Note: This article was originally published November 22nd on Value Investor's Edge, a Seeking Alpha subscription service.
Since the beginning of 2016 spot and time charter rates for crude tankers have been under pressure. This move can be traced to one main factor, an oversupply of vessels in relation to current demand.
The supply-side cycle is often created by owners reacting to market conditions. These orders take some time to hit the water, so conditions may be different than the period in which those orders were made.
This is exactly what happened as rates in late 2014 and throughout 2015 were some of the best in recent years, topping 100k/day for VLCC's a couple times. Owners placed orders just before and during this time. But the large scale of orders as they hit the water began to alter the market and created a disequilibrium trending toward lower rates.
These reactionary owners have now responded to low rates by curtailing orders for newbuilds which has now created a projected shortage of vessels in the future. Of course, this was helped by a couple other factors including tighter credit and private equity fleeing the scene.
Now, looking at the current order book we can now make some future predictions based on this cycle. Additionally, we will discuss another factor that will lead to a rebalancing of this market.
Companies engaged in the ownership of crude tankers include DHT Holdings (NYSE:DHT), Nordic American Tankers (NYSE:NAT), Euronav (NYSE:EURN), Frontline (NYSE:FRO), Gener8 Maritime Inc. (NYSE:GNRT), Navios Maritime Midstream Partners LP (NYSE:NAP), Ship Finance International Limited (NYSE:SFL), Teekay Tankers Ltd. (NYSE:TNK), Tsakos Energy Navigation Ltd. (NYSE:TNP) and Navios Maritime Acquisition Corporation (NYSE:NNA).
On October 25th I published an article entitled "Large Crude Tanker Rates Rebound, But Is This Move Sustainable?" which examined the order book in depth. The conclusion read:
While rates have recovered a bit off the very depressed levels and forecasts for a stronger Q4 seem to be materializing due to several factors, it is far too soon to view this bearish situation as over.
Waning global oil demand coupled with high deliveries in the crude tanker market for larger vessels will begin to really take hold in the first half of 2017, when many of these vessels are scheduled for delivery.
On November 11th, shipbroker Charles R. Weber noted:
The average net growth of crude tanker fleets for 2016 is projected at 5.8%, versus 2.5% during 2015 and ‐0.1% during 2014; during 2017, the number is expected to rise further still, to 7.8%.
After that 7.8% hits the water, newbuilds will slow dramatically for what looks to be an extended period of time.
Typically, it takes about 18-24 months for a VLCC to be delivered these days as starving shipyards commence production almost immediately after a deal is signed.
That 7.8% of supply growth set to hit the water in 2017 represents many of the 72 VLCC's ordered in 2015. But 2016 has seen a drastic shift as only 14 VLCC's have been ordered in 2016.
2013-2014 saw an average of about 40 VLCC's ordered per year over that time which highlights how busy 2015 was and how 2016 has slowed.
This thinning orderbook looks to be setting up a rebalancing of supply starting toward the end of 2017 and moving through 2018, if orders for newbuilds remain in check.
Just a brief side note: Here we are talking about the tanker market as it relates to charter rates which is distinctly different from a stock market which typically discounts stock prices ahead of time.
Crude tankers have a finite life span, typically about 25 years but can vary depending on market conditions. If rates are high, the increased OPEX for an older vessel might be justified and therefore scrapping may be prolonged. Conversely, if rates are low early scrapping may be an option especially if rates are below and/or projected to remain below OPEX for enough of the vessels remaining life span.
Currently, there are 677 VLCC's on the water. However, 125 of those are over 15 years of age with 30 of those being above 20 years. Normally, this wouldn't be big news, but a recent mandate out of the IMO will have a significant impact. Once this mandate comes into effect, or even a bit before that time, a rebalancing of the fleet will begin to take place.
International Maritime Organization
The Ballast Water Management Convention will enter into force on September 8th, 2017.
