Teekay Tankers - The Best Opportunity On The Water

Summary

• Significantly reduced demand caused by COVID-19 paired with inadequate OPEC production cuts has locked crude oil in contango.
• With oil storage dwindling, TNK can leverage their storage capacity to provide oil producers with an alternative storage method.
• TNK’s high proportion of spot rate vessels allows them to benefit from skyrocketing tanker rates, as oil production continues to outweigh demand.

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This article was co-authored by Bayan Alizadeh.

With a market cap just above $750 million, Teekay Tankers (NYSE:TNK) is well poised to benefit from the flood of crude oil in the market, due to inadequate OPEC action and overall reduced demand for oil globally in the midst of COVID-19. At the core level, their business involves transporting oil to where it is needed around the world. With a robust fleet of over 50 tankers, they are capable of carrying both crude oil and clean petroleum on their vessels, which hedges them nicely against the risk of a flattening contango of oil prices in the near future.

Founded in 1973, TNK is the world's largest mid-sized tanker company. The company has transformed from a regional shipping company into one of the world's biggest players in marine energy transportation.

While their usual business revolves around transporting oil, recently the demand for oil storage on tankers has heavily increased due to the global surplus of oil caused by the pandemic. This is great for TNK because instead of taking long haul journeys from Saudi Arabia to China that are extremely costly, TNK can now make more money anchoring offshore. Given that their largest cost is fueling their vessels and that oil storage is in high demand, TNK can now increase their revenue while decreasing their costs by storing oil instead of transporting it.

Beneficial Market Conditions

In the aftermath of the historic expiry of the May futures contract for WTI crude, which saw the price of this contract plummet 321% to an unprecedented level of -$37.63, there continues to be a slump in spot oil prices. A continuous decline in the spot price of crude oil along with busy activity from traders rolling over their current futures contracts to those with a more distant expiry has further amplified the contango spread of this commodity. Contango in the oil market refers to the situation when futures contracts of crude oil are trading above their spot price. Contango is an indication of a near-term oversupply of oil and prompts traders to store this crude oil for future sales when the price has recovered. In the month of April, U.S. Energy firms have already cut the most oil rigs in a single month since 2015, and there are still major storage issues for this oil.

To address this influx of oil on the market earlier this month, OPEC agreed to cut 9.7 million barrels of oil a day, or around 23% of their total production levels in the months of May and June. While this reduction slightly ameliorates the storage issue, it's not proportional to the decline in demand for oil which is estimated to be upwards of 25 million barrels a day. Since these production cuts are scheduled for May instead of being put in place immediately, oil supplies will continue to increase throughout the month of April and further exhaust the limited storage space available on land. While Kuwait has already started cutting its oil production following the OPEC meeting, there still seem to be lingering tensions between Saudi Arabia and Russia due to their conflicting views on production cuts. Such disagreement between these countries originally led to the postponement of the OPEC meeting earlier this month, as Saudis wanted Russia and the other major OPEC producers to share the burden of new production cuts. While a short-term deal has been made involving these two countries, it's possible tensions will continue to escalate leading to more supply issues in the future.

With about 3.2 billion barrels of crude oil already in global inventories, America's largest oil storage facilities are quickly reaching their maximum capacity. Taking a closer look at the rapidly decreasing capacity in the oil storage tanks at Cushing indicates that domestic land storage for oil is being quickly exhausted. With a storage capacity of 76 million barrels Cushing, Oklahoma is home to the largest oil storage containers in the nation and serves as the delivery point for WTI crude oil futures. As WTI contracts are fulfilled, the crude oil is delivered to Cushing where it is stored and sent out through a complex series of pipelines. With May futures contracts expiring earlier this week, the CME Group expects over 2.4 million barrels of crude to be delivered to Cushing in the next month. With diminishing capacity at this facility and land-based storage facilities throughout the world, oil producers will start looking for alternative storage methods like the oil tankers operated by TNK.

Source: Financial Times

Fleet and Pricing Structure

TNK operates a fleet of 55 tankers that carry crude oil and natural gas around the world. The company owns four types of ships including VLCC, Suezmax, Aframax, and LR2. This diversified portfolio allows TNK to operate anywhere in the world.

The Very Large Crude Carrier (VLCC) can hold up to 2 million barrels of oil, making it perfect for crude oil storage in this contango market and transport between continents when demand recovers. The Suezmax, which can hold up to 1 million barrels of crude oil, is the maximum size able to operate in the Suez Canal and allows for easy transport from Saudi Arabia to Europe. The Aframax can carry around 750,000 barrels of oil and has the advantage of relatively small size, allowing it to deliver oil to almost any port in the world. Finally, the Long Range Product Tanker (LR2) is the most flexible tanker in TNK's fleet, able to hold clean petroleum products such as jet fuel and heating gas products, as well as crude oil. The company owns the majority of its fleet outright, allowing them to reel in profit as oil storage becomes a bigger issue around the world.

