Tag Archives: VLCC

The ‘Joneses’ and the Keystone Pipeline: Not so Strange Bedfellows

The Keystone XL pipeline, bringing primarily Canadian heavy crude from the oil sands of Alberta and West Canada to the US Gulf, celebrated recently its fifth anniversary in the … planning stage.  Like anything energy-related, it’s an expensive (estimated construction cost of more than $7 billion), big scale project (2,100 miles of pipeline with eventual daily capacity of 830,000 barrels of oil or about 10% of the present import oil needs of the US) that would slice through the middle of the US (environmental concerns to be addressed) and potentially serious geo-political implications (between the cheap, plentiful and politically-stable production from Canada and the so-called ‘oil glut’ of domestic production, the ‘Saudi America’ could afford in the future to be more self-centered geo-politically.)

Expected approval for the construction of the pipeline has recently faced renewed, strong opposition, and president Obama – the ultimate decision maker in this case – has set a high hurdle for the approval: it has to be proven that the pipeline will be emissions-neutral in order to get approval; a fairly high order for an energy project, since by definition energy projects suppose to create energy and (most unfortunately emissions; that’s how humans have learned to make energy.)   For now, any decision has been pushed back for the spring next year, but some smart money has started hedging their bets.

The Keystone XL pipeline, whether it gets built or not, whether sooner or later or maybe never, can have implications in the shipping industry, whether for the international flag or Jones Act tanker markets.

Canadian and U.S. Crude Oil Pipelines and Proposal (Source: Courtesy of Canadian Association of Petroleum Producers)

Canadian and U.S. Crude Oil Pipelines and Proposal (Source: Courtesy of Canadian Association of Petroleum Producers)

In a previous post, we discussed the possibility that the Canadians may augment and add new mileage to the pipeline system from West Canada / Alberta heading west to the open sea in an effort to sell their oil to the international market (read China). Kinder Morgan has been working on the TM Expansion to Burnaby (BC) / Anacontes, but the new pipeline project of Enbridge Gateway seems to be running against its own wave of (environmental concerns and) opposition.  The proposed TransCanada Energy East pipeline project (mostly based on converting natural gas pipelines to crude oil pipelines, about 2,800 miles of pipeline, and 1.1 million b/d) could bring Canadian oil eastward and along the border with the US to Québec City and St John, for local processing partially, but mostly for international exports. The TransCanada project could be technically more challenging going through harsh terrain and given the length of the project, the cost of building up the pipeline can be very expensive.  There have been rail routes with substantial spare capacity going both west and east of Alberta, that can theoretically substitute for the pipelines, and they have been doing terrifically in the short term, in terms of capacity and also allowing rail companies to show superb earnings reports.  Canadian oil heading west or east, whether through a pipeline or in rail cars, it will be a positive development of the international tanker industry, as such oil could be loaded on international flag tankers to head west (China and the Pacific Rim, possibly benefiting VLCC and Suezmax tankers), and possibly in smaller quantities moving south onto the few refineries on the US West Coast (USWC), likely benefiting aframax sized tankers.  Crude oil from East Canada, most likely would – given its heavy nature – find buyers in the refineries of the US Gulf Coast (USGC) and international flagged aframax tankers likely would be the main beneficiaries.

Construction of the Keystone XL pipeline likely will be a great benefactor of the Jones Act tanker and the international flag product tankers.  Unlike crude oil produced in the US that cannot be exported according to US law, Canadian oil reaching the USGC through the Keystone XL pipeline can be exported (of course, depriving the US of the benefit of accessing plentiful oil.)  However, based on the economics of the business, given that Canadian oil is heavy and refineries along the USGC are geared toward processing heavy oils (and that’s how they achieve superior margins), Canadian oil coming out of the Keystone pipeline most likely will end getting processed domestically, depriving international flagged crude oil tankers of the potentially new trade.   However, the Jones Act trade, whether for crude oil or refined products would benefit having to move bigger volumes along the Gulf Coast, around Florida, and the Atlantic and East Coasts.  Also, international flagged product tankers would be the other beneficiary of the pipeline based on additional refined product exports.  However, for international product tankers, this may be a mixed blessing and minor negative trade-off from their currently great state where USGC refineries process more West Texas Intermediate (WTI), Louisiana Light Sweet (LLS) and other top quality grades, resulting in higher production of diesel and a better (triangulating) export trade with Europe, as discussed in previous post.

