Crude Awakening


By Jack O’Connell 2016-01-08 11:38:42
It’s the best tanker market in a decade, says one analyst, and it’s likely to continue.

Last year at this time I did a column on LPG, the “other gas.” It was leading the way in the volatile shipping space, and it continues to outperform. China recently became the largest importer of U.S. LPG, surpassing Mexico and Canada and further driving demand for the gas that is a staple in most parts of the world.

But now there’s a new sheriff in town, and a most unlikely one. He comes in the form of VLCCs, Suezmaxes, Aframaxes and Panamaxes. Yes, the tanker market is back and going full bore with rates up across the board and strong quarterly earnings performances. While the rest of the shipping industry drowns in a sea of overcapacity, tankers represent a lifeline of opportunity.

Low Oil Prices

It’s tempting to attribute the turnaround to low oil prices, and they have certainly been a factor. Low oil prices have fueled an unexpected increase in global oil demand, which had been stagnating in recent years due to crude prices averaging $100/barrel. Now that they’ve been cut in half, demand for oil is booming and so is the need for tankers to transport it.

That, in turn, has translated into higher ton-miles for tankers. Okay, “ton-miles” is one of those cutesy terms that analysts use to measure tanker performance, and I don’t like it either. It means the distance traveled on a particular route multiplied by the number of tons of oil transported. The longer the journey and the more oil carried, the more profitable the voyage.

Which is why VLCCs are leading the way. They have the most capacity (two million barrels or 275,000 tons). They also travel the longest distances (Middle East to China, Middle East to Europe, Middle East to U.S. Gulf). So they’re the most profitable.

Suezmaxes come next in size. They hold about a million barrels or – I’ll let you do the math – (blank) tons of oil. They’re a North Sea favorite. Aframaxes at 800,000 barrels are the preferred mode for West African oil, much of which went to the U.S. in days of yore but now – post-shale oil boom – goes to India and countries in Europe.

By the way, roughly half of global oil production travels by sea. So if global oil output is 90 million barrels a day, about 45 million are shipped by tanker. Every day. Forty-five million more barrels. And if the average voyage is maybe 10 days, well, you can see that you need a lot of tankers. (Okay, here’s my trivia question for the day: What country recently passed the U.S. as the world’s biggest importer of oil?)

The relationship between low oil prices and tanker performance is an interesting one, but – at the risk of embarrassing myself vis-à-vis my colleague Allen Brooks, who knows a lot more about these matters than I do – it’s safe to say that low oil prices are a boon to the tanker business since more oil gets shipped.

If you want to get technical about it, Michael Webber at Wells Fargo Securities says that tanker equities “have carried a -0.72 correlation with crude over the last 12 months, with the group acting as a solid hedge against commodity prices.” In other words, low oil prices are good for tanker stocks and high oil prices not so good. So there!

Other Factors

Low oil prices are not the only reason for the tanker boom, of course. Geopolitical factors are another. What will be the impact of renewed Iranian exports, for example? Or the possibility of U.S. exports, for that matter?

I’m all for U.S. exports, by the way (thanks for asking). They would further increase tanker demand, perhaps leading to more Jones Act tonnage, and they would relieve the supply overhang currently plaguing U.S. producers. More than that, they would stimulateincreased domestic production, thereby keeping prices low on the home front and consumers happy.

Here’s another factor: contango. I know, that’s another of those fancy Wall Street terms designed to confuse the average investor. “Contango” means that future oil prices are higher than current prices (in tech-speak, that contracts for out-month deliveries of oil on the commodity futures trading market are priced at higher levels than contracts for near-month delivery).

When you have contango, you have a strong incentive to use tankers for floating storage. In other words, buy the oil now at a low price, store it onboard a supertanker, and sell it later when the price rises. That’s good for the tanker business.

But the biggest factor underpinning the strong tanker market is no doubt the limited supply of vessels. Unlike the dry bulk and container markets, where overcapacity has driven rates down to below breakeven, tanker owners have exercised remarkable restraint as far as newbuilds are concerned – at least so far. In a recent report, Wells Fargo’s Webber estimates total tanker fleet growth (VLCC, Suezmax, Aframax) at 2.7 percent this year and 6.5 percent next year, which he considers manageable and “supporting relatively strong utilization levels.”

