What Happens to Shipping if Cheap Oil is Here to Stay?

Container ship Image courtesy of Seaspan

The collapse of oil prices over the last eight months -- to five-year lows -- has been a both a boon and a curse depending on the industry. Given that shipping companies and Master Limited Partnerships, orMLPs are a favorite among high-yield investors, let's take a look at what might be in store for this industry should crude prices remain low for several years.

Effect on shipping depends on what kind of shipper you ownFor dry goods shippers such as Navios Maritime Partners and Seaspan Corporation cheap oil is beneficial as it greatly decreases the cost of fuel. For example, according to Gerry Wang, CEO of Seaspan, fuel costs are down by about 50% from their highs in 2014.

In addition, lower oil prices can increase economic growth, which helps raise the demand for shipping. During its most recent earnings conference call, Seaspan indicated that it expects demand for shipping in 2015 to grow by 6% to 7% over 2014's levels.

However, Thanassis Martinos, managing director of Eastern Mediterranean Maritime,believes that dry goods shippers may still face an oversupply problem that might result in charter rates increasing perhaps 20% compared to a potential 50% increase for tanker rates in the foreseeable future.

Mr. Martinos' concern is a valid one given that the current growth rate for new dry shipping tonnage is about 6% per year over the next three years. Thus the expected global demand growth for dry goods shipping -- which is likely aided by long-term cheap oil -- in 2015 may be offset by the continued growth in dry shipping supply.

MeanwhileAngeliki Frangou, Chairwomen and CEO of Navios Maritime Partners,is more cautious about the near-term prospects of her industry. On one hand she believes that low oil prices will act "like a tax benefit to the whole economy," especially for China, Japan, South Korea, India, and Europe.

On the other hand, anemic economic growth in these economies -- one of the contributing factors to lower oil prices -- might result in demand for dry shipping falling short of current expectations.

Crude tanker boom may be short-livedOne of the most direct kinds of shippers benefiting from low oil prices are oil tanker operators such as Nordic American Tankers and Capital Products Partners . These shippers have experienced 62% and 191% increases in Suezmax tanker

Oil tanker image courtesy of Ship Finance International

charter and spot market rates, respectively, in the last year.

According toHerbjorn Hansson, Chairman and CEO of Nordic American Tankers, this is largely due to a supply constraint on this size of tankers, which is expected to continue for several more years.

However, I feel I should warn investors that tanker rates can be extremely volatile and some of the recent increase in demand for tankers may be due to what is known as the contango trade. Basically this means that oil speculators are renting oil tankers to store super cheap oil because they are able to obtain crude for less than guaranteed selling price of futures contracts.

Should oil prices recover, then this contango storage demand could dry up as quickly as it appeared, and day rates for tankers could potentially fall as quickly as they soared.

Takeaway: Cheap oil is generally good for shippers, but choose your shipping investments carefullyIf you're an investor in dry goods shippers, increasing day rates might happen thanks to increased global trade, which might be an indirect benefit of cheap oil -- but don't build your entire investment thesis around this idea, as charter rates can be extremely volatile and hard to predict. Similarly, while the recent decline in fuel costs is likely to help margins in the short-term, oil prices are notoriously volatile. Therefore it's best to invest in top quality shippers, especially those with a solid track record of either stable or growing payouts such as Navios Maritime Partnersor Seaspan-- just in case oil prices recover and the rosy predictions regarding rising charter rates in 2015 don't pan out.

Chemical tanker image courtesy of Ship Finance International

Given the possible short-term nature of the recent boom in tanker rates, I think long-term investors are better off choosing tanker companies that have both diversification into non-oil tanker ships and improved cash flow predictability through long-term contracts. Thus I like MLPs such as Capital Products Partners -- whose fleet of 35 shipsis split between container ships, oil tankers, and chemical tankers, and whose average remaining charter contract is 8.5 years-- far more than Nordic American Tankers, which not only has a fleet that is 100% oil tankers, but also relies exclusively on spot market rates.

The article What Happens to Shipping if Cheap Oil is Here to Stay? originally appeared on Fool.com.

Adam Galasowns units of Navios Maritime Partners and leadsThe Grand Adventuredividend project, which owns Navios Maritime Partners and Seaspan in several portfolios.The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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