Stefanos Kazantzis speaks about VLCC Asset Market Contango
Stefanos Kazantzis, Financial Advisor of McQuilling Services Marine in an interveiw discusses the recent upswing in VLCC asset prices and current developments in the asset markets. Excerpts:
About Asset Contango:
Asset Contango is a situation where the future price of an asset is trading at a higher level than the spot price. We can see this in commodities viz oil represented by the future contracts. Coming back more specifically to the VLCC asset market we view new building as future assets price and secondhand tonnage represents the current asset environment.
Going forward from October 2013:
Back in October 2013 we saw prices for new buildings on VLCC prices at $ 87 million and at the same time the prices for five year old vessels were well above $ 57 million. Over the next few months there was a short rise in the price of new building up until about April of 2014 where the current pricing of new building just about $ 103 million. So that upswing is around 20%. At the same time current prices for five year old asset was $ 65 million a 14% rise from October 2013. Looking more closely at the period we saw that in the fourth quarter the prices for new building accelerated at a more rapid pace. Actually five old assets had a small dip which was represented with a weaker TC and its environment and they generally recovered just about February of this year when they had a nice upswing pace in a short term pace on the market. So we compared them side by side and saw that the rate of growth for the VLCC new building was far greater than one for the five year old asset, which for us represented as an asset Contango.
The upgrade on price forecast helps to better project asset Contango:
I don’t know many analysts who I know of who could have better projected the recent run up in the prices of new builds. It was quite am impressive run. Coming back to the tanker market outlook in what we do in our forecasting methodology is that we take a quantitative based approach. We use a regression model which looks at the TCE earnings as our main independent variable, and for new buildings we also include the price of steel that is the largest cost in production of an asset and for secondary tonnage we also include liabor as another explanatory variable. Unfortunately we were not able to predict the recent rise in VLCC new buildings but we believe that there are certain other factors at play. We could give a little more closer attention.
Elaborating the factors:
One of the things we are seeing quite a bit of and I believe it started in 2012- 2013 period was that there was re-emergence of institutional capital by which we mean private equity. Private equity has been the main driver recently in focusing the new tonnage and the way the evaluations are done from the private equity as investor perspective is that it is more on the income based approach. In the income based approach it looks are the future potential cash flow of an asset and uses a discount rate approach for the investor to discount the rate appropriate for the investor to discount them back and come up with the present evaluation. I think there are some trickily elements in the discounted cash methodology particularly when you are looking at some of the longer term earning potential. You have to I think make some tricky assumption in. Those can vary significantly with what the potential are for an asset. Other things we are looking into are some of the fuel efficient vessel that are in the water and beginning to deliver results in terms of efficiency and these things will play a role in the earnings and environment and what we think is the potential earning that come forward.
Reasons for this approach:
We want to make sure that our clients when they look at our tanker market outlook we give a very fundamental sound story as to why we think certain asset behave in a certain way. This methodology eliminates lot of the market noise or sentiment that is prevalent in the market place. We believe that it helps to understand better what potential that exists. Ultimately, earnings are going to be the main driver in the asset prices. We are happy to look at other components such as the income based approach, try to qualify some of this sentiments and noise, but ultimately we believe in our fundamental story. It is not always easy to be little more cautious in predicting or projecting asset values especially when the environment is really very vibrant and we see lot of new entrants into the space. We try to temper that and try to kind of rely on the quantitative approach. Two years from now we are hopefully that we can look back and that we delivered to our clients a very reasonably and sound offer.