Managers are scrapping fewer crude tankers, but caution is needed:

What scrapping activity shows

For a near-term fundamental outlook, investors can look towards ship scrappage (retirement) activity. The rate at which companies scrap ships often reveals whether the shipping industry is facing excess capacity. When excess capacity pressures the shipping industry, firms will often retire older ships to relieve pressure on costs and increase cash flow. So rising or elevated shipping scrappage reflects a short-term negative outlook for shipping companies.

Scrappage data remains elevated

Ship scrapping data is released weekly basis by IHS Global Limited. The crude tanker industry scrapped zero vessels from October 4 to October 11. Based on the average past eight weeks of data, scrapping activity has fallen from 2.63 in mid-September to 1 vessel per week as of October 11.

The rolling average data indicator is encouraging on a very short-term basis, because it means companies prefer to hold onto vessels rather than scrap them. While the last four weeks of data have been positive, we remain in wait-and-see mode to see whether scrapping activity can stay below one per day.

How to interpret scrapping activity

Even though scrapping does support rates from falling further, and companies as well as analysts often point to the pool of old ships that can be scrapped, rising scrappage more or less reflects low rates that are pressuring companies to relieve industry oversupply. Since companies will try to employ vessels as long as they can if rates are high enough to make profits, investors should interpret rising scrappage as a negative, while falling scrappage is positive.

Effect on tanker stocks

The recent data is positive, and it’s a sign to be optimistic. But caution is necessary, as scrapping activity can rise, which could mean a negative short-to-medium-term outlook for crude tanker stocks such as Frontline Ltd. (FRO), Teekay Tankers Ltd. (TNK), Ship Finance International Ltd. (SFL), and Nordic American Tanker Ltd. (NAT). This also applies to the Guggenheim Shipping ETF (SEA).

Source: market realist.

http://marketrealist.com/2013/10/managers-scrapping-fewer-crude-tankers-caution-needed/