© 2013 Basil M Karatzas & Karatzas Marine Advisors & Co.

No part of this blog can be reproduced by any means and under any circumstances, whatsoever, in whole or in part, without proper attribution or the consent of the copyright and trademark holders.

Shipping Paranoia

In one of the best business books ever written, in our opinion, ‘Only the Paranoid Survive‘ by the former CEO and Chairman of Intel Andy Grove, the then young executive Grove is agonizing with Gordon Moore, co-founder of Intel and brilliant engineer (of the ‘Moore’s Law’ fame in the semiconductor industry), about the price war ensued by the Japanese in the DRAM memory chip business and Intel’s precarious position.

Only the Paranoid Survive

Only the Paranoid Survive

Grove recalls early in the book:

“I looked out the window at the Ferris wheel of the Great America amusement park revolving in the distance, then I turned back to Gordon and I asked, “If we got kicked out and the board brought in a new CEO, what do you think he would do?” Gordon answered without hesitation, “He would get us out of memories.” I stared at him, numb, then said, “Why shouldn’t you and I walk out the door, come back and do it ourselves?”

This may seem like a casual observation, but Intel effectively invented the DRAM chips and Moore’s suggestion to get out the market was almost sacrilegious.  Intel did indeed move away from memory chips and into value-added ‘mother boards’ and laughed all the way to the bank for the next decade or so by riding the ‘Wintel’ infrastructure of the PC market. (Different times, different gadgets!)

It’s amazing how vested people become in a situation, whether job or company or industry. As long as one is on the ‘inside’, the never-ending cyclical path around the water well seems to be a purpose by itself. It takes often some stepping-back in order for one to get a better perspective of the right priorities, like Grove’s insightful question what would a new team with a clean slate and mandate do to solve a problem.  Apparently both Grove and Moore had intimate knowledge of the company, the industry and the engineering behind them and the answer become obvious instantly; a new team may have to spend time on consulting reports, take more time, do their own analysis and possibly could never see the ‘light’.

Shipping and maritime are integral industries in our every day lives, and no doubt they will remain important going forward. However, the dramatic drop in asset prices (compared to 2008 peak pricing levels) has induced a tremendous wave of newbuildings. It almost seems like a race to the shipyards (at least the ones that provide competitive pricing and lenient payment terms) to build more and more vessels in the mainstream markets; bit more fuel efficient than older vessels, bit bigger in cargo capacity within same asset class, bit better standards of workmanship than the ones from fresh yards a few short years ago.  However, in our opinion, the amount in newbuildings is not justified by the market economics and demand for cargo.

2013 09SEP PARANOIA B

We run two basic scenarios evaluating historic returns on major asset classes in shipping: under the first, long-term scenario (TABLE 1), the vessels were bought and paid for at the beginning of 2001 and were held till present; purchase price and residual price are real (nominal) prices and freight rates have been the average freight for the whole period; operating expenses (inclusive drydock) are shown in the table herebelow for each category; also, it is assumed 60% mortgage on the vessels at 6% interest rate. The IRR is calculated for each asset class, and the returns have been ranging from single digit rates (MR tankers with 8%) to highly respectable 37% for capesize vessels. It needs to be noted that historically, 2001 has been a good year for one to enter the market and the almost twelve years of this scenario include the best shipping cycle known to man.

Under the second scenario (TABLE 2), since the beginning of 2006 till present, the same assumptions have been maintained.  Returns however under this scenario range from negative returns to barely adequate of 14% again for capesize vessels.  In 2006 asset prices had already moved significantly higher than 2001 and since then, there has been ‘the best of times and worst of times’ in terms of freight rates with extreme example in early 2008 capesize and VLCC freight rates at $150,000 pd spot market and negative freight rates in 2009 and 2010 (‘back haul’ to reposition vessels).

We acknowledge that our scenarios are rather simplistic by presuming average rates and average financing terms and holding onto the assets, thus excluding any ‘asset play’ (capital gain from asset appreciation) when sometimes where most of the opportunity lies in a highly volatile industry like shipping.

Shipping and maritime are rather risky business and the cost of capital (discount rate) has to be rather high. The achieved historic returns really do not justify an investor being aggressive on acquisition pricing or one orderbook.

Going back to the newbuilding race, are investors are losing the trees for the forest? The vessels for the ocean? Revisiting Grove’s question, if one was not vested in a company or an asset class or the industry, what would have been the ‘right’ thing to do?

