Frontline - A Turnaround With A Tailwind

| About: Frontline Ltd. (FRO)
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Summary

Chinese demand is lifting Frontline's charter rates off 10 year lows and above breakeven.

Oil market meltdown is creating a deep contango in the futures market and lifting storage demand in repeat of 2008.

Frontline controls 7 percent of the world crude tanker fleet and offers an excellent path to leverage the rate turnaround.

Shares of Frontline Limited (NYSE:FRO) have been catching a bid recently due to rising demand from China and others seeking to take advantage of the steep drop in oil prices. The Norwegian oil tanker company founded and controlled by John Fredriksen recently traded as low as $1.16 per share on concern of mounting losses and that it would be unable to roll a $170 million bond due in April. However, in late November the company released Q314 earnings with average day rates up 40 percent over Q214 and above breakeven. This turnaround in day rates and news of massive Chinese oil deliveries has taken shares of Frontline significantly higher along with the crude tanker group. The renewed demand in the crude tanker market is also being attributed to the deepening contango in the oil market. Together these developments have combined to move industry average daily crude shipping prices above breakeven - tipping the supply/demand equation toward the shipper for the first time in several years.

Mr. Fredriksen and Frontline control 7 percent of the carrying capacity of ship born oil. They own or lease 40 very large crude carriers, VLCC's and Suez-Max's. Mr. Fredriksen entered the crude shipping market in the 1980's, during the Iraq-Iran war when few would risk transport of Iraq or Iranian war zone oil. The world renowned risk taker has built a fortune now estimated at $13.2 billion that includes the world's largest fleet of supertankers, a deep water drilling company and 128 dry bulk carriers. These businesses are cyclical and this summer the world crude tanker fleet was operating at rates 40 percent below breakeven - 10 year lows. In the Q314 conference call held in November, 2014 the Company reported that the crude market had turned and the average Frontline day rate for the quarter was above breakeven by $1,000 for VLCC's and $6,500 Suez-Max's.

Frontline owns or leases 25 VLCC and 14 Suez-Max crude carriers. It will take delivery of one new Suez-Max in January, 2015 with no new ships under construction. The total world fleet of VLCC is 635 with 450 Suez-Max.

VLCC and Suez-Max

Very large crude carriers, VLCC are the largest operating cargo vessels in the world, up to 1,500 feet in length. They carry cargo through the Suez Canal but are too large for some major oil ports. The Suez-Max class is about 1,100 feet in length and the immediate class below VLCC. Suez-Max class can enter most world harbors including those in the Gulf of Mexico. The price of a new VLCC runs between $96 million and $97 million and Suez-Max runs between $65 million and $67 million.

Conference Call

On November 25 Frontline reported earnings for the Q314 with a loss of $.60 per share versus a loss of $.81 per share for Q214. The improvement in earnings was the result of increased charter days and usage rates.

Frontline VLCC

Frontline Suez-Max

Industry average VLCC

Industry average Suez-Max

Day Rates Q214

$12,500

$12,400

$13,000

Day Rates Q314

$23,900

$19,500

$24,600

$13,000

Rates as of 11/25

$35,000

$30,000

Frontline fleet average operating expenses increased from $9,000/day in Q214 to $10,400/day Q314.

Break even rates

Frontline VLCC

Frontline Suez-Max

Q314 Average charter rate/day

$23,900

$24,600

Frontline break even *

$22,900

$18,100

* Break even expenses include fuel, interest cost, corporate overhead, dry-dock and rents. They do not include CapEx.

Market Outlook

Industry utilization rates are increasing. Between 2009 and 2014 the world fleet utilization rate averaged between 80 and 85 percent. Between 2004 and 2009 the average rate was in excess of 85 percent and Management indicated in the Q314 call that the industry is currently approaching the 85 plus utilization rate. Factors contributing to this increase include:

* Geography trading has changed with increased traffic going from the Atlantic to China. This is increasing ton miles versus historic routes from the Middle East to China.

* A strong contango within the oil market is creating a demand for oil storage. While still mostly terrestrial storage may soon spill into the tanker market.

* Lower prices are increasing demand. The International Energy Institute, IEA, estimated Q314 oil demand increased 1.6 million barrels per day versus Q214.

* World demand for oil tanker charters is forecast to increase 3.5 percent in 2015.

Contango in the Oil Market

A contango has developed in the world crude oil markets. A contango is a situation where the futures price of oil is above the spot price, where the market is willing to pay more for oil at some point in the future than the daily price. The arbitrage is profitable when the cost to carry, storage plus interest, is lower than the locked in price of the oil at the time the trade is placed.

Traders often see a deep or steep contango as bottom for oil prices. In 2008 the economic crisis caused a deep contango and put a floor into the market where oil fell from $140 a barrel to $35 a barrel. In 2008 Cushing, OK storage peaked at 35 million barrels. Today, Cushing is storing about 25 million barrels. The 2008 contango was steep enough to include tankers for storage but industry analysts do not believe the current contango has hit levels needed to spur floating storage trades.

China Demand

Recent news reports indicate that as many as 83 VLCC crude carriers are bound for Chinese ports, the largest number since data was initiated in 2011. China may be taking advantage of the low prices to store oil. China's strategic petroleum reserve is scheduled to purchase as much as 50 million barrels through 2015.

Frontline Short Interest

Frontline closing share price on November 28 was $1.28. Short interest on that day was 7.8 million shares or 10.8 percent of the outstanding shares. With an average daily volume at just under 1 million shares, it would take 8 days to cover the outstanding short position.

Beginning on Wednesday, December 12, the share price of Frontline began to move closing at $1.60, up $.30, with almost 4 million shares traded. Since Wednesday, Frontline's share price and trading volume have increased daily with Monday's closing price $2.87 and volume reaching 10 million shares. Given the rapidly changing fundamentals and price action, one could assume that some of this volume is short covering.

Summary

Demand for oil and seagoing crude transportation is increasing because of the drop in oil prices. Chinese buying and a deep contango in the oil futures market are spurring world demand. The rising day rates for VLCC and Suez-Max carriers have turned the operating results for the Frontline.

Conclusion

As a long term follower of John Fredriksen and Frontline, I intrigued to see the dramatic swing in market sentiment for the Company. Mr. Fredriksen is world famous risk taker with a history of betting on the right side. I think he is on the right side of the trade today. I would purchase Frontline anywhere below $5 per share. The reward is much greater than the risk at these prices.

Disclosure: The author is long FRO.

The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.