In the past week, I have taken my optimism on tankers from level 10 to 11. It started with the withdrawal of the Saudis from the cartel formerly known as OPEC + in order to spill oil and crush the American shale, but it has progressed far beyond that, as various American cities have found blocked. Just warning, I'm going to generalize, I'm going to round off a few numbers and if you're an empirical purist, you will probably be offended.
In large numbers, the world produces 100 million barrels of oil per day (barrels / day) and consumes about as much. As a result, supply and demand are generally balanced to a few hundred thousand barrels / day at any time. In fact, we have extreme price volatility when the balance is much higher than that. The market was roughly balanced at the beginning of this year, until the arrival of COVID-19 in China. When the Chinese went into quarantine, their demand for oil collapsed by about 25% and remained suppressed for about two months. Even today, two months later, demand has still not returned to pre-flu levels. Given that the rest of the world is currently aware of COVID-19, I expect global demand for oil will also decrease by 25% in the affected regions, offset by the partial recovery in China. Suppose global demand is going to drop 20% or 20 million barrels / day over the next 50 days (yes, I'm probably mistaken at a few million barrels / day. Treat it). In addition, I expect the Saudis and their former OPEC + friends to spill a few million more barrels / day, so my 20 million barrels / day may not be that far after all. Let's call it a total of 20 million barrels / day of surplus oil for 50 days. We are now talking about 1 billion barrels in excess (give or take a little). By transposing the slow recovery in China to the rest of the world, assume that the world surplus decreases to 10 million barrels / day after 50 days and remains at this level for another 100 days. That is another billion barrels, and together you have 2 billion barrels of excess oil over the next 150 days (5 months) that will be released to the market. Where will it all go?
Trump last week bragged that we would fill the Strategic Oil Reserve "at the top". Sounds impressive right? Well, the richest nation in the world needs only 75 million barrels to fill the SPR. Do you see the magnitude of the problem? 2 billion barrels is a lot of oil. Over the past decade, the world has managed with an inventory of about 2.5 to 3 billion barrels of oil. While land storage is filling up quickly, there is literally nowhere to put this oil, except tankers. Related: $ 1 oil: Saudi Arabia's attempt to crush American shale
If you knew that billions more barrels were coming to you, why would you buy a barrel today, unless you intend to use it today? In fact, you would be almost assured that oil would be cheaper tomorrow if you wait. So how do you make someone buy oil today? You lower the price, very low, so low that a trading house is ready to store it in the hope of being able to sell it at some point in the future. Trading houses tend to make massive leverage bets, they don't want these bets to be at the whim of the price of oil, they want to lock these bets as safe stuff.
Fortunately, there is a reasonably liquid futures curve.
Watch it today; you can buy physical Brent Crude today and lock in the price 12 months into the future and guarantee a profit of $ 16 a barrel ...
And in the past six months, the gap has never been higher ...
It's a great return, except you have to pay someone to store it. This is where my tankers come in.
Interest rates are actually zero today, so you have no financial cost, your only real cost is renting the tanker. Suppose you set aside 2 million barrels (the size of a VLCC) for a year and sell futures contracts for profit of $ 22 million (2 million barrels at $ 11 each) . How much of this profit do you think you should share with the owner of the VLCC? If you thought it was the bulk of that profit, you are qualified to work for Vitol. Keep in mind that the guys with the tankers can buy them for several companies that can take a position safely and profit almost indefinitely. Suppose you give traders $ 2 million and keep $ 20 million - well, it's a crazy profit. The type of tanker that would be chartered for storage is probably only worth about $ 25 million and contains less than $ 5 million in equity. If you own this tanker, you have just blocked a return on four times your equity in just one year. Not bad! Now traders tend to approach the start of the curve. You earn $ 8 for the first 6 months of storage and the curve at 3 months is even steeper at $ 5. Can you imagine earning $ 5 a barrel, four times a year? You earn $ 20 in contango. As you can imagine, the trading houses want to lock the tanker and go straight into the teeth of the contango. Don't worry about the amount of Vitol that will make - they are big boys and can take care of themselves. What matters is what the owner of the tanker does. Let's just say he does so many things that he's not afraid to lock up his ship for a very long time.
