Spot, or day, rates for large crude oil tankers were down anywhere from 25% to 65% (depending on the class of vessel), year to year, in the second quarter of this year, driven by an overcapacity of ships, unexpectedly high refinery maintenance shutdowns, and the stoppage of oil imports into Japan as its refineries closed in the aftermath of the devastating earthquake and tsunami in March. In fact, rates achieved by many vessels were below the break-even earnings level. And prices continued to fall into the third quarter in the face of a slowing global economy and the release of strategic petroleum reserves by the United States and 27 other countries. The International Energy Agency (IEA) and others have indeed, lowered their forecasts for oil consumption for the second half of this year and 2012, particularly for the United States.
Contrast that with the rate picture for LNG Carriers, which has risen from a low of just over $20,000 per day in June of 2010 to just under $100,000 per day currently. It seems that energy consumers are awakening to the advantages of LNG as an alternative to oil and coal. Too, early development of the LNG industry was as a local market or served regionally via pipelines. Things are rapidly changing today as natural gas becomes a globally traded commodity, requiring the need for many more LNG Carriers. The IEA estimates that world consumption of natural gas could rise by over 50% over the next 25 years.
Under these circumstances, Teekay Corporation (TK) was able to secure short-term charters (with extension options) at favorable rates for two smaller LNG Carriers in April. All of its other gas carriers are on long-term stable charters, as are most in the industry. For example, Overseas Shipholding (OSG) has a 49.9% interest in four LNG Carriers that are on 25-year hire to Qatar Liquefied Gas Company. The vessels’ likely life-long, annuity-like contracts are profitable, but would be much more so at today’s rates. The aggregate cost for the construction of the vessels was $918 million. These were ordered in 2004 and placed into service in 2008, but construction costs, if anything, may have come down since then, as bidding activity is less active these days.
The tragic events in Japan that took the wind out of the oil tanker sails has actually bolstered interest in LNG Carriers, driving rates up by about $15,000 per day since March. Fears of nuclear disasters have given investors pause on reactor development, and not just in Japan. Many countries in Europe have temporarily shut down nuclear reactors for inspection, and several plants that were in the planning stage may never be built. The European Union has recently created a multimillion dollar fund to study the feasibility of switching to LNG.
Natural gas also burns much cleaner than those other carbon-based fuels. Used as an alternative to diesel as a propulsion fuel, for instance, LNG reduces carbon emissions by 25%, sulfur oxides by nearly 100%, and nitrogen oxides by 85%. Ever-tighter emissions standards/regulations should obviously favor LNG over coal, as well.
Two previous reasons why LNG caught on slowly was its price volatility and questionable supply. But there have been massive discoveries of natural gas in recent years, especially within shale rock formations in the U.S. Some of those resources were just not recoverable a short time ago, but new techniques such as horizontal drilling and hydraulic fracturing (or fracking) has made those deposits available today. Domestic gas reserves have doubled in just the last two years. This has driven down the cost of natural gas tremendously. America could very well become a major energy exporter. Wouldn’t that be ironic?
Some have questioned the safety of gas, but it is its explosive nature that makes it an efficient energy source. Too, when in a liquid state for transporting LNG is not ignitable. At the end-market site, using natural gas for a heating or cooking fuel can be very dangerous, a trade-off that must be considered and reduced through modern controls.
To help meet its unquenchable thirst for energy, China has been scouring the world for resources, and it has been turning toward LNG more and more often. China is especially attracted to natural gas in North America and Europe, which will require ocean transportation.
Growing interest in natural gas as a fuel has spurred investments in infrastructure projects for liquefication, regasification, import/export terminals, and storage, which should make gas even more attractive over time. Natural gas is also finding its way as a propulsion fuel for vehicles. In Europe, gas has long been used to power small boats and ferries, even cruise ships. The U.S. market has been slower to catch on, but the first duel diesel- and LNG-fueled vessels are now being built for domestic use. Moreover, LNG appears especially well suited for owners of large land-based vehicle fleets like trucks and municipal bus lines. In July, Chesapeake Energy (CHK) said it will invest $150 million to fund the development of LNG truck-fueling stations, which should help drive demand. Clean Energy Fuels (CLNE), which supplies natural gas as an alternative fuel for vehicle fleets, stands to benefit, as well.
The small size of most companies’ LNG Carrier fleets relative to their crude oil tanker and petroleum product carrier fleets leaves most tanker companies swimming in red ink this year. Growth in the LNG market bears watching, though, as this is truly a bright spot in the industry. There are no pure play LNG Carrier companies, although Teekay owns a 43.6% interest (including the 2% sole general partner interest) in Teekay LNG Partners L.P. (TGP), which has a fleet of 17 LNG Carriers (two are of which are chartered back to the parent company) against 11 conventional tankers, and was profitable in the June period.
Another consideration, vessel owners are notorious for being undisciplined and over-ordering vessels during prosperous times, only to regret those decisions when markets turn sour. About 30 LNG Carriers, without signed charter contracts, were ordered in the first seven months of 2011. Although strong market growth should provide that these vessels get absorbed at profitable rates, the question remains what will the owners buy next. The spot market should become larger over time, and that is not a good thing for current conservative-leaning investors.
At the time of this article’s writing, the author did not have positions in any of the companies mentioned.