Bearish Thesis for Oil Tankers is Absolutely Ridiculous

by | Apr 24, 2020 | Investment Ideas | 0 comments

I have read both bullish and bearish cases for the oil tankers and I have to conclude that the bearish case for oil tankers is absolutely ridiculous.

Imagine that it cost $100,000 to build a condo. Under normal circumstances, you can rent for an amount that allows you to have net income of $833 per month or $10,000 per year. Let’s ignore mortgage. Under such scenario, you are making 10 percent on your money.

Then, something weird like Coronavirus happens and your town is the only town that can cure it. As a result, loads of people start moving into your town skyrocketing rental income. Now instead of making $2,500 per quarter, you are making $100,000 per quarter. You double your money every quarter.

Would you sell your condo to somebody else for $100,000? Absolutely not. You are not that dumb. You would milk that cash flow for as long as you can and the last thing you would worry about is how long the rental rates will stay high.

This is what we have in the oil tankers right now but even better because instead of buying that condo for $100,000, you can buy it for $50,000 and still make $100,000 per quarter because many of the oil tanker stocks are selling for less than their liquidation values.

The bears say, “But the rates will collapse?” Ok so what? Are the oil tanker stocks trading at multiple times NAV? Are they trading for 10 times current run-rate earning? Whey the do, then we can talk about a bearish case.

If the mentioned condo was selling for $4 million, then I would worry, but as long as it is selling for $50,000, then I will keep laughing all the way to the bank and you can keep shorting the stock or sitting on the sidelines shaking with fear of rates collapsing.

You see the beautiful thing about the oil tankers is that their stocks don’t have to go up. The dividends alone will generate so much return that stocks can stay at the current levels forever. Actually, it will be easier to hold them when they are cheap while collecting dividends. If they were 5x now, then selling them versus collecting dividends would be a conversation that we could all have in our heads.

For example, Scorpio Tankers is probably earning close to $1 billion per quarter at the current rates. This is just a rough estimate. Considering that the market cap is close to $1 billion, should I worry? Absolutely not. The CEO recently bought $2 million of call options. If the stock price does not go up significantly, then he will lose $2 million by January 2021. I prefer to be on his side.

While everybody seems to agree that at some point the party in the oil tankers will end. The discrepancy is the timing. In the following interview, the CEO of Euronav said that the oil tankers are going to be needed for storage as long as the production stays higher than demand.

How anybody thinks that the production and demand will be in balance during the second half of 2020 is beyond me. The producers will keep producing more than there is demand until they can’t. I am not saying that they are not going to cut. What I am saying is that they will always be behind. They all seem to think that demand is just going to go back to normal the moment we are released from quarantine. This is what happens when the demand for something grows for decades year after year.

The oil storage problem has been in the news for some time. Did the US producers cut? No. Trump even encouraged them to keep pumping. Now the land storage is gone as shown in the following interview.

The storage broker said that it does not matter how much money you have, there is no storage. Of course this is not completely true but it is a powerful statement. For the right price, there is always storage especially on the oil tankers.

During 14th Annual Capital Link International Shipping Forum, the CEO of Euronav said that the entire fleet of VLCCs is available for storage at the right price.

That’s the point – the floating storage is the only game in town. Right now, the oil tankers have a monopoly on the oil storage. With every passing day, more oil tankers are being taken out of the fleet to store oil. This pushes the rates for moving and storing oil up. Then, the demand for storage increases even higher while the supply of vessels keeps shrinking.

In two weeks, you will see headlines like this.

“A third of VLCCs are storing oil.”

“The world is running out of supertankers.”

“What happens when all the oil tankers are storing oil?”

“Are we going to have to burn the excess oil?”

“We might all have to be filling up our bathtubs with oil.”

Finally, when we are released from quarantine, the demand for oil will increase, but the oil in the storing vessels will still be there. It will not magically disappear. It will take a long time to work off the excess. Per following interview, it will take three years or more.

Because the storing vessels will be out of the fleet, the new demand will overwhelm the non-storing vessels thus keeping the rates high.

So the music will not end anytime soon. It will get louder. You are free to leave the dance floor or not join the dance floor at all. I will start dancing harder because I know next song is going to be even better. Expect the rates to go toward $400k or $500k before they come down to $100k which is still a fantastic level.

Disclosure: Long EURN, DHT, TNK, and STNG

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About Mariusz Skonieczny

Mariusz Skonieczny is the founder of Classic Value Investors.