The point is, we're going to need hundreds of tankers to store the 2 billion barrels of excess supply. But wait, there is more !! Think of the oil curve. If oil is in the $ 20 range today, nobody spends capex for drilling. Where do you think production will be in 2023? And 2025? I bet it's millions of barrels, maybe even tens of millions. Once the margin calls are made, where do you think the 2023 oil futures will trade? $ 50? $ 75? $ 100? Have you seen how many stimulants they launch on the world economy every day? It will take time, but the demand will come back with a vengeance. I don't know where the 2023 oil will be traded, but I guarantee it will be VERY steep in the first month. This is not a contango problem of a few months, it will last a while because all this inventory keeps the beginning of the heavy curve. How long? A surplus of 2 billion barrels which is absorbed with a daily deficit of 5 million will take 400 days to operate. Meanwhile, the cost of storage is going to be astronomical. The first month will be on the ground and the deferred months will be in the sky. This will attract more and more tankers playing every part of the curve with all of that free Federal Reserve rescue money.
Now suppose that the few hundred older VLCC tankers go into storage. This seriously jeopardizes the global supply of fleets of approximately 800 vehicles actively transporting crude oil. When 26 COSCO tankers were sanctioned last fall, rates peaked in 10 years. What happens when a few hundred leave the transport fleet? Well, the tariffs go to Pluto. At current daily charter rates of around $ 200,000 for the transportation of oil, a VLCC earns $ 70 million, which is a staggering return on a 10-year ship worth about $ 50 million. . Even better, the owner probably only invested about $ 20 million. This means that at the current rate, the owner earns 3.5 times their money each year. Ironically, despite all of this, most oil tanker stocks are trading at around half the net asset value. This means that they earn about 5 to 8 times their market capitalization in a year. By the way, this is not theoretical. There have been almost 100 fixations in the past 10 days and almost all of them north of $ 150,000. There have been dozens of time charters for storage. That happens. Even if the rates drop to $ 100,000, the tankers will earn unfathomable revenues.
I have been following tankers for two decades now. Since 2009, each peak has been short-lived as there was a ceaseless excess supply. This one is really different. No national leader wants to end the foreclosure too soon and kill people. Instead, the incentive is to be as aggressive as possible with the foreclosure, throttle the economy and give the impression that they are doing something to protect people from something terrifying that most people don't understand. What politician wouldn't want to stand there on national television, flanked by important people who talk about what they are doing to protect you, while giving you free stimulus money? It’s the biggest election campaign ever. Even Trump is getting into the act and we all know he is focused only on the stock market. What if global demand drops by 30 or 40% in the coming months? What if we had 5 billion barrels of excess crude? I don't know how to quantify all of this, but there is a lot of blue sky in terms of how politicians can screw up our economy and how much demand could collapse. What happens if the Contango costs $ 30 because the first month goes to teens? I can build scenarios for you where modern tankers make $ 300,000 or $ 500,000 a day and stay there for two years. I saw quite a few bindings at the $ 300,000 level last week - it is clear that the guys chartering ships think this is the new standard. Related: Traders Struggle To Be First To Drop Crude Oil
Again, I could also say that politicians realize that the throttling of the economy is a mistake and we have set aside only a few hundred million barrels. I am trying to build conservative models and I tend to think that rates are bouncing a lot with average rates below today's levels. Here again, as the storage absorbs the ships, I find it hard to understand how the prices drop considerably if the charterers need tonnage.
Last week, I noticed that oil tankers "are perhaps the greatest job I have ever seen in my entire investment career." Now, I'm ready to go on record and say there won't be a better one for decades. While the big cities of the world are blocked and the demand for oil collapses, someone has to store it. I recently invested more money and reserved all of my Altisource (ASPS - USA) and Uranium Participation Corp (U - Canada) portfolio solutions to add more tankers. I think both ASPS and U are up sharply, but nothing has the kind of advantage that tankers have. There are only a few moments to invest where you can bet big with an unusually low risk - it's the best I've ever seen and I have to fund it somehow - even if it does means taking losses on some of my favorite positions.
I know what the next obvious question is; What if the Saudis stop flooding the market? My answer is, "Who cares? We are all locked out. I look out my window. Car traffic has halved. Cruises do not go as often on the deck of my pool and air travel has decreased considerably. We'll end up defeating the flu, but by then there will be billions of barrels in excess to manage. The Saudis are a rounding error in all of this. Our government says it could last 18 months or more. Are you kidding? Where will all the oil go? Now is the time to be greedy on oil tankers.
By Harris Kupperman via Zerohedge.com
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