Why the crude oil shipping industry could bottom (Part 3 of 9)
The Baltic Dirty Tanker Index
To get a sense of where supply and demand are meeting, look no further than the Baltic Dirty Tanker Index, an index that represents the overall price of transporting crude oil across water. Compiled daily by the Baltic Exchange for rates settled in the spot market on a time charter equivalent basis, it’s widely considered a leading indicator due to its timeliness. When the index rises over the medium to long term, you can expect tanker stocks to benefit from higher rates, as higher rates mean higher earnings.
Rates are depressed
On November 5, the Baltic Dirty Tanker Index stood at 608. Overall, the tanker index remains in a downtrend since late 2009, making new lows on every bounce and trough. However, it has been trying to find support around 580 as shipping companies scrap vessels and many companies aren’t able to cover their operating costs.
Rates have been depressed, as lower U.S. imports and elevated levels of supply growth have negatively impacted fleet utilization—the number of ships that are being employed—despite increases in Chinese imports. As competition rose, shipping rates fell. Although we’ve seen positive signs out of tanker orderbooks, and longer travel distance from the Atlantic to China as well as higher Chinese imports should help rates in the future, the short-term outlook remains negative.
Waiting for a trend reversal
The lower bound of the chart above reflects the rates the industry tries to support. As rates come down, companies will scrap ships, go bankrupt, cancel new deliveries, or delay deliveries. So, as time passes, the industry comprises a fleet portfolio that can do business at cheaper rates.
The upper bound is the level that companies will try to take advantage of by receiving new ships. A breakout of the downtrend will mean there aren’t enough new ships to keep rates low anymore. If that happens, expect tanker stocks to rise—similar to what we’ve seen for dry bulk stocks.
Rates could bounce later than you think
As the orderbook is now at the lowest level seen in several years and most companies aren’t able to cover operating costs at current rates, we’re unlikely to see rates fall much further. According to Wood Mackenzie, China’s oil import is expected to surpass the U.S.’s around 2017. After accounting for longer travel distance from the Atlantic to China, the total demand for tankers may become positive in 2015 and 2016. Since there are two or three more years for that, investors should be cautious. The worst for crude tankers may be over, but companies that aren’t generating positive cash flows could still face bankruptcy or restructuring.
If stocks like Frontline Ltd. (FRO), Nordic American Tanker Ltd. (NAT), Teekay Tankers Ltd. (TNK), and Tsakos Energy Navigation Ltd. (TNP) could survive through the short to medium term, investors would likely be rewarded. Investors looking for safer plays in the crude tanker industry can seek out the Guggenheim Shipping ETF (SEA), which invests in well-financed shipping giants around the world.
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