What Drives Vessel Values?

One thing I have learned about the tanker industry is that it is very close to a pure supply/demand driven market. The charterers use their leverage on the hundreds of owners to drive rates down when they can, and if there is a scarcity of vessels in a region, owners will drive rates up as much as they can. This is also true of vessel values. With the exception of how much they cost to build as a floor, most vessel values are directly related to what their expected earnings are and what owners are willing to pay.

We have done a lot of research on vessel values and read a bit of George Soros, and we can definitely agree that values are driven by two major factors; expected earnings of the vessel, and the amount and availability of leverage obtainable to finance the vessel.

When looking at expected earnings, it is important to note that spot earnings are not the primary drivers of values, time charter rates are. However, it is important to note that spot earnings are important drivers of time charter rates, along with future expectations so they warrant paying attention to. The problem is that spot earnings are very volatile in the short term, and tend to move in several cycles during the course of a single year, where as time charter rates are more stable and include expectations of future earnings, not just the current market trend. Running a quick regression analysis you can ascertain that there is a very high correlation of vessel values to one year time charter rates, and an even higher correlation to three year time charter rates. More specifically, the typical price of a five year old VLCC is over 90% correlated to the one year time charter rate over the past 10 years. The correlation to the three year time charter rate is even higher.

The other driver of vessel values is the availability of lending. Recently, this has become a very important aspect of driving the values of assets. Long ago before the Lehman Collapse, most major shipping banks were throwing money at owners, loaning anywhere between 70% up to even 85% of vessel values (which were at historical high levels) at LIBOR plus a margin of less than 1%. This madness helped increase values even further as owners would only have to dish out $20 million to purchase a vessel worth $100 million and would be paying very low interest rates on that loan to boot! After the Lehman Collapse, most shipping banks stopped lending completely, which caused the Sale and Purchase market to dry up entirely. This was more pronounced in the drybulk market, mainly because when the banks stopped lending they also stopped issuing Letters of Credit, which virtually drove trade to a standstill. On the tanker side, this wasn't as much of an issue as the counterparties tended to be Oil Majors, with higher credit ratings than most banks. However, the global financial crisis caused banks to review their lending portfolios, and to their surprise the shipping portion was less profitable (and more risky) than loans in other areas. This caused values in the tanker industry to fall towards the end of 2008, despite the continued strength in earnings. In 2009 as earnings collapsed, banks pulled back lending to the industry even further, which coupled with the declining earnings caused vessel values to fall more than 50% in some cases.

What does this mean for values? Well, looking at the sale and purchase market in the tanker industry, you can see that things are finally starting to normalize. The combination of lower asset values and stabilizing earnings have started to make vessel acquisitions appear attractive. Banks are again starting lend money to would-be purchasers (although at maybe 50% to 60% of asset values at LIBOR plus a margin closer to 3%-4%), and this has thawed the sale and purchase market at the moment. We see room for values to increase another 10% to 20% from here if time charter rates remain at current levels. If earnings increase, we could see values increase further than that!