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The Big Haul

Ordinarily, the phrase in the tank is one that makes investors cringe, but this time around might prove an exception. Tankers, those giant ships that haul everything from oil to iron ore, are in high demand, which means they're likely to have plenty in the tank for months to come. The great ships haul about half of the world's oil, and chartering tankers is highly profitable business, when the business

Ordinarily, the phrase “in the tank” is one that makes investors cringe, but this time around might prove an exception.

Tankers, those giant ships that haul everything from oil to iron ore, are in high demand, which means they're likely to have plenty in the tank for months to come.

The great ships haul about half of the world's oil, and chartering tankers is highly profitable business, when the business climate allows them to operate at full capacity.

Now is one of those times, and that bodes well for the stocks of those companies.

With oil inventories below par and an economic recovery under way, the U.S. has been sucking up oil like crazy. In times of low oil inventories, each marginal barrel must come from transport not storage. And because Alaska and Venezuela are increasingly difficult sources of oil, the U.S. is forced to draw most of its resources from the Arabian Gulf. China, also oil-needy, gets most of its crude from the Gulf as well.

“God must have been a shipowner,” says Michael McClure, chairman of Baltic Freight Indices. “Why else would he have located things so far from where they are needed?”

Slippery Demand

The International Energy Agency says demand for oil should increase 3 percent this year. That's the fastest pace in 24 years, and it should translate into a 5 percent to 6 percent increase in tanker demand, according to Jefferies Research.

Contributing to this prediction is OPEC, which is raising output to keep too-high oil prices from stalling the global engine. The first week of June, The Wall Street Journal reported, the Saudis and Emirates would soon pump “significantly larger volumes of oil.” That cargo is destined for tankers heading to the U.S. and China.

“It's the biggest boom in 30 years,” says Peter Georgiopoulos, CEO of tanker owner-operator General Maritime.

Over the past year, in line with firming rates, tanker shares rose 110 percent, versus 14 percent for the S&P. That doubling in industry cap makes tanker stock fine currency for acquisitions and concentrates more capacity into fewer hands, a trend that mirrors consolidation among producers — think ChevronTexaco, ConocoPhillips and ExxonMobil.

Oil tanker customers “like making one phone call” to arrange for all their shipping-related needs, says, Teekay CFO Peter Evensen, and the consolidation is giving them what they want.

Despite this barrage of favorable news, tanker shares remain reasonable. Multiples, now at five, six and seven, are up from last year's two, three and four, but remain well under the 20-odd multiples commanded by some oil drillers and the 16 posited by Mister Market.

True, tanker cycles traditionally run short. “Strong markets lasted maybe six months and helped you recover years of losses,” says Basil Mavroleon, managing director of tanker-broker Charles R. Weber.

But this time around appears to be playing out differently.

“The point about this cycle is not how strong but how long,” says Evensen. “Is the energy shortage now chronic? If the answer is yes, that would be incredibly bullish.”

Evensen dismisses fears that too many newbuilds (new tankers) will hurt rates, claiming tanker firms are holding back on orders.

“I love it when ship owners are cautious,” he says.

Mavroleon notes three other bullish factors: the phase-out of single-hull tankers in favor of safer double-hull vessels, geopolitical concerns about Iraq and Saudi Arabia and strong import demand from China.

“Without China,” admits Mavroleon, “I'm on vacation.”

Tanks Very Much

According to The New York Times, there are about 3,600 oil tankers in service, though the 435 VLCCs (very large crude carriers, which can each can carry two million barrels) transport about one-third the world's oil. The rest is divided between the smaller Suezmaxes and Aframaxes.

Frontline, which in June transferred ownership of the majority of its ships to a new entity, Ship Finance, is the top charterer of VLCCs. Teekay dominates in midsized Aframaxes and is No. 2 in Suezmaxes. (Tanker classes designate voyage limits, making Suezmax vessels the largest able to navigate the Suez Canal.)

The volatility of tanker rates is key. During the Venezuela oil strike, rates leaped as charterers replaced short haul Venezuelan oil with long haul Arabian oil, which traveled about six times as far and exerted twice the ton-mile demand. The bounciness of tanker spot rates raises the appeal of locking in rates over time, a process known as time chartering.

Teekay is the world's largest tanker company, transporting about 10 percent of seaborne oil. It has been accumulating tanker assets of late, paying $800 million cash in 2002 for Navion, the shipping subsidiary of Norway's Statoil, in a purchase that added short-haul shuttle tankers connecting North Sea oil platforms to refineries. In April, Teekay bought the Spanish shipper Tapias for $810 million, getting nine Suezmax vessels and four liquid natural gas (LNG) carriers in the bargain. The transaction positions Teekay as the leading oil supplier to Spain, while providing access to the potentially critical technology of liquefied gas, which Fed Chairman Alan Greenspan recently claimed will be necessary to meet U.S. energy needs in future.

CEO Bjorn Moller claims the Tapias buy will help Teekay reduce spot exposure by increasing cash flows from long-term time charters and is promising $400 million in fixed-rate cash flows for 2004. Teekay shares currently trade at a modest six times expected 2004 earnings of $6 per share, a level at the lower end of its historical range of four-to-20 times and well below the average tanker multiple, which, according to Jefferies Research, is 8.5 times. (Jefferies' target price for Teekay is $45 per share.)

On the Front Lines

Frontline dominates the VLCC and Suezmax tanker markets and is heavily leveraged to the long hauls that disperse Middle Eastern crude around the globe. When massive amounts of oil are needed, there is no better way to cargo it than on VLCCs, which, at 1,100 feet in length, are each about the size of three-and-a-half football fields.

In June, Frontline paid a huge dividend of $5 per share and transferred ownership of 47 tankers to Ship Finance, assigning existing shareholders a one-quarter stake. New Frontline retains nine VLCCs and three Suezmaxes plus ITC, a 10-tanker unit that provides long-term charters to BP and Chevron.

The new arrangement contains a number of buffers, including a $250 million cash reserve and partial profit-share from Frontline that are designed to ensure predictable cash flows and make reasonably secure the regular payment of high dividends to Ship Finance investors.

Jefferies considers the new shares “an attractive yield play on the tanker market.”

Taking the measure of Ship Finance, Jefferies calculates a net asset value of $12.90 and argues, compared with other high-yielding tanker firms, shares deserve a 50 percent premium-to-asset value, which sets a target of $19.35.

Income-hungry investors, considering the built-in buffers, solid assets and improved prospects for global oil, might consider taking a position in Ship Finance for the long haul.

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