The last few years have been challenging for the global shipping industry. The industry's downturn began following the financial crisis of 2009 and the subsequent global recession. The only exception, though, was the LNG tanker market, which benefited from growing LNG demand in Asia.
However, just as the wider shipping industry is seeing a recovery, the LNG tanker market has entered a downturn. Indeed, LNG charter rates have more than halved compared to last year. Despite this scenario, Teekay LNG Partners L.P. (NYSE:TGP) is an attractive proposition as the partnership is largely protected from short-term volatility in LNG freight rates and is well positioned to capitalize on growth in the LNG market in the long term.
Short-term LNG freight rates down sharply
The global recession resulted in the shipping industry entering a prolonged downturn. Between 2007 and 2009, ship owners in the crude oil, oil products, and dry freight market ordered new vessels. However, just as the capacity increased, the global economy entered a recession. Not surprisingly, freight rates fell sharply.
In contrast to the broader industry, the LNG tanker market, however, was doing well up until last year. Spot rates in the LNG tanker market averaged $150,000 per day in mid-2012, driven by robust demand for LNG from Asia. However, 2013 was the peak for the LNG tanker market. According to RS Platou, spot rates averaged $48,000 per day, while 12-month time-charter rates averaged $65,000 per day, last month. Year to date, spot rates have averaged $56,000 per day, while 12-month time-charter rates have averaged $71,000.
The sharp decline in freight rates is mainly due to fleet growth and limited cargoes, according to Teekay. The company noted in a recent presentation that ongoing production outages are limiting spot cargoes in the market, and at the same time, the LNG fleet is set to grow by more than 30 ships in 2014. Nearly half of these ships are uncommitted to long-term projects. Back in February Golar LNG Limited (NASDAQ:GLNG) described the LNG tanker market as very challenging due to these reasons.
The LNG tanker market has entered a downturn just as the freight industry in general is seeing a revival. Despite the gloomy near-term outlook for the LNG tanker market, Teekay LNG Partners is a good bet.
Teekay LNG still looks attractive
Indeed, Teekay LNG is still an attractive proposition due to two main reasons. Firstly, while short-term rates have fallen sharply, the company is by and large protected from this as 100% of its LNG fleets operate under fixed-rate contracts through 2015. As a result, Teekay saw a 12% increase in its generated distributable cash flow in the first quarter of 2014. More importantly, the company has limited exposure to potential market weakness in the next three years, according to Peter Evensen, CEO of Teekay GP LLC, which manages the master limited partnership (MLP).
Evensen noted back in May that the company expects short-term volatility in the LNG shipping market to continue through 2016, prior to the expected start-up of several new LNG liquefaction projects. Indeed, the LNG market is expected to grow significantly in the long term, driven by strong demand from China. And this is the second reason why Teekay LNG is a good bet.
Indeed, the MLP is well-positioned to capitalize on growth in the LNG market. Recently, Teekay LNG was one of the companies chosen by the Yamal LNG project to build gas carriers worth $5 billion. Teekay LNG has signed a Letter of Intent (LOI) to provide six icebreaker LNG carriers for the Yamal LNG project in Russia through a 50:50 joint venture. Teekay's joint venture partner is a China-based LNG shipping company.
The Yamal LNG project, which is being developed by Novatek, France's Total SA (NYSE:TOT), and China's CNPC, already has the required permits. The LNG plant will have three trains with total capacity of 16.5 million tons of LNG per year, with the first LNG train currently scheduled to start-up in late 2017. The main market for LNG will be China.
Indeed, as I noted in an article last month, demand for LNG from China will be strong over the next few years as the country cuts its reliance on coal to meet its energy needs. The Yamal LNG project is looking to capitalize on this demand, and Teekay LNG's exposure to the project makes it a good long-term bet. The company expects the six LNG newbuildings for the project to be delivered between 2018 and 2020. The vessels will operate under 25-27 year fixed-rate charter contracts, according to Teekay LNG. Additionally, the project will need several conventional LNG carriers for which Teekay LNG will bid later this year.