Frontline plc Q3 FY2023 Earnings Call

Good day and thank you for joining us. Welcome to the Q3 2023 Frontline plc Earnings Conference Call. All participants are in a listen-only mode. Please note that today’s conference is being recorded. I would now like to turn the call over to your speaker today, Lars Barstad. Please proceed.

Thank you all for joining Frontline’s third quarter earnings call. I want to point out that Q3 this year began with challenges, and remind everyone that July, August, and September are typically referred to as the summer lull in the tanker industry. The excitement in June raised our hopes for a strong fall market. While the results are not extraordinary, they are better than some past periods. The tanker market remains robust, with more potential for upside than downside. However, there are several factors at play that I will discuss in this presentation. Before I pass it to Inger, let’s review our Q3 numbers. In the third quarter, Frontline achieved an average of $34,600 per day on our VLCC fleet, $37,600 per day on our Suezmax fleet, and $33,900 per day on our LR2/Aframax fleet. We experienced a more typical distribution among the segments, which adjusted as we moved into Q4, with 81% of our VLCC days booked at $48,100 per day, 70% of our Suezmax days at $50,300 per day, and 70% of our LR2/Aframax days at $51,300 per day. Please note that these figures are based on a load-to-discharge basis and will be influenced by the number of ballast days we have by the end of Q4. It's also important to mention that these numbers exclude the 24 VLCCs being delivered this quarter and next. Since we can only recognize revenues when the vessels are loaded, these new vessels are not expected to have a significant impact on Q4 revenues. Now, I will hand it over to Inger for the financial highlights.

Thanks, Lars, and good morning and good afternoon, ladies and gentlemen. Then I think we can turn to slide 4, Profit Statement. Frontline achieved total operating revenues net of voyage expenses of $232 million in the third quarter and adjusted EBITDA of $173 million. We reported a net income of $107.7 million, or $0.48 per share, and adjusted net income and net profit of $80.8 million or $0.36 per share in the third quarter. Adjusted profit in the third quarter decreased by $129 million compared with the previous quarter. That was mainly driven by a decrease in our time charter equivalent earnings due to lower TCE rates in this quarter, which was partially offset by fluctuations in other income and expenses. The adjustments in the third quarter consist of a $17.9 million gain on marketable securities, a $1.7 million share losses of associated companies, a $400,000 unrealized loss on derivatives, and $11.1 million of dividends received. Let’s then look at the next slide, slide 5. Frontline has strong liquidity of $715 million in cash and cash equivalents, including the undrawn amount of our senior unsecured revolving credit facility, the marketable securities and minimum cash requirements for the bank as of September 30, 2023. The current portion of long-term debt in the balance sheet at the third quarter includes $91 million from a loan due in the first quarter of 2024, which was refinanced in November 2023, and $75.3 million related to the senior unsecured revolving credit facility, which we, in October 2023, extended to the first quarter of 2026. We have no remaining newbuilding commitments and no meaningful debt maturities until 2027. We also have a healthy leverage ratio of 52%. Then I think we can turn to slide 6. We estimate average cash cost breakeven rates for the fourth quarter of 2023 of approximately $28,200 per day for the VLCCs, $25,700 per day for the Suezmax tankers, and $17,100 per day for the LR2 tankers, with a fleet average estimate of about $24,200 per day. The fleet’s average estimate includes drydock for 7 Suezmax tankers this quarter, where one vessel only includes 50% of its drydock cost due to docking in between two quarters, and also one VLCC in the fourth quarter. The cash breakeven rates excluding drydock costs is estimated to be $2,000 lower or $22,200 per day. We recorded OpEx expenses, including drydock, in the third quarter of $7,400 per day for VLCCs, $7,500 per day for Suezmax tankers, and $7,100 per day for the LR2 tankers. One Suezmax entered drydock in the third quarter and finalized in the fourth quarter. Q3 fleet average OpEx, excluding drydock, was $7,400 per day. Then lastly, let us look at slide 7 and how the acquisition of the 24 VLCCs was funded. As we can see from the slide, we will finance the purchase price of $2.35 billion for the 24 VLCCs with a bank facility of $1.4 billion, $252 million cash proceeds from the sale of the 13.7 million shares of Euronav to CMB, $49 million cash on hand, $99.7 million from our senior unsecured revolving credit facility and also $540 million from the shareholders of Hemen. The ambition is to minimize the need for cash from the shareholder loan through Frontline’s capacity to releverage the existing fleet due to the historically low loan to value and/or sale of older non-eco, less efficient vessels. With this, I leave the word again to Lars.

