The price of oil has little to do with the profitability of the tanker operators. Rather, boosting tanker fortunes is the interplay between the balance of worldwide demand for oil and for oil-shipping vessels supply. Driven in large part by increased consumption in China and reinforced by the recovering U.S. economy, global oil demand continues to grow. Bracing the upward pressure on charter fees created by demand growth, new rules requiring safer double-hulled vessels have caused a shortage in supply. Bears will argue the supply/demand scenario has tipped against the shippers. But we believe that, long term, the trend is still working in their favor. The International Energy Association expects global oil demand to rise from 79 mb/d (million barrels per day) in 2003 to 121 mb/d in 2030. In that time, net interregional trade will more than double to 65 mb/d, with most of the sourcing coming from the Middle East. Certainly, some of the increased demand can be met with pipelines. Nonetheless, a large portion of it must be filled using tankers. The IEA predicts that the share of world oil demand traveling through the Strait of Hormuz (the coastal constriction between the Gulf of Oman and the Persian Gulf) will grow from 20% in 2003 to 36% in 2030. The share taken by the Strait of Malacca (between Malaysia and the Indonesian island of Sumatra) will grow from 14% to 20% over those years. China will surely be sucking down a good portion of that growth. The IEA says China became the world's second-largest petroleum consumer in late 2003, besting Japan. Last year, Chinese oil demand grew 15% to 6.37 mb/d, about one-third of U.S. consumption, as oil filled energy and transportation needs. China has only met a small portion of that demand with domestic supply. As a result, crude oil imports soared 75% from 1.38 mb/d in 2002 to 2.42 mb/d in 2004, and now account for 40% of Chinese oil demand. Growth in Chinese demand is expected to slow to 5.7% in 2005, but that's still far above any other region, with the global average at 1.7%. North American demand is expected to grow 0.9%. Special Offer: Value investing beats the market consistently! The Prudent Speculator has returned an annualized 19% for the past 20 years, making it the top-performing newsletter tracked by the Hulbert Financial Digest since 1985. It's also tops for the past ten- and 15-year periods. Click here to check out all of the stocks currently on the Prudent Speculator Thus, growing global oil consumption will continue to bolster demand for tanker services. In the meantime, rising global concern over environmental damage caused by oil spills has dramatically altered the supply side of the equation.
The U.S. Congress passed the Oil Pollution Act in 1990, the year after the Exxon Valdez spilled 11 million gallons of crude oil in Alaska. Under new rules, shippers must use double-hulled vessels to carry oil to and from U.S. ports by 2015. Double-hulled vessels are essentially a ship within a ship, enabling the tanker to sustain extensive damage to its outer hull without spilling its oil contents. Reacting to the disastrous impact the single-hull tanker Prestige had on Spanish and Portuguese coasts when it ran aground in November 2002, the European Union, as of October 2003, no longer allows single-hulled vessels to carry heavy-grade oil (heavy crude, fuel oil and bitumen; the latter is used to make asphalt and tar) to its ports. The EU's decision prompted the International Maritime Organization to hasten its phaseout of single-hulled vessels from 2015 to 2010. As of April of this year, no single-hulled tankers above 5,000 dead-weight-tons are allowed to enter the ports of its 150 member nations--with some exceptions. The shift to double-hulls has had a dramatic impact on the fortunes of those companies able to meet the need. The only major trade routes where single-hulled tankers are still allowed to haul fuel oil are between the U.S. and the Caribbean. On those routes, double-hulled vessels have been able to generate a premium relative to single-hulled ships, as the latter must vie for a lower number of qualifying cargoes. Ship charterers concerned about the potential liability for spills are willing to pay more for peace of mind. As a result, says ship broker Poten & Partners, the day-rate discount on single-hull shipments since January 2004 has been about $10,000 to $12,000.
The concerns investors currently have regarding the tanker business are many, though two remain most prominent. First, the phasing out of older ships has not taken place as rapidly as had been expected. Thus, new additions to global fleets will augment, rather than replace, existing ships. To comply with new rules--and to combat rising prices due to both increased demand and higher steel costs--tanker operators went on a buying spree. Ship broker and research firm P.F. Bassøe estimates that 90 VLCCs (Very Large Crude Carriers) and 75 Suezmax tankers are to be delivered by 2008. Classified according to their capacities, tanker types most commonly discussed are: VLCC, which carry over 200,000 metric tons of oil; Suezmax, which may pass through the Suez Canal and carry 125,000 to 200,000 metric tons of oil; and Aframax, which stands for American Freight Rate Association size, and which carry 80,000 to 125,000 metric tons of oil. The second conern is that easy access to capital has led to the creation of many new competitors, which are eager to cash in on what have been strong global oil-shipping markets. Special Offer: Since May, small-cap growth stocks have come back with a vengeance. Click here to download "Ten Small-Cap Stocks to Buy Now," a new special report from Forbes Growth Investor. Oil shipper Frontline (nyse: FRO - news - people ) spooked investors in May when it said markets were not as strong as they had predicted. Average daily time charter equivalents achieved in the spot and period markets by Frontline's VLCCs and Suezmax tankers were $77,500 and $55,200, respectively, compared with $111,200 and $85,000, respectively, in the fourth quarter of 2004. First-quarter 2004 comparable figures were $74,900 and $59,100, in that same order. As the accompanying chart shows, such volatility isn't uncommon, and so isn't yet worrisome. Day rates will be volatile, but should remain at profitable levels for most shippers. In fact, Bassøe, in its July 1 weekly report, said, "For the first time in a couple of months, the VLCC market has experienced back-to-back weeks of strong activity...the demand/supply balance has definitely improved from the owners' perspectives.” We are currently buyers of Frontline and Ship Finance (nyse: SFL - news - people ). We would be buyers of OMI (nyse: OMM - news - people ), were their share prices to dip back below $20.01. Other oil shippers we have recommended in the past but have not yet closed out include General Maritime (nyse: GMR - news - people ), Overseas Shipholding, Teekay Shipping (nyse: TK - news - people ) and Tsakos Energy (nyse: TNP - news - people ). These companies, on average, are trading at just 5.8-times trailing earnings per share and offer generous dividend yields. Excerpted from the July 2005 issue of The Prudent Speculator, a Forbes Publication By Mark Mowrey Forbes www.forbes.com http://www.forbes.com/investmentnewsletters/2005/07/19/frontline-teekay-omi-vlcc-cz_mm_0718soapbox_inl.html?partner=rss