Just one year ago, shares of shipping companies operating very large crude carriers (VLCC) like Frontline (NYSE: FRO), Teekay Tankers (NYSE: TNK) and Scorpio Tankers (NYSE: STNG) were 85-95% off their all-time highs. Since then, many shipping stocks have rallied with some up more than 100%. The question is if this is the beginning of a new bull market or the often seen “dead cat bounce”.
After a vicious 10-year bear market as a result of massive overcapacity (too many ships), demand may start to outstrip supply and shipping stocks may be at an inflection point, due to several developments.
IMO 2020 regulation
IMO 2020 mandates that as of January 1, 2020, all ships must either burn fuel with less than 0.5% sulfur content or install scrubbers to burn traditional bunker fuels. As January 2020 approaches, shippers must either:
Bloomberg reported in July 2019 that the global shipping industry may be “underhedged and – in many cases – wrongly hedged” for IMO 2020 which could very well lead to an increase in rates for product tankers. (“It’s a minute to midnight for IMO2020, Clarkson and Enerjen say”)
In October of this year, daily rates for ships on the benchmark Persian Gulf-China route began to pass the $100,000-a-day mark and amid geopolitical risks these rates briefly soared to $300,391 a day according to data from the Baltic Exchange in London. Those same vessels, which can carry 2 million barrels of crude, were earning $25,000 a day just a month earlier.
The significant operating and financial leverage that is characteristic of many shipping companies, could translate into strong profits for those product tankers that are IMO 2020 ready.
IMO 2030 regulation
Harris Kupperman is a shipping expert who describes the impact of IMO 2030 as follows:
“IMO 2030 is a somewhat ambiguous set of goals by various international acronyms to reduce greenhouse gas emissions in shipping by the year 2030, and further yet again by 2050 (50% global reduction from 2008 levels). As nothing (with actual enforcement power) has been decided, no one knows what the ultimate mandate will look like. However, it’s nearly certain that new regulations will be forthcoming. As you can imagine, a company ordering a vessel today for a 2022 delivery is expecting a 20 to 25-year lifespan for that vessel. If it becomes obsolete in 2030, they will likely take a sizable impairment that cannot be justified to shareholders. Naturally, banks want nothing to do with financing vessels until there is more clarity on regulations.
Until there is clarity on the chosen propulsion system for future vessels, new building orders will likely be restricted. Remember, shipping bull markets typically die from new supply overrunning demand growth. If future supply is restricted at a time when product tanker demand looks set to ramp due to IMO 2020, it could be quite explosive. More importantly, this cycle of elevated rates may be prolonged a good deal due to lack of ordering.”
When not one, but two CEOs in the same industry vote with their money, one pays attention. Over the past three months, Robert Bugbee, the CEO of Scorpio Tankers Inc (NYSE: STNG) purchased call options via three separate transactions on 450,000 common shares (or 4,500 call option contracts) with strike prices of $28, $32 and $33 and an expiration of January 2020 for a total consideration of $1,198,000.
On November 29th, 2019, Robert Hvide Macleod, CEO of Frontline Management AS, purchased 202,000 shares of Frontline (NYSE: FRO). In addition to the stock, he holds options that give him the right to acquire 798,000 more shares.
Of course, even two CEOs do not make a trend. We’ll have to see if they are starting one.
Shipping is a highly cyclical industry with heavy financial leverage. As a result, shipping stocks are highly volatile and very sensitive to ever changing charter rates. The jury is still out on whether these developments will propel shipping stocks higher. In the meantime, it seems an industry worth watching.
Disclosure: Monocot Wealth Management has positions in Frontline (NYSE:FRO), Scorpio Tankers (NYSE: STNG) and Nordic American Tanker Shipping (NYSE: NAT).
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