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DHT Holdings: Management Is More Realistic About The Headwinds Than Biased Investors

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About: DHT Holdings, Inc. (DHT)
by: Robert Boslego
Robert Boslego
Portfolio strategy, oil & gas, medium-term horizon
Summary

DHT Holdings share price has dropped 33% since early January, but remains 45% higher than a year ago.

Tanker rates were high, but many of DHT Holdings' ships were stuck in China to benefit.

Now rates are much lower, and the scrubber retrofits were to be done in China and there's no telling how long they will be delayed.

Weak market conditions are being projected for 2020, according to McQuilling Services.

And there is no end in sight to the coronavirus which is decimating China's oil demand, so a short in DHT should be considered.

Note: This research report was first published to subscribers of Boslego Risk Services February 10, 2020.

DHT Holdings Inc. (DHT) share price has fallen about 33% since the start of 2020. However, it still remains about 45% higher than a year ago.

During 2019, expectations grew for how the shipping regulation, IMO 2020, would support tanker fixtures and the earnings of shipping companies when it would go into effect on January 1, 2020. Worries about the availability of supplies of the compliant fuel and its cost fueled beliefs that there would be a shortage of available tanker tonnage and that rates would continue to be very strong in 2020 and beyond.

The enthusiasm went into high gear when the U.S. imposed sanctions on China’s COSCO Dalian shipping unit on September 25th for transporting Iranian crude, which sent VLCC spot shipping rates surging. Momentum investors entered the tanker market as speculators, driving tanker names much higher. Investors who had high expectations for IMO 2020 impacts confused the surge as confirmation of their thesis. So, when the inevitable peaking in tanker rates occurred, their "confirmation bias" was so strong that they remained long tanker names, mistaking the surge in share prices with the arrival of IMO 2020, and disregarding the development of new data that went against any beneficial impact of the regulation.

Confirmation bias is the tendency of individuals who hold a strong position to search desperately for information that confirms a previously held view and to ignore information that refutes it. It is an apophenia - “the general tendency to mistakenly perceive connections and meaning between unrelated things.”

Source: DHT

DHT’s fleet consists of 27 crude oil tankers in the VLCC segment, with 23 in the spot market and 4 on time charter. To comply with IMO 2020, the company retrofitted part of its fleet with scrubbers and also added two new-builds with scrubbers, for a total of 12 tankers.

In 4Q 2019, the spot rate averaged $59,200 across the fleet.

But as of February 4th, the tanker charter equivalent (TCE) spot rates had fallen precipitously. Trygve Munthe, co-CEO, explained in the Q4 2019 Earnings Conference Call on February 6, 2020:

“From the matrix on Slide 8, you see the rate of different TCE returns based on the same roll scale rates. Whilst the non-eco, non-scrubber ship will make about $16,500 a day in the current market, a scrubber fitted eco ship will make more than twice that, namely about $35,400 per day. You can also see that the scrubber premium base and current bunker prices are about $13,700 a day for non-eco ships and $9,400 per day for eco ships. It is lower for the eco ships because of lower consumption, of course. The eco premium is about $9,500 a day for non-scrubber ship, while it drops to $5,200 a day for scrubber fitted ships. The value of the fuel efficiency is lower for the scrubber fitted ships because HFO is cheaper than compliant fuel. And in this context, you may want to note that the composition of our 23 spot ships is such that we would average about $25,600 per day under these world scale and bunker price assumptions.”

Furthermore, he explained issues with their first quarter to date's spot bookings.

“We have frankly been a bit unfortunate with are scheduling. Over the past two months, we have had a number of ships tied up in congestion in Chinese ports. This affected our numbers negatively in two ways: firstly, because these ships were only earning yesterday's demurrage rates when the prevailing market was much higher; and secondly, because the ships missed the opportunity to get fixed when the market was at its strongest. By the time the ships finally came free of the Chinese delays, the spot market had already started receding. Frustrating indeed, but this is how the cookie crumbles for us this time around.”

The company had planned to do retrofits of scrubbers on six more ships,

But the problem is that this work is to be done in China, and we all know how the Wuhan virus has thrown that country into disarray. Right now, the shipyards are not in a position to even do the scheduled work, let alone any additional tanker retrofits. They simply do not know when their full labor force is going to be able to return to work. We are in continuous dialogue with our yard, and we'll certainly do as well as we can within the limits of what is possible. But at this stage, we simply cannot provide you more accurate information on when these six retrofits will happen.”

