africa. As you might expect, the Middle East alone accounts for nearly 36 percent of global oil exports; the FSU and Africa each account for roughly 15 percent. These three regions taken together are responsible for two-thirds of global oil trade.
And the world’s reliance on oil trade is only going to increase in coming years. Oil production in key consuming nations such as the US and China is falling or, at the very least, not growing fast enough to keep pace with demand. Therefore, these nations will become increasingly reliant on oil imports to meet demand.
China is a perfect example of this trend at work. Consider that, a decade ago, China imported less than 1 million barrels of oil per day; according to the most recent figures from BP, China now imports more than 4 million barrels per day (bbl/d). That’s a more than fourfold increase in 10 years.
Tankers are key to this global trade in oil. Some 90 percent of all oil shipped from the Middle East is shipped by tanker. Globally, roughly 40 million barrels of oil per day are shipped on tankers; tankers account for just less than three-quarters of global trade.
And longer term, it’s a reasonable assumption that the world’s reliance on tankers will increase. According to the Energy Information Administration (EIA), the Organization for the Petroleum Exporting Countries (OPEC) will actually grow marginally in importance as an oil supplier in coming years. But the EIA also sees most of that supply growth coming from the Persian Gulf region; because oil exports from the Persian Gulf are predominately shipped on tankers, this would raise the importance of tanker trade.
An understanding of the tanker industry is important for reasons other than the potential growth in tanker trade. Tanker rates and chartering activity can offer important clues to broader trends in the crude oil markets.
Much of the world’s tanker capacity isn’t owned directly by major oil producers. Instead, third-party tanker operators own the ships and lease them to companies that need to ship oil. Tanker firms charge a daily fee, or day-rate, for leasing these ships.
There are two basic types of tanker contracts: time charters and spot contracts. Time charters involve leasing ships under long-term, sometimes multi-year contracts at fixed day-rates or rates that adjust based on inflation or some index. Occasionally, time charter contracts also include profit-sharing agreements that allow tanker owners to earn higher rates in extremely tight, strong tanker markets.
Spot contracts are signed based on short-term tanker supply-and-demand conditions. Typically, tankers booked under spot deals are leased for one-off trips. Spot rates can vary wildly based on both seasonal and longer-term factors that I highlight later in today’s issue.
The advantage of time charters is they offer stability and predictability in cash flows over time. Tanker operators with a high proportion of charters won’t experience wild swings in profitability based on volatile spot rates. However, spot contracts typically offer higher returns for tanker owners during strong tanker markets; operators have a sort of tradeoff between stability and a shot at big profits.
Some tanker operators target mainly spot deals, while others have a tendency or stated operational guidelines to sign time charters. Most operators use a blended strategy of mixing time charters and spot deals in an attempt to have the best of both worlds. As a rule of thumb, spot-heavy contractors will outperform firms with heavy exposure to time charters during strong markets for tanker rates.
The other differentiating factor when it comes to tanker operators is the mix of ships in their fleet. There are three important factors to consider when it comes to tanker fleets: ship size, double-hull tanker proportion of the fleet and fleet age.
There are currently around 1,979 crude oil tanker ships operating around the world with a total carrying capacity of 296 million deadweight tons (DWT). DWTs are a measure of a ship’s total weight capacity, including stores, crew, fuel, water and equipment—the higher the DWT capacity, the larger the ship. The table below highlights some of the major classifications of crude oil tanker ships and their size in DWT.
Source: m-i-link.com, Bloomberg
Very large crude carrier (VLCC) ships account for about 25 percent of the global oil tanker fleet by number and half the world’s capacity in terms of DWTs. Sometimes you’ll hear the term ultra-large crude carrier (ULCC); these are typically ships with more than 300,000 DWT in capacity. For ease of analysis, I’m including the ULCCs in the VLCC category.
VLCCs are the most valuable type of tanker and cost around $155 million to build new at this time; because of steadily rising raw materials prices and shipyard bottlenecks, that cost is rising. A typical route for a VLCC tanker would be from the Arabian Gulf to Japan or the US Gulf Coast.
According to IMAREX, a tanker data firm, the current rate for shipping crude oil from the Arabian Gulf to Japan is about $157,000 per day. The chart below shows the approximate day-rate for this common VLCC route over the past several months.
Source: Bloomberg, IMAREX
Note these are spot rates; the volatility in rates is clear from this chart. In just the past year, VLCC rates over this route have varied from lows around $35,000 per day to as high as $200,000 per day.
Of course, even at $35,000 per day, a tanker firm is likely making money from its ships. According to tanker giant Frontline’s first quarter release, its cash cost breakeven rate for VLCC ships was around $31,500 per day. Based on those numbers, it’s easy to see just how much a firm like Frontline makes at current rates.
To complicate matters a bit further, tanker rates aren’t always quoted in terms of dollars per day. A common quotation is percent of worldscale. Worldscale is short for Worldwide Tanker Nominal Freight Scale—a scale of standard freight rates between various ports around the world. This scale is published by a London-based firm every year. The higher the worldscale rate, the stronger rates are.
For example, check out the chart below.
Source: Bloomberg
This chart shows the worldscale rates for a VLCC tanker traveling from the Arabian Gulf to the US Gulf Coast over the past several months. It’s clear that the rates for this tanker route have also been firming up in much the same way as for the Arabian Gulf to Japan.
The tanker rate indexes I charted above are based on actual data for tankers chartered through global shipbrokers. Like any other market, rates change from day to day. Many of these brokers publish records of fixtures for tanker ships.
For example, late last week, ExxonMobil chartered a 285,000-DWT, single-hull VLCC tanker from Frontline called the Front Highness. This is one of Frontline’s older, least-valuable ships; it was built in 1991.
The Front Highness is scheduled to load its cargo July 2 in the Arabian Gulf for transport to the Far East (possibly China). The rate charged for this charter is 165 percent of worldscale. This fixture and others like it would enter into the calculation of rate indexes, such as those I highlighted above.
Smaller Suezmax and Aframax tankers are also important to global tanker trade, accounting for 18 percent and 23 percent of global tanker tonnage, respectively. Although not always the case, these ships tend to be used to haul oil over shorter distances.
A common Suezmax route would be from West Africa to the US Atlantic Coast. This charter would cost roughly $70,000 per day at the current time, up from $55,000 earlier this month and down from highs around $90,000 earlier this year. Just as with VLCCs, Suezmax rates can be volatile but have been ticking higher recently.
A common Aframax route would be from the North Sea to Europe. The rate for such a route is also currently around $100,000 per day. Another common route—Kuwait to Singapore—offers current rates closer to $40,000 per day.
A few additional points are worth noting. Older ships tend to receive lower day-rates than more modern vessels; they’re also considered less valuable.
Several providers offer data on exactly what ships are worth. For example, a new VLCC tanker is worth about $155 million, while a 15-year-old VLCC ship is worth around $97 million, according to Bloomberg. Valuing a tanker operator’s fleet requires taking into account not only the types of ships owned but the age of the fleet.
The final consideration is the percentage of ships that are double hulled. Double-hulled tankers are considered far safer against spills than single hulls; in fact, single-hull tankers will likely disappear entirely from the world scene over the next few years.
An international maritime governing body, the International Maritime Organization, has mandated that single-hull tankers be retired and scrapped by 2010. Most have already been scrapped or soon will be. Obviously, single-hull ships are far less valuable; a 15-year-old single hull VLCC is worth less than half a double-hull ship of the same age.
Finally, note the difference between dirty and clean tanker rates. The term clean refers to refined products that don’t leave a residue on the inside of a tanker’s hold. This might include jet fuel or motor gasoline. Dirty refers primarily to crude oil
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The most-often-quoted index of tanker rates is the Baltic Dirty Index (BDI), published by a group called the Baltic Exchange. The BDI summarizes the performance of tanker rates for a long list of different tanker sizes and tanker routes. It’s an excellent overall indicator of where rates are headed in the tanker space. Check out the chart of the BDI over the past several years.
