NYQ:FRO | Oil Tanker Stocks - Sailing To Success Or About To Sink To New Depths?

4th May '20 by Mark Simpson

5 comments 912 reads

The following is a detailed write-up of in investment idea that we covered on Large caps live this morning and thought it would be of interest to readers here.

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For those who’ve not noticed there is a battle going on in the twittersphere. It has been kicked off by the dislocation in the oil price, which in turn has been a consequence of covid19. Let me start with a brief history.

Despite increasing green technology, oil demand over the last decade has increased from about 86mbd in 2010 to just over 100mbd in 2019. Estimates were for it to be 101mbd in 2020.

Until, that is, governments around the work implemented a complete lockdown, travel bans and working from home protocols to try to prevent the exponential transmission of Covid19 overwhelming health services.

This meant that some 20-30mbd were taken out of global demand in under a month. OPEC reacted swiftly by convening a meeting, which then saw Saudi & Russia fall out and both countries reacting by INCREASING oil production rapidly to go after market share.

This meant the front month WTI actually went negative last month. People who owned contracts that meant they had to take physical delivery were unable to obtain the storage they needed and had to sell at any price to avoid taking physical delivery, in effect paying others who had got storage access to take the oil off their hands.

It seems so otherwise fairly sophisticated traders got caught out by this, and we saw Interactive Brokers admit to a potential $80m liability from customer accounts as a consequence of this move.

The negative oil price was only in WTI, since this has to be settled physically in Cushing, Oklahoma – the US oil pipeline crossroads. More flexible contracts such as Brent, named after the UK’s biggest oil field discovery in the 1970s have been weak but nowhere near as volatile as WTI.

The role of storage has kicked off the current twitter debate which centres…

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Macro

4th May '20

Isnt the problem with the Bull case for shipping with respect to WTI that the Oil has to get to the coast via a pipeline from storage at Cushing, and it cant get to the coast in volume because:

1. Cushing is full

2. Cushing likely to stay full until demand can empty it. Demand from the refineries nearer the coast is weak. There can never be enough ship based storage to store all of the production output.

3. Producers have sold their production ahead on the futures market and will continue to produce as lack of storage at Cushing is "not their problem" (yet).

4. Producers want someone (the US Gov?) to pay them to halt production and until then they are motivated finanically to continue.

Mark Simpson

Hi Macro,

Did you mean to write 'the problem with the Bull case'? or 'Bear case'?

Because all those factors you mention are bullish for tankers not problems. They are bearish for the oil price but definitely not for the required storage capacity at sea.

aflash

Tks-useful comparaisons which confirm my conclusion in buying TNK.

Since studying the issue I have seen the price move from 16 to 25 and back down to 19 but it got down to 12 in late February.

Teekay seems a reputable group of companies. They have two other incorporations. One (TGP) Teekay LNG partners is for Liquified Natural Gas and since it is a by-product of fracking I imagine supply will dry up.

To my way of thinking there are two possible solutions:

1. US Gov compensates US producers feeding Cushing not to produce. In effect pay them the value of the futures contracts they enetered into. Outcome is bearish for Tankers. US Gov creates some national control mechanism for domestic production. US Producers are effectively bailed out and so are the banks that financed them. US Energy independence.

2. US Gov doesn't compensate US producers feeding Cushing. US Gov still doesn't introduce a national control mechanism for domestic production level. There is a market failure on WTI futures contracts every month until the US producers hedges have expired (3 - 6 months?). Pipelines and storage remains full until then. Most of the Oil never makes it to the Tankers. Outcome is bearish for Tankers. Many US producers are forced out of business. Many banks that financed them lose a lot of money. US Energy dependence.

5th May '20

Ah that makes more sense, thanks for the clarification.

If the US government pays for not producing then that will reduce oil production and be bearish for tankers, but if the bailout makes up for low prices in order to keep energy independence this would keep production artificially high and be bullish. With no bailout agreed yet this can go against both the potential bull and the bear points.

In reality, WTI & crushing is a bit of side-show, despite getting all of the headlines. Oil from there certainly can make it into tankers, otherwise MBS wouldn't have sent Saudi oil to the US via tanker to heap on the pressure on US oil, but the flow will be minimal if at all, given the refineries for that oil are in the US. Here you are much more likely to see refinery products being tankered offshore, hence the current high LR2/1 rates.

You have to take a global view. Oil production is about 100mbd, it probably increased 2-3mbd in the Russia/Saudi pump war, subsequently OPEC+ agreed to cut 9.7mbd although cheating will see this more like 7 probably. Norway agreed to cut + US shale decline probably takes out another 3, so let's say 10mbd cut and down to 90mbd real production.

Oil is mainly used for road & air transportation and consumption is down around 30mbd during the worst of the lockdown in western economies. The current consensus is that everything is opened up in Q3 and oil consumption bounces back to the 100mbd consumption, leaving a 10mbd shortfall, and the inventory draws in Q3/4 will undo the inventory build of Q2 by the end of 2020, at which point the OPEC+ cuts expire and we are back to a balanced market. Tanker rates go back to just above cost rates in a competitive market with normal utilisation.

That scenario may be what happens, and for the rest of the economy & jobs that is by far the best outcome, but for the reasons given in the original article, then I am not convinced by that outcome personally, mainly due to secondary effects form high unemployment. But then I have never been one for the consensus view.

Oil Tanker Stocks - Sailing to success or about to sink to new depths?

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Mark Simpson

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