Have fundamentals changed? Is recovery imminent?Earlier this week, we published a series that showed why the tanker industry is unlikely to recover soon (see 7 points that reflect tanker fundamentals say recovery isn’t looming). As oil shipping companies have risen lately due to higher oil
prices—driven partially by continuous improvements in the U.S. economy
and the lower dollar, but mostly due to unrest in Egypt—investors may be tempted to jump in and hope to make profits.
Investors expect certain industries within shipping to recover later this year or next year. But are we seeing new developments, such as the supply and demand outlook, that will change the fundamental short-term outlook of the tanker industry? Let’s take a look. We update several of the key indicators in the last series weekly.Why are supply and demand important?Supply and demand of ships are the most important factors that affect shipping rates, which in turn affects earnings and share prices in a highly commoditized industry such as shipping. Unlike Samsung and Apple, which have features that set them apart from each other beyond price (think design, versatility, and compatibility), the shipping industry offers little differentiation between companies, so shipping firms rely most on rates. That’s why supply and demand are so important in the industry, because they affect shipping rates. When supply growth outpaces demand, competition among shipping firms rises, which leads to lower shipping rates. On the other hand, if supply growth can’t meet demand growth, customers will have to pay higher rates to transport goods across the ocean. The latter case is negative for customers but positive for dry bulk shipping firms, because it increases profitability. Higher profitability will often drive share prices higher.The significance of ship ordersOne measure that reflects managers’ assessment of future supply and demand differences is the number of ships on order. When managers expect future demand to increase more than supply, if they also expect to generate profits with the investment, they will often place new ship orders. But when managers expect excess capacity to continue or grow, they will refrain from placing more orders—sometimes even delaying them for a price. So, the number of ships on order rising is a positive sign that shipping rates will likely rise in the future. Since tankers generally take more than two years to construct (sometimes up to five years), the metric is often more relevant to long-term investment horizons.Early sign of recoveryFor the week ending July 19, the number of crude tankers on order fell by 4 basis points (0.04%) as a percentage of existing ships to 6.45%, as published by IHS Global Limited last Friday.1 The decrease suggests that construction firms began to work on more ships than there were new orders. The fall is normal in a recovering market because companies will often venture out slowly when ordering new ships so that they don’t over-purchase and harm industry profitability in the future. But the drop continues to suggest that managers aren’t quite optimistic regarding long-term prospects.Drawn inference
Nonetheless, the expectation of a shipping recovery (higher future demand growth relative to supply growth) has halted the decline in the number of ships on order since a year ago. As we’ve seen ship orders fall below 6.0%, which supports the theory of a shipping recovery, tanker companies such as Scorpio Tankers Inc. (STNG), Nordic American Tanker Ltd. (NAT), Ship Finance International Ltd. (SFL), and Tsakos Energy Navigation Ltd. (TNP), as well as the Guggenheim Shipping ETF (SEA), should perform well in the future.
Investors expect certain industries within shipping to recover later this year or next year. But are we seeing new developments, such as the supply and demand outlook, that will change the fundamental short-term outlook of the tanker industry? Let’s take a look. We update several of the key indicators in the last series weekly.Why are supply and demand important?Supply and demand of ships are the most important factors that affect shipping rates, which in turn affects earnings and share prices in a highly commoditized industry such as shipping. Unlike Samsung and Apple, which have features that set them apart from each other beyond price (think design, versatility, and compatibility), the shipping industry offers little differentiation between companies, so shipping firms rely most on rates. That’s why supply and demand are so important in the industry, because they affect shipping rates. When supply growth outpaces demand, competition among shipping firms rises, which leads to lower shipping rates. On the other hand, if supply growth can’t meet demand growth, customers will have to pay higher rates to transport goods across the ocean. The latter case is negative for customers but positive for dry bulk shipping firms, because it increases profitability. Higher profitability will often drive share prices higher.The significance of ship ordersOne measure that reflects managers’ assessment of future supply and demand differences is the number of ships on order. When managers expect future demand to increase more than supply, if they also expect to generate profits with the investment, they will often place new ship orders. But when managers expect excess capacity to continue or grow, they will refrain from placing more orders—sometimes even delaying them for a price. So, the number of ships on order rising is a positive sign that shipping rates will likely rise in the future. Since tankers generally take more than two years to construct (sometimes up to five years), the metric is often more relevant to long-term investment horizons.Early sign of recoveryFor the week ending July 19, the number of crude tankers on order fell by 4 basis points (0.04%) as a percentage of existing ships to 6.45%, as published by IHS Global Limited last Friday.1 The decrease suggests that construction firms began to work on more ships than there were new orders. The fall is normal in a recovering market because companies will often venture out slowly when ordering new ships so that they don’t over-purchase and harm industry profitability in the future. But the drop continues to suggest that managers aren’t quite optimistic regarding long-term prospects.Drawn inference
Nonetheless, the expectation of a shipping recovery (higher future demand growth relative to supply growth) has halted the decline in the number of ships on order since a year ago. As we’ve seen ship orders fall below 6.0%, which supports the theory of a shipping recovery, tanker companies such as Scorpio Tankers Inc. (STNG), Nordic American Tanker Ltd. (NAT), Ship Finance International Ltd. (SFL), and Tsakos Energy Navigation Ltd. (TNP), as well as the Guggenheim Shipping ETF (SEA), should perform well in the future.