Nobody likes a crash. It doesn’t matter whether we are talking about airplanes or stocks, the word ‘crash’ is often used to describe something catastrophic. What if there are companies or business sectors that are benefiting from a crash? No, not from an airplane crash, but from the collapse of the most valuable energy commodity, crude oil. Tanker companies certainly fall into this category. As much as the turmoil in energy markets are hurting the oil majors, it’s leading to substantial gains for the leading tanker companies in the world. After carefully considering the dynamics of the industry, it’s reasonable to conclude that this business sector provides an attractive investment opportunity for prudent investors. The time horizon for this play is between 1-12 months.
How is the tanker industry benefiting from the oil crash?
Generally, a global decline in business activities is seen as an adverse development for tanker companies. This is because the primary business activity of this industry is to transport oil from one place to another. A decline in economic activities results in a decline in the demand for oil as well, which leads to lower income for the tanker industry. But, this time around, things are very different.
Whenever the demand for oil declined drastically, the OPEC+ alliance and other major oil-producing countries took decisions to cut back the production in a bid to stabilize oil prices. However, things were quite different this time around as Russia did not agree on the supply cuts proposed by Saudi Arabia, resulting in an energy price war. This, on the other hand, has led to an oil glut, even though the OPEC+ alliance agreed on supply cuts a few weeks later.
Declining demand and increasing supply only lead to two things; a significant collapse in crude oil prices and a shortage of oil storage facilities. The second development forms the thesis for oil tanker companies. For instance, Aljazeera reported on April 29 that worldwide storage facilities are operating at 85% utilization levels, meaning that these facilities can only take a very limited number of oil barrels in the coming weeks. The situation in the United States, in particular, is nothing like we have ever seen. Storage facilities in Cushing, Oklahoma are operating at record-high utilization levels, which was the primary reason behind oil’s historic collapse into negative territory on April 20.
The situation is not improving either. Supply cuts are in place to take 10 million barrels of oil out of the market per day, but the demand side impact is estimated to be 30 million barrels a day. Even with the proposed supply cuts, there would be a significant oversupply in the market, meaning that the energy industry is forced to look for innovative storage solutions. And this presents an opportunity for tanker companies to make hay while the sun is shining.
VLCCs, or very large crude carriers, are living their best dreams. These ships can carry around 2 million barrels of oil, and the companies that operate these ships are renting out the ships as temporary storage facilities. Not surprisingly, these companies are charging absurdly high prices for oil companies that are willing to pay premium prices to store oil. For instance, Euronav CEO told The New York Times last week that they are charging close to $300,000 per day for renting out these ships whereas the rates are generally close to $30,000 under normal circumstances. This is a clear indication of the expected earnings of tanker companies in the coming quarters.
The question is, how long will this continue? You never know! Such is the nature of the pandemic. Many thought that this virus would be contained within the borders of China, which was proven to be wrong. Not even the best epidemiologists in the world have an idea as to when things will return to normalcy. Therefore, the demand for tankers could remain at elevated levels for more than 2 months, leading to exponential growth in revenue for the leading companies operating in this industry.
What happens after the party?
Don’t be disheartened if the demand for oil storage facilities decreases drastically following the expected revival of global economic growth. When this happens, global manufacturing activities will increase. Tanker companies would be required to once again perform what they usually do; transport oil from one place to another. The per-day rates will fall, no doubt. But, tanker companies will still make good money with the expected surge in demand for oil transportation vessels. Any investor who is betting on the tanker industry today will continue to benefit even after oil market dynamics return to the normal state.
Tanker stocks to look out for
Euronav (EURN) is one of the companies to look out for as it is the largest independent player in this industry. Teekay (TK), Frontline (FRO), and Nordic American (NAT) are a few other companies that would benefit from the increased demand for tanker storage facilities.
Despite this very attractive opportunity, only the shares of Nordic American have reported gains since the beginning of the year. As illustrated in the below chart, shares of all the other companies have declined in the YTD period.
The best way to play the expected growth of the tanker industry is to avoid Nordic American shares and bet on the other three companies mentioned in this article. This opportunity should be pursued by investors with a time horizon of around 12 months.
The risks of betting on tanker stocks
The primary risk to this thesis is a sudden increase in demand for crude oil in the next couple of months. This could only happen if the major industrial giants such as the United States, the United Kingdom, and India decide to lift mobility restrictions. However, this is a very unlikely scenario as the return to normalcy will be a very slow process. Wuhan, the original epicenter of the virus, is still finding it difficult to get back to business even though it has been close to a month since the economy was reopened.
Doubling down on attractive opportunities when they come along is a recipe for success for any kind of investor. Today, such an opportunity is available with tanker companies. While there are risks involved, the risk-reward profile is favorable for investors. The best way to bet on the expected growth of this industry is to invest in the shares of the largest publicly listed tanker companies.
Disclosure: I am long Euronav shares.
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