Monday, July 22, 2013

FRO is a 5-10 bagger in a year I think

The WTI-Brent spread has narrowed very quickly lately, and the two are now more or less equal. Years ago WTI used to trade very tightly w/ Brent, but the increased supply of Bakken and Canadian oil sands oil created a bottleneck at Cushing, so Cushing oil has been cheaper than Brent for a couple years now until basically now. Crude prices right on the Gulf of Mexico were juxtaposed between the price at Cushing and other international prices. It appears the supply constraints in getting US oil to the Gulf have been resolved as evidenced by the price narrowing, and more pipelines are due to come online later this year, as well, which should guarantee WTI doesn't drop to a steep international discount again.
Because of the glut of cheap Gulf of Mexico oil, there was no need to charter VLCC (oil tankers) to bring world crude supplies to US refineries, which are the best in the world. FRO is the pure play in this space. FRO has languished during this time, and is now priced for extrapolation into near-bankruptcy. Now that the old oil price relationships have returned, there is suddenly now a need to charter oil tankers again. It takes time to build ships, and the supply overhang of ships for the past several years should now be quickly taken up. VLCC rates have jumped in the past couple weeks, and I forsee them jumping far more as long as Brent doesn't jump back to a big premium again. Rates dont have to return to anywhere close the 200-300K/day rates of '08 for a severe inflection in equity pricing to take place as the stock gets repriced for extrapolation as a sustainable profit-making enterprise.
Trading considerations, psychology
I'm not one to pick bottoms, but I believe this is a bottom in FRO, and it can go much, much higher. A way to hedge this would be to short WTI against Brent. The idea isn't to expect any gain on the hedge, but if for some reason the spread widens back to where it was, then the small gains on the oil spreads should offset the small losses on FRO, while if the spread stays around where it is now, or WTI goes to a premium to Brent, then the small losses on the oil spread should be overwhelmed by the massive gains on FRO Another trade on this narrowing theme is to be long Dec '14 and Dec '15 WTI against short Brent futures at the same expirations because WTI is still discounted to Brent by ~$7-8/brl at those expirations, a trade which I have on as well, but FRO has much more explosive potential. I'm long and I'M NOT GOING TO TAKE A SMALL GAIN. I would not be surprised to see a 5-10 bagger on this within a year. I will not burden you w/ fancy financial projections at this time, as there is no point until the VLCC rates stabilize at a new equilibrium. Suffice it to say that any sustainable increase over the breakeven rate of 25K/day will bring about a rapid rise in the price of FRO. The short interest for FRO currently stands at ~10M shares. Perhaps that's from capital structure arbers who are long debt and have been winning. Either way, it is time for them to cover. This stock is too small to be on the radar of many funds. The higher it goes, the more buyers will come in.
I'm also long (VLCCF), (DHT), and (DRYS)