A ship called ‘Arosa’

There has been an almost continuous series of headlines recently with eulogies for the death of early generation double-hull tankers, especially VLCCs.  No doubt that freight rates are low, and no doubt that asset prices have dropped by about 50% for this type of vessels in 2011.  But again, not all news is bad, and shipping life can be  as spicy as some of the Captain’s exotic port calls!

In 1993, the shipping company Neda Maritime of the Lykiardopulo Group received delivery of the good vessel MT ‘AROSA’, the second ever built double-hulled VLCC (291,000 DWT ordered at Hitachi Zosen in Japan.)  At that time, double hull vessels were still an avant-garde in shipping, without any record of expected commercial history or technical behavior, but mandated by OPA 90 and the Exxon Valdez accident.  At that time, newbuilding prices were in the low $90’s million, but the Lykiardopulo Group has had a reputation of building floating temples to the shipping gods, so the cost for this vessel was reported  at the time at just below $100 million (nominal prices).  Just a few weeks ago, the very same vessel under the same name and still under same ownership was sold to Thai interests at about $24 million for conversion to floating storage; similar vintage vessels had the unfortunate fate recently to face the ship breakers’ torch at a salvage price of around $20 million. 

If we were to assume that the vessel at her delivery was financed with standard terms of first preferred mortgage of about 60% leverage and eight year tenor at 6% annual interest, and employed on continuous one-year time charters (average rate over the last twenty years of about $35,000 per diem) and 95% utilization rate, and all other standard industry practices, the vessel would have generated less than 15% return for her owners, until her sale.  Not bad returns at all for such a shipping project, given that the vessel had to trade in the weak freight markets of late 1990’s and the first early years of this century, and of course the abysmal rates of the last couple of years.

It seems that despite the weak freight markets of recent and precipitous decline of asset prices, still long-term projects in shipping can be profitable on an operating basis if approached correctly: a good, traditional owner orders a high quality vessel from a good yard and trades the vessel through the cycles.  No ambitions of a) correctly timing the market, b) investing with a three-to-five year investment horizon (unlike some financial owners), c) utilizing the best financial engineering available or d) making money by building ‘cheap’ vessels.  So far, so good.

As it happens in shipping, there are often other aspects that make an interesting story even more so.  The calculations above are based on the assumption that the vessel was always employed at one-year rolling timecharters at prevailing rates.  In reality, there is at least one instance when this good vessel was fixed in the spot market to ExxonMobil in 2004 for a voyage from Middle East to Japan at about $230,000 per diem, or gross freight revenue of about $30 million; that’s proceeds from one trip!  And, sure there were a few similar equally profitable trades  during her career.  Thus, the IRR numbers above are good enough for forensic analysis without providing all the excitement and profits of the actual trading.

And, to reach deeply in the spice cabinet now, there have been rumors that at the top of the market, in early 2008, the owners had received offers for the sale of the vessel at $110 million, but such offer at the time was deemed to be on the low side and was accordingly rejected.  That’s true: a vessel delivered in 1993 at a cost of less than $100 million, fifteen years later, she was obtaining offers in excess of the construction cost (that’s the nature of shipping!) In retrospect, that would had been an ideal trade: cashing out on the vessel at the absolute top of the market after making a killing operating the vessel in the fertile years of the super-cycle (2004-2008) and just before the dive to the bottoms of the abyss.  But again, hindsight is always perfect.

In the Captain’s judgment, the moral of the story is that asset play and timing the market is always good but cannot always be depend upon to deliver ordinary returns.  But, it can deliver extra-ordinary returns! And, just because a vessel is sold in a bad market at a ‘perceived’ weak price, it doesn't mean that the owner necessarily lost money from the investment or they didn't make money!  Quite the opposite!

And a question to keep one up at night, whether for philosophical or commercial reasons: imagine the poor soul who made the offer to buy the vessel at the top of the market at the now exorbitant price of $110 million and the offer was rejected!  What would have happened today if they had bought the vessel?  How the investment return numbers above would look like?  Probably instead of profit, the very same sale price might have looked like the ‘haircut’ of the century! 

Was it luck? Was it karma?  Was it greed?  Was it perspicacity?  

© Basil M Karatzas, 2011.  No parts of this blog can be reproduced in any way by any means under any circumstances without the prior written approval of the owner of the blog.  Copyright strictly enforced.

