Continued from Part 1
The significance of ship orders
One measure that reflects managers’ assessment of future supply and demand differences is the number of ships on order. When managers expect future demand to increase more than supply, if they also expect to generate profits with the investment, they’ll often place new ship orders. But when managers expect excess capacity to continue or grow, they refrain from placing more orders—sometimes even delaying them for a price. So the number of ships on order rising is a positive sign that shipping rates will likely rise in the future. Since tankers generally take more than two years to construct (sometimes up to five years), the metric is often more relevant to long-term investment horizons.
Order activity showing weakness
For the week ending August 2, the number of crude tankers on order as a percentage of existing ships stood at 6.46%, as published by IHS Global Limited last Friday, which was 0.01% higher than the week before. 1 Orderbook as a percentage of existing capacity in deadweight tonnage, however, continued its downtrend, falling from 9.82% to 9.74%.
At the beginning of the year, we saw managers returning to the shipyard to sign contracts for new ships to be constructed. As a result, we saw a turnaround (or possible turnaround) in the number of ships on order and the orderbook. This was encouraging, as it reflects managers’ optimism regarding the long-term outlook of the tanker industry.
Although the number of tankers on order looks to be basing—which is an early sign of a recovery in the near future—the weak turnaround in orders shows that fundamentals aren’t as strong as managers thought, with many uncertainties remaining. Plus, the weakness in the data raises some key questions about who’s buying these assets. Are orders coming from a few major companies, such as Scorpio Tankers Inc. (STNG), which has been aggressively placing new orders for fuel-efficient ships, or is it an industry-wide trend? Perhaps Scorpio is the only major company that’s driving ship orders up and an industry-wide recovery isn’t there yet.
A quick recovery unlikely
Tanker companies are quick in the earnings presentations to discuss the fact that orderbooks are at a record low compared to a few years ago. Although this will certainly provide some great long-term investment opportunities for investors, as low tanker rates won’t last forever, perhaps it’s too early to say that tanker companies are in a recovery this year.
If the industry is recovering, the recovery will likely be slow. Since tankers can take up to five years to construct, this bodes negative for tanker companies such as Scorpio Tankers Inc. (STNG), Nordic American Tanker Ltd. (NAT), Ship Finance International Ltd. (SFL), and Tsakos Energy Navigation Ltd. (TNP), as well as the Guggenheim Shipping ETF (SEA) in the short to medium term.
Learn more about indicators that reflect tanker fundamentals
- Analysts often common-size order figures as a percentage of existing capacity or existing ships to factor in growth of ships over time. ↩
More From Market Realist