I’ve written about the oil supply/demand often, and my last post about the pipeline business highlighted an inconsistency. Now an article by the Financial Times adds yet another wrinkle to the subject when put in context.
In short, the tanker sector is faced with oversupply, and the rates have collapsed as of last week. From FT:
The executives were speaking amid a slump that has sent the rates paid to charter ships way below vessel operating expenses. The average short-term spot market rate to charter a very large crude carrier – the largest widely-used class – from the Gulf to Far East on Friday stood at just $1,795 per day, compared with the $29,800 that Frontline (NYSE:FRO), the biggest listed tanker operator by fleet capacity, recently said such vessels needed to break even.
For reference, Far East includes China. An article on Minyanville on July 12 had some different numbers, and only two months ago the low rate was $5,045 for a shorter route.
From the beginning of the year to June 10, VLCCs traveling from the Middle East to the Far East commanded an average day rate of $19,129—well below Frontline’s break-even rate of roughly $29,700 per day. At times these day rates dipped to as low as $5,045.
Recently Frontline reported earnings, and had this to say, according to MarketWatch:
Oslo-listed oil tanker giant Frontline Ltd. Friday said it swung to a $35.25 million net loss in the second quarter, from a year-earlier profit of $81.49 million, due to weak demand for tankers that has continued into the third quarter.
The argument for higher oil demand can still carry the day, and the flip side that tanker supply expanded beyond reason could be the cause. A point is made that companies are taking delivery of tankers ordered before the crisis, but the counter-point is that the decline in oil demand was already in motion in the U.S. and Europe during the pre-crisis era, and anyone would be able to see that emerging market demand was hardly compensating.
Thus, the tanker oversupply is curious at best, since one is to believe that executives in the business have very good and reliable information about their markets. I can see a couple of companies taking a misstep, but not a whole industry.
The low rate in the first excerpt above is 94% below the break-even line, and that is not a slight adjustment by any measurement, regardless of industry. In addition, the argument goes that when demand takes into consideration emerging markets, there’s a net increase. Well, what’s the problem then with the tanker market if demand has not dropped considerably, or has actually increased?
In March 2010, The Wall Street Journal indicated that the tanker business had hope for the future, having endured tough times:
Oil-tanker companies, after posting heavy losses in the fourth quarter, are more optimistic for 2010 as the economic recovery is expected to stimulate oil consumption and boost shipping volumes.
At that time I could understand the hope, since we were rebounding. But to learn that even major players are facing bankruptcy – Moody’s downgraded General Maritime (GMR) to Caa3, or just above default – is a bit confusing. The company’s market cap is $48 million, yet as of June it had $1.7 billion in assets and only $1.4 billion in liabilities. Gross fixed assets doubled between 2007 and 2010, while it appears that long-term debt was recently converted to short-term debt to benefit from lower rates. GMR trades for $0.38 and it may still be expensive.
In April of this year, MarketWatch reported that Goldman Sachs had reservations about tanker stocks:
Oil-tanker stocks look risky as the U.S. ramps up domestic crude production, analysts at Goldman Sachs Group Inc. (NYSE:GS) said Thursday. The investment bank said the industry will face a "prolonged down cycle" as the U.S. reduces oil imports from the Middle East, resulting in fewer routes for tankers.
Thus the "unsophisticated" investor may ask: Aren’t the same tankers being used to transport oil to emerging markets? And what exactly justifies the West Texas Intermediate/Brent spread of $26?
The official supply/demand numbers are next in line for some serious inquiries, and as the oil story continues to evolve, we keep looking for the puzzle pieces.