This blog is only intended for entertainment and discussion purposes; no responsibility can be assumed for taking or failing to take any action upon information contained in any part of this blog.

Should you desire to discuss the content of the blog or obtain commercial advise or opinion, please feel free to contact us at info@bmkaratzas.com.

What would Onassis do?

Since the statement of 'What would X (please insert an unimpeachable authority of your choice) do?' has become a banality, the Captain could not resist the temptation but to ponder on what Onassis, a world renown shipping magnate and entrepreneurial figure par excellence would do in the present environment in shipping.

There is no question that freight rates are the lowest in the last decade, if not longer, and the dark clouds of poorly conceived and ill timed deliveries of new-built vessels compounded with a sickly world economic recovery make for a very inviting picture for investing in shipping.  The fact that shipping banks are plagued by a garden variety of banking problems of regulatorily deemed low capitalization and still high exposure to non-performing loans, whether real estate or elsewhere, and high political / sovereign / currency risk, especially in Europe, one would wonder why any reasonable investor wouldn't heavily be invested in shipping.  Something that even Onassis himself might be contemplating from a round corner in the big sky above the Scorpios Island right now.

Asset prices are as low as they have been in the last decade, at least. Ten-year old VLCC tankers trade at less than $40 million, at a time when their present salvage value is just below $ 20 million, and likely a newbuilding contract can be signed at $80 million or so. Based on a twenty-five year design life, a ten-year old vessel has fifteen years to trade.  The premium of today's market value over scrap is about $15 million, so, on a straight line, depreciation stands at one million dollars per annum, or about $3,500 per diem.  Assuming $10,000 per diem vessel operating expense, including dry-docking provision, the vessel has less than $15,000 per diem cash break-even point.  Wouldn't that low break-even be enticing enough to bring new buyers to the market?  

Of course, such game is not for everyone.  Charterers for VLCCs are very not very keen on tonnage right now, so buyers have to have deep enough pockets to add working capital to the project, as this may be required.  Additionally, a strong commercial name will be required to properly maintain, manage and assuringly trade the asset.  Any new comer will likely need to partner with an old shipping hand.  

And, of course, given that no banks today are keen to finance new clients, or even established clients, and definitely not ten-year old tankers, this is primarily a game for investors with their own equity, which in exchange, allows them to drive asset prices down.

It's tough to tell what Onassis would do under the circumstances.  There are tempting opportunities in shipping in terms of vessel pricing and vessel availability, just as when there were plenty of surplus vessels to be sold after WWII (Liberty vessels). Despite the gloomy prospects then, shipping minded and determined ship owners, including young upstarts, made out just fine.  This is what Onassis did then, but is THIS another exceptional entry point to the cycle? Sure, by the time shipping reaches the next port call, the answer will be clear...but likely by then the wind will be gone from the sails by then!

© Basil M Karatzas, 2011.  No parts of this blog can be reproduced in any way by any means under any circumstances without proper attribution or the prior written approval of the copyright holder of the blog.  Copyright strictly enforced.

This blog is only intended for entertainment and discussion purposes; no responsibility can be assumed for taking or failing to take any action upon information contained in any part of this blog.

Should you desire to discuss the content of the blog or obtain commercial advise or opinion, please feel free to contact us at info@bmkaratzas.com.

Pipe-dreams and nightmares in the tanker markets

While market research in shipping is usually pre-occupied by analyses for tonnage supply and demand, events in complimentary industries to shipping often can have equally important implications. 

For instance, in the pipeline industry in the North America, while Keystone XL planned pipeline to bring crude oil from Canada to the Gulf Coast run aground with regulatory concerns, the acquisition by Enbridge Inc. of a 50% stake in the Seaway Pipeline from ConocoPhillips, and the ensuing decision by the new owner to reverse the flow of the pipeline from Cushing, Oklahoma, to the Gulf Coast (Freeport, Texas), the impact to the tanker market cannot be ignored.  It is still difficult to precisely quantify to impact to the shipping markets and pinpoint which asset classes in shipping will be affected most, but, based on current information, in Captain’s opinion, tanker vessels will negatively be impacted by the events while product tankers have the most to hope from.

