In options, traders and analysts often talk about the time premium, which is the extra price you have to pay to buy the right to buy a stock or house at a given price for a certain duration. The longer the duration, the more valuable the option. But if shipping rates are likely to increase over that duration, the more valuable that contract will be too.
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Like options, secondhand vessels have “time premium” stamps on them. This is due to the fact newbuild vessels can take up to five years to construct. So between now and then, buyers of secondhand vessels can enjoy some early profits. In a normal market, this is positive.
In addition, older vessels tend to be more expensive to maintain and are worth less in the secondary market. So there’s some discount to secondhand values. Given that the life of a vessel is roughly 25 years, five-year-old vessels are typically valued at 80% of the company’s purchase price. But considering that newbuild prices fluctuate over time, we may assume that five-year-old vessels trade at a minimum 80% to newbuilds. Let’s call this the “secondhand discount.”
The secondhand-to-newbuild price ratio
The combination of the time premium and secondhand discount affects the price of secondhand vessels as a percent of newbuild prices—the price ratio. In a normal market, the time premium is positive so five-year-old values tend to be above 80% of newbuilds’ prices. This was the case between 2001 and 2009. But in a depressed market, the time premium could be negative. This happens when money spent on purchasing vessels today isn’t going to compensate the new ship owner adequate returns for the appropriate risk. So it’s not beneficial to own tankers in the short to medium term, as has been the case since 2011, as rates are now so low that companies are barely making anything.
Negative price ratio
While the price ratio for VLCC (five-year-old value divided by newbuild price) rose from 60.9% in September to 64.2% in October, the ratio for Suezmax and Aframax continued to fall. Suezmax’s ratio fell from 74.1% to 72.3% while Aframax’s fell from 61.2% to 59.4%. Again, this shows that ship owners continue to see a depressed market for crude tankers overall the short to medium term. As long as the ratio remains low, stocks and ETFs like Frontline Ltd. (FRO), Teekay Tankers Ltd. (TNK), Tsakos Energy Navigation Ltd. (TNP), Nordic American Tanker Ltd. (NAT), and the Guggenheim Shipping ETF (SEA) with its tanker exposure will be negatively affected.