Source: Bloomberg
The first point to note about this chart is the prominent spikes. These spikes tend to happen every year, primarily during the winter months. Sometimes the high in rates is before the end of the year, and other years, it’s shifted slightly into the new year. In contrast, note how rates are often depressed during the summer months of each.
This really isn’t a big mystery. The reason for these spikes has to do with the time of year when most countries build up inventories of crude oil. The US provides a convenient example. Check out the chart below for a closer look.
Source: EIA, Bloomberg
This chart shows crude oil inventory levels for each year going back to 2003. I normalized the data to make it more directly comparable. What’s clear is that US oil inventories tend to build from late summer through late spring. This is because refiners are attempting to build their stocks of crude oil ahead of the summer driving season—the period of peak demand. In contrast, from roughly May 31 through late August/early September, refiners draw down those inventories.
Because the US only produces about 6.9 million barrels of oil per day and consumes 20.6 million, oil imports are a major factor in building inventories. When refiners are trying to build inventories, they’re likely looking to accept more tanker import deliveries. During these periods, tanker demand is high, which is why rates rise. In contrast, in midsummer, refiners are drawing down their inventories, so demand for tanker shipments is low, as are rates.
The other key feature of the chart is that the seasonal trends aren’t the same every year. Some years rates are generally higher, and the seasonal spikes are of greater magnitude. One such instance was the mid-2004 to early 2005 period. An analysis of the factors that brought about the extraordinarily strong tanker market of the 2004-05 winter season is instructive.
Source: EIA, Bloomberg
The basic construction of this chart is familiar to The Energy Strategist readers: I highlighted several similar charts in the June 4, 2008, issue, Crude Realities. There are four lines on the chart, one representing the actual inventory level, one representing the trailing five-year maximum inventory levels as reported by the EIA, one representing the five-year minimum inventory level and one representing the average level. Because this chart covers the period from early June 2004 through late May 2005, the five-year averages, maximums and minimums are based on the years 1998-99 through 2003-04.
The turquoise line in the chart represents the actual inventory picture during this period of 2004-05. What’s clear is that, from early June through late August, US oil inventories were below the five-year average level. Then, in September, US inventories collapsed to five-year lows, falling below the five-year minimum range. This could be considered a dangerous level; refiners would have been eagerly looking to bring stocks back to more-normal levels.
Although a number of factors conspired to bring those inventories to below-average levels, one of the most obvious was an active hurricane season. The 2004 hurricane season wasn’t quite as destructive from an energy infrastructure standpoint as the 2005 season, but you must remember the context. At the time, 2004 was the most destructive season in recent memory.
According to EIA estimates, Hurricane Ivan, a Category 5 monster, was the worst storm of the year for energy-related interests. The storm shut down US oil production, totaling 27 million barrels; the US needed to import more oil to cover that outage.
But note what happened in the winter of 2004-05. Inventories built up rapidly in the US. By early 2005, in fact, inventories were above average. And by that summer, oil inventories were above the upper end of the average range.
This large build in inventories was accomplished partly by accelerating imports, and this, in turn, caused a shortage of tankers in some markets. Rates for all sorts of tankers shot higher.
Of course, this inventory restocking was only one factor that pushed up tanker rates during this period. Oil demand during this period was also strong in 2004 and 2005. According to the International Energy Agency, global oil demand jumped by 3 million bbl/d in 2004 and a healthy 1.1 million in 2005.
In percentage terms, the 3.5 percent jump in oil demand for 2004 was the highest since 1978. Check out the chart below for a closer look.
Source: BP Statistical Review of World Energy 2008
Strong growth in oil demand spells a strong uptick in global oil trade. And much of this demand growth was met by increased production of oil from the OPEC-10 producers; these nations export most of their oil via tankers, helping to drive more tanker demand.
And we can’t ignore the supply side of the tanker market. Rising oil trade and inventory restocking can pull demand for tankers, but the effect this has on rates depends to a great extent on how many tankers are available for chartering.
Tanker availability depends primarily on two factors: newbuild supply and scrapping. As to the latter point, tankers can be scrapped for any number of reasons. In recent years, the prime reason has been the phaseout of single-hull tankers as mandated by the International Maritime Organization.
And other older tankers are scrapped for the simple reason that the rising cost of raw materials makes them more valuable as a source of metal. Some older tankers are being refitted to operate as floating crude storage facilities, drilling rigs or as floating production platforms.
The second source of new supply is simply newbuild ships. It takes several years to build a new tanker; the exact construction time depends on the type and size of the vessel, as well as the availability of shipyard capacity. A few different data providers offer information on how many new tankers are on order, how many new ships are being ordered and the total size of the tanker fleet.
The tanker supply picture was also bullish back in 2004-05. Check out the following chart.
Source: Bloomberg, Lloyd’s Registry Fairplay
This chart shows the total order book of new tanker ships globally expressed in percentage terms. In other words, the current value of 38.4 percent indicates that new ships are on order with a total DWT equal to 38.4 percent of the total operating global fleet.
This dataset, provided by Lloyd’s Registry, only goes back to the beginning of 2005. However, it’s clear that the order book for new tankers was weak until late 2005 to early 2006. That suggests the tanker supply wasn’t growing quickly back in late 2004 and early 2005.
Bottom line: In 2004-05, rising demand for tankers hit a stagnant supply, causing rates to shoot higher. Exacerbating that problem was an unusual inventory restocking drive in the wake of the 2004 hurricane season.
By way of comparison, we can also see from the chart of the BDI above that the winter of 2006-07 was extremely weak for tanker rates. The normal seasonal spike in rates just wasn’t evident during this time period. Not surprising, some of the same effects that drove the 2004-05 tanker bull market drove the bear market in rate of 2006-07. Check out the chart of US oil inventories during that period.
Source: EIA, Bloomberg
This chart is constructed in a similar fashion to the chart of 2004-05 inventories. As you can seen, US crude oil inventories set new highs throughout the entirety of 2006; in fact, inventories didn’t normalize until mid-2007.
Also note that crude oil stocks actually fell toward the end of 2006. Refiners didn’t need to build stocks of crude because inventories were already bloated. Instead, these companies simply drew down their existing stocks.
I won’t belabor the point by presenting all the details here, but suffice it to say that oil stocks across the developed world were glutted back in 2006. The lack of a normal inventory restocking trend explains, to a large extent, why tanker rates remained depressed during the seasonally strong winter months of 2006-07.
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There’s no equivalent springtime spike in tanker rates in any of the years covered in the BDI chart above; even in 2004-05, tanker rates were relatively weak in the late spring and summer months. Once again, the inventory data offer a clue as to why tanker rates are so unseasonably strong. Check out the chart below.
Source: EIA, Bloomberg
I highlighted many of these trends in the most recent issues of both TES and The Energy Letter. To summarize, the oil market looks tight right now on an inventory basis. Over the past two weeks, oil inventory drawdowns have been running at a far-faster-than-expected pace.
Inventories looked bloated earlier this year but are now well below average levels; even more interesting, oil inventories are declining now in a period when we should be seeing strong builds in inventory.
And it’s not just the crude oil inventories. Stocks of gasoline and distillates in storage also continue to hover at lower-than-ideal levels. Stocks of both types of refined product are in the lower half of their average range for this time of year.
And without delving into a lengthy discourse, suffice it to say that inventories across the developed world are low for this time of year. According to the EIA’s most-recent, short-term energy outlook, inventory builds in the second quarter across the developed world have been far lower than average.
One year ago, inventories in the developed countries jumped 71 million barrels from the end of the first quarter to the end of the second quarter. This year, the EIA is looking for only a 30-million-barrel increase. This suggests continued tightness in inventories through the remainder of the summer.
Just as in the prior cycles I outlined above, tight oil inventories during a time of year when inventories should be building spells one thing: an uptick in demand for imports. There’s already anecdotal evidence of larger volumes of oil headed west on tankers toward the Atlantic Basin from the Arabian Gulf.
Saudi Arabia, the one country with meaningful spare production capacity, has announced plans to boost its output. Higher Saudi output often means more demand for VLCC ships to transport that crude to supply-constrained markets.
There are a few additional indicators suggesting tight supply. For example, IMAREX, the freight data firm I mentioned above, also offers futures contracts that can give us an idea of expected future tanker rates.
