BELGISCHE ZEEVAARTBOND vzw.
LIGUE MARITIME BELGE  asbl.
Koninklijke Maaschappij  - Société Royale

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Tankers - A good or bad investment?

At the current time charter equivalent (TCE) revenue levels in the tanker sector, the subject of investment attractiveness seems out of place.

However, those familiar with the tanker industry know that shipping is a cyclical market and high markets follow low ones, just as surely as low markets follow high ones. As a result, McQuilling Services looked at the subject of comparative investment attractiveness recently.

First, the consultants assumed that going forward, there is a great degree of uncertainty in terms of what asset prices and TCE revenues will be at any given point in the future. Recognising the dangers of using the past to predict the future, they nonetheless wanted to establish some context for what future market behaviour might look like.

To do this, they wanted to show the range of rates of return that could be realised for each tanker asset class if the market highs and lows for freight rates and asset prices were experienced seen during the period 1997 through 2008.

McQuilling calculated the average annual TCE revenue for each asset class and found the maximum and minimum experienced between 1997 and 2008. Going forward, it was assumed the vessels were employed 360 trading days per year on the primary trades for the vessel class at these levels, but did not incorporate any assumptions for optimised deployment.

Next, the figures were run through an acquisition calculator to determine the rate of return on an equity investment in each specific asset class.

Financing costs were not included — only cash flows from TCE revenues and cash flows from operating costs to evaluate the overall project attractiveness. The pre-construction interest payments were included, as well as the proceeds from the sale of the vessel for scrap at the end of 25 years.

A discounted cash flow analysis was performed against the initial investment and the internal rate of return (IRR) was found for each asset class at the minimum and maximum TCE revenues and asset prices.

The results are most interesting when viewed graphically. Figure 1 illustrates the IRR wedges corresponding to each tanker class. Each wedge represents the boundary of possible IRRs experienced for each tanker type during the 1997-2008 trading period. The top corners of each wedge represent the case of maximum TCE revenue at the minimum and maximum asset prices. The bottom two corners represent the minimum TCE revenues at the minimum and maximum asset prices.

The shapes are theoretical in that a specific asset price/TCE revenue combination within the shape may not have been observed during the period, but all possible combinations were included in the area described by the wedge.
A comparison of the IRR wedges in Figure 1 produced some useful observations. Clearly, the VLCC sector had the most potential for strongly positive IRR performance, but about a quarter of the IRR possibilities are negative. Suezmaxes had less IRR upside potential, but also less probability of negative returns.

For the smaller sectors, the probability of negative IRRs diminishes, until only positive IRR results are recorded for MR tonnage.

However, the best IRR for this wedge is only about 25%, compared to more than 40% for the VLCC sector.

In evaluating the wedges, the size of the VLCC wedge was quite a bit larger than the other sectors, pointing to greater asset price and TCE revenue volatility over the period in question.

Also noted was that in order to access the potential of the elevated returns of the VLCC sector, a great deal more capital was required. At average prices of $95.6 mill over the 1997­2008 period, almost three MR tankers averaging $35.7 million each could be purchased for the price of one VLCC.

On each wedge, the IRR was plotted as a diamond shape resulting from the combination of the current asset price for each tanker class and a TCE revenue corresponding to the average for the 1997-2008 period. In all cases the IRR is positive, albeit lacklustre.

The IRR wedges are a way to consider the comparative investment attractiveness across different tanker sectors. Their size and shape represent the potential rates of return that might be observed going forward, based on the historica) time period 1997-2008.

As mentioned at the beginring of this study, predicting the future based on the past is risky business but results do help to provide a perspectine on the possibilities of the market.

Of course, the freight markets must recover from their current cyclical lows before any of the foregoing becomes more than just a theoretical exercise.

When they do, the use of IRR wedge analysis described herein may provide some insight to market participants on the tanker sectors of choice in the future, McQuilling concluded

 

Tanker Operator Dec 2010

 

 

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