De-Risking Oil Tanker Investment Decisions

12 May 17

Whether to invest in new oil tanker capacity or charter tonnage is a complex decision.
Crude oil and its derivative products currently meet the world’s primary energy needs, and are commonly transported around the globe by tanker vessels. Investing in tankers is an extremely risky business owing to the volatile nature of the oil market and the high capital cost involved. An alternative to owning tanker ships is to charter vessels. This way, shipping companies do not lock-in capital and avoid the risk of foregoing a return on their investment.

Vivek Subramanian and Nursery Alfaridi S. Nasution completed a thesis research project to design a buy-or-lease decision making tool to help maritime companies make tanker investment decisions. The research was carried out for their MIT-Malaysia Master of Science in Supply Chain Management program thesis, and was supervised by Dr. Ioannis Lagoudis.

Several factors influence tanker investment policy decisions, the main one being the level of freight rates. Newbuilding and secondhand prices are characterized by high variability over time and significantly correlate with freight rates. Since the impact of demand and supply is a consequence of macro-economic conditions, which in turn dictates how the market functions, it is highly challenging to predict or forecast freight rates and vessel prices for a 20- to 25- year horizon – the lifespan of such assets.

Thus, a major challenge for oil producers is to design a sustainable investment strategy given the market volatility in freight rates and asset values.

The buy-or-lease decision-making tool assists maritime companies in calculating the range of costs and quantifying the risks associated with different investment strategies. By using Monte Carlo simulation, the Net Present Value of the total costs of pursuing the various strategies are analyzed to help make the investment decision.

Using the model to analyze an investment in a Very Large Crude Carrier or VLCC, four possible investment strategies are presented in Figure 1.

Figure 1. Investment Decision Options

The total cost of each strategy was computed, and the simulation model was used to help quantify the risks associated with pursuing the mentioned strategies. The input parameters were varied to produce different scenarios, and the expected Net Present Value of the total cost was simulated to provide a probabilistic view of the results.

As presented in Table 1, an indicative set of results is assessed based on a set of assumptions as previously stated, using average costs for different investment periods and the coefficient of variation (CoV).

Table 1. Investment Decision Assessment

Among the key findings is that the time charter option appears to be least risky strategy since it shows the lowest CoV and reasonably low total investment cost when compared to the other investment options. It’s notable that the discount rate, which captures the opportunity cost of capital in addition to helping adjust the value of future cash flows, plays a crucial role in determining which strategy to pursue. A higher discount rate tilts the decision in favor of chartering vessels; a lower discount rate favors buying and operating the vessels.

Regardless of which investment strategy is chosen, several qualitative factors should be given due consideration. These include current global fleet capacity and age, projected demand, steel prices, piracy threats, regulations and macro-economic conditions.

The development of alternative sources of fuel represents another set of risks, since tankers that are designed to carry oil might not be suitable for the transportation of other energy products such as pressurized gas. Such a disruptive change could render the capital-intensive investment useless before the end of its lifetime.

This article was written by Vivek Subramanian, Nursery Alfaridi S. Nasution and Dr. Ioannis Lagoudis. The Malaysia Institute for Supply Chain Innovation is a member of the MIT Global SCALE Network.