July 19, the Strait of Hormuz, one of the world’s busiest shipping routes: four powerboats are jolting at high speed over heaving waves heading towards Stena Imperio I, a small, 50,000-tonne oil tanker destined for Saudi Arabia. They are manned by soldiers in balaclavas flying the Iranian flag.
The 23 men on board the tanker, a crew from Lithuania, India, Russia and the Philippines, are caught unawares when a helicopter hovering over their heads starts to drop soldiers on deck. Within minutes the vessel is captured and changes course, turning towards Iranian coastal waters.
The Stena, a Swedish-owned ship sailing under the British flag, was raided in answer to the British Navy’s hijacking, only a week earlier, of an Iranian tanker near Gibraltar, nudged into action by the US.
Peculiarly, neither freight rates nor the oil price moved significantly upwards, either because the markets had already fully digested the growing tensions in the Gulf or they did not believe that the chances of another devastating war in the Middle East had indeed increased.
Some commentators have argued, too, that very little depends on Gulf oil these days, with the US becoming an ever bigger oil producer thanks to ever more efficient ways of extracting oil from shale deposits thought uneconomical only 15 years ago. This is wishful thinking, of course.
The shale bonanza of the US is certainly a crowning achievement of engineering and drilling technology. And growing US exports definitely have a sizable impact on oil prices, keeping them low even when major producers go missing, like Venezuela, Libya, Syria or embargoed Iran.
Yet, of the two trillion tonnes of ‘seaborne’ crude, as the trade by tank ships is called, 36 per cent still pass the Strait of Hormuz. It is one of the busiest shipping corridors in the world – too much black stuff moving through conflict-prone territory to be complacent.
We retail investors may wonder how this affects the share price of those companies that actually own the vessels now cruising at a heightened security risk for ships, cargoes and crews. The risks include not only hijacking but also sabotaging, as recent bomb attacks in the Gulf have highlighted.
It can be expected that the seamen’s salaries and insurance premiums will go up, increasing the cost of operating oil fleets. Will the share price of companies like Frontline, DHT Holdings, Euronav or Scorpio Tankers suffer? Is it worth investing in times of crisis?
The income streams of oil shipping consist of voyage charters, the price charged for single cruises, and time charters, where vessels are typically rented out to oil producers and traders for a year or two. Costs consist of salaries, expenditure for finance and capital, depreciation, insurance of the vessel (not the cargo, which is insured by the charter party) and fuel costs.
The profitability of oil shipping depends on many factors. Economic growth and hence the need for fossil fuels have an impact. The rise of China was a major boost for shipping, while the shrinking need for crude imports in the US had a detrimental effect.
I do not see the world, alas, being weaned off crude oil any time soon
Business cycles are signified by boom and bust. A dearth of transport in 2007 for instance catapulted freight rates from $20,000 per day to more than $300,000 in a short time. In 2012 rates plummeted to $7,000, less than the average of $12,000 daily expenses needed to keep tankers going. At the heart of it is the supply of new ships coming to the market.
The dramatic price rise in freight costs in 2007 led to an order frenzy of new crude carriers. This resulted in a glut of idle capacity, reducing rates into loss-making territory. Many brand new tankers were all of a sudden worth much less on the second-hand market, damaging the balance sheets of shipowners and forcing them into fire sales and even bankruptcy.
Substantial income is derived from tankers which do not sail. Commodity markets are normally characterised by a ‘contango’ situation, where the price of future deliveries is higher than the achievable spot price. This is explained by the cost of securing future deliveries, optimistic growth expectations and the compounded costs of term finance.
In such situations shrewd trading houses will buy cargo today, load it and wait on anchor for future delivery. Such arbitrage possibilities can be highly lucrative, boosting the fortunes of traders like Vitol, Glencore, Trafigura or Gunvor. When margins between the future and present value of crude fall below the costs of such floating storage, charter interest will diminish.
In times of increasing doubts about the health of the economy, when future prices can then fall even below those on the spot market, a situation called ‘backwardation’, the business of renting out ships which just hang around, is all but dead.
For a long time the future of crude transport seemed to be ever bigger vessels, the Ultra Large Crude Carriers as they are called. ULCCs are longer than the Empire State Building is high. The Seawise Giant measures 458 metres and can carry 500,000 metric tonnes of crude.
As most ports were not deep enough for them to land they had to unload into smaller vessels outside the harbour. This seems uneconomical today. Most of these behemoths ended up as permanent storage facilities for the upstream industry.
For those of us who remember the devastation caused by Amoco Cadiz on the coast of Brittany and Exxon Valdez in the Prince William Sound in Alaska, it is a reason to rejoice. For those who invested $120 million per piece it is a rather sad affair – they are now worth much less.
A very interesting point was made by the research house Maritime Strategies International, as was reported by The Financial Times recently. As we should expect a future of declining use of fossil fuels (peak demand) due to climate change-related policies, the total value of the $160 billion worth of tankers should fall in tandem with the value of oil companies, which would see a large part of their crude reserves ‘stranded’.
Oil tankers cannot be converted into anything else. Once you ship less crude many vessels will become idle. Shipowners, for once not ordering too many ships but already owning too many, will struggle to survive as their assets will diminish in value and typically astronomic debt becomes unaffordable.
I consider this an overly optimistic scenario. I do not see the world, alas, being weaned off crude oil any time soon. What will weigh on shipowners much sooner, I hope, will be more stringent environmental regulations, forcing them into upgrading older vessels and paying much higher fuel costs once carbon prices will be added.
A glance at the share prices of the leading players in the tanker business shows some interesting features. No matter if the companies are registered in Monaco, the Bahamas or Belgium, most lead figures are North European, like Frontline CEO John Fredriksen, who is the largest shareholder of both Frontline and DHT Holdings, two of the biggest tanker owners.
These companies carry typically high debt, have an astronomic price/earnings valuation resembling some tech start-ups, good profit margins when they make profit, are rather parsimonious with dividends if they pay any at all and have a balance sheet which is a matter of opinion. Their share prices fluctuate wildly over the years, between 100 per cent gains and 50 per cent falls per year, reflecting market boom and bust, which is a regular incidence.
Scorpio Tankers (today’s share price $28.12) has a market value of $1.45 billion, Euronav NV (€9 per share), the largest such company, is worth €1.75 billion, DHT Holdings ($5.87 per share) has a stock value totalling $0.8 billion and Frontline $1.35 billion with today’s share price of $8. Frontline has a shiningly positive cash flow, which makes it stand out among pears. It has therefore a price to book value of 1.12 which shows too for its fleet of modern vessels. It also has the highest profit margin: 16.80 per cent.
It’s a risky business – unpredictable, exciting, favouring only the most astute gamblers. Family-owned businesses and majority shareholders will do better than us retail investors.
Andreas Weitzer is an independent journalist based in Malta. He reports on the economy, politics and finance. The purpose of his column is to broaden readers’ general financial knowledge and it should not be interpreted as presenting investment advice or advice on the buying and selling of financial products.
andreas.weitzer@timesofmalta.com