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Spot-Market Blues: A Tale of Two Tanker Companies

By Peter Staas on June 10, 2011

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To say that the past three years have been challenging for companies that own and operate oil tankers is an understatement. At the height of the financial crisis and Great Recession, tanker companies struggled to cope with the evaporation of short-term financing and reduced oil consumption.

The economic recovery has brought little relief for tanker companies with substantial exposure to the spot market, where vessels are available for short-term leases. Although US oil demand continues to recover from its recessionary nadir and consumption in China and other emerging markets has increased markedly, spot rates have recovered only marginally over the past few years.
In many ways, these challenges are the industry’s own doing: Tanker capacity has swamped demand for oil shipments. The roots of this overhang trace back to the last bull market for tankers, when many operators ordered new vessels from shipyards based on overzealous assumptions about demand trends.

The industry’s current order book stands at 137 new vessels–about a third of the existing fleet of double-hulled vessels–62 of which are slated for delivery in 2011 and 59 of which should arrive in 2012. Recognizing their plight, tanker operators have sought to cancel or postpone these orders.

According to the world’s largest supertanker operator Frontline (Norway: FRO, NYSE: FRO), the industry abstained from ordering any very large crude carriers (VLCC) in the first quarter and 28 percent of new vessels slated for delivery during that period have yet to arrive. Moreover, some tanker operators have converted outstanding VLCC orders into carriers capable of carrying liquefied natural gas (LNG), a market where tanker rates continue to climb amid rising demand for natural gas in Europe and Asia. Meanwhile, only 13 Suezmax ships were delivered, a slippage of 43 percent.

From the beginning of the year to June 10, VLCCs traveling from the Middle East to the Far East commanded an average day rate of USD19,129, well below Frontline’s break-even rate of roughly USD29,700 per day. At times, these day rates dipped to as low as USD5,045.

With only 11 percent of its fleet covered by long-term charters in 2012 and break-even rates that offer limited profit margins on an average day rate of USD34,500, Frontline will continue to struggle. Given these challenging fundamentals, it’s little wonder that the company’s Vice President in late May told delegates at Nor-Shipping conference: “We have to go through a lot of pain before we’re into profitable territory. We have just started on a down cycle, which is going to be brutal.”

Frontline’s difficulties stand in stark contrast to Knightsbridge Tankers (NSDQ: VLCCF), a smaller operator that has 77 percent of its tankers booked under time charters.

Knightsbridge owns four VLCC tankers. One ship operates on the spot market and is managed by a cooperative. The other three VLCCs are on time-charter deals: One expires in June 2011, one in May 2012 and the final one in August 2012.

In addition to VLCCs, Knightsbridge also owns two smaller dry-bulk carriers, ships designed to transport dry commodities such as coal, grains and metals. These two ships, both built and put into service last year, aren’t due to come off their time charters until 2014.

Because Knightsbridge’s fleet is small, the single spot VLCC provides some leverage to an improvement in spot rates. Meanwhile, the time-chartered ships offer a bit of income stability that supports the firm’s 9.3 percent dividend yield. And with an average break-even rate of USD18,700 per day, Knightsbridge will have much more flexibility than Frontline when its current time charters expire.

Despite the differences between the two companies, Frontline Chairman John Fredriksen’s bearish outlook on the spot market for supertankers prompted shares of Knightsbridge and other companies with low operating costs and solid time-charter coverage to sell off. Frontline is regarded a bellwether for tanker stocks; many investors assume that the industry’s fortunes follow those of its largest operator.

Investors looking for high yields and attractive valuations would do well to take advantage of this temporary misunderstanding.  The graph below lists the charter coverage for nine prominent tanker companies.



To learn more about Elliott Gue’s top tanker picks, sign up for a free trial of The Energy Strategist.

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