Investment In Tankers: The Case For Optimism

Lloyd's List for September 12, 1978, reported that two 1971-72, 255,000-dwt VLCCs had recently changed hands for some $7 million each. This was somewhat lower than the price level ruling during the first half of 1978, when the average secondhand price for a VLCC was about $38.5 per dwt or, say, about $9.5 million for a 250,000-dwt ship (which compares with an estimated scrap value of some $3.4 million and a 1974 newbuilding price in the $40- 45 million range). Indeed, it appears that ships traded in the sale and purchase market during 1978 have tended to change hands for significantly less than their exyard prices when new. Beyond doubt, the capital values of both new and secondhand tankers are presently very depressed both in relation to historical price levels and, in the case of secondhand tonnage, to the underlying real costs of ship construction. This observation prompts the following questions: (1) Why is the market so low (what are the determinants of tanker prices) ?

(2) Are tankers a good investment at present price levels?

(3) How long is the market likely to remain depressed?

(4) Are there any differences between the investment potential of the various types and sizes of tanker ?

"INVESTMENT IN TANKERS: THE CASE FOR OPTIMISM," the most recent survey by the Research Division of H.P. Drewry (Shipping Consultants) Limited sets out to answer these questions.

A detailed analysis of the determinants of tanker prices leads to the conclusion that three factors are contributing to low tanker prices.

(1) The very low levels of freight rates, particularly for large ships, that have prevailed since late 1973.

(2) Remarkably gloomy expectations regarding future earnings from tankers.

(3) A general lack of finance for the purchase of tankers.

Examination of the behavior of tanker prices over past tanker market cycles leads to the conclusion that, in broad terms, the trading of ships on capital account appears to have been more profitable than the long-term operation of tonnage and that, given judicious timing, large tankers have tended to provide the greatest scope for absolute capital gains.

However, it now appears that the tenuous link between past and future secondhand price trends has been severed, and forecasts based on a mere repetition of the increases in prices (expressed in percentage terms) witnessed in the past would seem based on an invalid methodology.

From the example then of potential capital gains developed in the report, it appears that supply and demand in the tanker market regain an approximate balance, there will be a demand for newbuilding tonnage, and that this tonnage will cost the shipowner more than an equivalent ship bought at the depressed capital values prevailing during mid- 1978. It follows that when the newbuilding once again becomes the marginal ship which sets the level of tanker rates, the NPV of earnings from a ship bought today will be considerably greater than the purchase price of this ship, i.e., that a capital gain will have been made. From the examples given, it appears that the potential for profit arising from buying tankers today for resale when the market recovers is considerable.

However, the timing of the market recovery is critically important in determining the magnitude of any likely gain (even to whether a gain can be made at all).

An in-depth investigation of the likely date of tanker market recovery (by size category) suggests that overall equilibrium should be seen early in 1984, and leads to the overall conclusion of t h e report—that secondhand tankers at the prices ruling during mid-1978 are a sound investment, with ships in the VLCC and ULCC categories seeming to offer particularly attractive investment opportunities, with spectacular profitability being indicated for cheap VLCC tonnage.

Newbuildings are not generally attractive—the risk of loss if market recovery is delayed is too great. As shown by the examples, the profits made by an investment in tankers are related directly to the timing of market recovery— the earlier the better. With a delayed market recovery, the profits arising from tanker investment tend to fall, but the sizes of tanker offering the best potential do not alter. Thus, small ships, except in the case of newbuildings, do not appear likely to offer good investment prospects; the range 40-175,000 dwt offers particular analytical problems, but the ships taken to be representative of this size range do not come out of the comparisons particularly well.

However, it may be that this size range, especially the smaller ships in the range, up to perhaps 85,000 dwt, may enjoy particular advantages in the market place prior to 1982, the year at which the calculations used in the report commence— the capital values of these ships may benefit from this trend and enjoy a minor upsurge in prices. More than any other sector of the market, the details of the specific ships in question are fundamental to any investment in this intermediate size range. This leaves large ships, typified here by 250,000-dwt and 370,000-dwt tonnage. On the basis of the assumptions used, there is no doubt that these large tankers are the most attractive investment at the levels of price prevailing during mid-1978. Even if market recovery is delayed until 1987, provided the purchaser can continue to finance the maintenance of his ship, he will still make a profit of, at a minimum, some 30 percent of the present value of the total cash he puts at risk in buying a VLCC/ULCC.

"INVESTMENT IN TANKERS: THE CASE FOR OPTIMISM," priced at U.S. $160 for all overseas orders of £75 for U.K. orders, is available from HPD Shipping Publications, 34 Brook Street, Mayfair, London W1Y 2LL, England.