U.S. Markets closed

Why lower supply growth is not enough for crude tankers

Xun Yao Chen

Key crude tanker trends (October 25–30) (Part 5 of 9)

(Continued from Part 4)

Why is capacity important?

In a commoditized industry, supply is an important metric that directly impacts companies’ top line or revenue performance. When excess supply is building (higher supply compared to demand growth), competition among shipping firms will increase, as firms will try to use idle ships and shipping rates will fall. This will negatively affect companies’ revenues, which also affects earnings, free cash flows, and share prices.

Crude Tanker Capacity Growth (Year-Over-Year) 2013-10-31

Supply growth coming down fast

Year-over-year growth has been falling rapidly lately. In mid-2013, it was at 4.0%. On October 4, it was at 2.68%. Last week, October 25, growth stood at 2.27%, which was slightly higher than 2.20% seen the prior week. These supply growth measures use deadweight tonnage, the weight that ships can safely carry, rather than the number of ships.

Year-over-year growth is often used to adjust for possible seasonality and short-term noise. As figures for demand are often quoted on a year-over-year basis for the same reason, it makes it easier to compare supply and demand.

A coincident or lagging metric

Analysts often consider capacity growth a lagging or coincident indicator. This is because there’s usually a lag between the times managers see increased demand growth, place new orders, and get the vessel delivery.

Conversely, when demand growth is falling, shipping firms can’t simply cancel orders from shipyards. So supply growth could remain elevated and impact shipping rates negatively. Falling capacity growth is negative for shipping companies—unless supply growth does fall below demand growth and rates rise.

Excess supply may persist

It remains questionable whether supply will outpace demand this year. Last year, crude oil export rose 1.4% on an annual basis. According to RS Platou, oil shipments fell by 2.2% during the first seven months of the year because of weak US and Chinese imports. Rates could fall a bit more or stay depressed in the short to medium term, based on current trends.

Waiting for an opportunity down the road

However, lower capacity growth would have a long-term positive impact on supply, shipping rates, and the crude tanker business for stocks like Frontline Ltd. (FRO), Nordic American Tanker Ltd. (NAT), DryShips Inc. (DRYS), and Teekay Tankers Ltd. (TNK)—especially when supply growth is sitting at historically low levels. Bankruptcy is still a possibility, though, so beware. This would also be long-term positive for the Guggenheim Shipping ETF (SEA), but it may be more of a 2014 or 2015 story. In the meantime, it may be time to hibernate.

Continue to Part 6

Browse this series on Market Realist: