If you think this bear market in energy has been vicious, imagine if it just kept getting worse for the next three years. That’s how things have gone until quite recently for crude and products tanker owners.

The gloom finally started lifting last fall once the price of oil began coming down. Since the decline has been driven by oversupply rather than faltering demand, it would be reasonable to assume that lower oil and fuel prices will stimulate additional consumption and trade flows.

There are in fact already signs of that taking place. Year-end US gasoline demand set a seasonal record, according to government estimates, while California excise tax receipts showed gas use there at its highest levels since 2007 in October.


Meanwhile, China has hired an armada of supertankers to bring cheap oil to its shores for storage.

But, growing demand aside, there’s another reason oil tanker charter rates have recently shot up to multi-year highs.

This has to do with the crude futures curve and specifically a condition known as contango, in which spot prices and near-term futures trade below the longer-dated contracts. Contango can make it profitable to store crude for delivery at higher prices later, whereas the opposite state, known as backwardation, discourages storage.

Backwardation prevailed for years until October, when contango took hold, and it has since only deepened.


Major crude traders responded the same way they did to the 2008-9 collapse, by hiring dozens of tankers for floating storage. They hope to score big as they did five years ago by selling crude into a recovering market at a healthy markup. Tanker owners, in turn, can only hope the contango grows more pronounced.

It has been doing just that over the last month. With US and global crude inventories at record highs and land-based storage tanks filled nearly to capacity the contango could in fact expand to depths last plumbed since 2009. Whether it will do so will depend on how quickly North American  output slows. So far it hasn’t much, but North Dakota’s plummeting rig count suggests it will in the second half of the year.

In the meantime, it’s a ship owner’s market for a change, albeit still well off the highs hit in late 2007. Back then, a VLCC (very large crude carrier, the second-largest tanker class) fetched  day rates above $200,000. Now day rates are pushing $90,000, and while that’s doubled just since November few expect the bonanza to last, with analysts forecasting a 2015 average rate just under $40,000.

That could prove low, because while demand could remain high for fundamental reasons supply this year will be limited by the relative paucity of newbuilds after the protracted shipping slump.

Tanker stocks have already moved up in response to the industry’s recent stroke of good fortune. Teekay Tankers (NYSE: TNK), the crude and product tankers offshoot of global shipping giant Teekay (NYSE: TK), has rallied more than 60% since mid-October.

But some perspective is in order. TNK’s current share price of $5.47 is down from more than $11 four years ago and $20 on launch in late 2007. The quarterly dividend has dropped from $1.07 in late 2008 to 3 cents every three months nowadays.

Even that token payout yields 2.2% at the current price, yet TNK is capable of much more than that. In the third quarter, cash available for distribution totaled 19 cents per share, which if paid out in full would equate to a 13% yield at the current price. Fourth-quarter results due to be reported sometime next month are likely to be better still, and if the current rates for the mid-sized carriers that make up the bulk of TNK’s 32-ship fleet hold up, they could produce $2 or more in cash available for distribution on the course of the year.

Source: Teekay Tankers presentation

Management has so far deflected questions about when it might increase the payout and by how much, but parent Teekay does have a financial incentive to increase the yield and showcase the fleet’s earnings power. Much of TNK’s fleet will be working at the still climbing spot rates this year.

Given the scale of its sponsor, strength of cash flow and the quality of management, TNK may be one of the safer ways to play a very risky industry, though it is by no means a safe one. We’re adding TNK to the Aggressive Portfolio. Buy below $6.

Our other crude tanker recommendation is as risky as they come, or at least that’s how it’s perceived after repeat brushes with insolvency left it heavily leveraged. But while Frontline (NYSE: FRO) won’t win any corporate beauty contests, it is also startlingly cheap, selling by some estimates for as little as two times Enterprise Value (EV) to EBITDA based on current rates for its fleet of 39 tankers, including 24 VLCCs.

That enterprise value is comprised of $240 million or so of equity market cap poised precariously atop $1.1 billion of debt, which is one reason the stock has been very volatile. The other is that Frontline’s largely retail shareholder base appears to still be suffering from post-traumatic stress after the stock sank from $27 not quite three years  ago to $2 and change today.

The share price jumped from $1.40 on Dec. 9, when all the tanker stocks were getting dumped out with the shale bath water, to $4.63 on Jan. 12, and now that price has been nearly halved.

Investors have long feared that the company won’t be able to repay a $225 million convertible bond issue maturing in April. In fact, debt-to-equity swaps have reduced the looming bill to less than $130 million, a sum Frontline ought to be able to produce from cash on hand as of the end of the third quarter and cash flow for the subsequent six months.

Investors also apparently fear further dilution, witness the stock’s 19% plunge Thursday after the company upped its at-the-market stock sales registration from $100 million to $150 million.

Therein lies the opportunity for the risk-tolerant and patient speculator cognizant of the recent upturn’s extent and likely staying power. We’re adding FRO to the Aggressive Portfolio. Buy below $3.

The case for products tankers is in many ways similar to that for haulers of crude: lower prices are likely to boost demand and therefore shipments. This market segment will see a bigger fleet increase thanks to higher percentage of newbuilds coming out of shipyards, but rates have still firmed as growing refinery exports from the US, Mideast and East Asia require more ships to reach a wide array of destinations.

Like crude carriers, product tankers benefit from savings on cheaper fuel, since fuel is their biggest expense. TNK, for example, has estimated that every $10 drop in the price of a barrel of crude produces bunker fuel savings of $2,400 per day per ship.

And while big yields are now scarce in the crude tanker space, Capital Products Partners (NASDAQ: CPLP) still offers one from its fleet of 18 medium-range product tankers, four Suezmax crude carriers, seven containerships and the odd bulker.

CPLP is a master limited partnership that’s chosen, like many of the other shipping peers, to be taxed as a corporation, and as such reports its distributions on form 1099. Its fourth-quarter payout works out to an annualized yield of 10.2% based on the current price, with 1.2x distribution coverage.

Management has already committed to hiking the per-unit payout, which has been flat since 2010, by an unspecified amount this year.

Like many players in the industry, CPLP is responding to improved demand by seeking to increase its exposure to spot rates. All four of its crude tankers and most of the product haulers come off charter sometime this year.

The unit price is down 13% since CPLP wisely sold 17.3 million units at $10.53 in early September.


Source: Capital Products Partners presentation

On the Nov. 2 conference call, the CEO noted that spot rates improved in both products and crude shipping during the fourth quarter.

And while the there was  a flurry of orders for new products tankers at the first hint of an improvement following the lows of 2012-13, the shipyards are now sold out for the next two years with global orders still down from their levels in 2006-08, even as demand continues to improve.

We’re adding CPLP to the Aggressive Portfolio. Buy below $10.