Tuesday, July 10, 2007

Frontline and Friends on Fire

Frontline and Friends on Fire
by Toby Shute
July 10, 2007
(Motley Fool)

Thursday's spike in Frontline (FRO) shares reminded me that I hadn't looked at any of the crude oil shippers in a while. After a little digging, I turned up a few potential explanations for the pop, one of which can be safely ignored -- and one that can't.

Around the time I reviewed the first-quarter results of Nordic American Tanker (NAT), overcapacity started weakening freight rates for crude carriers. One explanation pegs the capacity glut on slowed import demand from China, which was busily executing refinery turnarounds. This maintenance work's seasonal, routine nature makes me think that spot rates' pre-summer softening shouldn't have surprised anyone. Sure enough, these companies' stocks have shown no significant weakness. Tiny Top Tankers (TOPT), for one, has seen shares surge since mid-May.

Not everyone is celebrating the group's buoyancy. Citigroup analyst John Kartsonas noted in early June "that currently there is limited value in any of the tanker stocks we cover, as valuations have reached unsustainable levels."

If that's the case, why has Frontline, the bellwether of the group, ramped higher in the past week?

Ignore the recently resurfaced buyout rumors involving ExxonMobil. Frontline is Norwegian billionaire John Fredriksen's golden goose, and he's not likely to take a gander at any takeover offer.

Any theoretical buyout premium is a pittance compared to the massive cash flows this world-leading tanker operation consistently pumps out.

Instead, concern yourself with the supply and demand outlook for tankers and crude oil. The two factors are related, but have their own individual dynamics. Tanker oversupply seems to be kept in check right now by both the phasing out of single-hulled units, and the usage of some units to store oil rather than deliver it. With oil futures in contango - i.e., pointing higher in future months -- it becomes economic to sit on the oil for a while.

As far as the crude oil market goes, increases in supply and demand alike are a recipe for higher freight rates. Futures contracts on the benchmark supertanker route are pointing higher -- roughly double their present level, according to Imarex. This outlook seems to be supporting Frontline, Overseas Shipholding Group (OSG), and Tsakos Energy Navigation (TNP), even as they float near 52-week highs.


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