Continued from Part 1
The significance of ship orders
One measure that reflects managers’ assessment of future supply and demand differences is the number of ships on order. When managers expect future demand to increase more than supply, if they also expect to generate profits with the investment, they will often place new ship orders. But when managers expect excess capacity to continue or grow, they will refrain from placing more orders—sometimes even delaying them for a price. So, the number of ships on order rising is a positive sign that shipping rates will likely rise in the future. Since tankers generally take more than two years to construct (sometimes up to five years), the metric is often more relevant to long-term investment horizons.
Early sign of recovery
For the week ending July 12, the number of crude tankers on order dropped 25 basis points (0.25%) as a percentage of existing ships to 6.49%, as published IHS Global Limited on Friday.1 The decrease suggests construction firms began to work on more ships than there were new orders. The fall is normal in a recovering market because companies will often venture out slowly when ordering new ships so that they don’t over-purchase and harm industry profitability in the future. But it also means that managers aren’t expecting a strong recovery and are cautious.
As a general rule—and it’s not a golden rule—investors should know whether orders or prices are rising non-stop. As most who’ve seen the tech bubble or the recent collapse in gold prices know, when prices sky-rocket, the hike is usually driven by speculation or hype. While some people may be lucky to have gotten in early, those who join later believing their investment will be a long-term thing will put themselves at much greater risk, as the trend can reverse any time. When it does, prices usually plummet faster than what most people can react to.
The expectation of a shipping recovery due to higher future demand growth relative to supply growth has halted the decline in the number of ships on order since a year ago. Since the trend has remained up so far, which continues to support the theory of a shipping recovery, tanker companies such as Scorpio Tankers Inc. (STNG), Nordic American Tanker Ltd. (NAT), Ship Finance International Ltd. (SFL), and Tsakos Energy Navigation Ltd. (TNP), as well as the Guggenheim Shipping ETF (SEA), should perform well in the future.
Because managers are often slow to adjust to changes in demand, shipping rates will likely rise from current depressed levels within the next few years. But managers’ cautiousness, illustrated by the weak rise in the number of orders, reflects a slow recovery ahead.
Learn more about indicators that reflect tanker fundamentals
© 2013 Market Realist, Inc.