Tuesday, April 15, 2008

Who says Oil and Water don't Mix?

As the summer of 2008 approaches, we can expect the typical Hollywood big-budget blockbuster movies and we can also expect blockbuster oil prices. With the price of oil on a steady rise, $4.00 a gallon may become a familiar sight this upcoming driving season. Based on analysis by Haye Capital Group (HCG), the probability of oil reaching $125.00 per barrel in 2008 is 78.9%. With the specter of recession in the background and the rise in commodity prices (corn, wheat, etc.) in the foreground, we need to find ways to hedge these seemingly never ending fiscal difficulties. Seventy percent of the price you pay at the pump is attributed to the oil per barrel price, $113.79 as of this past Tuesday, April 15th. The question is how do we make money in this challenging environment?

In this blog we are going to focus on how to take advantage these oil price increases. One possibility is to focus on an oil exchange traded fund or ETF such as (USO) while another possibility is dealing with oil stocks of those companies directly or indirectly servicing the oil industry. For example, the companies that transport crude oil and petroleum products are an essential link in the global energy supply chain. Most oil is transported either by ship or by pipeline. Two out of every three barrels of this transported oil is shipped in oil tankers. The remaining third is moved via pipeline. It is clear that the shipping industry plays a crucial role in the oil business.

The best way to play oil prices is to invest in the global shipping business. This is one of the least followed aspects of the oil service industry. In addition to never going out of business, they offer an extremely high dividend. Certain shipping companies responsible for the transportation of crude and petroleum could make an interesting oil play if they've made a sufficient investment in their fleets. Due to various environmental incidents , the International Maritime Organization has ordered that by 2010, all single hull ships transporting oil be phased out, and only double hull ships be used for oil transport. This new, stricter regulation has reduced the number of tankers available to ship oil. Therefore, assuming oil consumption remains the same, there will now be reduced supply to meet the original demand. A supply-side crunch will increase tanker spot rates. This implication adds increased pressures on the price of oil, and makes the shipping companies with the most double hull ships much more attractive to shippers than their single hull brethren.

We've reviewed several shipping companies and their related stock, taking into account the beta and dividend yield of each in order to determine the shipping stocks which best act as a hedge to higher gas prices in the real world. All of the stocks chosen move in a narrow and predictable range which keeps their yields relatively steady. This is advantageous as an oil hedge since the key to using these stocks as a hedge includes taking advantage of the cash dividends paid out by each company. HCG is most concerned with the dividend yield and the low beta value of those stocks with lower volatility, since it allows us to build a dividend yield that acts as a bond yield, and provides a hedge to the prices at the pump.

Based on analysis by HCG, the five most promising investments in descending order (first to last) are:

Frontline (HCG favorite) : (FRO) is one of the oldest and largest tanker companies in the world with a true global presence extending from the Persian Gulf to the Gulf of Mexico. With a current beta of 1.22 and a dividend yield of 17.1% that translates into an $8.00 dividend. This stock historically trades in the $31.00-$42.00 range.

Ship Finance International: (SFL) is a shipping company that is engaged in the ownership and operation of vessels and offshore related assets.

Knightsbridge Tankers: (VLCCF) is an international tanker company whose primary business activity is the international seaborne transportation of crude oil.

Double Hull Tankers: (DHT) operates a fleet of double hull tankers.

General Maritime (speculative): (GMR) is the most speculative play of our five. They had a decrease in both revenue and net income in 2007. Their positives include an aggressive share buyback program and the maintenance of their dividend. They didn't cut their already high dividend in spite of a decrease in revenue and net profit for 2007. The company is positioning itself for a rebound in the second half of 2008.

The oil shipping industry is dependent on a strong global economy with a healthy appetite for crude oil and crude products. If the global economy is thrown into a recession, and the global demand for oil declines, you can expect tanker stocks to take a hit as well. Also take note that tanker spot rates and fixed rates, which are the prices shippers set for their services based on the number of ships chartered, are tracked by and provide the bulk of a shipping company╩╝s revenue stream. These rates also tend to be highly cyclical. However, as long as there is demand for crude oil to be transported from producers to consumers, oil shippers will remain afloat and an investment in oil shippers should be profitable.

With any stock please do your own due diligence to see if it is a good fit for your portfolio. We do not own a position in any of the stocks mentioned in this blog.

4 comments:

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Anonymous said...

Very interesting article. When is your next blog coming and do you have any opinion on where our current stock market is headed? Should foreign stocks become our primary focus these days? What effect will the upcoming election have on stock prices?

Lawrence Haye said...

Its a bear market for the summer '08, with the DOW below 11k with a possible bottom in September at 10250-10500. I see '09 economy being in stagflation. Owning foreign stocks is a good idea for diversification but I believe the return on equities in the USA markets will be greater than the global equity markets( Asia, Europe, South America, etc)over the next 18 months. Which ever candidate wins, will be come the 21st century Jimmy Carter and will only last one term.

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