Currently, tanker asset prices are red-hot, with second-hand values and new building prices at their highest levels in the last 15 years amid strong market fundamentals. While high freight rates and tight tonnage availability have underpinned second-hand values, the tight availability of shipyard facilities has inflated new-build prices, sources Drewry.
Market Dynamics
The rally in new building prices started in 2021, with a flurry of orders in the container sector, tightening the slot availability at top yards. Even though tonnage ordering in the container sector has eased now, the bargaining power of yards remains high because of a boom in new orders in other sectors, including tankers, keeping prices elevated. On the other hand, second-hand values started gathering momentum in 2022, following a surge in charter rates because of the shift in trade patterns due to the Russia-Ukraine war, which aided the demand for tankers. Consequently, a jump in demand for older tonnage from the emergence of the new trade routes also underpinned the second-hand values of tankers in 2022.
Mid-size tankers were the main beneficiaries of this shift in the trade because of the EU sanctions on Russia; however, demand for VLCCs started to revive in 2023, with strong growth in long-haul trade from the Atlantic market to Asia with a rebound in Chinese demand. Strong demand coupled with a low order book, particularly VLCCs, resulted in a strong S&P market, where older vessels are fetching prices surpassing their initial costs. The price for a five-year-old VLCC increased from around $69 million in 2019 to about $110-113 million in 1Q24, a whopping 60% rise in the past five years.
Investment In Five-year-Old VLCC
We have arrived at projected IRR and Equity IRR, taking our long-term forecasts of charter rates, and second-hand price (five-year-old) of $113 million.
Based on our calculation, we believe a five-year-old vessel in the period market for 20 years should offer a project IRR of 7.2% and an equity IRR of 9%, using 70% debt/equity in our base case. We found that the Equity IRR of 9% is lower than the cost of equity of 9.7%. Additionally, the project IRR of 7.2% is lower than the WACC of 8.3%. While the difference between IRR and cost of capital looks narrow, if asset prices improve, IRR will further reduce, making the investment even less attractive.
In a bull case, the equity IRR of 10.5% is higher than the cost of equity of 9.7%, suggesting rising freight rate environment favors shipowners. Project IRR is lower than WACC even under the bull case. In the bear case, both equity IRR and project IRR are lower than the required rate of return.
Key Assumptions
We have calculated equity IRR and project IRR (levered IRR) using Drewry’s time charter forecast for the next five years and the mean reversion model for the charter rates beyond five years. We have assumed off-hire days, intermediate and special survey costs based on our understanding of the market and the remaining useful life of the vessel to be 20 years. Our cost of equity and WACC are representative of a US-based investor with low business risk, the highest credit rating and assumes financing at prevailing market rates. We have calculated equity IRR and project IRR under three scenarios- Bull, Base and Bear. These scenarios are based on our time charter rates forecast for the next five years for each of these scenarios and charter rates obtained by the mean reversion model thereafter.
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Source: Drewry
