We are in erratic times with the price of oil, making any investment in the energy sector inherently unpredictable. The CBOE Crude Oil Volatility Index (INDEXCBOE: OVX), an index that measures the volatility of crude oil prices, surpassed 60.0 on February 3, a level not seen since 2009. In other words, crude oil prices are more volatile than they have been in over five years.
That makes it difficult to find reliable investment vehicles. According to the Wall Street Journal, in December and January market analysts issued 98 downgrades to energy stocks, but also 62 upgrades, suggesting that investment advice is all over the map.
Seeing as how we here at the Executive Report have also missed some calls on the energy sector during the Great Oil Bust of 2014-2015, we will take a bit of a different tack this week.
Oil Glut? Forget Producers and Refiners, Buy the Shippers
The oil bust means there is a heck of a lot of oil sloshing around. But just because there is oversupply that does not mean that there isn’t demand for oil. While oil demand may not be as high as many had anticipated, it is still at its highest levels on record. The IEA says that global oil demand hit 94.4 million barrels per day in the fourth quarter of 2014, an all-time high and 1 million barrels per day higher than the year before.
As we have mentioned in recent weeks, the collapse in oil prices makes it difficult to find the upstream companies that will provide investors with returns. But one way of profiting from energy is to bet on owners of oil tankers, which are positioned to benefit from demand that keeps on rising.
Not only that, but a collapse in oil prices actually helps oil tanker companies in multiple ways.
First, bunker fuel is cheaper, which means tankers have lower fuel costs when moving oil cargo around the world. For every $10 drop in the price of oil, tankers can save $2,400 per day in lower bunker fuel costs.
Second, simple Econ 101 says that oil demand will rise when prices drop. The fourth quarter IEA figures of global oil demand suggest that tanker companies will have more business moving oil across the globe. Tanker rates in the 3rd quarter of 2014 were $9,000 per day higher than the same period a year before.
Third, not only is demand higher overall, but lower oil prices improve refining margins. This could lead to additional demand growth as refineries churn out extra product and refined petroleum products are put onto tankers.
The fourth reason is perhaps the most interesting. One of the more unusual developments of the oil bust over the past year is the fact that oil for delivery several months in the future is trading much higher than its spot price. This is a phenomenon known as “contango,” which creates its own set of opportunities. This happens because the markets expect an oil glut to persist in the short-term, which should begin to balance out towards the end of 2015.
Oil traders are seeking to capitalize on the peculiar pricing conditions by buying up cheap oil today and storing it for sale at a later date. Some of it is being put into traditional land-based storage tanks at various places around the U.S. and around the world. But traders are also increasingly leasing out large oil tankers and storing oil at sea.
Reuters found that about 12 to 15 million barrels of oil were being stashed at sea on very large crude carriers (VLCCs) as of mid-January. That number will certainly rise over the first and second quarter of 2015 as more traders get into the game. After the financial crisis in 2009, an estimated 100 million barrels of oil were stored at sea, awaiting a higher price.
All of these conditions create an enormous business opportunity for tanker fleets. Let’s take a look at a few.
Teekay Tankers (NYSE: TNK) owns a fleet of crude oil tankers of various sizes, including LNG ships, Aframax, Suezmax, and VLLCs. One of Teekay’s top priorities has been freeing up its fleet to be used increasingly in spot transactions, as opposed to multi-year contracts at fixed daily rates. Why? Because tanker rates are at their highest levels since 2008. With higher spot prices, and Teekay’s clever maneuvering to transition its fleet to 82% spot exposure, the rates it is receiving for bookings are rising (see next two charts). Teekay saw its stock price collapse along with the fall in tanker rates in 2009, but that provides a great entry point for investors as tanker rates tick up.
Another tanker company that will see improved business is Nordic American Tanker Ltd. (NYSE: NAT). Unlike Teekay, Nordic is more of a pure play on oil tankers, as opposed to both oil and refined product tankers. The company just beat analysts’ estimates of with quarterly earnings of $0.01 per share, and was upgraded by Zacks. It also increased its dividend to $0.22 per share, or an 8.44% yield. Another factor that works in favor of the entire tanker sector as a whole is the short-term supply constraints – total tanker fleets are expected to remain relatively constrained, and supplies of Suezmax tankers may even decline in the coming years. That benefits the tanker sector, but Nordic actually announced that it may purchase two Suezmax tankers for delivery in 2016 and 2017. This is a bold move and will set the company up for strong growth prospects over the next few years.
Finally, there is DHT Holdings (NYSE: DHT), another pure play on oil tankers. The edge that DHT has is that its fleet of VLCCs is much larger and also relatively new. This means that it stands to benefit the most on crude oil trade. DHT is also contracting with Hyundai Heavy Industries (KRX:009540) to build six new VLCC tankers, at an average price of about $95.5 million each. DHT is expecting that its revenue will continue to see quarterly improvements through the rest of this year.
Oil tankers are not exactly household names, but they are set to be beneficiaries of the oil bust that has struck over the past six or seven months. Crude oil demand was already rising inexorably upwards, but it should be supercharged because of the fall in prices. That has oil tankers positioned to cash in. The tanker market has been hit over the last few years as rates of declined, but it has finally turned a corner and is poised for growth.