Major oil companies such as Exxon Mobil Corp (NYSE: XOM) and Saudi Aramco have locked up about one-third of global tanker capacity by building their own fleets or chartering vessels under long-term contracts.
Independent operators own the remaining two-thirds of global capacity and lease these ships for a daily fee to customers looking to ship or store crude oil.
Some vessels trade in the spot market, where ships are available immediately and pricing reflects prevailing supply and demand conditions; others operate under time charters that pay the owner a fixed day-rate for the duration of the contract.
Shipowners aren’t compensated based on the value of the crude oil or refined products transported in their tankers, nor do they take ownership of these volumes.
Nevertheless, the tanker industry is notoriously cyclical.
In the past, buying these stocks when the supply of available ships begins to shrink and demand strengthens has generated big gains for savvy investors. During the 2002-05 bull market for tankers, many of the largest publicly traded shipowners delivered total returns that exceeded 1,000 percent.
However, the subsequent bust proved equally devastating, with a number of former high flyers slashing their dividends to the bone, undergoing painful restructurings or declaring bankruptcy.
Rising global oil consumption drives demand for tankers to carry deliver this crude and tends to be a positive for day-rates. Accordingly, flat or falling oil prices, which stimulate demand for seaborne imports in China and other key markets, can act as a tailwind for the tanker industry.
In contrast, demand destruction catalyzed by high energy prices often results in falling day-rates and a poor operating environment for independent shipowners.
In this regard, the business cycle for tanker companies differs from most energy-related sectors, which benefit from rising oil prices and constrained supply growth.
The evolution of oil trade patterns also drives tanker demand.
Producers in the Persian Gulf region historically have transported 80 percent to 90 percent of their crude oil via tankers; rising demand for crude oil produced in tanker-dependent OPEC states tends to tighten this shipping market.
Growing tanker traffic on trade routes that involve lengthier voyages also bodea well for demand and day-rates.
On the supply side of the equation, investors must pay attention to ordering activity, the backlog of under-construction tankers and the scrapping of old vessels.
The tanker industry has endured periods of overbuilding and consequent supply gluts throughout its history. Upturns in day-rates sow the seeds of their own demise, as shipowners order new vessels to take advantage and inexperienced operators enter the market on a speculative basis. Inevitably, the growing supply of new vessels leaving the shipyards swings the market into an oversupply, depressing day-rates.
And although most tankers have an operating life of 25 to 30 years, some shipowners may market older vessels more aggressively when day-rates are strong. However, when a supply overhang develops in the tanker market, participants have fewer qualms about decommissioning and scrapping older, less-efficient vessels.
Making money in tanker stocks requires timely entrances and exits; investors should remember that this isn’t a space to buy and hold, despite the appealing yields.
To understand the industry’s prospects for the next few years, let’s examine how the supply and demand dynamics have played out since the early 2000s.
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Elliott and Roger on Jul. 26, 2018
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