Scorpio Tankers Inc. Q3 FY2021 Earnings Call

Hello and welcome to the Scorpio Tankers Inc. Third Quarter 2021 Conference Call. I would now like to turn the call over to Mr. Brian Lee, Chief Financial Officer. Please go ahead, sir.

Thank you, and thank everyone for joining us today. Welcome to the Scorpio Tankers third quarter earnings conference call. On the call with me are: Emanuele Lauro, our Chief Executive Officer; Robert Bugbee, President; Cameron Mackey, Chief Operating Officer; Lars Dencker Nielsen, Commercial Director; James Doyle, Senior Financial Analyst. Earlier today, we issued our third quarter earnings press release, which is available on our website, scorpiotankers.com. The information discussed on the call is based on information as of today, November 11, 2021 and may contain forward-looking statements that involve risk and uncertainty. Actual results may differ materially from those set forth in such statements. For discussion of these risks and uncertainties, you should review the forward-looking statement disclosure in the earnings press release that we issued today, as well as Scorpio Tankers SEC filings, which are available at scorpiotankers.com and sec.gov. Call participants are advised that the audio of this conference call is being broadcast live on the Internet and is also being recorded for playback purposes. An archive of the webcast will be available on the Investor Relations page of our website for approximately 14 days. There are slides available on scorpiotankers.com on the Investor Relations page under Reports and Presentations. For those asking questions, please limit the number of your questions so everyone has a chance. If you have any specific modeling questions, you can contact me later and discuss offline. Now, I'd like to introduce Emanuele.

Thank you, Brian. And welcome to our third quarter results call, everybody. Over the quarter, the market weakness caused by the pandemic has disappointingly continued. We continue to believe that the recovery has been deferred rather than canceled. The reasons for this conviction are the following. First, world refined products consumption is normalizing. Diesel, gasoline, and North American demand are already back at 2019 levels. Jet fuel is lagging a bit behind, but with signs of improvement as we are seeing U.S. and European travel, for example, now flowing more freely since earlier this week. Asia should follow suit soon with key strategic locations like Singapore easing the proper restrictions. Second, the seaborne ton-mile demand per barrel consumed is higher as a result of an acceleration of refinery shutdowns from the pandemic and new refineries that have opened and come online. We expect ton-mile demand to exceed 2019 levels over the next few months due to refinery closures, and seaborne exports of refined products are expected to increase by over 5% in 2022, meaning that we will exceed pre-COVID levels soon. Third, vessel values have inflated significantly and at Scorpio Tankers, we have a very high gearing to this. Despite cash losses in the quarter, our equity NAV per share may have increased. Asset values on 5-year-old MRs have increased by 8% year-to-date. Five-year-old LR2s have increased by more than 20% year-to-date, and newbuilding prices on MRs and LR2s are year-to-date up more than 20%. Fourth, scrapping has picked up and yards are full, meaning supply will remain constrained for several years. Product tankers scrapped year-to-date hit 32 MRs, which is the largest number of MRs scrapped on record. In addition, there have been 3 LR1s and 8 LR2s scrapped so far this year. Lastly, with our ECO and scrubber-fitted vessels, we are well-positioned in an environment of rising fuel prices and widening spreads between grades of fuel. The spread between scrubber-suitable HSFO and the low-sulfur oil is $150 per ton at present and it is growing. Because of our investment in scrubbers, at this current $150 per ton spread the Company would generate an additional $70 million in TC in 2022. To sum up, our modern, exposed fleet remains very well-positioned. We have continued to focus on sensible balance sheet and liquidity management ahead of the normalization of ton-mile demand and ahead of the upswing in rates, which we are finally experiencing now. With that, I will turn the call to Lars, please.

Thanks, Emanuele. Let me first say that much of the world, excluding China perhaps, continues to roll back COVID-19-related restrictions. The predominant trend towards reopening, treating COVID-19 as an endemic issue and recognizing that restricting movements through lockdowns is not a viable long-term solution, continues. Nevertheless, the widespread vaccination rollout remains a keystone, solidifying the tanker recovery. During our second quarter 2021 earnings call, we stated that we would only expect a meaningful rally at the back end of 2021. This prediction is maintained and we can now see several green shoots developing in various product tanker segments. The demand picture is improving by the day. In the last call I stated that the U.S. had recovered to near pre-COVID demand levels. We looked for Latin America demand to recover as a critical market determinant. We can now note that South American mobility indices are up by 33% year-over-year through October with the vital product import region Mexico well in recovery mode. Argentina is the first major South American economy to post gasoline demand at pre-pandemic levels. Overlay that with the closure of the Limetree Bay refinery in the Caribbean and the ton-mile exposure to supply Latin America becomes compelling for the products trade. We have now subsequently seen a material rise in the U.S. Gulf MR market index. Daily earning rates increased from $6,000 to between $16,000 and $20,000 per day over the last two weeks, led by strong Latin American and Mexican demand. This increase in implied product demand immediately impacts the U.S. product export markets and has had an immediate positive earnings impact on the MR and LR1 sectors. Furthermore, we can see from mobility data that vehicle utilization is recovering well within India (+82% year-over-year), the Eurozone (+42% year-over-year), and North America (+35% year-over-year). These mobility trends should continue to see further recovery, and the positive inertia remains and is translating into improving rates daily. It is evident from the data that the world is in recovery mode and it is encouraging. The global refinery runs have now exceeded 80 million barrels per day for the first time since pre-COVID. We've also already seen a return of 8 million barrels in refinery runs since November of last year. The new easing of U.S. travel restrictions will add at least 250,000 barrels per day of crude demand through increased jet fuel consumption. While jet holds the promise of an imminent, albeit more gradual product recovery, the EIA has reported that U.S. gasoline and distillate consumption has finally returned to the 5-year pre-pandemic seasonal averages. Conversely, stocks are drawing at pace. The tail end of refinery maintenance, the backwardated price structure, and rising consumption have reduced stocks to the lowest since November 2017, with U.S. East Coast gasoline inventories at the lowest in nearly seven years. U.S. jet inventories last week alone posted a 1.79 million barrel stock draw. The market fundamentals hereon will be supportive for trans-Atlantic arbitrage opportunities and product markets. According to energy data, global commercial crude stocks are now 34 million barrels below October 2019 levels, which constitutes a very material and rapid draw of 600 million barrels from May 2020. The much-discussed global overhang has disappeared and today offers minimal slack in the crude supply chain. Refinery margins remain positive and will underpin higher run rates globally. As the market emerges from the seasonal refinery maintenance period, we anticipate a robust end to the fourth quarter with firmer rates across all product segments. In October, refinery maintenance generated a decrease of 8.7 million barrels per day of refined product globally. For November, approximately 4 million barrels per day of capacity comes back on stream, with a further 2 million barrels per day in December. Thus, we anticipate that 7 million barrels per day of global refining capacity will return by the end of January. A substantial return of volume into a market with low stocks facing high refinery margins, where weather delays and increased ton-miles will add to bottlenecks and logistical complexities, is bullish for rates. Ton-miles have also shown growth signs led by an increase in long-haul trade of naphtha going east and gasoline moving west. As various refinery closures occurred, they have contributed positively to the ton-mile dynamic over the year while volumes have steadily increased. On the back of these increased volumes and long-haul nature of the trades, LR2s have moved substantially and this again has moved up spot earnings from the mid-teens to $25,000 per day. We also anticipate that Australia, having now closed half of its refining capacity, will see a dramatic increase in import volumes as that region emerges from their extended lockdown and product demand returns. Going back to basics: given that demand is up, stocks are down, refinery utilization continuously north of 90%, suppliers inelastic with a benign order book, we expect to see a material upturn in market pricing. The growing pains of logistical chains trying to adapt to a post-COVID world will provide a lot of positive market volatility over the next couple of quarters. The fleet continues to age with 7% of the world fleet over 20; scrapping is accelerating, and so far over 150 tankers have now left for the breakers. In addition, as Emanuele said, newbuilding prices have increased 20–25% this year and tanker newbuilding berth capacity is being taken up by containers, bunkers and gas. So we feel well-positioned as the larger product tanker owners with a modern eco-fleet to take advantage of the next market cycle. Thank you very much.

Thank you, Lars, very much indeed. I think we'll just go straight to questions, please.

Thank you, sir. At this time, we would like to take any questions you might have for us today. We have our first question from the line of Omar Nokta with Clarksons Securities, please go ahead.

Thank you. Hey, guys, good morning. Lars gave a pretty good overview of what's going on in the market and you discussed the outlook. I wanted to dive into that a little deeper. This quarter, the third quarter, is increasingly viewed as perhaps the trough. We've seen low rates in 3Q, but everyone is now showing guidance that suggests 4Q will be healthier and spot rates have improved. You're showing that in your guidance as well. Do you feel that the way things are shaping up at the moment that the fourth quarter has the potential to pivot to a stronger market in 2022? Do you agree that 3Q can be viewed as the low point and that this improvement currently underway has legs for recovery?

Omar, was that a question for me?

Yes.

I think Q3 has for a number of years been considered to be the trough and there's always been some discussion about whether the market will pick up by Thanksgiving. It has certainly done so well in advance of Thanksgiving. There are many different factors playing into this. Be it the high flat price, be it the low stocks, refining margins being healthy across the board, the run rates now moving up. We haven't even touched fully on all of the energy substitution effects because of issues around naphtha or the high pricing on propane and what that means for cracking naphtha. There are many factors converging at the same time and it's not really a surprise to me that when suddenly all of these things come into play at once, markets churn through the positions that have been long and elongated for a while and then suddenly you see that there are no further ships available. We saw that in the U.S. Gulf last week and the week before where suddenly it moved up very quickly. We've been watching the data and when it coalesces, the market moves. I'm confident to say that, based on these elements, this move is real. We just have to digest positions that have been building up and then move into a much more balanced market. The same thing is happening in the Middle East with the distances moving west. There's no substitution to the crude carriers because additional vessels are not being delivered from the yards, so now these product trades are coming into their more natural environment. Naphtha has moved strongly throughout the year and that has continued. What we're seeing is that the different markets are now moving in unison, which is important because once utilization levels pass certain points, volatility plays into the rates. For example, west-to-east rates moved up materially in a short period and that's significant. It's not surprising to us and I don't think it's surprising to many of the larger players in the market. One additional point is that the gapping we've seen in LR2 rates, which have slowly crept up and then in a few trading sessions jumped to higher levels, is a very important development. This is happening at least 2.5 weeks before Thanksgiving, so it's early in the season and the market still hasn't experienced cold weather or other seasonal factors. All of this is supportive of the change and supports confidence that we've moved past the low point.

I think one thing to add here is what Lars is describing: this real drive forward, the gapping of LR2 rates and the speed of change. The LR2s slowly moving up to $20,000 and then in a matter of two or three trading sessions going to $25,000 is very encouraging. This is happening well before Thanksgiving and on top of what has been a record warm October. The market still hasn't had the usual seasonal effects, and yet we're experiencing this improvement, which supports the view that we've moved past the low point.

This location hasn't had cold weather or other seasonal effects, so as Lars is saying, this is truly supportive of the change and supports the confidence that we've moved past the low point.

Thanks, Robert. Yes. It definitely feels like we're getting the confluence now of the seasonality and the cyclicality coming together.

It's coming in all markets. You're seeing a little bit of tightening in the Aframax and Suezmax markets too, which is helpful.

Yes. Quite, it's broad-based. And just a follow-up, Lars: you discussed the LR2s and gave a good rundown of the MR market in Latin America. The LR2s have been gapping up to $25,000. Anything in particular driving that?

Omar, it's not really just what we're saying here; this matches the market data published this morning. We're echoing what the market is showing.

Okay.

We're already echoing what you have published this morning.

Yes. Could you give maybe a flavor of what you've seen? Is it a particular type of cargo? You mentioned naphtha, or is it a broad-based churning out of positions?

I'll put some color around it. We're seeing LR2s moving from the continent down to West Africa. We're seeing LR2s out of the U.S. Gulf going east. We've seen the usual flows out of the UK Continent and the Mediterranean, which have been the staple trades on light ends. Naphtha is primarily going long-haul into Asia. TC1 eastbound runs from the Arabian Gulf to the East have picked up again. There have been turnarounds in the Middle East that have completed. What is interesting is a lot of product moving into Australia on big ships as well. It doesn't take very much to shift the whole supply dynamics into the owners' favor because you're stretching out positions and doing a lot of different types of business. We are seeing an increase in the diversity of the cargo base.

Great. Very good. Thanks, Lars. And thanks, Robert.

Thank you.

Thank you. Our next question comes from the line of Jon Chappell with Evercore, please go ahead.

Thank you. Good morning, everyone, or good afternoon. Lars, starting with you again and following up with Omar: we've had fits and starts with this recovery that everyone has been calling for. The LR2 momentum recently seems to give more confidence that this is real. Two-part question: 1) Does the LR2 market tend to be a leading indicator for the rest, given the dynamics you described? 2) What could go wrong that causes another setback?

We've had fits and starts as you said. One short-term pain in the past was the immense stock draws in many regions. Also, the front-end pricing was so strong that the backwardated structure meant people weren't doing storage. Regarding LR2s, they are a very important market along with the MRs. Sometimes they work in unison and sometimes they don't. Right now in the West it's moving very strongly and we've seen LR2s move up in the Middle East as well. Before LR2s moved, we saw a jump in LR1s as positions tried to get into a sweet spot. When the LR2 market moves across the board in a positive direction — both eastbound and westbound flows — it soaks up many vessels, which then benefits LR1s. MRs sometimes operate differently due to logistical constraints and vessel size, though there is correlation over longer periods. At present, the general trend is upwards across segments.

Okay. That's fair. Robert and maybe Brian, we know the market is all that matters, but with Scorpio specifically there is immense focus on liquidity. You laid out a path to $280 million and of course you have a bit over $70 million of quarterly debt amortization with limited CapEx. Based on everything Lars laid out, there will be cash flow generation in the immediate future. But if there isn't and it's another headfake, what's the plan B on bridging the gap through the debt amortization for next year, including the convert, given the liquidity situation today?

At first pass, Jon, the primary strategy has been to allow ourselves the liquidity to play for time. That's the main strategy. We're seeing the world continue to improve in its dynamics—vaccination rollouts and reopening—and that's our basis. If the outlook changes materially, we have levers to act. For the year, we're paying down amortization and we can refinance along the way. We have a brand-new fleet, and the time charter market is strong. The Company is trading above NAV in many cases; there won't be any material issues in refinancing versus selling assets if needed. We're not operating from a doomsday scenario right now. It's best to continue executing the strategy we've been pursuing.

Again, vessel values have continued to increase and refinancing each time has added to liquidity. We have the ability to sell or refinance ships and add liquidity when needed.

Okay. That's what I wanted to hear. Thank you, Brian.

Thank you.

Sure, Jon.

Thank you. Our next question comes from the line of Randy Giveans with Jefferies. Your line is now open.

Howdy, gentlemen. How's it going?

All right, Randy. How are you?

Quite good. Thank you, Randy.

Two questions from me. First, on the fuel spread: you mentioned that a $150 fuel spread will result in, I believe, $77 million in cash savings for 2022. Is that just a random number or why use $150? Is there a forward curve there or is that what your expectation is? And if so, are you able or willing to hedge some of that spread?

James?

A couple of things, Randy. The $150 was chosen because that's the spread today. We used the current spread rather than assuming it will increase, even though we expect it to widen. On hedging, the short answer is we haven't looked at it. It would arguably be a speculative move, and we have not discussed it. You shouldn't expect us to hedge the scrubber spread.

But your expectation is that $150 is conservative, is that right?

That's right. We see it increasing, but since we are at $150 now, we used that to conservatively project the impact for 2022 under the assumption that conditions stay the same.

Got it.

Maybe we should have phrased it that we expect the spread to widen, but at present it's $150. If it remains at $150, we would realize roughly $77 million on sales. That is the basis for the calculation.

No problem. Second question on liquidity. You continue to raise liquidity with sale-leasebacks, boosting your cash position. How does this impact your weighted interest rates and maybe your breakevens now?

Our breakevens have gone down over the past year and a half because interest rates have gone down, so we've saved on interest. Also, vessel values have gone up, allowing these transactions. Overall leverage relative to market value hasn't increased materially. When you refinance, the debt amortization profile typically follows the vessel's depreciation profile—repayment structured toward the vessel's economic life. For example, refinancing a 5-year-old vessel could be repaid over the remaining 10 years of depreciation. That's where these refinancing liquidity events come from.

Okay.

You have to view this against a new fleet. This strategy wouldn't work on an older fleet. We strongly believe the market is improving; we're already making positive cash flow today. This can swing quickly given the operating leverage the Company has, if we see moderately good rates.

Sure. Just to clarify, the increased liquidity is not coming at a cost such as a distressed rate. What is the typical cost?

You're correct. It's not coming at a distress cost. We're not paying distressed interest rates on these transactions, so your point is well made.

Got it. All right, that's all I want to clarify. Thank you so much.

Thank you.

Thank you.

Thanks, Randy.

Thank you. Our next question comes from the line of Ken Hoexter with Bank of America. Your line is now open.

Hey, good morning and good afternoon. Great update. I just want to ask about MRs quickly. You noted different markets move at different paces. With newbuilding prices up as you discuss, is MR more muted in terms of your 4Q bookings and outlook? Is there a reason for that disconnect relative to the other groups?

By muted, what do you mean?

I'm looking at your 4Q bookings and rates to date; you have bigger moves in some groups, and you highlighted LR2 step-ups, but the 4Q outlook for MRs looks flat. Why is that?

The guidance was given as of October 1st, and through October the market was still very much in the trough, so many bookings were taken at trough levels. What we're seeing now in the past couple of weeks is exactly what we anticipated and discussed on the last call. Latin America was the missing piece during the last quarter—U.S. demand was recovering, but Latin America was still impacted by lockdowns. Now, many South American markets are back: Mexico, Argentina, Brazil, Chile. With issues such as the Limetree Bay refinery closure and other regional dynamics, the Atlantic Basin picture changes materially. MRs are primarily used in those markets and once demand flips, it can happen quickly. TC2 (continent to U.S. Gulf) hasn't moved yet because European stocks are low and there are regional constraints, but at some point that will force the issue. We're seeing markets in the West move strongly and markets in the Arabian Gulf start to move. When these markets move in unison, the whole market strengthens. Add to that cargoes moving out of China long-haul and limited deliveries of larger crude carriers in November and December, and you have a market that can tighten swiftly. We are also seeing Aframax and Suezmax pick up. So the MR market can respond quickly once the various components align, and that's what we're seeing start to happen.

Quick follow-up: if the price gap moves up, would that cause any move to reopen shuttered refining capacity in Australia? And second, any thoughts on a potential reestablishment of a U.S. crude export ban impacting the market?

On the U.S. export ban, that's a political issue and very hard to predict. If such a policy were enacted, it's not clear how that would filter through quickly and decisively. Regarding Australia, reopening a refinery is a long-term decision. You can't simply reopen a refinery overnight; it's a complex structural decision. Ton-miles have been increasing and as volumes rise with the world opening up, the need for more ships grows. So while regional refinery choices matter, the current ton-mile trend supports higher demand for shipping.