A year ago, the day-rate for a VLCC tanker traveling from the Arabian Gulf to Japan was less than $50,000 per day. Currently, that rate is just more than $150,000—triple the year-ago level. Even more important, look at the forward curve of tanker rates based on IMAREX data.
Source: Bloomberg, IMAREX
This curve shows that the futures market is looking for tanker rates to remain elevated through the summer and into the early fall. These rates represent an unusually high plateau for the summer months.
Other longer-term factors also support rates. For example, as I pointed out in the last issue of TES, US oil demand looks weak in 2008 thanks to sky-high prices and weak economic growth. But in the developing world, demand growth continues to look strong; total global oil demand should see growth of a healthy 1 million bbl/d this year.
Check out the chart of non-OPEC production growth below.
Source: Bloomberg
This chart depicts the EIA’s estimates of non-OPEC oil production growth this year. Note late in 2007, the EIA and International Energy Agency were looking for growth in non-OPEC oil production of more than 1 million bbl/d this year.
But that figure proved hopelessly optimistic. A series of delays to major projects, coupled with faster-than-expected production declines in nations such as the UK and Norway, has cut that growth projection to just 310,000 bbl/d.
With non-OPEC production weak, more oil will need to be transported from OPEC and, in particular, the Arabian Gulf. This is a long, highly profitable journey for tanker ships. And there’s no real alternative to tankers for moving oil out of the region.
Another factor that effectively reduces supply is a practice known as slow-steaming. Tanker ships burn an oil-based fuel known as bunker fuel. By cutting their average speed, tankers can burn less fuel to travel the same distance. It’s essentially akin to us all deciding to drive down the motorway at 35 mph instead of 65 mph to save gasoline.
The downside is that it takes far longer to travel the same distance. Obviously, ships in transit aren’t available for chartering. Slow-steaming takes ships off the global market for longer periods of time. But with bunker costs booming, we’ll likely continue to see a trend toward more slow-steaming tankers.
Finally, there’s the matter of tanker supply. As you can see from the chart of newbuild orders above, the existing fleet of ships currently under order for delivery is equivalent to 40 percent of the existing fleet. That’s a big number, and it’s been rising steadily in recent months.
But this veritable flood of new supply isn’t likely to impact rates in 2008 or even early 2009. A large number of these ships aren’t scheduled for delivery until after the halfway point of 2009. And the scrapping of older ships, including single hulls, will continue helping to offset newbuild supply. Therefore, the supply/demand balance in the tanker industry looks to favor tanker operators through at least mid-2009.
There’s a chance that the supply tightness will continue far beyond that. Specifically, the world’s shipyards are full and near capacity; a number of newer shipyards have limited experience building large-scale tankers. We’ve already seen the construction schedules for some newbuilds slip, and this is likely to continue going forward.
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The table below certainly isn’t an exhaustive list of tanker stocks, but it includes some of the larger, US-traded tanker names. I offer a few key columns of data for each tanker firm. For the most part, those metrics are common and self-explanatory; however, price to net asset value (Price to NAV) may be unfamiliar.
NAV is nothing more than a measure of the actual current value of these tanker firms’ assets. To calculate NAV, I looked at each firm’s existing, operating fleet of tankers.
Based on the type of tanker and its age, I assigned a value to each ship. These values are based on data provided periodically by Simpson Spence & Young Futures (SSY). This gives an estimate as to the current value of the ships. This differs from the book value of the tankers, which is based on historical costs, not present values.
From this fleet value figure, I added in current assets such as cash and liquid assets. I then subtracted debt and other liabilities from the total. The result of this lengthy calculation is a rough approximation of the value of each company in liquidation after all debts have been paid off.
Please note that NAV calculations aren’t an exact science. I accorded no value to newbuild ships, and because SSY doesn’t publish values for all ship types, I was forced to make a few approximations based on recent sales data I’ve seen. All the cash and debt values were taken from the firms’ most recent quarterly reports; in most cases, this was the first quarter report.
No two NAV calculations are exactly alike; however, my approximations match roughly what I’ve seen published elsewhere. I’d say that the figures below are, by and large, slightly more conservative than some NAV estimates I’ve read; I attempted to err on the side of caution.
Price to NAV offers a useful valuation metric in the tanker industry. Levels below 1 suggest the firm is trading at a discount to the value of its assets. Check out the table of tanker stocks below.
*Dividend Yield as of 06/17/08
Source: Bloomberg, SSY, Company Reports, The Energy Strategist
Note a few broad trends. First, firms with heavy exposure to the spot market, such as Frontline and Nordic American Tanker, tend to trade at a valuation premium to firms that have heavy time-charter coverage. Second, these spot-market firms have outperformed the group average so far in 2008. That phenomenon is the result of a strong tanker market and high returns in the spot market.
As always, I’ll look to add more oil tanker firms to my coverage universe in upcoming issues. Also note that I’m not including dry-bulk shipping firms to this list. Dry-bulk shippers transport commodities such as coal and iron ore; I’ll leave a detailed description of that industry to an upcoming issue of TES. Here’s a quick rundown of each stock in the table and my current advice on each.
Frontline—Frontline is a spot-market-focused tanker firm with a fleet consisting primarily of VLCC and Suezmax carriers. Frontline has a history of paying out large dividends and, to its credit, has maintained that policy even during relatively weak markets for tankers.
The company has undertaken some innovative strategies to return value to shareholders. For example, Frontline has created several smaller firms over the past few years. One such creation is a company that converts older tankers into useful assets such as floating production platforms. And Frontline has also formed companies to own some of its ships contracted under long-term time charters. In most cases, Frontline eventually spins off these companies to shareholders as special dividend payments, a way to return cash to shareholders.
Frontline’s fleet consists of a total of 62 tankers, including 38 VLCCs and 16 Suezmax carriers. All but one Suezmax and six VLCC carriers are double-hull tankers. The average age of the fleet is somewhat higher than the industry average: Frontline’s average Suezmax tanker is 11.3 years old, and its average VLCC is 9.3 years old.
To help ameliorate this situation and make up for retiring single hulls, Frontline has a significant order book of new tankers. The list includes eight new Suezmax tankers, with the first due for delivery in the third quarter of this year and the last due in late 2010. And Frontline has 10 VLCC carriers, several with capacities exceeding 300,000 DWT due for delivery from the first quarter of 2009 through the second quarter of 2012.
Frontline’s huge fleet is an advantage because, as I noted earlier, regional tanker markets can offer different returns. Because Frontline has exposure to just about every imaginable tanker market, it’s well placed to benefit from strength no matter where in the world it occurs.
Frontline remains among my favorite tanker stocks longer term and one that I’ve rated a buy in the How They Rate Table for more than a year. I see the valuation premium as generally well deserved, given Frontline’s high dividends and significant spot market coverage. I’m looking for an opportunity to buy into Frontline in the model portfolios; however, the stock looks extended near term.
Nordic American Tanker—Nordic American Tanker owns a fleet of 12 Suezmax carriers with an average fleet age of 8.5 years. All of Nordic American’s tankers are double hulls, and the company has two new Suezmax carriers on order for delivery, one in the fourth quarter of 2009 and one in April 2010. Nordic American’s fleet is impressive when you consider that, in late 2004, the firm owned just three Suezmax carriers.
The firm estimates that its breakeven cost for tankers is just $9,500 per vessel per day, compared to average rates in the first quarter of $46,600. At anything over that breakeven rate, Nordic can pay generous dividends for shareholders.
There’s absolutely nothing to fault with Nordic’s fleet or strategy. The only potential knock against the firm is that it trades at the highest valuation on both a price-to-NAV and price-to-earnings basis of any tanker firm covered in the above table. But much of that is justified by Nordic American’s heavy spot-market exposure and pristine balance sheet. I’m adding Nordic American Tanker to the Gushers Portfolio as a buy under 42 with a stop at 31.25.
Note that this is a wide stop for Nordic and that I’m adding it to my Gusher Portfolio because of the inherent volatility of the tanker market. Don’t be fooled into thinking this is a safe stock by the large dividend yield.
General Maritime (GenMar)—Proven Reserves holding GenMar owns a fleet of 11 Suezmax and 12 Aframax carriers, with an average fleet age of 6.3 years and 12.9 years, respectively. The company employs a mixed time-charter/spot-market contracting strategy. As I noted earlier, the benefit of this is stability; GenMar has locked in nearly $176 million in revenues under contracts for 2008 alone.
The disadvantage: GenMar’s average time charter offers a rate around $36,000 to $38,500 per day, significantly lower than what the company could earn in the spot market right now. For example, a Suezmax operating between West Africa and the US Atlantic Coast could earn in the $68,000 to $70,000 per day range in the spot market today.
GenMar has two Suezmax ships scheduled for delivery over the next year, and the company has been expanding its fleet in other ways as well. For example, GenMar recently bought two 6-year-old Aframax tankers from a Belgian shipper for $137 million.
Finally, General Maritime offers a 7.5 percent dividend yield and has been buying back stock in recent quarters. Trading at a significant discount to NAV with considerable upside from the strong spot market, General Maritime remains a buy in the Proven Reserves Portfolio.
Teekay Tankers—There are several firms bearing the Teekay name, including Proven Reserves bellwether Teekay LNG Partners (NYSE: TGP). I’m covering Teekay Tankers because it has the most-direct exposure to tankers; parent Teekay Corp (NYSE: TK) is more widely diversified. Teekay Tankers is really just a subsidiary of Teekay Corp.
Teekay Tankers owns nine Aframax carriers and two Suezmax ships. And its parent company owns a total of 32 tankers that would be suitable for Teekay Tankers to acquire. Over time, it will likely gradually acquire many of these ships; this offers the company a cheap way to grow its fleet.
Although Teekay Tankers has locked in rates for about half its fleet this year, the percentage of the fleet covered by charters falls gradually as you move through 2008 and into 2009. Teekay Tankers will gain more spot exposure as the year progresses.
I suspect that Teekay Tankers is trading at a cheap valuation relative to its NAV and on a price-to-earnings basis mainly because it’s a relatively new stock with a limited trading history and low average daily volume. That puts it under the radar screen of many investors.
Also note that, unlike Teekay LNG Partners, Teekay Tankers is taxed as a normal corporation, not as a master limited partnership. Teekay Tankers is added as a buy to the How They Rate Table.
Overseas Shipholding—Overseas Shipholding owns a mix of Aframax tankers, refined product carriers and VLCCs, with a blended average age of about 9 years. Like most of the firms in the above table, Overseas Shipholding employs a mixed contracting strategy but is more heavily weighted in favor of time charters. Overseas Shipholding has a newbuild order book totaling six Aframax carriers, two Suezmax ships and two VLCCs.
Overseas Shipholding looks cheap on an asset-value basis and has attracted interest from other operators in recent months, including Frontline founder John Fredrickson. But given the strong tanker market and the firm’s heavy contract coverage, Overseas could afford to pay out a more generous dividend, like many of its peers. Overseas Shipholding is a hold in the How They Rate Table.
Knightsbridge Tankers—Knightsbridge owns a fleet of four VLCC ships. These are all older, double-hull ships, with an average age of nearly 13 years.
Knightsbridge’s fleet is heavily covered by time charters, giving it little exposure to the spot market upside near term. The firm does have some exposure, thanks to profit-sharing agreements covering two of its ships, that offers upside in strong tanker markets. Knightsbridge is also getting into the dry-bulk business, buying two newbuild Capesize carriers scheduled for delivery in mid-2009.
Knightsbridge is one of the most expensive tanker firms on the above table and has some of the lowest exposure to the spot market. The upside in this stock is overdone this year. Although the stock could still see upside, based on the halo effect of strong tanker rates, I’m adding Knightsbridge Tankers to the How They Rate Table as a sell.
Note that the ratings in the How They Rate Table are relative. I think most of the tanker stocks will perform well over the next six to 12 months, including Knightsbridge. However, I’m rating it sell because I see better value elsewhere.
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Some analysts are calling into question Centerra’s ownership of a mine in Kyrgyzstan. But this isn’t really material to Cameco.
Uranium prices continue to hover around $59 per pound, well off last year’s highs but also well off their decade lows of less than $10 per pound. The supply/demand balance for uranium looks tight; there’s room for a rebound in prices as utilities return to the market later on this year. Cameco remains a hold in the Wildcatters Portfolio.
CGG Veritas—France-based CGG Veritas is the world’s largest operator of deepwater seismic vessels. The stock has been drifting slightly lower since it reported weak first quarter results. But the main problem from the first quarter is temporary: A mechanical problem with one of its major ships has forced lengthy repairs.
We’ve heard from Schlumberger (NYSE: SLB) and other services firms that there’s been no drop in demand for seismic services. This dip offers a buying opportunity for those not yet in CGG Veritas.
Hercules Offshore—Shallow-water drilling giant Hercules Offshore continues to rally. A fleet status report is expected this week. Many believe that report will show further evidence of strengthening in Hercules’ Gulf of Mexico jackup business. Hercules Offshore remains a buy; I’m raising my buy target to 37.
Sasol—South African energy giant Sasol remains my favorite play on coal-to-liquids and gas-to-liquids technologies. But the stock has remained far above my buy price for weeks. I’m, therefore, cutting Sasol to a hold in the Proven Reserves Portfolio.
In addition to these updates, please note last week’s flash alert. It offers suggestions for hedging many of the big winners in the TES Portfolios.
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Neil, Roger and I will discuss infrastructure, partnerships, utilities, resources and energy, and tell you what to buy and what to sell in 2008.
Click here or call 800-970-4355 and refer to priority code 011361 to attend as our guest.
Thanks to growth in oil trade and global oil demand, investing in tanker stocks can be extraordinarily rewarding. Better still, tanker firms earn huge free cash flow when tanker freight rates are healthy; many return this cash to shareholders as dividends. The result: Some of the firms I outline in today’s issue generate dividend yields of 12 to 17 percent.
In This Issue
But tanker stocks can also be volatile, especially those exposed to the tanker spot market. In this issue, I’ll take a closer look at the factors that differentiate tanker stocks, the fundamentals that drive tanker rates and how to play the current tanker boom.As demand for energy imports increases, tankers will be an increasingly valuable sector. The key to profiting from this industry is understanding what it entails and what separates the winners from the losers. See Tanker Trade.
Oil inventories play a significant role in tanker rates, depending on the time of year. And adverse weather can also impact rates as well. See Tanker Rates.
As oil inventories continue to tighten, imports will be in higher demand. Tankers are the only real solution, and with nearly all ships currently providing service already under contract, demand for tankers will only increase as well, spelling bigger profits for tanker operators. See The Current Outlook.
I’ve had exposure to this market through several Portfolio and How They Rate recommendations. But I see value in others in well. Here’s an update. See How to Play It.
Check on how several Portfolio companies are holding up here. See Portfolio Update.
I’m recommending or reiterating my recommendation in the following stocks:
- CGG Veritas (NYSE: CGV)
- Frontline (NYSE: FRO)
- General Maritime (NYSE: GMR)
- Hercules Offshore (NSDQ: HERO)
- Nordic American Tanker (NYSE: NAT)
- Teekay Tankers (NYSE: TNK)
- Cameco (NYSE: CCJ)
- Knightsbridge Tankers (NSDQ: VLCCF)
- Overseas Shipholding (NYSE: OSG)
- Sasol (NYSE: SSL)
Tanker Trade
Crude oil consumption has certainly been rising in recent years, particularly in the developing world. But an equally important trend is the rise in crude oil traded across international borders. Consider the chart below.Source: BP Statistical Review of World Energy 2008
Total global oil exports have risen 34 percent over the past decade, compared to a rise of just less than 16 percent in total global crude consumption. Trade is growing at more than twice the pace of demand.
It’s also important to note the source of global oil exports. Check out the chart below for a closer look.
Source: BP Statistical Review of World Energy 2008
The largest oil exporters are the Middle East, the former Soviet Union (FSU) and Africa. As you might expect, the Middle East alone accounts for nearly 36 percent of global oil exports; the FSU and Africa each account for roughly 15 percent. These three regions taken together are responsible for two-thirds of global oil trade.
