7 points that reflect tanker fundamentals say recovery isn’t looming (Part 4)

Market Realist

Continued from Part 3

The importance of capacity

Capacity, in a commoditized industry like shipping, is an important metric that directly impacts companies’ top line, or revenue performance. When capacity grows faster than demand, competition will rise among individual shipping firms as they try to use idle ships and cover fixed costs. This will lower day rates, which will negatively affect bottom-line earnings, free cash flows, and share prices for tanker companies.

(Read more: Diana Shipping: the most undervalued dry bulk shipping company)

While ship orders reflect managers’ expectation of future demand and supply, investors also look at capacity growth to get a sense of how fast current supply is growing and whether demand will meet it, instead of simply relying on managers, who can get caught up in the day-to-day operation without seeing the bigger picture.

(Read more: Shipping recovery continues with additional purchases, long-term opportunity)

Elevated supply growth

For the week ending July 12, tanker capacity measured in deadweight (the weight that a ship can safely carry across oceans) grew 3.83% year-over-year—lower than the 4.15% seen last week and 4.40% the week before—based on data provided by IHS Global Limited. This is the lowest increase the industry has seen in at least five years. Capacity growth hit as high as 11% and 8% in 2009 and 2011, as managers got too caught up with an increased flow of business before the financial crisis. As managers expected oil trade to continue to grow rapidly, they placed large orders of new ships, which eventually led to oversupply.

(Read more: Tanker capacity continues to grow faster than demand, negative outlook)

Year-over-year capacity growth has fallen from peak levels because managers refrained from purchasing more new ships when they realized how much they ordered. While this is a positive development, supply growth remains above demand growth. According to RS-Platou, an international ship and offshore brokers and investment bank, the oil trade fell 2.6% during the first four months of this year compared to last year, which was far lower than the supply growth of 4.76% over the same period.

Effect on tankers

This has continued to pressure tankers such as Tsakos Energy Navigation Ltd. (TNP), Ship Finance International Ltd. (SFL), Nordic American Tankers Ltd. (NAT), and Teekay Tankers Ltd. (TNK) earlier this year, even while the broad market rose higher. The Guggenheim Shipping ETF (SEA) has fared better, as several of its holdings are listed in Japan, which has performed well lately. Since construction activity is near a five-year record low (see Part 3), capacity growth should fall further over the next few months. But unless growth falls below demand growth, tanker rates are unlikely to rise.

Learn more about indicators that reflect tanker fundamentals

Continue on to U.S. oil import, Part 5, or go back to see the list of indicators, Part 1.

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