Thank you very much, Inger. As I started with in the introduction, Q3 was a challenging quarter. Just so the audience on slide 8 can remind themselves, if we look at the three graphs at the bottom side of the slide and look at July, August, and September, you’ll see the state we were in. Despite this, we managed to churn quite a good return for this quarter, I believe. The big theme in Q3 was definitely the G7 price cap that came into force, in earnest, on Russian crude, and increased scrutiny on the fleet sailing with Russian crude. A lot of these vessels and owners decided to return to the non-Russian fleet, which increased supply, essentially competing with the Frontline fleets as we progressed through Q3. On the positive side, China continued to grind with record import volumes along with U.S. exports surprising to the upside, incurring very healthy ton miles. We got U.S. sanctions on Venezuela lifted. I’ll come back to that later. We did see, as we got into Q4, a growing political risk and the Israel/Hamas conflict. This has yet to affect the physical kind of trade of ships, per se, but it’s a security concern regarding our seafarers, and it’s also an operational concern when we sail through the area. I’ve also mentioned earlier in presentations that we do have normal seasonality at play, now that we have fewer amounts of black swans in operations in the market post-COVID. We return to OPEC action and OPEC’s eagerness to balance markets. On that note, let’s move to slide 9. I was actually just trying to check on Twitter whether OPEC has come with a statement yet. But it seems that people are betting on a 1 million barrel per day cut for next year or during next year, in addition to Saudi Arabia’s 1 million barrel voluntary cut. I think it's prudent to remind the audience that OPEC output and production aren't necessarily equal. Output and production do not equal exports. As oil demand is very firm, we also need to remember that OPEC is not the only supplier. Additionally, these production targets leave room for individual nations to adjust their export levels, and exports seem to be more correlated to domestic demand amongst the large producers rather than the stated OPEC targets. What we’ve experienced since August this year, for instance, is that Saudi Arabia's exports have actually increased. If we look at an aggregated graph on the right-hand side looking at all OPEC producers, we’ve observed the same trend. So, while production is coming down in line with adjusted targets, exports are increasing. Ultimately, I believe it's oil revenues that matter most for these nations, making OPEC's commitment to balance the oil market likely difficult considering the alternative sources of crude we currently have. With that, let’s move to slide 10 and discuss some tanker narratives. One surprising aspect is the stickiness of Russian exports amidst a very stated policy against it. The market is also quite amazed about Iran, who is heavily sanctioned, managing to maintain, and even increase, their exports as we enter the second half of this year. Lastly, Venezuela is a new entrant to the table where U.S. sanctions have been lifted. Additionally, U.S. exports are at record highs and increasing. In terms of Venezuela, we expect their exports to potentially increase by around 300,000 barrels per day short-term, reaching 600,000 to 700,000 barrels per day annually. This is not a massive number, but as we see, there are 4 to 6 VLCCs available in late November and December. That is a significant number of vessels not available for U.S. exports, which will likely tighten up the Atlantic market to some extent. Lastly, we’ve noticed that 2.5 million barrels of refinery capacity have returned after fall maintenance. Since a good portion of this volume is directed towards oceangoing oil, this amounts to a significant percentage of the 42 million barrels of oil transported daily. Let’s move to slide 11. We’ve included in this presentation what we call the very long view, which offers interesting insights from both a products and crude perspective. There's new oil production capacity coming from West of Suez, including increased production from Brazil, new productions in Guyana, and a continuous rise in shale productivity. At the same time, strong refinery capacity is being built up East of Suez, benefiting both crude transportation and product trade as refined products will flow back West of Suez. It's essential to note that future tanking capacity does not reflect these projections or trade extensions. Let’s then move to slide 12 and examine order books. We revisit this slide every quarter, and it’s not materially changing. We see virtually no new orders for VLCCs over the last quarter, and the order book stands at 1.8% of the fleet. I believe it’s the first time, at least in my time in shipping, that we’re only looking at 3 VLCCs to be delivered next year. This will affect the markets come Q1. Typically, you would see a significant number of VLCCs being delayed from the previous year into Q1, but this is likely to affect the demand for LR2s as many of these vessels on their maiden voyage will carry refined products. These will not be available in Q1 next year. We’ve seen both the Suezmax and LR2 fleet increase, predominantly in 2026 and to some extent in 2027, most recently. This indicates that the yard's capacity to build in 2026 is waning, shifting focus more towards 2027. As I’ve stated several times, this presents a lengthy period ahead where fleet growth is expected to be muted. Also, keep in mind that the effective age of a clean trading LR2 is much closer to 15 years than 20 years. Finally, on page 13, I want to spend some time discussing EU ETS. As most listeners are aware, the EU has imposed a tax or a fee on carbon emissions inside and concerning EU and EEA operations, effective January 1, 2024. The EUA exposures for current voyages heading into 2024 are already in play. 100% of emissions on voyages within the EU and the EEA must be accounted for. Additionally, 50% of emissions on voyages in and out of the EU and EEA will apply. This scheme will cover 40% of total emissions in 2024, 70% in 2025, and 100% in 2026. This represents a substantial change in how shipping operations are managed within the EU. For every ton of carbon we emit inside the EU or during passage through, we emit 3.2 tons of carbon. This implies we must purchase carbon credits for each ton emitted. EUAs are readily accessible and can be traded through various exchanges. The European Union will monitor this, and we need to report through our normal MRV reporting to the authorities. The significant question here is whether our industry is truly prepared for this change. At Frontline, we have chosen a pragmatic approach. First, we possess a modern and energy-efficient fleet, meaning that our emissions are likely lower than those of our competitors. We’ve decided to treat this from a voyage cost perspective, essentially viewing it as an additional fuel cost factored into our voyage calculations and freight calculations. Overall, just 60% of our voyage days are exposed to the EU ETS. It is crucial to note that this change is imminent. There have been discussions in the press about this, with ongoing talks between charterers and owners about how to manage this from a charter party and legal view. Worldscale has already incorporated EU ETS into their Worldscale calculation, but how this will play out as trading patterns develop next year remains to be seen. Now, let’s move to slide 14 and go through the summary. Tankers are performing well. Looking at the bottom chart here, it’s important to recognize that the combined tanker fleet is performing adequately. The expectation should be around the VLCCs, at least according to the most recent market developments. Frontline has significantly bolstered its VLCC position, gearing up for tighter fundamentals. The fundamental backdrop remains: we have decade-low order books and further extending lead times for replenishment. By this transaction, Frontline has enhanced its operational leverage as global oil demand is set to grow. Short- and medium-term oil demand expectations are optimistic, evident in the numbers. We have seen increased political risk, creating tension in the oil and freight markets. Nonetheless, we believe that Frontline’s large modern fleet and efficient business model is prepared as this next chapter unfolds. Thank you very much for that. I will now open up for questions.