Those “relatively strong utilization levels” have boosted average VLCC rates this year to well north of $60,000/day, more than double the level of a year ago. (Remember, it’s a cyclical business.) Tanker companies are literally “printing money,” to use one of my old friend Gerhard Kurz’s favorite expressions, so enjoy it while you can.

How to Play It

Okay, let’s get down to specifics. The current darling among the tanker group is Euronav NV, a company I’ll admit I never heard of until recently and which somehow has leaped to the top of the hill. The Antwerp-based company has grown by leaps and bounds in the last couple of years and now boasts an industry-leading 57 tankers (mainly VLCCs and Suezmaxes).

Interestingly enough, most are non-eco vessels. They don’t rely on slow-steaming or expensive technology to save on fuel costs. In fact, they can steam as fast as they want and still save money because bunker prices are less than half what they were a year ago. That means faster turnaround times, which pleases customers and gives EURN a leg up on the competition.

Wells Fargo’s Webber recently initiated coverage of EURN with an “Outperform” rating. He says the stock could go to $17 from its current level of $14. Not a big deal, really, but made sweeter by a hefty dividend yield, currently running at close to 10 percent. Like a lot of companies in the shipping and MLP space, EURN has what’s called a “pass-through” dividend payout model, meaning it’s committed to paying out in the form of dividends all or most of its earnings. In EURN’s case, the pass-through rate is 80 percent of operating income.

The gurus at Drewry Maritime Equity Research agree that EURN is a top pick and say the stock could go north of $18. And as the company continues to bulk up, adding vessels and income, dividends will increase.

But EURN is not the only game in town. The same scenario holds true for much of the “dirty” tanker group – DHT Holdings, Nordic American, Tsakos Energy Navigation and Teekay Tankers, to name a few. They all look good and, given the current market dynamics, a rising tide does indeed lift all boats.

“Clean” vs. “Dirty”

“Dirty” tankers, as you savvy readers know, refers to crude oil carriers. “Clean” tankers or clean product carriers refers to tankers that transport diesel fuel and gasoline and jet fuel and other refined products that, by comparison with black oil, are relatively “clean.” And the good news is that product carriers are benefiting from the same rosy conditions that have made crude carriers so profitable in the last 12 months.

Product carriers are smaller than crude carriers. They are also more sophisticated in terms of their construction, often having six or eight or twelve compartments that carry separate products or different grades of gasoline, say. They have names like LR-2s, LR-1s, MRs (no, not “misters” but “medium range”) and Handymax. The biggest, LR-2s, are about the same size as an Aframax (800,000 barrels). The typical product tanker – more than half the global fleet –  is an MR that displaces 50,000 dwt and carries 350,000 barrels.

Scorpio Tankers is a top choice here. Its ticker is STNG – get it? Cowen & Company’s Sam Margolin gives it an “Outperform” rating and thinks the stock could reach $13 (at this writing it’s trading at just over $9). At that price its current dividend yields just over five percent. And if you can get five percent or more on your money these days, grab it!

STNG has a growing fleet of 77 vessels and is one of the biggest players in the product tanker sector. Like its competitors, it’s benefiting from increased exports of distillates (another word for refined products like diesel and gasoline) from both the U.S. and Middle East, many of them headed to Europe and Latin America.

Here’s another company with an attractive dividend and good prospects: Ardmore Shipping. It’s an Irish company, based in Cork City, no less, which is probably why I like it (okay, its corporate address is Bermuda, but we all know what that’s about). The name itself is Irish and means “great height,” which perhaps is a reflection of its ambitions.

Ardmore is much smaller than Scorpio with “just” 24 chemical and product carriers, but they’re all modern eco vessels that command high rates. Ardmore recently adopted a pass-through dividend model amounting to 60 percent of operating income, which at its current price of $12 represents a yield of 10 percent. Now there’s reason to raise a glass, matey, preferably Guinness! – MarEx