Sometimes even long-term contracts can’t fully protect a master limited partnership from its customers’ woes. That turned out to be the case for three of international shipper Capital Product Partners LP’s (NSDQ: CPLP) charters with Overseas Shipholding Group (OTC: OSGIQ).
The master limited partnership (MLP) typically charters its vessels to top-notch counterparties, such as state-owned energy giants Petrobras (NYSE: PBR) and Pemex. Overseas Shipholding Group (OSG) likely seemed to be of similar quality, as it’s among the largest oil tanker companies in the world. But the company filed for Chapter 11 bankruptcy protection on Nov. 14 after suffering from a steep drop in global shipping rates.
In what appears to be merely a coincidence, CPLP’s unit price hit its 52-week low on unusually high volume the day prior to OSG’s filing. The MLP’s units fell almost 20 percent to $5.79 during the Nov. 13 trading session, but recovered much of that loss by the close. Of course, that timing also coincides with a decline in the broad market and the MLP space, as well as a sharper correction among CPLP’s fellow shippers. CPLP’s units currently trade well above that low (recently at $7.83), though they’re still down more than 13 percent from their one-year high.
Perhaps that mid-November swoon priced in much of the bad news resulting from OSG’s bankruptcy because unit prices barely budged in response to CPLP’s announcement that it had agreed to take a 52 percent haircut on the day rates for its three bareboat charters.
The three medium-range tankers were under long-term charters with OSG subsidiaries through 2018 at a daily rate of $13,000. Under the new proposal, the day rate would drop to $6,250. And that’s still contingent upon approval by both OSG’s board of directors as well as the bankruptcy court.
CPLP also intends to pursue claims during bankruptcy proceedings for the difference between the original contracted rates and the new, lower rates. That loss adds up to roughly $37 million, with the prorated amount equivalent to nearly 5 percent of 2012 revenue.
The MLP’s fleet is largely comprised of medium-range (MR) tankers, with 18 MR tankers, four crude carriers, four container ships, and one dry bulk vessel. The medium-range (MR) tanker market faces substantial pressure due to oversupply resulting from newbuildings that were ordered amid the energy market’s historic ascent during the middle of the last decade. MR tankers typically transport refined petroleum products and are significantly smaller than crude carriers.
In its annual outlook for the tanker market, maritime consultancy McQuilling forecasts that MR tankers will be unprofitable over the next several years as operating costs exceed earnings. However, those estimates may be for standard time charters, as opposed to bareboat charters. Even so, McQuilling’s analysis is still relevant to CPLP, as its fleet has a mix of both types of charters–eight vessels under bareboat charter and 19 under time charter.
Under a standard time charter, the owner of the vessel operates the tanker with its own crew, whereas a bareboat charter involves simply renting out the vessel itself with no crew or provisions. In the latter arrangement, the operating expenses are far lower. In fact, CPLP lists the operating expenses for the three MR tankers under charter to OSG as just $250 per day. By contrast, the operating expenses for some its other vessels under a standard time charter range from $6,500 to $7,000 per day.
CPLP also has a more sanguine view of the MR time charter market than McQuilling. In terms of the supply of vessels, management notes that the orderbook for newbuildings with scheduled deliveries from 2013 to 2017 remains at a relatively low level, equal to roughly 12.6 percent of the current global fleet. For context, 2008 was the past decade’s peak year for orders of newbuildings, which were equivalent to about 50 percent of the worldwide fleet. Meanwhile, slippage remains at elevated levels (recently near 55 percent), as shipping companies postpone newbuilding deliveries due to difficulty securing financing.
Time charter rates also improved dramatically during the fourth quarter, after hitting a low in October. And management expects global production of refined products will slightly outpace fleet growth due to a substantial increase in refinery capacity in Asia and the Middle East.
At the same time, CPLP is also diversifying its fleet to include container vessels, which typically transport manufactured goods. In January, the MLP acquired two post-Panamax container vessels in a dropdown transaction with its general partner in exchange for two of its VLCC (very large crude carrier) tankers. Both container vessels are under charter with the Maersk Line through 2015 at a day rate of $34,000.
Then late last week, CPLP announced that it would be acquiring two additional container vessels from its general partner for $130 million. The new vessels were built this year and are both under 12-year time charters with Hyundai Merchant Marine Co at a day rate of $29,350.
Prior to this transaction, CPLP reported that its existing fleet had an average remaining charter duration of 3.7 years (excluding the three MR tankers under contract with OSG), and that 81 percent of the fleet days in 2013 were already under charter.
Management stated that these acquisitions support the current distribution, while also allowing for the possibility of distribution growth in the future. So it appears that CPLP has already more than offset the loss in cash flow from the three MR tankers under charter with OSG. Indeed, analysts with Wells Fargo believe the distribution is not only sustainable, but that these latest acquisitions will boost 2013 distributable cash flow (DCF) by 5.8 percent and 2014 DCF by 8.4 percent.
Units of CPLP currently yield 11.9 percent. That may sound enticing, but the extraordinarily high yield reflects the significant challenges the MLP faces dues to its exposure to the refined product shipping market. Indeed, units of the MLP have lost 3.1 percent annually over the past five years. Even worse, the MLP’s units have fallen nearly 76 percent from their high of $32.50 in mid-2007.
CPLP’s cumulative annual distribution peaked at $2.28 in 2009 and is currently set at $0.93 per unit, still down almost 60 percent from that earlier payout. Clearly it’s crucial for the MLP to continue diversifying its fleet in order for its distribution to start growing again.
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