Frontline: How To Profit From The Iranian Oil Embargo

| About: Frontline Ltd. (FRO)

Since Europe banned crude oil imports from Iran on 1 July 2012, the Baltic Dry Index has shot up 10% already from 1000 to 1103 (Chart 1). The reason for this spike isn't because Europe is banning crude oil imports from Iran, but rather the consequence of it. Due to this ban, Iran has renewed its threat to close the Strait of Hormuz. Approximately 20% of the world's oil, which is about 35% of seaborne traded oil, passes through this strait. As this strait is closed down, oil tankers need to make a detour, which will increase the price of oil and increase the tanker rates. The availability of tankers will go down due to this forced rechartering of routes, which will decrease oil supply. As a consequence oil tankers will store oil in anticipation of rising oil prices and this will be beneficial to the oil tanker industry. On 4 July 2012, the situation got even worse, with Iran threatening to strike 35 U.S. military bases within minutes. We will see that these events will be beneficial to the Baltic Dry Index and oil prices in general.

First off, the oil price has shot up more than 10% since 1 July 2012 partly due to supply disruption from Iran to Europe. The beneficiary of this event is Russia, which supplies 30% if Europe's need for oil. I already wrote an analysis on this here. The disruption of Iranian oil will not be offset by the production of Saudi Arabian oil as Saudi Arabia is already producing at their maximum capacity. So oil prices will continue to rise due to supply disruption. Investors can buy the Market Vector Russia ETF Trust (RSX) in anticipation of higher oil prices and its benefits to the Russian economy.

Second, the Baltic Dry Index has reacted to this Iran event. The Baltic Dry Index consists of the following ships in order of decreasing deadweight: Capesize, Panamax, Supramax and Handysize. From Charts 1 to 4 we can see that the spike in the Baltic Dry Index was primarily due to the increase in the Baltic Capesize Index, which is the index that tracks transports of minerals and oil through Capesize vessels.

Capesize vessels are typically above 150,000 long tons deadweight (DWT), and ships in this class include oil tankers in the Very Large Crude Carrier (VLCC) and Ultra Large Crude Carrier (ULCC) classes. Most of the crude oil carriers that currently travel through the Strait of Hormuz are VLCCs carrying oil to markets in East Asia. This is why the Baltic Capesize Index is impacted the most here.

(Click to enlarge)

Chart 1: Baltic Dry Index

(Click to enlarge)

Chart 2: Baltic Capesize Index

(Click to enlarge)

Chart 3: Baltic Panamax Index

(Click to enlarge)

Chart 4: Baltic Supramax Index

The dry-bulk shipping industry isn't a sector I would recommend due to the slowing economy. If you really do want to bet on the closing of the strait of Hormuz there is one company I recommend: Frontline (FRO). This company is specialized in oil tankers/dry bulk shipping and has one of the largest VLCC fleets in the world (42 VLCCs). Its fleet composition is mainly VLCC's, so you will be betting on the tanker rate outlook of crude oil carriers (figure 1).

(Click to enlarge)

Figure 1: Frontline ((NYSE:FRO)) Fleet Composition

Dahlman Rose rated Frontline a buy. They currently have a $9.50 price target on the stock. Dahlman Rose said the upgrade was based on a favorable risk/reward scenario with recovering fundamentals and high tanker rates through the next 12 months. Frontline had a dividend yield of 2%, but has recently suspended dividend payment.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

About this article:

Author payment: $35 + $0.01/page view. Authors of PRO articles receive a minimum guaranteed payment of $150-500.
Tagged: , , , Shipping
Want to share your opinion on this article? Add a comment.
Disagree with this article? .
To report a factual error in this article, click here