And now we’re going to take our first question, and it comes from Jon Chappell from Evercore ISI.

I have three quick clarification questions. Lars, if I can start with you. So, the slide on the output versus production versus exports is very interesting. Obviously, the exports have started to pick up significantly since August. But if I look at your quarter-to-date bookings on the VLCCs, they are only a little higher than what you achieved in the full third quarter. You also insinuated that because of ballast days, that number comes in lower than 48,000, probably an even shorter or more narrow outperformance relative to the third quarter. What’s been holding back the seasonal recovery in the fourth quarter for VLCCs, given the meaningful increases in exports since August?

That's an excellent question, and it’s a daily discussion point among us at Frontline. The general activity in the tanker market is extremely high. There are many cargos being worked and fixtures conducted every day. However, quite a few players seem very comfortable doing last ton. One way to explain this, I will be frank. In the Middle East, about 70% of the cargos outbound are contracted, which means they are either under a COA or some form of time charter coverage. These contracts are priced based on the spot market or spot pools. Therefore, it leaves only about 30% of the cargoes coming into the spot market to negotiate. Looking at the balance among owners, many of the 30% owners participating in that market may not be inclined for the market to rise. They might be charterers and owners or for other reasons, so they’re not particularly interested in pushing this market up. Consequently, there are very few, or to reuse the term, real owners willing to hold back and fight for the next growth scale points. Regrettably, the market has become more efficient. In the VLCC markets, when we believe there will be a rise of 5 points based on the positioning of only one ship, that one ship may instead take last ton or 2 points lower. The dynamics are difficult to comprehend right now. Regarding Suezmaxes and Aframaxes, the increase in scrutiny, particularly by OFAC on former Russian traders, has added additional fleet supply in this conventional market, impacting prices. Essentially, it appears this market needs to grind a bit longer for tightness to become evident. Lastly, there is still a significant volume of oil being transported on ships operating outside of the legal or insurance frameworks. The population of ships over 20 years, for instance, includes a 1996 VLCC lifting Iranian crude, so one wonders why this continues.

