Why are LNG shipping stocks retreating after a brief surge?
Declining LNG spread pulls down spot LNG shipping rates and stock prices
We believe the recent decline in spot shipping rates is mainly driven by a fall in the spread between LNG prices in Asia and Henry Hub. The arbitrage between Asian LNG prices and Henry Hub has declined to USD 6 per MMbtu as of 21 January compared with USD 11.90 per MMbtu at the start of the year. Asian LNG prices have fallen as heating demand which peaked early this month is reducing. Temperatures in China and Japan are expected to rise in coming months, which should result in lower spot cargo purchases by Asian LNG importing countries. Apart from softening winter demand, easing of congestion at the Panama Canal has also led to lower spot shipping rates which resulted in the Baltic LNG index declining 16.4% in the last one month.
DMFR LNG shipping index declined 13.2% since mid-January with the fall in spot shipping rates. The Baltic LNG shipping index also fell 39.4% during the same period. We believe the relatively lower decline in DMFR LNG shipping index compared with the Baltic LNG index is due to the long-term view taken by equity investors. Previously, LNG shipping stocks reacted positively to the surge in shipping rates as the companies with spot fleet stand to benefit. DMFR LNG shipping index increased 24.8% in the last three months compared with a 35.7% increase in the Baltic LNG index.
LNG shipping prospects to be better in 2021 than in 2020
Despite the recent volatility in LNG shipping rates, we expect the prospect to be better in 2021 compared with the previous year. LNG demand recovery is expected to remain unhindered in 2021 with COVID-19 vaccination roll-out already underway in major countries and smaller countries expected to start their vaccination drives by end 2021. LNG shortage in Asian countries has increased due to high LNG demand in the winter. Many countries had to postpone their LNG purchase following high LNG prices in December and in most part of January.
We expect LNG spot charter rates for a TFDE vessel to average USD 69,000pd in 2021, up 11% from USD 62,000pd in 2020 following the recovery in LNG demand. With higher spot rates predicted, we expect LNG shipping companies with greater spot exposure to report improved earnings in 2021. Higher LNG spot rates should also translate into companies being able to increase their utilisation levels. However, companies with higher proportion of steam turbine vessels will not benefit as much since the demand for steam turbine LNG vessels continues to decline with deliveries of more advanced X-DF LNG vessels.
Higher leverage is a concern
Despite higher freight rates that we expect in 2021, we believe higher debt levels (debt/ equity and net debt/equity) will be a concern for investors, particularly for the companies that have a sizeable number of vessels on spot charter. Debt levels for the companies under our coverage increased last year on account of higher capex incurred on newbuild vessels.
We expect LNG shipping companies to report better earnings in 2021 compared with those reported in 2020 as LNG demand continues to improve. However, winning long-term charter at attractive rates will remain a challenge given high deliveries expected in 2021. We expect about 76 LNG vessels to be delivered in 2021, and about 20% of these vessels are still without any long-term contract. We prefer companies with solid revenue backlog, long-term cash flow visibility and healthy balance sheet.