As a very brief primer to the oil industry, the high quality West Texas Intermediate (WTI) oil usually trades at a premium to Brent oil; however, WTI is priced in landlocked Cushing, while Brent oil is the international (and mobile) benchmark for oil pricing.  However, due to a drilling boom induced by the $150 / bbl pricing during the pre-crisis years and increased domestic oil production in the inland US and advanced hydraulic fracturing techniques, there has been a flooding of WTI oil in landlocked Cushing that could not meaningfully transported to refineries besides those in continental US.  As a result, during the last two years, there has been the paradox of Brent oil trading at a premium to WTI, a premium that reached almost $28 / bbl in October.

The pipeline network in the US has mainly been intended to transport oil from south to north, primarily from the US Gulf Coast to Cushing and petroleum products mainly along the Atlantic Coast to the North / New York area.  The reversal of the flow, of Seaway Pipeline from Cushing to the Gulf Coast, means that WTI oil can now be refined along the many refineries in the Texas / Louisiana region or pumped along the pipeline network to the North for processing.  The Seaway Pipeline is planned to move about 150,000 bbl per diem by 2012 Q2 and 400,000 bbl per diem by the end of 2013 Q2.  To put the quantities into perspective, in 2012 Q2, the cargo of one suezmax tanker per week will be supplemented by the reversal of the pipeline, and, in 2013 Q3, a VLCC cargo every four days will be substituted by the reversal.  It has to be noted that crude oil cannot be exported from the US without onerous permits, and thus, the Cushing-originating oil cannot be exported and will end up processed in the US.  Without getting into a fine-tuned analysis, it becomes obvious, that crude oil tankers will negatively be affected by the reversal, with, most likely, VLCC and suezmax tankers as the biggest targets of the impact.

Refineries in the US, in general, are geared to process lower quality oils, and that’s how they can maximize their margins.  The ‘traditional’ output of the US refineries moves along the rule of thumb of 3-2-1, where a barrel of crude oil is refined to yield two-thirds of a barrel of gasoline and one-third of a barrel of distillate such as heating oil or diesel.  However, with the Gulf Coast refineries now having access to cheap and high quality WTI, in order to maximize their margins, they likely will switch to 2-1-1 ratio, where one barrel of crude oil will now yield one-half of barrel of gasoline and one-half of barrel of distillate.  The US is a big consumer of gasoline but always has excess capacity for distillates, especially for diesel.  Europe, on the other hand, is an area where diesel is more widely used and always in need for additional capacity.  Thus, most likely, refineries now will produce excess distillate that will end up in the export market, and most likely, product tankers stand to benefit from the switch.  Since the cross-Atlantic petroleum products trade is dominated by the MR2 tanker market, MR2 tankers likely will be the asset class to benefit the most.

Who ever said that to understand and assess shipping one only has to focus on the shipping markets?  The beauty of the shipping industry is not as magnificent and encompassing as the three-quarters of our planet that covers our planet, but also as elevated as the remaining one-quarter of lands where consumers live and dream.  Some times their dreams are long as a pipe…unlike the dreams that keep the Captain company with a pipe in his mouth on the cold nights on the bridge…   

© Basil M Karatzas, 2011.  No parts of this blog can be reproduced in any way by any means under any circumstances without the prior written approval of the owner of the blog.  Copyright strictly enforced.

This blog is only intended for entertainment and discussion purposes; no responsibility can be assumed for taking or failing to take any action upon information contained in any part of this blog.

Should you desire to discuss contents of the blog or obtain commercial advice or opinion, please feel free to contact us at info@bmkaratzas.com.

Electric Boats and Technological Obsolesce

The wide publicity of the grounding and the ensuing environmental damage by the tanker MT EXXON VALDEZ in 1989 brought the implementation of MARPOL regulations and the OPA 90 Act which effectively mandated the use of double hull tanker vessels.  Since there have been very few high profile maritime disasters since then, disasters that could trigger another round of regulatory reforms, newcomer players in shipping with short institutional memory assume that today’s vessels are meant to be traded for their whole design life of usually 25 years.  It is assumed the risk for technological obsolesce is minimal, and more or less a straight depreciating line over twenty-five years defines residual values.

