What scrapping activity tells investors
Scrapping activity does affect supply, but it’s best used as an assessment of the immediate to short-term fundamental outlook. The rate at which companies scrap ships often reveals whether the shipping industry is facing excess capacity. When excess capacity pressures the shipping industry, firms will often retire older ships to relieve pressure on costs and increase cash flow. So rising or elevated shipping scrappage reflects a short-term negative outlook for shipping companies.
Scrapping activity remains elevated and has just picked up
Ship scrapping data is released weekly by IHS Global Limited. From October 11 to October 18, the crude tanker industry scrapped three vessels. Based on the average past eight weeks of data, scrapping activity rose from a recent low of one vessel a week on October 11 to 1.38 vessels.
The rolling average data indicator is negative, because it likely points to current or expected short-term weakness in shipping rates. While the last four weeks of data have been positive, we remain in wait-and-see mode to see whether scrapping activity can stay below one per day.
Interpreting scrapping activity
Even though scrapping does support rates from falling further, and companies as well as analysts often point to the pool of old ships that can be scrapped, rising scrappage more or less reflects low rates that are pressuring companies to relieve industry oversupply. Since companies will try to employ vessels as long as they can if rates are high enough to make profits, investors should interpret rising scrappage as a negative, while falling scrappage is positive.
Effect on tanker stocks
The past four weeks of data have been positive, but caution is necessary, as scrapping activity just rose. This could depict a negative short-term outlook for shipping companies that operate a crude tanker business. These include Frontline Ltd. (FRO), Teekay Tankers Ltd. (TNK), DryShips Inc. (DRYS), and Nordic American Tanker Ltd. (NAT). This also applies to the Guggenheim Shipping ETF (SEA).