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A Timely Play To Capitalize On The Oil Price Drop

This week we take another look at some energy companies that could do well in a low-oil price environment. With WTI sinking to a fresh six-year low, investors should be wary of parking their money upstream at the moment.

As we discussed last week, companies with significant assets downstream are profiting from large margins these days.

Another exciting play is the oil tanker market. Upstream companies are getting their clocks cleaned with low oil prices, but the tanker market actually benefits when crude is selling on the cheap.

Why Oil Tanker Companies are Seeing The Best Market in Years

Teekay Tankers Ltd. (NYSE: TNK) is having a great year. We highlighted Teekay in an Executive Report in February 2015, and since then the stock is up 20 percent.

For the second quarter, Teekay reported earnings of $41.3 million, or $0.35 per share, compared to a loss of $4.1 million a year ago, or a loss of $0.05 per share. The company attributed the turnaround to several market factors working in its favor.

First, is the slow rate of supply expansion in the tanker market. After years of companies building too many new tankers, building has leveled off. Below is a chart from Teekay Tankers showing the slowing build out of new oil tankers. As you can see, up until just last year, the tanker fleet was growing quickly, and the expansion depressed tanker rates, pushing down revenues for all players in the sector. That drag on earnings has finally dissipated. As a result, tanker rates are at their highest level in years. 

ExecReport14Aug

As the chart shows, more tankers have been ordered and will be delivered in 2016 and beyond, so the tight market could be temporary.

But the slowdown in the growth of the tanker fleet came at a wonderful time for tanker operators. Oil prices collapsed, spurring demand for oil across the globe. U.S. motorists are hitting the roads at near record levels, and the same is true for drivers in other parts of the globe. Demand for oil continues to rise, which puts more tankers in demand and bids up their rates.

Moreover, tankers are in demand for oil storage. With global supplies expected to continue to exceed demand by at least 1.4 million barrels per day in the second half of 2015, according to the IEA, that will put more pressure on storage hubs around the world. As onshore storage fills up, tankers at sea are being leased for storage. Again, more demand for tankers improves cash flow.

As a result, tanker rates are surging. For example, daily rates for very large crude carriers (VLCCs) more than doubled in the second quarter of 2015 ($55,570 per day) compared to the same quarter in 2014 ($21,464 per day). The same thing happened with Suezmax tankers ($41,886 in Q215 vs $18,445 in Q214).

Finally, even the trade movements of oil are changing, leading to an increase in long-hauling. The surge in shale output means that less oil is traveling from West Africa to North America – a comparatively short journey – and much of that oil is instead going around the horn of Africa and traveling all the way to East Asia. More oil, taking longer journeys, on a global tanker fleet that is increasingly stretched thin. That has the recipe for a bull market for tanker companies.

Teekay is moving to take advantage of what it sees as the strongest market in years. The company announced its decision to buy 12 modern Suezmax tankers on August 5, a $662 million purchase that will significantly expand its oil tanker fleet. The purchase of the new tankers will reduce the average age of Teekay’s fleet by 1.2 years. Combined with Teekay’s existing 10 Suezmax tankers, the company will become one of the largest owners of Suezmax oil tankers in the world. Even still, with a market cap of just $850 million, there is a large upside for Teekay.

When the ships are delivered in October of this year, they will immediately enter service.

“Teekay Tankers will become one of the largest owners of modern Suezmax tankers at the right point in the tanker market cycle when positive market fundamentals support continued strength in spot tanker rates. Including the five Aframax tankers we acquired earlier this year, this acquisition will increase Teekay Tankers’ owned fleet by over 60 percent and solidifies our position as the largest owner and operator of mid-size crude oil tankers,” Teekya’s CEO Kevin Mackay said in a press release.

He went on to add: “With a larger fleet, we are better positioned take advantage of the growing demand for Suezmaxes resulting from greater long-haul Suezmax movements from the Atlantic to Pacific basins as well as the niche intra-regional voyages that are increasingly stretching Suezmax tonnage supply.”

Teekay’s competitors are doing well too. Euronav (NYSE: EURN), a Belgian-based oil tanker company, has seen its share price hit multiyear highs in July. Euronav reported second quarter earnings of $92.4 million, or $0.58 per share, up dramatically from a loss of $22 million the year before.

Other companies to take a lookat include DHT Holdings (NYSE: DHT), a smaller company that offers investors more exposure. DHT has a market cap of just $680 million, one-fourth that of Euronav. There is also Nordic American Tanker Ltd. (NYSE: NAT), a $1.27 billion company that also offers a nice dividend of 40 cents, or a 10.6 percent yield.

All of these companies are benefiting from the same market conditions that Teekay is experiencing, and all offer potential upside for the near term.

Temporary Play

In the same way that the oil sector sees booms and busts as projects ramp up and down in response to prices, the oil tanker market is an even more extreme example of that. For years the tanker market suffered from low rates due to oversupply. Now that the market is doing great, there have recently been more and more orders for more ships. That means that the bull market should continue for the rest of this year, but could start to sour a bit in the latter half of 2016 as more ships are delivered and push down rates. To be sure, the order book is nowhere near the levels of just a few years ago, but still, more supply is coming.

Investors should keep this in mind and consider investments to be a short-term hedge against any upstream positions




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