Thursday, August 20, 2009

All About Very Big Ships

Things we don't see very often, the very big container ships business. That is such a difficult industry to be in. You cannot just stop running the ships as most ships are still being paid off. Nothing to ship means zero income but you still have staffing cost. Even if you cut staff and take your ship out, you still have berthing charges, you cannot park your ship anywhere. It is so difficult to tweak "inventory", which is why the shipping rates can go up or down enormously. Even though share prices seem to have been rallying, that is indicative of a better economic environment 12-18 months down the road. Trading is still muted, less goods being shipped means a lot of capacity. The options you have are few, you can take the opportunity to do some ship repairs, but you cannot have zero income on such a huge asset for too long. There are two important developments surrounding these big ships. One is there has been a rapid rate of junking or destroying the ships. Two, is the contango way of using these ships to store oil betting on higher oil prices later on.

With demand for containerships declining given shrinking world trade, the number needed worldwide is falling. The result? Dormant ships, which represent an expensive carrying cost for their owners.Some are destroying capacity. You can take oversupply straight out of the market without the carrying costs of idle ships. So far in 2009 we have seen record numbers of containerships being sent off to scrap yards in India, Bangladesh, Pakistan and China.


Balancing that is the oil storage game. There is a kind of oceanic traffic jam out there among very large crude carriers (VLCCs), with something like 7% of them storing crude oil off the coast of Europe, Asia, or North America in anticipation of higher prices later this year. If the people contracting for such VLCCs are wrong, their carrying costs mount and it becomes likely that they just dump the product on the markets, further depressing prices.

Check the following figure of the current storage situation for both petroleum and clean products, like gasoil. While crude sea storage has declined from its peak earlier this year, clean products are floating out there is ever larger amounts.


I see oil and gas prices coming off a lot in the coming months as the buying seems to be tapering off. Much of the initial euphoria on all commodity prices over the first few months this year has been predicated on the China story. If the rest of the world don't recover faster, we could see too much too much "inventory being stored offshore", and when bad news start filtering through, these contango inventory will be scrambling to cut their losses. There is a carrying cost, and there is a currency issue as well. If you get a suddenly weaker USD coupled with a dipping commodity price trend, you could see a rush for the exits. The contango play is "too obvious" for it to work. Instead of storing real oil and gas in ships, one could really just do a options spread play, buy the current options/futures and selling the same contract 6-9 months down the road. All you have to do is to keep rolling forward the current contract until it matches the future delivery sell contract. If traders can do that so easily, what makes you think that these contango oil gambles will work out just as well? When it is so simple, it usually ends in disaster.

p/s photo: Yuri Ebihara

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