STNG - Scorpio Tankers' Climb Is Running Out Of Gas

Summary

• Demand growth for natural gas is starting to stabilize when compared to coming out of COVID in 2021 and early 2022.
• Increased refinery capacity and net additions could put downward price pressure on ton-mile fees.
• Europe has largely pivoted away from Russian-imported natural gas by importing via pipeline from Norway and other countries.
• STNG returned over 250% in 2022, but additional upside is not worth the risks and better value can be found elsewhere.

Investment Thesis

Scorpio Tankers ( STNG ) has continued its impressive run thus far in 2023, after the 250% climb it made last year. As I previously wrote here , much of this run has been attributed to an increase in demand for tanker shipping services caused by a supply shortage of refined petroleum products coming out of COVID-19. However, demand for these products is starting to stabilize to pre-COVID levels and adjustments are being made in the supply chain that will affect ton-mile prices. This, coupled with a very mild winter in much of the Eurozone where the Russia-Ukraine conflict was causing strains on the supply of gas, is reason to believe demand for tanker shipping services in the short-to-medium term is starting to stabilize and there will be downward pressure on ton-mile prices. I believe STNG's climb is running out of gas and better value can be found elsewhere.

Outlook

The increase in demand for tanker shipping services in 2021-2022 was hot, this growth was largely attributed to demand returning to pre-COVID levels as well as a shortage in refineries leading to higher post-refinement shipping costs ( S&P Global ). Additionally, demand for shipping services was forecasted to be higher, in part to the Russian invasion of Ukraine and its implications on the supply of natural gas to much of Europe. While tanker shipping services as an industry still have a positive outlook, it's starting to taper off in 2023 .

In the past year, natural gas demand stabilized, rebounding from historical lows during COVID. This return to normalcy put pressure on historically-low refinery utilization, leading to increased imports to make up for lost production in 2021 and early 2022. However, refinery utilization has been increasing from mid-2022 onward and is on track this year for the fastest rate for net additions over the last two decades. This will inherently decrease the mileage demand for tanker shipping, as refineries increase capacity closer to the source, putting downward pressures on ton-mile fees for post-refined products. In addition, Europe has proven resilient to supply disruptions as a result of Russia's invasion of Ukraine. While many European countries certainly experienced a natural gas crisis, a very mild Winter was the saving grace for what many experts were predicting would have a devastating impact on Europe's natural gas supply. Additionally, Europe is pivoting away from Russian-imported gas and is now receiving roughly 25% of its supply through the pipeline from Norway, and another 25% from nearby Qatar and Nigeria, and the U.S.

Risks

Many of the risks to this thesis stem from market/supply chain conditions mentioned in the Outlook section, rather than from STNG itself. Although many refineries are reopening and existing refineries are increasing capacity, there is risk that they do not open as quickly as expected, leaving tanker shipping in high demand and ton-mile fees high. There are also significant unpredictable risks surrounding Europe's gas situation and how it will unfold. I certainly didn't expect to see a one-year anniversary of Russia's invasion of Ukraine, and Europe's mild Winter surprised many experts who were forecasting more severe gas issues for the season. It's possible that a cold Winter 2023 could apply upward pressure on ton-mile fees and general shipping demand.

Valuation

STNG appreciated 250%+ in 2022 and has continued its climb in the first two months of 2023. However, I believe its current valuation is a bit rich, and the small marginal upside does not outweigh the risks - take your realized gains and find better value elsewhere.

According to analysts' consensus, the price target is around $70, roughly 12% over its current trading price of ~$62. At this point in time, Scorpio is trading at a P/B valuation 30% higher than the median, but it is also trading at its highest P/B value to date and well over its 5-year historical book value.

Conclusion

The tanker shipping industry continues to have a positive growth outlook, albeit a slowing growth rate forecasted for 2023 compared to prior years. STNG had an impressive run to finish off 2022, up over 250% for the year and strong growth YTD in 2023. With a slower tanker growth rate for 2023, demand for gas starting to stabilize and refineries kicking capacity increases into high gear, decreased ton-mile fees are expected. Given the speculation stemming from risk factors outside of STNG's control and STNG's current rich valuation, I think any additional upside is not worth the risks and better value can be found elsewhere.

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