And the world’s reliance on oil trade is only going to increase in coming years. Oil production in key consuming nations such as the US and China is falling or, at the very least, not growing fast enough to keep pace with demand. Therefore, these nations will become increasingly reliant on oil imports to meet demand.
China is a perfect example of this trend at work. Consider that, a decade ago, China imported less than 1 million barrels of oil per day; according to the most recent figures from BP, China now imports more than 4 million barrels per day (bbl/d). That’s a more than fourfold increase in 10 years.
Tankers are key to this global trade in oil. Some 90 percent of all oil shipped from the Middle East is shipped by tanker. Globally, roughly 40 million barrels of oil per day are shipped on tankers; tankers account for just less than three-quarters of global trade.
And longer term, it’s a reasonable assumption that the world’s reliance on tankers will increase. According to the Energy Information Administration (EIA), the Organization for the Petroleum Exporting Countries (OPEC) will actually grow marginally in importance as an oil supplier in coming years. But the EIA also sees most of that supply growth coming from the Persian Gulf region; because oil exports from the Persian Gulf are predominately shipped on tankers, this would raise the importance of tanker trade.
An understanding of the tanker industry is important for reasons other than the potential growth in tanker trade. Tanker rates and chartering activity can offer important clues to broader trends in the crude oil markets.
Much of the world’s tanker capacity isn’t owned directly by major oil producers. Instead, third-party tanker operators own the ships and lease them to companies that need to ship oil. Tanker firms charge a daily fee, or day-rate, for leasing these ships.
There are two basic types of tanker contracts: time charters and spot contracts. Time charters involve leasing ships under long-term, sometimes multi-year contracts at fixed day-rates or rates that adjust based on inflation or some index. Occasionally, time charter contracts also include profit-sharing agreements that allow tanker owners to earn higher rates in extremely tight, strong tanker markets.
Spot contracts are signed based on short-term tanker supply-and-demand conditions. Typically, tankers booked under spot deals are leased for one-off trips. Spot rates can vary wildly based on both seasonal and longer-term factors that I highlight later in today’s issue.
The advantage of time charters is they offer stability and predictability in cash flows over time. Tanker operators with a high proportion of charters won’t experience wild swings in profitability based on volatile spot rates. However, spot contracts typically offer higher returns for tanker owners during strong tanker markets; operators have a sort of tradeoff between stability and a shot at big profits.
Some tanker operators target mainly spot deals, while others have a tendency or stated operational guidelines to sign time charters. Most operators use a blended strategy of mixing time charters and spot deals in an attempt to have the best of both worlds. As a rule of thumb, spot-heavy contractors will outperform firms with heavy exposure to time charters during strong markets for tanker rates.
The other differentiating factor when it comes to tanker operators is the mix of ships in their fleet. There are three important factors to consider when it comes to tanker fleets: ship size, double-hull tanker proportion of the fleet and fleet age.
There are currently around 1,979 crude oil tanker ships operating around the world with a total carrying capacity of 296 million deadweight tons (DWT). DWTs are a measure of a ship’s total weight capacity, including stores, crew, fuel, water and equipment—the higher the DWT capacity, the larger the ship. The table below highlights some of the major classifications of crude oil tanker ships and their size in DWT.
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Tanker Types and Values
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Tanker Type
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DWT (Thousands)
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Approx. 5-Year-Old Value (Millions)
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Comment
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| Aframax | 76-116 | $71 | None |
| Panamax | 55 | 53 | Largest capable of transiting Panama Canal |
| Suezmax | 150 | 95 | Largest capable of transiting Suez Canal |
| VLCC | 200-300 | 144 | Acronym for Very Large Crude Carrier |
Very large crude carrier (VLCC) ships account for about 25 percent of the global oil tanker fleet by number and half the world’s capacity in terms of DWTs. Sometimes you’ll hear the term ultra-large crude carrier (ULCC); these are typically ships with more than 300,000 DWT in capacity. For ease of analysis, I’m including the ULCCs in the VLCC category.
VLCCs are the most valuable type of tanker and cost around $155 million to build new at this time; because of steadily rising raw materials prices and shipyard bottlenecks, that cost is rising. A typical route for a VLCC tanker would be from the Arabian Gulf to Japan or the US Gulf Coast.
According to IMAREX, a tanker data firm, the current rate for shipping crude oil from the Arabian Gulf to Japan is about $157,000 per day. The chart below shows the approximate day-rate for this common VLCC route over the past several months.
Source: Bloomberg, IMAREX
Note these are spot rates; the volatility in rates is clear from this chart. In just the past year, VLCC rates over this route have varied from lows around $35,000 per day to as high as $200,000 per day.
Of course, even at $35,000 per day, a tanker firm is likely making money from its ships. According to tanker giant Frontline’s first quarter release, its cash cost breakeven rate for VLCC ships was around $31,500 per day. Based on those numbers, it’s easy to see just how much a firm like Frontline makes at current rates.
To complicate matters a bit further, tanker rates aren’t always quoted in terms of dollars per day. A common quotation is percent of worldscale. Worldscale is short for Worldwide Tanker Nominal Freight Scale—a scale of standard freight rates between various ports around the world. This scale is published by a London-based firm every year. The higher the worldscale rate, the stronger rates are.
For example, check out the chart below.
Source: Bloomberg
This chart shows the worldscale rates for a VLCC tanker traveling from the Arabian Gulf to the US Gulf Coast over the past several months. It’s clear that the rates for this tanker route have also been firming up in much the same way as for the Arabian Gulf to Japan.
The tanker rate indexes I charted above are based on actual data for tankers chartered through global shipbrokers. Like any other market, rates change from day to day. Many of these brokers publish records of fixtures for tanker ships.
For example, late last week, ExxonMobil chartered a 285,000-DWT, single-hull VLCC tanker from Frontline called the Front Highness. This is one of Frontline’s older, least-valuable ships; it was built in 1991.
The Front Highness is scheduled to load its cargo July 2 in the Arabian Gulf for transport to the Far East (possibly China). The rate charged for this charter is 165 percent of worldscale. This fixture and others like it would enter into the calculation of rate indexes, such as those I highlighted above.
Smaller Suezmax and Aframax tankers are also important to global tanker trade, accounting for 18 percent and 23 percent of global tanker tonnage, respectively. Although not always the case, these ships tend to be used to haul oil over shorter distances.
A common Suezmax route would be from West Africa to the US Atlantic Coast. This charter would cost roughly $70,000 per day at the current time, up from $55,000 earlier this month and down from highs around $90,000 earlier this year. Just as with VLCCs, Suezmax rates can be volatile but have been ticking higher recently.
A common Aframax route would be from the North Sea to Europe. The rate for such a route is also currently around $100,000 per day. Another common route—Kuwait to Singapore—offers current rates closer to $40,000 per day.
A few additional points are worth noting. Older ships tend to receive lower day-rates than more modern vessels; they’re also considered less valuable.
Several providers offer data on exactly what ships are worth. For example, a new VLCC tanker is worth about $155 million, while a 15-year-old VLCC ship is worth around $97 million, according to Bloomberg. Valuing a tanker operator’s fleet requires taking into account not only the types of ships owned but the age of the fleet.
The final consideration is the percentage of ships that are double hulled. Double-hulled tankers are considered far safer against spills than single hulls; in fact, single-hull tankers will likely disappear entirely from the world scene over the next few years.
An international maritime governing body, the International Maritime Organization, has mandated that single-hull tankers be retired and scrapped by 2010. Most have already been scrapped or soon will be. Obviously, single-hull ships are far less valuable; a 15-year-old single hull VLCC is worth less than half a double-hull ship of the same age.