Okay, yes. I appreciate that. Thank you. Inger, the second question is for you. On slide 7, I completely understand the ambition to minimize the shareholder loan of $540 million. I see opportunities for refinancing and potentially selling some non-core vessels. However, your liquidity stands at $715 million. If I analyze this chart, I assume that $149 million, the cash on hand, $49 million, and the $100 million on the senior unsecured is part of that $715 million, which leaves us with $565 million of liquidity, more than the shareholder loan. Why can’t you utilize the existing liquidity to bypass a significant portion of that shareholder loan immediately, without becoming reliant on vessel sales or refinancing?

This $715 million includes shares in Euronav as part of financing for this transaction, so we need to exclude that first. Additionally, this total includes the undrawn amount from the senior secured revolving credit facility, where we stated we plan to use roughly $100 million of. Also, we must retain cash on our balance sheet to support operations and satisfy minimum cash requirements. So, we do need the cash of $540 million as well.

Last one, super quick, just to clarify fourth quarter dynamics. I believe you clarified that the revenue from the 24 VLCCs won’t be realized until January when they lift their first cargo. However, as interest expense will hit in December, what about operating expenses and depreciation? Will these expenses impact the profit and loss statement as soon as the vessels arrive, meaning the revenue will be the only aspect affected by timing?

Yes, you can assume that as many as 15 vessels will be delivered in the fourth quarter from these 24. If we assume that one vessel is delivered every second day in December, then we’re looking at approximately 255 operating days in December for these vessels. As you noted, operating expenses will begin accruing from the very first day of vessel delivery. We will also incur interest expenses on the loan drawdowns, alongside depreciation of the vessels. So, that's correct.

And the next question comes from the line of Amit Mehrotra from Deutsche Bank.

Hey, good morning, good afternoon, Lars and Inger. This is Chris Robertson for Amit. First question is for you, Inger. On slide 6, regarding drydocking expected for Q4, how have drydocking days trended recently? I understand they were quite elevated during the COVID congestion. Are they around 30 days now per vessel, or 35? Where does that sit?

For the drydockings assumed for the fourth quarter, they’re approximately 20 to 25 days for each docking.

Lars, maybe a market question for you. Regarding China, Chinese oil import demand has been robust this year, despite ongoing economic issues and problems in the property market. What are you observing in today’s Chinese oil product demand? What are your expectations regarding export quotas coming into 2024?

As you are correct, the economic headwinds dominating the narrative around China have not noticeably impacted crude oil import levels. Interestingly, the same trend holds for LPG and coal as well; China appears quite healthy in these areas. Over time, oil and oil products have transformed into more of a consumer good rather than an industrial one, which may explain this resilience. We’ve also noticed that China has seemingly built significant inventories as we proceeded into Q3, which they are now drawing on. On the export side of products, I think the upcoming winter’s behavior could be crucial, since we saw some of this last year. A fairly mild winter across the northern hemisphere globally led to China’s good willingness to grant product export quotas earlier in the year. Thus, product and product quotas appear dependent on weather. On the import side, we saw that China recently increased import quotas for fuel oil, which is a positive sign in light of fears around China not growing.

And the next question comes from the line of Omar Nokta from Jefferies.

Lars, as this call has progressed, we’ve started to see headlines indicating that OPEC Plus has agreed on a cut. It appears we’re still awaiting an official statement, but it looks like a 1 million barrel incremental cut. While we don’t yet know if that’s a true cut or merely a quota reduction, historically, there has always been a close relationship with VLCCs, namely that a cut is bad and a boost is good. However, this premise seems to have been challenged over recent quarters based on your insights from the presentation. As you contemplate this situation, how do you envision this market evolving shortly if indeed there’s a 1 million barrel reduction? While this may initially appear negative, broadly speaking, what do you expect this to mean for VLCCs and, let's say, Suezmaxes, in the upcoming months?

I’m tempted to say it’s flat out positive, but that wouldn’t be entirely accurate. The notion of OPEC cuts predominantly occurs in or around the Middle East. If we look back historically, this was when Middle Eastern countries significantly dominated total crude oil exports. The landscape has shifted; now the U.S., South America, even the North Sea and to some extent, West Africa, are major contributors. There is no doubt that the demand side is primarily East of the Middle East and East of Suez. Not to mention, I’m not the only commentator highlighting this—this scenario is quite favorable for U.S. fracking and production. This will also benefit long-haul crude oil. Nevertheless, it’s important to acknowledge that, initially, it is a bearish sign as it contradicts OPEC’s optimistic demand outlook. This is indeed something requiring deeper analysis. However, one must recognize that if demand remains constant, oil must be sourced from alternative suppliers. Moreover, production isn’t synonymous with exports, and we can observe that Middle Eastern exports correlate more with domestic consumption rather than the announced production quotas.

