What scrapping activity shows
For a nearer-term assessment of capacity growth, investors can look towards ship scrappage (retirement) activity. 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 shipping rates and maintenance costs. However, high levels of retirement reflect continued stress within the industry more than the potential effect in reducing pricing competition. So rising or elevated shipping scrappage reflects a short-term negative outlook for shipping companies.
Scrapping activity finally drops
The number of product tankers broken up since IHS Global Limited started to record the data in 2005 rose by one vessel from October 4, reaching 675 vessels on October 11. The figure using an eight-week moving average, which smooths data out to give a clearer trend, fell from 1.38 to 1 over the same period, which follows a decline from the recent peak of 1.5 seen in mid-September. This is somewhat short-term positive for tanker stocks, because it may suggest existing companies can support current rates, or that downward pressure on shipping rates is alleviating due to tighter demand-to-supply dynamics.
Interpretation of scrapping activity
Although companies often mention the fact that scrapping will support rates, the reality is that companies will try to employ vessels as long as they can if rates are high enough to make profits. So when scrapping activity rises, investors should interpret the increase as a short-term negative. On the other hand, when scrapping activity turns down, it often points to a positive outlook for rates. When scrapping remains low, like it did for most of October 2012 to July 2013 (see the above chart), investors should view it as a short-to-medium-term positive.
Impact on product tankers
Last week’s data was positive, and we could see lower scrapping activity in the weeks ahead. This would be positive for product tanker stocks such as Capital Product Partners LP (CPLP), Scorpio Tankers Ltd. (STNG), Navios Maritime Acquisition Corp. (NNA), and Tsakos Energy Navigation Ltd. (TNP). But if scrapping activity remains high, these stocks could be adversely affected. To a lesser extent, the Guggenheim Shipping ETF (SEA), which partially invests in product tankers, will also be negatively affected.