Finally, note the difference between dirty and clean tanker rates. The term clean refers to refined products that don’t leave a residue on the inside of a tanker’s hold. This might include jet fuel or motor gasoline. Dirty refers primarily to crude oil
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Tanker Rates
As you might expect, trends in tanker rates are the most important determinant in underlying tanker stocks. During strong run-ups in rates, tanker stocks, especially those levered to the spot market, tend to perform extraordinarily well.The most-often-quoted index of tanker rates is the Baltic Dirty Index (BDI), published by a group called the Baltic Exchange. The BDI summarizes the performance of tanker rates for a long list of different tanker sizes and tanker routes. It’s an excellent overall indicator of where rates are headed in the tanker space. Check out the chart of the BDI over the past several years.
Source: Bloomberg
The first point to note about this chart is the prominent spikes. These spikes tend to happen every year, primarily during the winter months. Sometimes the high in rates is before the end of the year, and other years, it’s shifted slightly into the new year. In contrast, note how rates are often depressed during the summer months of each.
This really isn’t a big mystery. The reason for these spikes has to do with the time of year when most countries build up inventories of crude oil. The US provides a convenient example. Check out the chart below for a closer look.
Source: EIA, Bloomberg
This chart shows crude oil inventory levels for each year going back to 2003. I normalized the data to make it more directly comparable. What’s clear is that US oil inventories tend to build from late summer through late spring. This is because refiners are attempting to build their stocks of crude oil ahead of the summer driving season—the period of peak demand. In contrast, from roughly May 31 through late August/early September, refiners draw down those inventories.
Because the US only produces about 6.9 million barrels of oil per day and consumes 20.6 million, oil imports are a major factor in building inventories. When refiners are trying to build inventories, they’re likely looking to accept more tanker import deliveries. During these periods, tanker demand is high, which is why rates rise. In contrast, in midsummer, refiners are drawing down their inventories, so demand for tanker shipments is low, as are rates.
The other key feature of the chart is that the seasonal trends aren’t the same every year. Some years rates are generally higher, and the seasonal spikes are of greater magnitude. One such instance was the mid-2004 to early 2005 period. An analysis of the factors that brought about the extraordinarily strong tanker market of the 2004-05 winter season is instructive.
Source: EIA, Bloomberg
The basic construction of this chart is familiar to The Energy Strategist readers: I highlighted several similar charts in the June 4, 2008, issue, Crude Realities. There are four lines on the chart, one representing the actual inventory level, one representing the trailing five-year maximum inventory levels as reported by the EIA, one representing the five-year minimum inventory level and one representing the average level. Because this chart covers the period from early June 2004 through late May 2005, the five-year averages, maximums and minimums are based on the years 1998-99 through 2003-04.
The turquoise line in the chart represents the actual inventory picture during this period of 2004-05. What’s clear is that, from early June through late August, US oil inventories were below the five-year average level. Then, in September, US inventories collapsed to five-year lows, falling below the five-year minimum range. This could be considered a dangerous level; refiners would have been eagerly looking to bring stocks back to more-normal levels.
Although a number of factors conspired to bring those inventories to below-average levels, one of the most obvious was an active hurricane season. The 2004 hurricane season wasn’t quite as destructive from an energy infrastructure standpoint as the 2005 season, but you must remember the context. At the time, 2004 was the most destructive season in recent memory.
According to EIA estimates, Hurricane Ivan, a Category 5 monster, was the worst storm of the year for energy-related interests. The storm shut down US oil production, totaling 27 million barrels; the US needed to import more oil to cover that outage.
But note what happened in the winter of 2004-05. Inventories built up rapidly in the US. By early 2005, in fact, inventories were above average. And by that summer, oil inventories were above the upper end of the average range.
This large build in inventories was accomplished partly by accelerating imports, and this, in turn, caused a shortage of tankers in some markets. Rates for all sorts of tankers shot higher.
Of course, this inventory restocking was only one factor that pushed up tanker rates during this period. Oil demand during this period was also strong in 2004 and 2005. According to the International Energy Agency, global oil demand jumped by 3 million bbl/d in 2004 and a healthy 1.1 million in 2005.
In percentage terms, the 3.5 percent jump in oil demand for 2004 was the highest since 1978. Check out the chart below for a closer look.
Source: BP Statistical Review of World Energy 2008
Strong growth in oil demand spells a strong uptick in global oil trade. And much of this demand growth was met by increased production of oil from the OPEC-10 producers; these nations export most of their oil via tankers, helping to drive more tanker demand.
And we can’t ignore the supply side of the tanker market. Rising oil trade and inventory restocking can pull demand for tankers, but the effect this has on rates depends to a great extent on how many tankers are available for chartering.
Tanker availability depends primarily on two factors: newbuild supply and scrapping. As to the latter point, tankers can be scrapped for any number of reasons. In recent years, the prime reason has been the phaseout of single-hull tankers as mandated by the International Maritime Organization.
And other older tankers are scrapped for the simple reason that the rising cost of raw materials makes them more valuable as a source of metal. Some older tankers are being refitted to operate as floating crude storage facilities, drilling rigs or as floating production platforms.
The second source of new supply is simply newbuild ships. It takes several years to build a new tanker; the exact construction time depends on the type and size of the vessel, as well as the availability of shipyard capacity. A few different data providers offer information on how many new tankers are on order, how many new ships are being ordered and the total size of the tanker fleet.
The tanker supply picture was also bullish back in 2004-05. Check out the following chart.
Source: Bloomberg, Lloyd’s Registry Fairplay
This chart shows the total order book of new tanker ships globally expressed in percentage terms. In other words, the current value of 38.4 percent indicates that new ships are on order with a total DWT equal to 38.4 percent of the total operating global fleet.
This dataset, provided by Lloyd’s Registry, only goes back to the beginning of 2005. However, it’s clear that the order book for new tankers was weak until late 2005 to early 2006. That suggests the tanker supply wasn’t growing quickly back in late 2004 and early 2005.
Bottom line: In 2004-05, rising demand for tankers hit a stagnant supply, causing rates to shoot higher. Exacerbating that problem was an unusual inventory restocking drive in the wake of the 2004 hurricane season.
By way of comparison, we can also see from the chart of the BDI above that the winter of 2006-07 was extremely weak for tanker rates. The normal seasonal spike in rates just wasn’t evident during this time period. Not surprising, some of the same effects that drove the 2004-05 tanker bull market drove the bear market in rate of 2006-07. Check out the chart of US oil inventories during that period.
Source: EIA, Bloomberg
This chart is constructed in a similar fashion to the chart of 2004-05 inventories. As you can seen, US crude oil inventories set new highs throughout the entirety of 2006; in fact, inventories didn’t normalize until mid-2007.
Also note that crude oil stocks actually fell toward the end of 2006. Refiners didn’t need to build stocks of crude because inventories were already bloated. Instead, these companies simply drew down their existing stocks.
I won’t belabor the point by presenting all the details here, but suffice it to say that oil stocks across the developed world were glutted back in 2006. The lack of a normal inventory restocking trend explains, to a large extent, why tanker rates remained depressed during the seasonally strong winter months of 2006-07.
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The Current Outlook
As the long-term chart of the BDI above illustrates, this year has been reminiscent of the 2004-05 period for tanker stocks. Tanker rates saw the largest spike in three years last winter, and we’re currently seeing a highly unusual late-spring spike in tanker rates.There’s no equivalent springtime spike in tanker rates in any of the years covered in the BDI chart above; even in 2004-05, tanker rates were relatively weak in the late spring and summer months. Once again, the inventory data offer a clue as to why tanker rates are so unseasonably strong. Check out the chart below.
Source: EIA, Bloomberg
I highlighted many of these trends in the most recent issues of both TES and The Energy Letter. To summarize, the oil market looks tight right now on an inventory basis. Over the past two weeks, oil inventory drawdowns have been running at a far-faster-than-expected pace.
Inventories looked bloated earlier this year but are now well below average levels; even more interesting, oil inventories are declining now in a period when we should be seeing strong builds in inventory.
And it’s not just the crude oil inventories. Stocks of gasoline and distillates in storage also continue to hover at lower-than-ideal levels. Stocks of both types of refined product are in the lower half of their average range for this time of year.
And without delving into a lengthy discourse, suffice it to say that inventories across the developed world are low for this time of year. According to the EIA’s most-recent, short-term energy outlook, inventory builds in the second quarter across the developed world have been far lower than average.