Out of their fleet of 55 owned and leased vessels, 48 of their tankers operate on a spot-rate pricing model while the remaining are fixed-rate and support vessels. This high proportion of their tankers being operated on spot-rates is advantageous in the current market conditions, considering that spot-rates continue to increase as the contango on oil prices widens and there is increased demand for storage.

Source: TNK Quarterly Report (Q1 2020)

In the past month, the 6-month charter rate for VLCCs has jumped from previously being between $40,000 and $80,000 to nearly $120,000 per day. Considering that VLCCs carry an average of two million barrels of oil, this increased daily rate translates to a cost of $10.80 to store a single barrel of crude oil on these vessels for six months. With the June to December WTI spread at just over $11 a barrel, this barely covers the storage costs and indicates how expensive floating storage on these large oil tankers has become.

Following the trend of increased tanker rates, in the first quarter of 2020, TNK increased its spot tanker rates to $51,700 per day for their Suezmax vessel and $38,600 per day for their Aframax vessels. These were a substantial increase from their fourth quarter of 2019 rates on these vessels which were $39,100 per day and $33,000 per day respectively. Given that the contango in oil prices has considerably steepened in the first quarter of 2020, TNK's spot-rates on their vessels can be expected to further increase, driving additional revenues during this period.

Historical Performance

In 2014, an oil surplus drove crude oil prices from $115 down to below $30 in a matter of months. In the same timeframe, TNK rose from $29.04 on June 2, 2014, up to over $40 in less than 6 months. In 2014, there was a surplus of 2 million barrels of oil per day produced worldwide causing spot prices to rise significantly. However, the COVID-19 pandemic has caused there to be a surplus of up to 35 million barrels of oil per day making oil storage even more vital and spot prices even higher. If history is any indication, TNK has the opportunity to rise significantly in the next several months.

Forecast Revenue Analysis

With tanker companies, the most important figure is the spot rate. The spot rate is the rate charged per day to rent a tanker for short term contracts. Because the spot rate is volatile and accounts for the majority of ships at sea, a higher spot rate can lead to much higher revenue. To demonstrate this, we projected the spot rates for Teekay Tankers fleet in order to see the change in revenue. Due to the increase in oil storage demand, we are projecting an increase in the spot rate per day throughout Q1.

In their last earnings call, TNK stated that the spot price for Q1 would be $51,700 a day for the Suezmax Tankers and $38,600 for the Aframax Tankers, which was a 32% and 17% increase from the previous quarter. This increase was announced in early February before oil storage became increasingly harder to come by.

Based on Teekay Tankers' 4th quarter earnings release where we found the breakdown of rates for each one of TNK's vessels, we projected their revenue given the evolving market conditions of Q1 2020. Considering the demand for oil storage, in our base-case scenario, we are projecting that in Q2 the Suezmax spot rate will be $75,000 and the Aframax spot rate will be $60,000. Given that LR2 is slightly smaller vessels, we projected their spot rate per day will be $50,000, which we determined should be the same as the fixed per day of Suezmax Tankers based on historical analysis. Finally, VLCC's carry double the volume of oil as Suezmax vessels so we projected a spot rate of $100,000 per day. We have provided our base-case analysis below.

Base Case Projection:

Created by Authors, using data from TNK's Quarterly Report (Q1 2020)

Projected Revenue Sensitivity Analysis

To further evaluate the company's possible revenue, we conducted a sensitivity analysis to test different spot rates and examine the revenue values they yielded. While we believe our estimate is conservative, sensitivity testing illustrates how TNK's revenue could be far greater than our estimate. In fact, TNK's revenue is poised to be much higher than in previous quarters. The last time Teekay Tankers beat on revenue was in Q2 and Q3 of 2019, during which the stock jumped over 30% in the 6 month period. We expect there to be a similar jump over the next 2-3 quarters as revenue continues to increase.

Created by Authors, using data from TNK's Quarterly Report (Q1 2020)

Additional Risks

The largest inherent risk to Teekay Tankers arises from the contango on oil prices flattening as the spot price is driven higher due to increased demand for oil. As countries begin to recover from COVID-19 and start opening up their economies, there will be restored demand for crude oil. In China, which is one of the first countries to open up its economy, fuel sales are expected to pick up in the second quarter as the government eases restrictions.

Conclusion

In conclusion, the contango and uncertainty in the oil market make Teekay Tankers a great play over the next several quarters. With crude oil at historically low prices and storage dwindling as the pandemic curbs demand, the company's ability to store millions of barrels of oil will continue to reel in historic revenue at lower operating costs for the foreseeable future. This makes Teekay Tankers a great investment before its earnings report on May 21, 2020.

Analyst’s Disclosure: I am/we are long TNK. 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.