A recent article on well established technologies for electric boats in Königsee lake in Bavaria since the beginning of the century and new technologies for ‘mass-made’ speed boats in Zürich Lake with 120 kilowatts (162 horsepower) and 60 km per hour top speed, made the Captain ponder whether electric tankers and dry bulk vessels might not be so far in the future.

The design of tankers, and all types of vessels in general, has evolved tremendously over the several decades, especially with the use of computers, AutoCAD and Fine Element Analysis (FEA), to provide for an almost pollution-free movement of commodities and finished products due to pollution that may be caused by the cargo itself when in an accident.  However, ‘forced’ technological evolution may come not only from regulators concerned with the cargo and the cargo holds/tanks arrangements, but also from regulators concerned with emissions and also the market place itself.

The Energy Efficiency Design Index (EEDI), adopted by the International Maritime Organization (IMO) in July 2011, mandates that newbuilding vessels delivered from 2015, 2020 and 2025 should have energy efficiency improvements of 10%, 20% and 30%, respectively, over the EEDI baseline index.  Possibly, in the present turmoil in shipping, 2015 and later years might seem a very lengthy proposition, especially for owners who may be financially insolvent by then; however, since shipping is an industry better planned in terms of decades, a great deal of vessels will be affected by such implementation, including vessels that are being delivered now or even in the last decade.  There will be waivers, no question, and the industry will be given time to adjust, just as it happened with the transition from single hull to double hull tankers that almost took more than a decade.  However, single hull tankers got lucky as the first decade of this century was one of the best ever in shipping with tight tonnage supply and single hull tankers proved to be much more profitable than any other type of vessel.  However, the EEDI implementation comes at a time when the market is extremely oversupplied with modern tonnage, and likely will not enjoy the luxury of time or be given the benefit of the doubt.  And, more importantly, while single hull tankers actually enjoyed the preference of the charterers due to their lower cost, the EEDI index works against the vessels and the owners and in favor of the charterers.  While there may be people who still question ‘global warming’ evidence or may be less than motivated to make an effort to reduce Greenhouse Gas Emissions (GHG), when an EEDI vessel offers 10% savings over a comparable vessel, it’s a no-brainer which vessel a charterer will choose, especially in an oversupplied market.  By way of illustration, 10% efficiencies for a VLCC that usually burns ninety tons per diem of bunker fuel translates to savings of nine tons of fuel per diem, which, at today’s price of more than $600 per ton, it economizes almost $5,500 per diem.  For a typical trip from Middle East to US Gulf, the savings can typically be almost $200,000 for the trip.  Maybe the day of a Prius VLCC may not be such a farfetched thought, after all.

© Basil M Karatzas, 2011.  No parts of this blog can be reproduced in any way by any means under any circumstances without the prior written approval of the owner of the blog.  Copyright strictly enforced.

This blog is only intended for entertainment and discussion purposes; no responsibility can be assumed for taking or failing to take any action upon information contained in any part of this blog.

Should you desire to discuss contents of the blog or obtain commercial advice or opinion, please feel free to contact us at info@bmkaratzas.com.

'Liner shipping business’

The first decade of this century has been characterized not only by the best shipping times ever, but also by a new breed of shipowner who was financially astute, capital markets cognizable and friendly, and with a mission statement of shareholder value optimization hanging high from the yardarm of their ships and their roadshow presentations. 

True to the spirit of the decade that made securitization of debt a very profitable alchemy of the financial industry by slicing risk into different ‘trade-able’ tranches, the shipping industry was fast at catching up with the ‘divide and conquer’ strategy.  While private shipowners stack to what had worked for them in the past, publicly traded owners devised business models that were appealing and sale-able to Wall Street and the institutional investors.  There were companies that were paying out based on spot VLCC market exposure, companies that were ‘yield driven’ irrespective of underlying shipping market conditions, capesize shipowners with full spot market exposure and a ‘China play proxy’ positioning, dry bulk owners to reflect the ubiquitous Baltic Dry Index (BDI); there were even owners that moved into the ice-class products tanker market, and post-crisis, there were plans for crude oil ice-class tanker IPO to exploit the lightness of such being in the public capital markets…

‘Mono-line’ shipping business models definitely have their advantages.  They optimize economies of scale, operational leverage, cost savings, and critical mass of modern tonnage to entice major charterers and trading houses, etc One additional benefit of such business models is that it’s easily understood and explained to the investment community, without undue complications and multiple layers and overlaps with inputs from other market segments and industries.  For example, for a VLCC owner of ten vessels trading on the spot market, the financial model was nice and neat: capital investments and financial expenses were known, operating expenses contracted to third parties at known daily rates were plugged to the financial model, and only the projection of future VLCC rates was the big unknown. Modeling out a year or so was rather easy…and unquestionably worked lively when the times were great.