Finally, he explained the headwinds in the market today that over-compensate for any benefits from IMO 2020:

“The outburst of the coronavirus is playing its part through a variety of factors. It is reducing near-term oil consumption in China by a meaningful number, hence imports and transportation [indiscernible]. The oil prices softened and refining margins have shrunk, reducing economic incentive for refiners to run at high utilization. OPEC is contemplating an additional production cap in response to this in order to manage price. Since September last year, some 26 leases leased, owned by Costco, has been tied up in sanctions preventing them from trading. These ships are now on their way back into the market or might a bit staggered as various operational issues needs to be resolved, such as higher approvals and banking operations made challenging by quarantine imports like Singapore. It is also a time of year that typically sees some reduction of seaborne trade, as refiners prepare for maintenance towards the end of the quarter and beginning of the next.”

“So in sum, we are realistic about the near-term weakness in the stock markets and remain positive of the outlook beyond this.”

To expand on DHT’s market commentary, I am quoting new information from three different reputable sources: Gibson, McQuilling Services, and Bimco. I also include new data from OPEC and Libya.

Rates "Changed Beyond Recognition"

On February 10, shipbroker Gibson reported that:

Just over two weeks ago China imposed a lockdown in Wuhan and other cities in Hubei province in an effort to contain the spread of the deadly coronavirus outbreak. Since then, further quarantines have been put in place, starting to cause disruptions across many global industries. Conditions in the crude tanker market have already changed beyond recognition. Currently, spot VLCC earnings on TD3C (nonscrubber) stand at just $16,000/day, compared to over $115,000/day in early January. The picture is similar for smaller size groups. The fear of coronavirus is not the only factor behind the decline in freight: the news that US sanctions were lifted on COSCO tonnage inevitably dampened the sentiment across the whole crude tanker complex.”

COSCO Sanctions Worth "$45,000/day"

COSCO sanctions were lifted January 31st. And McQuilling Services estimated, “Absent these sanctions, our models suggest that the final three months of 2019 would have resulted in a US $45,000/day downward adjustment to VLCC earnings.” Clearly, the lifting of sanctions has had a major impact on rates, more than offsetting any benefits from IMO 2020.

Gibson also reported:

Crude demand into China is also under pressure, with domestic refineries cutting runs. According to Argus estimates, Chinese refining throughputs declined by at least 840,000 b/d in January, while further cuts are widely anticipated in February. As reported by the Financial Times, executives at China’s largest refineries expect that the country’s oil consumption could fall by 25% this month, equivalent to a staggering 3.2 million b/d.”

Other disruption estimates are discussed in my oil article, which place estimates between two and three million barrels per day.

VLCCs "$24,600/day in 2020"

Looking ahead, McQuilling Services expects a weak freight rate structure in 2020 due to a modest demand growth of 1% resulting from lower-than-previously-expected long haul demand growth from the Atlantic Basis to Asia. Against the slow demand growth, it sees “high net supply growth from the release of floating storage vessels back into the trading fleet, waivers on COSCO tonnage, slower scrubber installation activity and a still formidable delivery schedule of 41 VLCCs this year.”

Gibson also expects delays in scrubber retrofits, resulting in greater availability of tanker supply. "Drydocking, scrubber and Ballast Water Treatment system retrofits in China are getting delayed due to yard closures. However, this also means that vessels that are scheduled for inspections and/or retrofits soon will be unable to do so and may continue trading, if classification societies grant extensions."

“On a weighted average basis, McQuilling Services anticipates spot market earnings for VLCCs to measure US $24,600/day in 2020 on a standard consumption basis, without the benefit of a scrubber.”

"It does remain abundantly clear that an extended shutdown of China will temporarily cripple the shipping markets and hit hard on freight rates,” commented Bimco's shipping analyst. With the coronavirus still in its early stages of the outbreak, the medium- and long-term implications are “immensely difficult” to forecast.

OPEC and Libya Production Cuts

OPEC is considering reducing its exports by an additional 600,000 b/d in the near term, in addition to the cuts announced in December. And that is on top of an outage in Libya, which has reduced production to under 200,000 b/d from 1.1 million. Tankers have left Libya without cargoes.

Conclusions

The road from feast to famine is short in the VLCC market. Confirmation bias has led investors to remain long shipping names, unable to protect themselves or benefit by shifting from long positions to short positions.

DHT has dropped 33% from its peak early this year. But because the stock remains 45% above the year-earlier price, I expect it to continue to drop for as long as the oil demand destruction in China remains high. Therefore, investors should consider a short position in DHT.

Disclosure: I/we have no positions in any stocks mentioned, but may initiate a short position in DHT over the next 72 hours. 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.