Ballast water may be taken on board by ships for stability and can contain thousands of aquatic or marine microbes, plants and animals, which are then carried across the globe. Untreated ballast water released at the ship's destination could potentially introduce a new invasive marine species. Hundreds of such invasions have already taken place, sometimes with devastating consequences for the local ecosystem. Ballast water systems are designed to mitigate this damage.
For a VLCC a ballast water system will cost approximately $2.25 million installed. These systems must be installed during the first dry docking following the implementation date.
These drydockings usually are based around mandated special surveys which are also not cheap.
Gibson Shipbrokers offered this insight:
The announcement of the Ballast Water Management Convention will have an impact on the older ships where many may not be considered viable to retrofit in terms of costs versus age and earnings potential.
On November 17th, global shipping consultancy Drewry reported:
Some owners are expected to bring forward fourth special surveys, if they fall around the scheduled deadline, in order to delay retrofitting BWTS to the fifth special survey. But vessel owners for which the survey is due after mid-2018 will probably have to either retro-fit BWTS or scrap their tonnage. The additional cost of retrofitting BWTS along with the special survey will force many owners to scrap younger vessels before the next survey is due.
Drewry's estimates indicate that about 74 crude tankers will have their fourth special survey due between mid-2018 and 2021, making them potential victims of the new regulation.
With the tanker market oversupplied and employment for older vessels increasingly difficult to find, owners may be even more likely to scrap these vessels ahead of the surveys.
In the Q3 earnings call, Gener8 Maritime's CEO, Peter Georgiopoulos stated:
This new environmentally, friendly regulation should not be overlooked. We believe they will change the way as ship owners think about their older assets as well as the behaviour of chaterers.
The implementation of the BWMC is significant for crude tankers since that class has seen the lowest number of demolitions over the past couple years. As rates for bulkers and containers collapsed over the past year or two many owners recycled vessels in anticipation of an extended market downturn to mitigate losses. However, tankers saw a prosperous 2015 and while rates in 2016 have been lower, they were no where near the disastrous rates for other segments. But the BWMC will add an additional cost that some owners of older vessels may not be able to justify. This should prompt an accelerated demolition schedule of older vessels which could promote a rebalancing sooner than would happen otherwise.
Given traditional demolition ages coupled with current orders, global fleet growth is actually projected to be negative in 2018 for the Suezmax segment with VLCCs following that trend in 2019, provided owners can keep orders for new builds under control.
However, the implementation of the IMO's BWMC could have a significant impact on that dynamic. Prior to the implementation of this mandate, 2018 looked to be a safe bet for a rebalancing of the crude tanker market.
Taken in conjunction with a couple more articles on crude which have come out or are in the works, I am paving the way for us to simply be aware that my previous timeline of a recovery in late 2018 may be a tad to pessimistic. When I made that initial prediction there was no BWMC yet and places like China and India had not experienced the shift to greater imports to the degree of where it currently stands.
Leo Vrondissis, CFO of Gener8 Maritime foresees "rates starting to tighten at the end of the third quarter into fourth quarter of next year. That's kind of what basic thesis is."
If that is indeed the case, and the stock market functions in the typical discounting manner, investors may be finding themselves looking at crude tanker stocks earlier than previously anticipated.
Of course, some are better positioned for this recovery than others. Here are some of the qualities that I personally would be looking for ahead of the anticipated market upswing.
There are several companies that are trading well below current NAV, presenting a better value proposition than others. Additionally, some of those have a very high degree of spot exposure. If you are unfamiliar with the term spot exposure, I encourage you to check out my Shipping 101 regarding chartering. Finally, some of those have a very young fleet profile which will be the most desirable to charterers. With a little research those interested in the crude tanker market can begin narrowing down the field to an investable few companies.
Thank you for reading and I welcome all questions/comments.
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Disclosure: I am/we are long STNG, TNP-D.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: I could initiate a long position in any of the listed stocks.