Fast forward to the lower arch of the business cycle, and canvassing the publicly traded shipping companies, it seems that shipping companies active in markets with a narrow focus that appealed to the investors in the past, have their fair share of problems.  After all, if the VLCC market is oversupplied and in a burning cash mode for more than a year now and with the underlying economics of the market still unfavorable, a narrowly focused VLCC owner has few options…the market is the market, and no much can change in shipping in the short term (sparing a geopolitical or macro-economic event or event of unforeseen nature).  However, if this particular VLCC owner had also exposure to other market segments such as product tankers or dry bulk vessels, or possibly in other horizontally integrated business such as ports, terminals, storage facilities, etc., then, they might have had a better chance… Of course, all shipping segments are highly correlated, and any diversification, whether vertical or horizontal, would not save from low freight rates, but might have increased the chances of survival…maybe ‘lard’ rather than ‘leanness’ make better buffers in shipping…

© Basil M Karatzas, 2011.  No parts of this blog can be reproduced in any way by any means under any circumstances without the prior written approval of the owner of the blog.  Copyright strictly enforced.

This blog is only intended for entertainment and discussion purposes; no responsibility can be assumed for taking or failing to take any action upon information contained in any part of this blog.

Should you desire to discuss contents of the blog or obtain commercial advise or opinion, please feel free to contact us at info@bmkaratzas.com.

Tanker Values, Again!

Just when the Captain thought that we all had figured out that vessel prices were in a precipitous fall and ship brokers were busy slashing their price list for vessels on their weekly reports, there you have a company like SK Shipping ordering allegedly three VLCC vessels this week at Hyundai Heavy (HHI) at $100 million each with a 2013 expected delivery date. The exact details of the transaction are not well known, but even the facts that a) someone places an order for more VLCCs in the present market and b) at a price of $100 million per vessel are extraordinary by themselves.  The Captain does not know the intent and the logic behind the buyers' decision in terms of employing the vessels such as whether the buyers have secured a long term employment contract or a contract of affreightment for the vessels, but this order, if true as reported, basically turns any attempts for vessel valuations, especially for modern expensive vessels, on its head.

VLLCs, of all vessels, in the last year have more or less been operating below cash break-even and it seems that several owners for such tonnage have been under pressure.  After more than six months of any meaningful activity in the second hand market, in the last forty days there have been several transactions of approximately ten-year old VLCCs at approximately $30 million, take or leave a couple of million, and thus there has been a realization that asset prices have dropped by more than 40% for such vessels since the early part of 2011.  At the face of a weak freight market and extreme difficulty at securing sufficient / competitively priced debt financing, and despite the fact that resale VLCCs were sold more than six months ago, it has been estimated that modern VLCCs, whether resales or newbuilding contracts, had to have dropped lower by a lot as well.  Most ship broker reports post VLCC newbuilding prices at $90 mil, take or leave a few million dollars, and much lower from Chinese yards.  But again, the SK Shipping order, is more or less 10% apart from the brokers' estimates, and it is even more impressive given that the yard where the order has been placed is a highly reputable, brand name yard and not in an immediate need of orders.

As a matter of reference, there are approximately 570 VLCC vessels today on the water with about 145 more of them on order; that is an outstanding orderbook of 26% of the world fleet; in more tangible terms, a brand-new VLCC is planned to be delivered every five days for the next two years.  And, for CAL2012, TD3 paper market from AG to Japan trades at about $8,200 pd at present, just at about the vessel daily operating expense.  And, in general, in terms of obtaining debt financing for a modern VLCC, the major quantitative terms might stand at about 50% leverage of the present FMV and on average 400 bps above cost of funds, if there is still a bank to consider financing such a vessel.  The present order therefore of SK Shipping for these three vessels at $100 million each shows a great degree of faith in the market and runs directly against any consensus estimates for the shipping and tanker markets, and the VLCC market in particular.

