Why a tranquil oil tanker space creates investor opportunity (Part 7 of 8)
Rising newbuild prices
Newbuild VLCCs (very large crude carriers) marched higher in March 2014, according to data from R.S. Platou—a leading international ship and offshore broking company. Newbuild prices for VLCCs, the largest common ship used to transport crude oil over long distances, rose from $97.5 million in February to $98.5 million—a 1.03% increase. Prices for Suezmax rose from $64.5 million to $65.0 million in March—a 0.78% increase.
Newbuild prices affect the Guggenheim Shipping ETF (SEA) and tanker companies such as Teekay Tankers Ltd. (TNK), Tsakos Energy Navigation Ltd. (TNP), Frontline Ltd. (FRO), and Nordic American Tanker Ltd. (NAT) because, alongside ship orders, they reflect company managers’ expectation of the industry’s future outlook and profitability.
If the outlook is expected to be favorable, managers will order more ships and push up shipyards’ utilization. Plus, if rates are expected to rise, or even when current rates are attractive to generate profitable returns, buyers will also be more willing to pay for higher prices.
A strong relationship
The close relationship between the Baltic Dirty Tanker Index (a benchmark for crude shipping prices) and newbuild vessel prices might imply shipping companies aren’t likely to invest heavily until they see strong signs that rates are expected to rise, perhaps because these vessels are expensive and industry players are cautious not to overextend and depress returns from past investments. Plus, if newbuild prices and prospective returns are currently high relative to expectations, managers will likely refrain from purchasing newbuilds as much.
Unlike shipping rates in the spot market, newbuild prices are less volatile and aren’t subject to seasonality. While newbuild prices and shipping rates have diverged at times, they’ve more or less followed each other in the past. Plus, since it takes about two or three-plus years to build a tanker, and each costs ~$60 million-plus, managers tend to focus on the longer-term prospects.
Given the historical relationship between newbuild prices and the Baltic Dirty Tanker Index, a newbuild VLCC price of $98.5 million suggests the Baltic Dirty Tanker Index would average 763 this year or in the near future, which is above the current 688 and on par with 2011–2012 averages. If newbuild prices continue to rise, they will likely suggest managers are optimistic.
Browse this series on Market Realist:
- Part 1 - Why a tranquil oil tanker space creates investor opportunity
- Part 2 - Why the Baltic Dirty Tanker Index shows investors must be patient
- Part 3 - The fall in US oil imports was distorted by last year’s numbers
- Commodity Markets