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Does volatility in Baltic TCE rates drive tanker shipping stocks?

The surge in COVID-19 cases in the past few days took a toll on stocks of tanker shipping companies and key US market indices. Dow Jones Industrial Average (DJIA) and Nasdaq slid 1,816 points (6.4%) and 543 points (4.7%) respectively between 23 October and 28 October. All six crude tanker shipping stocks under over coverage felt the heat and registered a value erosion between 5.6% (DHT Holdings) and 8.5% (Nordic American Tankers) over the same period.

All crude tanker shipping stocks under our coverage have been trading substantially lower than the peak in April which was on the back of a surge in demand for floating storage. Only Tsakos Energy Navigation (TNP) – a company with a diversified fleet and high charter coverage of ~67% – managed to gain 3.8% in the past one month whereas the other five stocks in our portfolio are in the red over the same period. DHT Holdings – the company with all VLCCs in its fleet and a balanced chartering mix (~55% time charter coverage and ~45% exposure to spot market) was down by 7.4% whereas the other four companies under the portfolio with relatively higher exposure to the spot market have fallen in double digits. With a value erosion of 16.2%, Nordic American Tankers (NAT) – the company that owns and operates a fleet of Suezmaxes with nearly 100% exposure in the spot market – lost the most in past one month, whereas Euronav, Frontline, and Teekay Tankers – companies with mixed fleet and higher spot exposure – declined more than 10% over the same period.

A surge in COVID-19 cases to curb vessel earnings
Crude tanker earnings and stocks of tanker shipping companies are expected to rally ahead of the seasonal firm vessel demand in winter. However, a second wave of the virus may hinder this recovery in the coming months. The new cases in the Northern Hemisphere and availability of ample tonnage could play a spoilsport for shipowners in the otherwise firm winter market. TCE rates have been declining across vessel classes, indicating weak demand and low earnings for tanker shipping companies.

Dow Jones Industrial Average (DJIA) and Russell 2000 have been on a steady upward trajectory after plunging in March; however, both the indices are still 6.6% and 6.4% lower respectively than their values on 31 December 2019. On the other hand, the DMFR tanker index (the index consists of the market cap of Euronav, Frontline, DHT Holdings, Teekay Tankers, Nordic American Tankers, and Tsakos Energy Navigation) has plunged 46.2% YTD. Although the index gained substantially in March and April with a surge in crude tanker earnings in the spot market, it remained below the initial indexed value of 100 on 31 December 2019 as the market discounted the fact that inflated vessel earnings are not sustainable. The index is on the decline after peaking in the latter half of April as all six stocks have slid over the past six months.

Pandemic leads to unprecedented volatility in vessel earnings and tanker shipping stocks
Global oil demand nosedived in April as the outbreak of the pandemic led to lockdowns across the world to contain the further spread of the virus and minimize the potential damages. Only essential economic activities were allowed to operate in most of the world, which led to demand destruction of nearly 30 mbpd in April. Hence, the crude oil market faced an unprecedented supply glut and demand for oil tankers for crude transport has dropped due to a sharp decline in the crude oil demand for consumption. The sharp decline in crude oil prices encouraged traders to cash on the contango opportunities by storing cheap oil on tankers now and sell it later. Key crude importers such as China and India also raised stockpiling activities to increase their strategic petroleum reserves (SPRs) at low oil prices. Additionally, oil producers also increased chartering activity to store oil on tankers because of the limited availability of conventional onshore storage and higher production. Meanwhile, output could not be curbed at the pace of decline in demand due to operational constraints. Accordingly, the demand for oil tankers ramped up and crude tanker day rates surged in March and April.

The tanker shipping market witnessed high volatility in spot rates with unusual peaks in March and April on account of the oil price war between Saudi Arabia and Russia in March and sudden demand destruction and surge in floating storage in April due to the pandemic. At the peak, VLLCs were earning above USD 200,000pd compared to an average of ~USD 13,300pd in February 2020. The average TCE rate for VLCCs stood at ~USD 152,200pd in April. The demand of other key carriers such as Suezmax and Aframax which together with VLCCs account for nearly 98% of the aggregate capacity of the world crude tanker fleet also inflated on the back of strong demand for crude tankers. Suezmax earnings in the spot market averaged ~USD 79,200pd in April compared to USD 26,700pd in February, similarly Aframax carriers earned ~USD 53,400pd in April compared to ~USD 21,200pd in February.

Market rebalancing efforts by OPEC+ normalises vessel earnings
Reducing global crude oil production and recovering demand eased the crude tanker supply as several vessels were released from floating storage and rejoined the trading fleet. Accordingly, average TCE rates for VLCCs plunged to ~USD 16,200pd in July from the high of ~USD 152,200pd in April. Average Suezmax earnings in the spot market also declined sharply to ~USD9,000pd in July from ~USD 79,200pd in April; similarly, average TCE rates for Aframax vessels fell ~90% to ~USD5,600pd in July from ~USD 53,400pd in April. Overall, the pandemic has led to unprecedented volatility in the TCE earning of crude tankers. The effect of the high volatility was reflected in all tanker shipping stocks under our coverage, and the DMFR tanker index surged ~56% within few weeks in April in tandem with the rise in Baltic TCE rates of crude carriers. Similarly, the continuous fall in Baltic TCE rates over the past six months took a toll on the stock of crude carriers, and the value of portfolio of tanker shipping companies under our coverage eroded by ~44% since the recent peak of April 2020.

Conclusion
Overall, tanker stocks will be under pressure until demand recovers and economic and commercial activities are restored. Meanwhile, stocks of tanker shipping companies are likely to recover only if COVID-19 cases slowdown and effective vaccine is developed.
Source: Drewry

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