One year ago, inventories in the developed countries jumped 71 million barrels from the end of the first quarter to the end of the second quarter. This year, the EIA is looking for only a 30-million-barrel increase. This suggests continued tightness in inventories through the remainder of the summer.
Just as in the prior cycles I outlined above, tight oil inventories during a time of year when inventories should be building spells one thing: an uptick in demand for imports. There’s already anecdotal evidence of larger volumes of oil headed west on tankers toward the Atlantic Basin from the Arabian Gulf.
Saudi Arabia, the one country with meaningful spare production capacity, has announced plans to boost its output. Higher Saudi output often means more demand for VLCC ships to transport that crude to supply-constrained markets.
There are a few additional indicators suggesting tight supply. For example, IMAREX, the freight data firm I mentioned above, also offers futures contracts that can give us an idea of expected future tanker rates.
A year ago, the day-rate for a VLCC tanker traveling from the Arabian Gulf to Japan was less than $50,000 per day. Currently, that rate is just more than $150,000—triple the year-ago level. Even more important, look at the forward curve of tanker rates based on IMAREX data.
Source: Bloomberg, IMAREX
This curve shows that the futures market is looking for tanker rates to remain elevated through the summer and into the early fall. These rates represent an unusually high plateau for the summer months.
Other longer-term factors also support rates. For example, as I pointed out in the last issue of TES, US oil demand looks weak in 2008 thanks to sky-high prices and weak economic growth. But in the developing world, demand growth continues to look strong; total global oil demand should see growth of a healthy 1 million bbl/d this year.
Check out the chart of non-OPEC production growth below.
Source: Bloomberg
This chart depicts the EIA’s estimates of non-OPEC oil production growth this year. Note late in 2007, the EIA and International Energy Agency were looking for growth in non-OPEC oil production of more than 1 million bbl/d this year.
But that figure proved hopelessly optimistic. A series of delays to major projects, coupled with faster-than-expected production declines in nations such as the UK and Norway, has cut that growth projection to just 310,000 bbl/d.
With non-OPEC production weak, more oil will need to be transported from OPEC and, in particular, the Arabian Gulf. This is a long, highly profitable journey for tanker ships. And there’s no real alternative to tankers for moving oil out of the region.
Another factor that effectively reduces supply is a practice known as slow-steaming. Tanker ships burn an oil-based fuel known as bunker fuel. By cutting their average speed, tankers can burn less fuel to travel the same distance. It’s essentially akin to us all deciding to drive down the motorway at 35 mph instead of 65 mph to save gasoline.
The downside is that it takes far longer to travel the same distance. Obviously, ships in transit aren’t available for chartering. Slow-steaming takes ships off the global market for longer periods of time. But with bunker costs booming, we’ll likely continue to see a trend toward more slow-steaming tankers.
Finally, there’s the matter of tanker supply. As you can see from the chart of newbuild orders above, the existing fleet of ships currently under order for delivery is equivalent to 40 percent of the existing fleet. That’s a big number, and it’s been rising steadily in recent months.
But this veritable flood of new supply isn’t likely to impact rates in 2008 or even early 2009. A large number of these ships aren’t scheduled for delivery until after the halfway point of 2009. And the scrapping of older ships, including single hulls, will continue helping to offset newbuild supply. Therefore, the supply/demand balance in the tanker industry looks to favor tanker operators through at least mid-2009.
There’s a chance that the supply tightness will continue far beyond that. Specifically, the world’s shipyards are full and near capacity; a number of newer shipyards have limited experience building large-scale tankers. We’ve already seen the construction schedules for some newbuilds slip, and this is likely to continue going forward.
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How to Play It
Tanker stocks have historically followed tanker rates closely, particularly those stocks with heavy exposure to the spot market. The current environment looks positive for rates for the reasons I outlined earlier in this issue and should be great news for tanker stocks as well.The table below certainly isn’t an exhaustive list of tanker stocks, but it includes some of the larger, US-traded tanker names. I offer a few key columns of data for each tanker firm. For the most part, those metrics are common and self-explanatory; however, price to net asset value (Price to NAV) may be unfamiliar.
NAV is nothing more than a measure of the actual current value of these tanker firms’ assets. To calculate NAV, I looked at each firm’s existing, operating fleet of tankers.
Based on the type of tanker and its age, I assigned a value to each ship. These values are based on data provided periodically by Simpson Spence & Young Futures (SSY). This gives an estimate as to the current value of the ships. This differs from the book value of the tankers, which is based on historical costs, not present values.
From this fleet value figure, I added in current assets such as cash and liquid assets. I then subtracted debt and other liabilities from the total. The result of this lengthy calculation is a rough approximation of the value of each company in liquidation after all debts have been paid off.
Please note that NAV calculations aren’t an exact science. I accorded no value to newbuild ships, and because SSY doesn’t publish values for all ship types, I was forced to make a few approximations based on recent sales data I’ve seen. All the cash and debt values were taken from the firms’ most recent quarterly reports; in most cases, this was the first quarter report.
No two NAV calculations are exactly alike; however, my approximations match roughly what I’ve seen published elsewhere. I’d say that the figures below are, by and large, slightly more conservative than some NAV estimates I’ve read; I attempted to err on the side of caution.
Price to NAV offers a useful valuation metric in the tanker industry. Levels below 1 suggest the firm is trading at a discount to the value of its assets. Check out the table of tanker stocks below.
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Tankers
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Company (Exchange: Symbol)
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Dividend Yield (%)*
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Price to NAV
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Forward Price to Earnings
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Time Charter Coverage 2008 (%)
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Time Charter Coverage 2009 (%)
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YTD Percent Change (%)
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| Frontline (NYSE: FRO) | 15.8 | 1.2 | 11.5 | 39.0 | 30.0 | 60.2 |
| General Maritime (NYSE: GMR) | 7.5 | 0.9 | 13.1 | 67.0 | 55.0 | 13.4 |
| Knightsbridge Tankers (NSDQ: VLCCF) | 9.7 | 1.1 | 13.4 | 100.0 | 70.0 | 34.4 |
| Nordic American Tanker (NYSE: NAT) | 11.9 | 1.3 | 14.3 | 9.0 | 4.0 | 26.8 |
| Overseas Shipping (NYSE: OSG) | 2.1 | 0.9 | 9.4 | 65.0 | 62.0 | 11.4 |
| Teekay Tankers (NYSE: TNK) | 12.0 | 1.1 | 9.7 | 52.0 | 25.0 | 10.0 |
Source: Bloomberg, SSY, Company Reports, The Energy Strategist
Note a few broad trends. First, firms with heavy exposure to the spot market, such as Frontline and Nordic American Tanker, tend to trade at a valuation premium to firms that have heavy time-charter coverage. Second, these spot-market firms have outperformed the group average so far in 2008. That phenomenon is the result of a strong tanker market and high returns in the spot market.
As always, I’ll look to add more oil tanker firms to my coverage universe in upcoming issues. Also note that I’m not including dry-bulk shipping firms to this list. Dry-bulk shippers transport commodities such as coal and iron ore; I’ll leave a detailed description of that industry to an upcoming issue of TES. Here’s a quick rundown of each stock in the table and my current advice on each.
Frontline—Frontline is a spot-market-focused tanker firm with a fleet consisting primarily of VLCC and Suezmax carriers. Frontline has a history of paying out large dividends and, to its credit, has maintained that policy even during relatively weak markets for tankers.
The company has undertaken some innovative strategies to return value to shareholders. For example, Frontline has created several smaller firms over the past few years. One such creation is a company that converts older tankers into useful assets such as floating production platforms. And Frontline has also formed companies to own some of its ships contracted under long-term time charters. In most cases, Frontline eventually spins off these companies to shareholders as special dividend payments, a way to return cash to shareholders.
Frontline’s fleet consists of a total of 62 tankers, including 38 VLCCs and 16 Suezmax carriers. All but one Suezmax and six VLCC carriers are double-hull tankers. The average age of the fleet is somewhat higher than the industry average: Frontline’s average Suezmax tanker is 11.3 years old, and its average VLCC is 9.3 years old.
