While scrapping limits supply growth and keeps rates from falling, 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.
Ship scrapping data is released weekly by IHS Global Limited. From October 25 to November 1, the crude tanker industry scrapped two vessels. Based on the average past eight weeks of data, scrapping activity rose from 1.38 to 1.5 vessels over the same period.
The rolling average for the past eight weeks of data is negative, because it likely points to current or expected short-term weakness in shipping rates. As new deliveries remain elevated, companies are trying to remove excess supply by retiring them and converting to steel.
So while orderbooks for tankers have shown some signs of positive future outlook, we remain in wait-and-see mode to see whether scrapping activity can continue to drop and stay low. If it did, we would likely see higher rates ahead, similar to what we’ve been seeing for dry bulks over the past few months.
Although scrappage supports 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.
The past few weeks of data have been positive, as scrapping activity has fallen from above 2.0 in September. 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), Tsakos Energy Navigation (TNP), and Nordic American Tanker Ltd. (NAT). This also applies to the Guggenheim Shipping ETF (SEA).
© 2013 Market Realist, Inc.
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