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January 07, 2009

Super Tankers, Super Volatile Oil Prices and Super BS
by Reggie Middleton

The recent oil shipping research that I released was actually quite timely. What appears to be adverse price movement (as can be said with the financial cos. research as well) is actually an opportunity. Be sure to attain positions in small increments. I will elaborate below, but first lets peruse this news item born from the bullish comments of Frontline's CEO.

From Bloomberg:

Oil traders are seeking as many as 10 supertankers to store crude, potentially taking the amount hoarded at sea to almost five days of European Union demand, according to Frontline Ltd., the largest owner of the vessels.

About 25 of the carriers, each able to hold about 2 million barrels of crude, were already hired for storage. There are enquiries for 5 to 10 more, Jens Martin Jensen, Singapore-based interim chief executive officer of the company's management unit, said by phone today. Traders are storing crude to take advantage of higher prices for supply in the future.

Thirty-five supertankers represent about 7 percent of the global fleet of very large crude carriers, according to data from London-based Drewry Shipping Consultants Ltd. Storing oil in tankers may buoy rental rates that fell by a record 78 percent last year as slower economic growth sapped demand for energy.

"I've never before seen storage demand on this scale," said Didier Labat, a Paris-based shipbroker at Barry Rogliano Salles who has worked in tanker markets for about 20 years.

Commodities prices fell the most in five decades last year, with crude dropping more than $100 from the peak of $147.27 a barrel in July, as simultaneous recessions hit the U.S., Europe and Japan. Oil demand in 2008 fell for the first time since 1983, according to the Paris-based International Energy Agency.

Traders are seeking to lease ships for three to nine months, Jensen said. Crude oil for December delivery traded at $61.90 a barrel as of 10:49 a.m. in London, $13.66 more than the February contract. Oil companies and traders may be able to profit from storing the oil, assuming shipping, insurance and financing costs are covered.

...

Iran, the second-largest member of the Organization of Petroleum Exporting Countries after Saudi Arabia, idled as many as 15 of its biggest ships in May to store crude oil. That contributed to three consecutive months of higher rental rates for ships.

The cost of delivering Middle East oil to Asia, the world's busiest route for supertankers, rose yesterday for the first time since Dec. 5, according to the Baltic Exchange in London.

Forward freight agreements advanced. The derivatives are used by traders to bet on the future price of hauling Saudi Arabian cargoes to Japan, an industry benchmark.

The contracts traded at about 46 Worldscale points for the fourth quarter, according to prices from Oslo-based broker Imarex ASA as of 10:34 a.m. London time. They closed at 45 yesterday.

...

Worldscale points are a percentage of a nominal rate for more than 320,000 specific routes. They give owners and oil companies a starting point for negotiating hire rates without having to calculate the value of each deal from scratch.

Frontline, based in Bermuda, has advanced 13 percent in Oslo trading this year. The five-member Bloomberg Tanker Index has gained 12 percent...

To contact the reporter on this story: Alaric Nightingale in London at Anightingal1@bloomberg.net

and this just crossing the wires as I type this article:

"US Crude Oil Inventories Rose 6.68 Million Barrels Last Week", hmmm! Methinks there may be some softening still, in these markets.

Now, what does this mean to my susbscribers? Well....

Frontline has been hired for floating storage for up to 50 mn barrels of oil, or roughly 20 to 25 oil supertankers over the past two months. There has been a recently surge in bookings for Very Large Crude Carriers (VLCC), which carries 2 mn barrels of oil, to store crude oil for future delivery owing to the oil market's contango structure wherein traders can buy oil and store it and simultaneously enter a forward sell contract. We believe that this arbitrage trading would not be sustainable once the spread between current spot and future prices normalizes to historical levels. We have computed historical Contango (Backwardation) for 1 month, 2 month, 3 month and 12 month oil price futures. The present contango for oil prices is highest since 2000. At present the 2 month, 3 month and 12 month oil futures are trading at a premium (discount) of $4.55, $6.76 and $14.51, respectively against average premium (discount) of $0.18, $0.21 and -$0.84, respectively, since 2000.

According to International Energy Agency, the cost of storage in VLCCs is around 90 cents a barrel per month and an additional 30 cents a barrel or more to cover capital costs, insurance and other costs. We have determined the possible arbitrage opportunity taking into consideration the above storage cost assuming that a trader buys oil at spot and stores oil for specific duration and simultaneously enters a short futures contract. Due to high contango in the futures contract there has been an arbitrage opportunity for an investor particularly in the month of December.

As a result many players (Royal Dutch Shell PLC, BP PLC, and Koch Industries) had booked VLCC for storage in December to exploit this trading opportunity. As premium in the future market normalizes due to market forces (in fact the premium in 3 month future contract has already declined from $13.3 as of December 22, 2008 to $6.7 as of January 6, 2008), speculative demand of vessels for storage purpose will ease. (We have already built in high capacity utilization rates for FRO in our model with net capacity utilization of 98% for own fleet vessels and 96.2% fir Managed fleet vessels for 4Q2008) Also we regard this news as negative for Frontline, since it reinforces our view that the company is finding it difficult to charter ships on voyages, in a markets already plagued by lower freight rates, and is resorting to short term demand fulfillment.

I welcome my subscribers to revisit the Frontline analysis as well as download the oil price arbitrage spreadsheet that accompanies this article. Professional subscribers should take particular notice of the macro argument made in the thesis.

Oil Price Arbitrage Addendum (Excel 2003) 2009-01-07 09:55:07 1.31 Mb

Frontline Investment Summary - Retail 2008-12-18 14:13:16 363.84 Kb

Frontline investment highlights - Pro 2008-12-18 14:16:07 473.47 Kb

Reggie Middleton
Reggie Middleton, LLC
Perpetual Interests, LLCTM
http://boombustblog.com/

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Copyright © 2007-2009 Reggie Middleton

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