© 2013 Basil M Karatzas & Karatzas Marine Advisors & Co.

No part of this blog can be reproduced by any means and under any circumstances, whatsoever, in whole or in part, without proper attribution or the consent of the copyright and trademark holders.

In shipping, hope always springs eternal

Since late spring, freight rates especially in the dry bulk market have improved, and with them, the market mood for the industry has managed to find some much needed buoyancy, at least in the short term. There has been also the completion of the IPO for Ardmore Shipping (ticker: ASC) in the product tanker market, the first shipping IPO in the US markets since Scorpio Tankers (ticker: STNG) went public in March 2010, again in the product tanker market. So far, so good (as long as one ignores the existing product tanker orderbook and the additional orders that have been placed with the proceeds of this IPO.)

At least, in the product tanker market, freight rates have been respectable and have been above cash breakeven levels for most of the time in the last three years. What has been amazing though, it’s the rumor mill that Peter Georgiopoulos and General Maritime Corp. may be chasing a fleet of VLCC tankers, possibly the A.P. Møller Maersk VLCC fleet of about twenty supertankers. Maybe also the highflying Navios Group have their sights on these vessels or on another package of the same asset class, but there is at least an official denial by the company in this case. Møller has announced in the recent past that they are interested in divesting of assets and lines of business that do not fit their competitive advantage in the market place (read anything but containerships, terminals and their related businesses), so there might be some truth to the rumor that a quality, modern fleet of supertankers may be up for sale.  There has been some activity in the VLCC market recently, after a long permafrost season in this market. Recently, Sinochem purchased four VLCCs from the Clipper Group (all vessels were already on long-term charters to Sinochem), HOSCO divested of two very young VLCCs to European buyers and Mitsui OSK Lines have sold four VLCCs in the spring this year; with the exception of the MOSK Lines fleet that were slightly older than ten years of age, the rest of the tonnage sold so far has been younger than three years of age. Last time such a modern VLCC was sold was in January 2011 when Daewoo sold a (resale) VLCC with her contract in default at about $79 million to Sinokor; as a matter of comparison, HOSCO’s comparable tonnage (at least in age) were transacted at $54 million, a meaningful drop in pricing.

The Møller VLCC fleet is about four years old on average, and, individually priced, the vessels should fetch less than $50 million each (at least if recent transactions offer any type of guidance in an admittedly very illiquid market with known problems of ‘price discovery’); so this is a one-billion-dollar deal. Again, so far, so good; one billion dollars would get excited any self respecting investment banker, institutional investor, market consolidator, highflying maritime executive or any executive trying to find his way to the top (again).

As life would have it, today John Fredriksen’s flagship company Frontline (ticker: FRO) reported 2013 Q2 earnings.   This is a company that routinely posts the best performance in the VLCC market sector, and rightly considered the ‘bell cow’ of the segment. Their earnings report reflected just a very lousy and oversupplied market: while their estimated cash break even is $25,000 per diem, their Q2 earnings averaged just above $14,000 per diem. They also took an asset impairment charge of about $81 million. More importantly, the forward guidance has been bleak based on unfavorable market dynamics and an oversupplied market going forward. For starters, the USA is not anymore a great market for the VLCCs with the shale oil discoveries, and the Chinese prefer their own tonnage for the import needs. And, by the way, while the world VLCC fleet stands at 639 vessels (624 of them are double hull with more than one-third of the world fleet newer than four years old), there are still 57 vessels under contact to be built (just about 9% of the world fleet). Not a bright picture, any way one sees it.

Vessel prices have come down a long way; it was reported at the time that the Møller four VLCCs ordered in August 2008 at STX Shipbuilding had a contract price in excess of $140 million each, thus the $50 million estimated present price per vessel now looks like walking out of the Louvre with a boatload of Monet masterpieces in your backpack.  And possibly a van Gogh, too. But again, these vessels were making $14,000 per diem in 2013 Q2 with a top operator and their cash breakeven has been at (more than) $25,000 per diem. Just because asset prices have dropped precipitously, it doesn’t mean that a buyer / investor at these levels still cannot lose money. But the fact that there are rumors and even appetite to talk about such projects in the present market environment, it’s at least entertaining. Probably the next step would be an IPO…

© 2013 Basil M Karatzas & Karatzas Marine Advisors & Co.

No part of this blog can be reproduced by any means or under any circumstances, in whole or in part, without proper attribution or the consent of the copyright and trademark holders.