And, one of the major implications of such newbuilding order, still if true as reported, it's that the 'intrinsic' and replacement cost of vessels still remains high.  No matter how low second-hand values have moved and how much eager buyers of distressed assets salivate about the prospects of 'vulture' acquisitions, modern tonnage is only available at strong prices, even stronger than the freight and financial markets may suggest.  And, such transaction provides for a solid benchmark in setting vessel valuations for documentation purposes at levels than are still within line of recent history and without causing undue concern to lenders and borrowers.

© Basil M Karatzas, 2011.  No parts of this blog can be reproduced in any way by any means under any circumstances without the prior written approval of the owner of the blog.  Copyright strictly enforced.

This blog is only intended for entertainment and discussion purposes; no responsibility can be assumed for taking or failing to take any action upon information contained in any part of this blog.

Should you desire to discuss contents of the blog or obtain commercial advise or opinion, please feel free to contact us at info@bmkaratzas.com.

Mirror, mirror on the wall, which shipping sector is the fairest of them all? (Tonnage demand economics)

While tonnage supply is easily understood and fairly quantifiable (after all, it typically represents existing vessels on the water and legally contracted vessels to be built, with a few exceptions such as ‘slippage’, ‘substitutions’, ‘cancellations’, etc.), forecasting shipping demand is the shallow reef where economists’ models casually shipwreck, and correct estimates thereof have been the source of great a many fortunes in shipping!

Large vessels like VLCCs, VLOC/capesize bulkers and post-containership vessels are susceptible to high volatility in their trading earnings, as they are disproportionally exposed to macro-economic and geopolitical events.  For example, it is a well-established fact that wars and armed conflicts, as repulsive and condemnable as they are, usually prove to be good for shipping.  Furthermore, since whole countries and economies depend on big vessels to feed industrial production with raw materials, their existence is noticed by governments and regulators, business conglomerates, etc   The Chinese, for example, have passed a directive over the last few years that most of the crude oil imported to China has to be carried on Chinese ‘controlled’ vessels by 2015.  Since the third quarter of 2011, already the majority of oil imported to China has been on Chinese ‘controlled’ vessels, a full three years ahead of schedule.  In a well oversupplied market such as the VLCC sector at present, the execution of such a directive exacerbates an already difficult market inequilibrium.  It’s a similar picture for the capesize market where the Chinese, as the driving force for iron ore and coal imports, have made it clear that they will not tolerate commodities exporters and independent owners to ‘dictate’ the market (the ‘China-max’ VLOCs spat with Vale comes to mind.)  

At the other end of the spectrum, smaller sized vessels such as panamax crude tankers, MR product tankers, handysize dry bulk vessels and handy containerships see their trading earnings range within a ‘reasonable’ range, usually no much below cash break-even in a bad market and a quintuple multiple of the vessel daily operating expense in a good market, almost most of the time.  Even during the bleakest days of 2008, handysize dry bulk vessels were busy and operating at cash break-even levels.  Usually smaller sized vessels have many trading routes to seek employment, many cargoes to move, many ports (even shallow or under-developed ports) to call, many charterers to attract to, many more localized pockets of economic activity to exploit …

Given that the consensus estimate for world economic growth is subdued over the next two years, ranging from 1.5% to 5% depending on the optimism of the model, smaller sized vessels seem to have the best prospects.  It does not seem that there will be any imminent outbursts of industrial production and productivity that will drive through the roof rates for macro-economically driven big vessels.  And, given that small vessels already trade on a cash flow positive basis in today’s depressed freight market (it has not been the case for VLCC and capesize vessels for almost a year now), with a favorable fleet profile, both in terms of newbuilding deliveries and demolitions due to aging, one is tempted to say that small is beautiful, whether tankers, dry bulk or containership vessels! 

© Basil M Karatzas, 2011.  No parts of this blog can be reproduced in any way by any means under any circumstances without the prior written approval of the owner of the blog.  Copyright strictly enforced.

This blog is only intended for entertainment and discussion purposes; no responsibility can be assumed for taking or failing to take any action upon information contained in any part of this blog.

Should you desire to discuss contents of the blog or obtain commercial advise or opinion, please feel free to contact us at info@bmkaratzas.com.