Drewry: Decoding stock prices volatility

Conventional storage to run out of space
Global oil demand will remain weak unless the world returns to pre-COVID-19 levels. The oversupply of nearly 20 mbpd (which is expected to decline gradually with improving demand and declining production) will lead to a surge in demand for crude oil storage as production cannot be reduced at the pace at which the demand has eroded in the last few months. Surplus oil is rapidly flowing into onshore storage capacities – commercial as well as strategic petroleum reserves (SPR) – across the globe. Market forecasts suggest that the world’s conventional oil storage – which can hold about 3.4 billion barrels – will run out of storage space by end May 2020 and thereafter flow into floating storage in oil tankers.

Increase in floating storage is inevitable
The Brent crude oil futures for June 2020 closed at USD 21.44 per barrel on 24 April. The spread between spot and future crude prices of April 2021 stood at USD 13.18 per barrel whereas cost of storing crude oil on a VLCC for the next one year is USD 14.99 per barrel.

Accordingly, traders would refrain from locking vessels for crude oil storage as the current charter rates for VLCCs are not profitable for traders. As of 25 April, nearly 160 million barrels of crude oil is stored at sea. With average oversupply of nearly 20 mbpd, oil companies will lock-in crude carriers to store the surplus production as the conventional onshore storage facilities run out of space over the next few weeks. Overall, the increase in floating storage is inevitable on account of operational limitations rather than storage economics as producers cannot turn off the oil taps at will. A conservative estimate suggests that nearly seven VLCCs per day will be required to store surplus oil even after the proposed production cut of 9.7 mbpd by OPEC+.

The rise in floating storage will limit vessel availability for active trade further increasing vessel day rates, which have already spiked due to the recent chaos in the global oil market. VLCC spot rates on Middle East-China (TD3C) surged 464.7% from ~USD 30,600pd on 5 March to ~USD 173,100pd on 24 April. Spot rates for other vessel classes also followed a similar trend over the same period as a continued decline in crude oil prices led to increased demand for crude carriers. The surge in spot rates initiated a rally in tanker shipping stocks with those under over coverage registering an average gain of 60.9% between 5 March and 24 April. Nordic American Tankers (NYSE: NAT) led the rally with a surge of 114.3% whereas the lowest gain of 34.2% was registered by Euronav NV (NYSE: EURN).

Strong correlation with Baltic FFA
The movement in tanker shipping stock prices has a strong correlation with the spot TCE rates and Baltic Forward Freight Agreements (FFA). The recent data suggests that Euronav NV (NYSE: EURN) stock price has a correlation coefficient of 0.66 with FFA for VLCCs on TD3+1_M (Arabian Gulf to Japan) whereas the correlation coefficient was 0.73 with FFA for Suezmax on TD20+1_M (West Africa to UKContinent). Frontline (NYSE: FRO) stock prices have a correlation coefficient of 0.66 with FFA for Suezmax on TD20+1_M (West Africa to UK-Continent) whereas the correlation coefficient was 0.70 with FFA for Aframax on TD17+1_M (Baltic to UK-Continent). DHT Holdings (NYSE: DHT) owns and operates only VLCCs and the company’s stock prices reflect a correlation coefficient of 0.71 with FFA for VLCCs on TD3+1_M (Arabian Gulf to Japan).

Shareholders to benefit from firm tanker market
Output outside OPEC+ will also decline gradually as high-cost producers such as shale oil producers in the US, sand oil in Canada, and offshore oilfields in Brazil and North Sea will find it difficult to sustain their operations at lower prices. Accordingly, crude oil oversupply will gradually narrow in 2H20 due to declining production and improving demand with gradual easing of lockdown measures in major economies. However, tanker spot rates are expected to remain elevated on account of increased demand for floating storage in addition to transportation trade as the global oil market is expected to remain oversupplied at least in 2020. Tanker companies are expected to register a record revenue growth on the back of firm freight rates and higher utilisation. Additionally, lower bunker expenses will further enhance their margins and profitability, and companies will transfer the benefits to shareholders through higher dividends, stock buybacks or debt repayments.Source: Drewry Financial Research Services Ltd

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