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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.
Ship scrappage falls, but may be temporary
Between September 20 and 27, the tanker industry scrapped zero vessels, according to data from IHS Global Limited. The figure using an eight-week moving average, which smooths data out to give a clearer trend, also fell—from 2.63 to 1.89 over the same period. This is a somewhat short-term positive for tanker stocks, because it may suggest existing companies can support current rates or that shipping rates are expected to rise.
On a long-term basis, however, the current level still remains significantly above 2011′s average. This is evidence that companies have been resorting to supply cuts in order to alleviate industry competition and downward pressure on shipping rates.
How to interpret scrappage 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-to-medium-term negative. On the other hand, you should view falling scrapping activity as a positive.
Effect on tanker stocks
Last week’s data was positive, but it’s too early to tell whether a long-term recovery is ahead for crude tanker business very soon. If demand growth does catch up with supply growth, however, investors can expect scrapping activity to fall. This development would be long-term positive for crude tanker stocks such as Frontline Ltd. (FRO), Teekay Tankers Ltd. (TNK), Ship Finance International Ltd. (SFL), and Nordic American Tanker Ltd. (NAT). This also applies to the Guggenheim Shipping ETF (SEA).
© 2013 Market Realist, Inc.