Stage Stores Evolves…
November 22, 2019
ESG = Excessive Share-price Growth
November 29, 2019

Tankers Keep Trending Better…

For my entire career, I have closely watched the Global Micro Trends I’m invested in (I have a new term and I intend to abuse it—sorry). I have to be honest, quite often, the trend sort of peters out. It’s often still a financial victory, just not what I had hoped for.

For instance, let’s look at my investment in the Greek ETF (GREK – USA). I’m up almost 20% after 6 months, but chose to book it over the past few weeks in the mid to high $9s. Why? It’s been 6 months and I gave it something of a time stop. I had thought that the belief in regulatory fixes would propel the market. While the market has rallied, the response was more subdued than I had hoped. Mitsotakis did what I expected him to do. He fixed some low-hanging fruit, went on the forever roadshow to promote Greece and got the market up. Unfortunately, running a country is hard, the Greek banks are still a mess and the economy remains reliant on tourism. As you can likely imagine, when someone’s disposable income drops, the first thing to be cut is tourism. With the Eurozone backsliding at the same time that China has hit an economic air-pocket, trips to the Parthenon are likely postponed a year or three. Longer term, I suspect that the Greek ETF does just fine because Mitsotakis is competent enough to fix enough of the problems that plague Greece. Unfortunately, this isn’t going to happen during my time-frame and I’m happy to book my gains. GREK outperformed the broader S&P by a rather healthy margin over the past 6 months and I’m content to declare victory and move on. While the gains are less than I had hoped for, they’re still better than many other alternatives.

That’s how it often goes with trends. I start with high expectations and end up with a nice win, just no escape velocity. The offset to this is that sometimes, things go much better than I had expected. Take my experience with Uranium last decade. How could anyone have guessed that the Cigar Lake uranium mine, one of the largest uranium mines on earth, would flood and panic utility buyers into the spot market? What should have been a decent investment return based upon utility restocking, became a life-changing score. In finance, you often cannot predict which way things will go. They key is to put your capital in the path of strong trends and then adjust your position according to how the trend is playing out—sometimes you simply get lucky. Due to the multi-bagger nature of big wins, they propel your aggregate performance well beyond your hedge fund competition—especially when you play them big. This is why, going forward, I intend to focus so much more of my attention on these Global Micro Trends as opposed to simply seeking out cheap stocks. It’s the tailwind from the trend that brings the computers aboard in a buying frenzy.

Look at how the bull market went into ludicrous mode after Cigar Lake flooded…

I bring this all up because my shipping Global Micro Trend, in particular the product tanker segment, keeps improving beyond my initial bullish expectations and the market seems slow to realize it. To start with, there has been reduced vessel ordering all year. This shouldn’t be a surprise—for most of the past year, vessel owners have been focused on balance sheet repair, not ordering. The forward orderbook is sitting at near its lowest level in modern history and there is a near-record proportion of the fleet about to hit the 15-year old bracket where product tankers start migrating into the dirty market due to degradation of epoxy liners potentially contaminating cargoes. More importantly for product tankers, depending on who’s numbers you’re looking at, more than a dozen and possibly as many as three dozen LRs went dirty this year. That’s significant fleet shrinkage. Those vessels will not return to the clean market unless Aframax tankers dramatically under-perform. Hence, the bar which demand must cross over the next few years is unusually low. If IMO 2020 lives up to expectations, we’re likely at the cusp of a super-cycle. However, even better news recently popped onto everyone’s radar; what some are calling “IMO 2030.”

What is IMO 2030? It is a somewhat ambiguous set of goals by various international acronyms to reduce greenhouse gas emissions in shipping by the year 2030, and further yet again by 2050 (50% global reduction from 2008 levels). As nothing (with actual enforcement power) has been decided, no one knows what the ultimate mandate will look like. However, it’s nearly certain that new regulations will be forthcoming. As you can imagine, a company ordering a vessel today for a 2022 delivery is expecting a 20 to 25-year lifespan for that vessel. If it becomes obsolete in 2030, they will likely take a sizable impairment that cannot be justified to shareholders. If you think back to last decade’s double-hull tanker mandates, a lot of guys tried to be ‘clever’ by ordering much cheaper single-hull tankers and ended up looking like fools after those vessels became obsolete and no counter-party would touch them. No one wants to be the guy who has to announce a similar blunder—it’s a career ender!!! Naturally, banks want nothing to do with financing vessels until there is more clarity on regulations. Even if the financing was forthcoming, 8-year debt amortization cycles dramatically increase the cost of capital, thereby raising necessary return expectations in a capital-intensive business.

Until there is clarity on the chosen propulsion system for future vessels, newbuilding orders will likely be restricted. Remember, shipping bull markets typically die from new supply overrunning demand growth. If future supply is restricted at a time when product tanker demand looks set to ramp due to IMO 2020, it could be quite explosive. More importantly, this cycle of elevated rates may be prolonged a good deal due to lack of ordering.

Remember these rates do not include triangulation.

I don’t mean to beat the product tanker drum too many times on this site, but my thesis has continued to materially improve all year with IMO 2030 being yet another example of an unexpected bullish catalyst. In the past few weeks, charter rates have responded quite dramatically and it increasingly looks like rates and cash flow will overshoot my most optimistic expectations—meanwhile the public securities have yet to really respond. To me, that spells opportunity as it will be hard for investors to ignore the gusher of cash flow that is about to arrive.

I invest in lots of trends. Some work spectacularly, others don’t and there’s a lot of muddle in-between. It’s the reason that I follow along so closely as it’s important to know when something has changed that makes you want to really push your bet. Those opportunities are the ones where the trend’s strength exceeds even the most bullish investor’s expectations. That is happening now in tankers and particularly in product tankers.

Disclosure: Funds that I control are long shares of DSSI, NNA, STNG, TNK

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