As we proceed, it seems more non-OPEC production will start filling the gap. Regarding the 24 VLCCs coming on board, you've financed those, and you've been vocal about not needing to raise equity to fund the transaction, revisiting the liquidity earlier with Inger. Any updated insights on the need or willingness to issue equity, even though your leverage remains at 52%? I'd like to hear your updated thoughts on the potential desire to tap into equity to mitigate the transaction risk.

Not really. I believe we have been quite clear in this presentation, and Inger clearly stated that we have sufficient capacity within our existing operations at Frontline, to use another term. We're also exploring options to divest certain assets to maintain our very modern fleet. Thus, our position remains consistent with what we communicated when we announced the transaction.

Thank you. I just wanted to confirm that. And one last point regarding dividends. You've had an informal policy of distributing 80% of earnings, which was recently highlighted due to lower net debt gearing. How are you considering dividends moving forward? Will that percentage change once the deal is completed and you reach higher leverage, or are you still comfortable maintaining that 80% threshold?

As you rightly pointed out, we don’t have a formal policy, but the expectation has been around 80%. We’ll continue this as long as the market allows. This is why we don’t adopt a policy—we seek flexibility to avoid being compelled to pay dividends when it’s financially unfeasible. Ultimately, this decision is at the discretion of our Board. However, we do have a primary shareholder especially interested in dividends, suggesting you should expect this trend to continue.

Now we’re going to take our next question, and it comes from the line of Greg Lewis from BTIG.

Lars, I have a question regarding potential pockets of oil production outside of OPEC. Guyana has emerged as a bright spot. As we evaluate volumes from South America, how do you foresee the situation? Additionally, recent headlines suggested there might be tensions rising; Venezuela appears to have unhappiness regarding Guyana, with talks of an invasion. Could you enlighten us on the current volumes from Venezuela and Guyana to the international market? If disruptions occur, which segments of the tanker market are likely to be most affected?

The Venezuelan exports, and this is strongly encouraged by the U.S., will likely focus on alleviating sanctions. The U.S. refining industry requires these barrels since they can't refine more shale alone, so they will need this crude mixed into refineries. Thus, most of this Venezuelan oil likely travels short hauls using Aframax and possibly Suezmax into the U.S. Recently, we have observed a significant number of VLCC cargoes being built up, with some potentially being directed towards India. The expectation is that Venezuelan exports could range between 300,000 to 400,000 barrels per day before the sanctions and may, short-term, increase to around 600,000 to 700,000 barrels per day in export capacity. The distribution of this oil among the U.S., Europe, or Asia is challenging to determine. Keep in mind that Venezuela reportedly owes China a few billion dollars for this oil from financing agreements made years ago. In terms of Guyana, they're currently producing and exporting around 450,000 barrels per day as it’s a small nation with minimal consumption. One could assume that due to the U.S. interests controlling the oil production, there’s likely support for Guyana in protecting its territory. Nevertheless, operations are running as usual in Guyana as we speak. It’s worth noting we’re mildly optimistic about rising output from Latin America overall, given the robust performance seen from U.S. production this year, surpassing many expectations despite limited DUCs and CapEx.

As I think about the queue at the Panama Canal, clearly, that looks like it’s impacting the smaller segment of the product tanker markets. I understand that containerships are getting priority over product tankers, which is pulling product tankers further down the queue, possibly even causing some MRs to reroute through the Strait of Magellan. Is there any notable knock-on effect impacting the LR2 market, given your focus there?

I wouldn’t characterize the impact as significant. We haven’t frequently been exposed to the Panama Canal. There have been occasions where we ballasted through from the other end, but overall, I would downplay the impact on larger clean vessels. We haven’t observed a substantial tightening or increased ton miles for those, to be honest.

Thank you. There are no further questions at this time. I would now like to hand the conference over to Lars Barstad for any closing remarks.

Well, thank you all very much for listening in. I wish you a pleasant day, and hopefully, there are some, I’ve used the term fireworks, at least a few firecrackers left in this market as we move into December. Thank you.

That does conclude our conference for today. Thank you for participating. You may now all disconnect. Have a nice day.