To help ameliorate this situation and make up for retiring single hulls, Frontline has a significant order book of new tankers. The list includes eight new Suezmax tankers, with the first due for delivery in the third quarter of this year and the last due in late 2010. And Frontline has 10 VLCC carriers, several with capacities exceeding 300,000 DWT due for delivery from the first quarter of 2009 through the second quarter of 2012.
Frontline’s huge fleet is an advantage because, as I noted earlier, regional tanker markets can offer different returns. Because Frontline has exposure to just about every imaginable tanker market, it’s well placed to benefit from strength no matter where in the world it occurs.
Frontline remains among my favorite tanker stocks longer term and one that I’ve rated a buy in the How They Rate Table for more than a year. I see the valuation premium as generally well deserved, given Frontline’s high dividends and significant spot market coverage. I’m looking for an opportunity to buy into Frontline in the model portfolios; however, the stock looks extended near term.
Nordic American Tanker—Nordic American Tanker owns a fleet of 12 Suezmax carriers with an average fleet age of 8.5 years. All of Nordic American’s tankers are double hulls, and the company has two new Suezmax carriers on order for delivery, one in the fourth quarter of 2009 and one in April 2010. Nordic American’s fleet is impressive when you consider that, in late 2004, the firm owned just three Suezmax carriers.
The firm estimates that its breakeven cost for tankers is just $9,500 per vessel per day, compared to average rates in the first quarter of $46,600. At anything over that breakeven rate, Nordic can pay generous dividends for shareholders.
There’s absolutely nothing to fault with Nordic’s fleet or strategy. The only potential knock against the firm is that it trades at the highest valuation on both a price-to-NAV and price-to-earnings basis of any tanker firm covered in the above table. But much of that is justified by Nordic American’s heavy spot-market exposure and pristine balance sheet. I’m adding Nordic American Tanker to the Gushers Portfolio as a buy under 42 with a stop at 31.25.
Note that this is a wide stop for Nordic and that I’m adding it to my Gusher Portfolio because of the inherent volatility of the tanker market. Don’t be fooled into thinking this is a safe stock by the large dividend yield.
General Maritime (GenMar)—Proven Reserves holding GenMar owns a fleet of 11 Suezmax and 12 Aframax carriers, with an average fleet age of 6.3 years and 12.9 years, respectively. The company employs a mixed time-charter/spot-market contracting strategy. As I noted earlier, the benefit of this is stability; GenMar has locked in nearly $176 million in revenues under contracts for 2008 alone.
The disadvantage: GenMar’s average time charter offers a rate around $36,000 to $38,500 per day, significantly lower than what the company could earn in the spot market right now. For example, a Suezmax operating between West Africa and the US Atlantic Coast could earn in the $68,000 to $70,000 per day range in the spot market today.
GenMar has two Suezmax ships scheduled for delivery over the next year, and the company has been expanding its fleet in other ways as well. For example, GenMar recently bought two 6-year-old Aframax tankers from a Belgian shipper for $137 million.
Finally, General Maritime offers a 7.5 percent dividend yield and has been buying back stock in recent quarters. Trading at a significant discount to NAV with considerable upside from the strong spot market, General Maritime remains a buy in the Proven Reserves Portfolio.
Teekay Tankers—There are several firms bearing the Teekay name, including Proven Reserves bellwether Teekay LNG Partners (NYSE: TGP). I’m covering Teekay Tankers because it has the most-direct exposure to tankers; parent Teekay Corp (NYSE: TK) is more widely diversified. Teekay Tankers is really just a subsidiary of Teekay Corp.
Teekay Tankers owns nine Aframax carriers and two Suezmax ships. And its parent company owns a total of 32 tankers that would be suitable for Teekay Tankers to acquire. Over time, it will likely gradually acquire many of these ships; this offers the company a cheap way to grow its fleet.
Although Teekay Tankers has locked in rates for about half its fleet this year, the percentage of the fleet covered by charters falls gradually as you move through 2008 and into 2009. Teekay Tankers will gain more spot exposure as the year progresses.
I suspect that Teekay Tankers is trading at a cheap valuation relative to its NAV and on a price-to-earnings basis mainly because it’s a relatively new stock with a limited trading history and low average daily volume. That puts it under the radar screen of many investors.
Also note that, unlike Teekay LNG Partners, Teekay Tankers is taxed as a normal corporation, not as a master limited partnership. Teekay Tankers is added as a buy to the How They Rate Table.
Overseas Shipholding—Overseas Shipholding owns a mix of Aframax tankers, refined product carriers and VLCCs, with a blended average age of about 9 years. Like most of the firms in the above table, Overseas Shipholding employs a mixed contracting strategy but is more heavily weighted in favor of time charters. Overseas Shipholding has a newbuild order book totaling six Aframax carriers, two Suezmax ships and two VLCCs.
Overseas Shipholding looks cheap on an asset-value basis and has attracted interest from other operators in recent months, including Frontline founder John Fredrickson. But given the strong tanker market and the firm’s heavy contract coverage, Overseas could afford to pay out a more generous dividend, like many of its peers. Overseas Shipholding is a hold in the How They Rate Table.
Knightsbridge Tankers—Knightsbridge owns a fleet of four VLCC ships. These are all older, double-hull ships, with an average age of nearly 13 years.
Knightsbridge’s fleet is heavily covered by time charters, giving it little exposure to the spot market upside near term. The firm does have some exposure, thanks to profit-sharing agreements covering two of its ships, that offers upside in strong tanker markets. Knightsbridge is also getting into the dry-bulk business, buying two newbuild Capesize carriers scheduled for delivery in mid-2009.
Knightsbridge is one of the most expensive tanker firms on the above table and has some of the lowest exposure to the spot market. The upside in this stock is overdone this year. Although the stock could still see upside, based on the halo effect of strong tanker rates, I’m adding Knightsbridge Tankers to the How They Rate Table as a sell.
Note that the ratings in the How They Rate Table are relative. I think most of the tanker stocks will perform well over the next six to 12 months, including Knightsbridge. However, I’m rating it sell because I see better value elsewhere.
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Portfolio Update
Cameco—Cameco has sold off somewhat over the past two weeks. Much of the drop is a result of spillover selling from the company’s separately traded gold subsidiary, Centerra Gold.Some analysts are calling into question Centerra’s ownership of a mine in Kyrgyzstan. But this isn’t really material to Cameco.
Uranium prices continue to hover around $59 per pound, well off last year’s highs but also well off their decade lows of less than $10 per pound. The supply/demand balance for uranium looks tight; there’s room for a rebound in prices as utilities return to the market later on this year. Cameco remains a hold in the Wildcatters Portfolio.
CGG Veritas—France-based CGG Veritas is the world’s largest operator of deepwater seismic vessels. The stock has been drifting slightly lower since it reported weak first quarter results. But the main problem from the first quarter is temporary: A mechanical problem with one of its major ships has forced lengthy repairs.
We’ve heard from Schlumberger (NYSE: SLB) and other services firms that there’s been no drop in demand for seismic services. This dip offers a buying opportunity for those not yet in CGG Veritas.
Hercules Offshore—Shallow-water drilling giant Hercules Offshore continues to rally. A fleet status report is expected this week. Many believe that report will show further evidence of strengthening in Hercules’ Gulf of Mexico jackup business. Hercules Offshore remains a buy; I’m raising my buy target to 37.
Sasol—South African energy giant Sasol remains my favorite play on coal-to-liquids and gas-to-liquids technologies. But the stock has remained far above my buy price for weeks. I’m, therefore, cutting Sasol to a hold in the Proven Reserves Portfolio.
In addition to these updates, please note last week’s flash alert. It offers suggestions for hedging many of the big winners in the TES Portfolios.
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Speaking Engagements
Be sure to wear a flower in your hair when you venture west to San Francisco. I’ll be heading to “The City” with Neil George and Roger Conrad Aug. 7-10, 2008, for the San Francisco Money Show.Neil, Roger and I will discuss infrastructure, partnerships, utilities, resources and energy, and tell you what to buy and what to sell in 2008.
Click here or call 800-970-4355 and refer to priority code 011361 to attend as our guest.
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