Understood. One final question: any reason the Company didn't buy back stock in the quarter? You repaid $450 million of debt and have about $200 million of cash, and I see Mr. Bugbee has been buying stock personally.

We've been consistent: we want to ensure that we're seeing the data hold. We're not arrogant enough to assume it's 100% certain. Until the markets cross over roughly $17,000 to $17,500 per day—levels where we start to make real net cash and build significant cash—we aren't going to repurchase shares aggressively. We'll continue to focus on maintaining liquidity until we consistently see that improvement.

Appreciate it. Thanks, Rob. Thanks, Lars.

On the U.S. export point, whatever the U.S. does on export policy won't change global demand for products in South America or elsewhere. Arguably, it could be a net positive for product tankers because it may create more inefficiency and longer ton-miles.

Agree.

Thanks, Ken.

Thank you. Our next question is from the line of Gregory Lewis with BTIG. Please go ahead.

Thank you and good morning, everybody. I only have one question for Brian. Regarding the recent sale and leaseback transaction for the four LR2s and two Handies announced earlier this month: you mentioned increases in advance rates and higher asset prices. Realizing these vessels were probably rolling off leases or financings from a previous financing one to three plus years ago, is there any way to think about the increased liquidity you're mentioning, maybe not on a specific vessel level but in terms of percentages?

You have to look at the entire fleet and how it's financed; you can review our filings to see where individual vessels were financed. This will happen organically as vessels come up for near maturities and we refinance. We have 131 vessels and about 30 financings out there, so we'll be doing this on a regular basis. It's difficult to express it as a single percentage across the fleet because it depends on each vessel's financing and maturity profile.

I was wondering if the advance amount able to borrow on those six ships has gone up or down.

It definitely went up. Some of those bank financings were replaced by sale-leaseback, and the vessel values have increased since the initial financings two years ago.

Okay. All right, guys. Thank you very much.

Thanks, Gregory.

Thank you. The next question is from Magnus Fyhr with H.C. Wainwright. Please go ahead.

Hi. Good morning. Two questions. First, given the weak rates over the last year, your clients were used to attractive rates. With rates moving up in the last few weeks, has this caught your clients by surprise? Do you see them preparing to go longer on time charters?

It's clear to me that many clients now want to take long-term charter coverage. We're seeing interest in 1-, 2-, 3-year terms and some are looking at five-year terms. They see that as the market rebounds and they want to secure cover. Rates concluded in the market show customers are willing to pay significantly more than recent spot prints to secure future cover. This is a leading indicator that customers believe the market is on a rebound.

Is there a rate level at which you would consider entering longer time charters, or is this currently the best time to do time charters?

There is virtually no supply on order this year—record low deliveries. The debate has been whether demand will come back and when. If this confirmation continues over the next few weeks to months, it will be very difficult to generate a supply response in product tankers. The market could tighten for multiple years and generate strong returns. Given our position and the fact we've just come off a trough, it's not the time for us to be chartering out vessels aggressively. We want to preserve upside for shareholders.

Great. Second question: you've been playing defense the last year on liquidity. With the market improving, do you feel you have the right fleet and positioning for the next two to three years? Do you feel well-positioned?

We have the largest product tanker fleet in the world by deadweight among public companies and the newest public tanker fleet. We've invested in environmental modifications like scrubbers. Most of our drydocking was completed during the weak market, so we're set with limited CapEx ahead. We have high earnings per share leverage, and we believe we're extremely well-positioned. There's no urgency to change the fleet composition right now.

Great. That's what I wanted to hear. Thank you.

Thank you.

Thank you. Our next question is from the line of Liam Burke with B. Riley. Your line is now open.

Thank you and good morning. Robert, I want to ask: as leverage kicks in and cash flow accelerates, the priority after debt service, I presume, is to return cash to shareholders because you're happy with your asset base. How would you look at returning cash to shareholders?

We've been consistent: first we need to get to the position where we can sustainably generate cash. We're focused on that. If markets trade above the roughly $17,000–$17,500 level and we can generate real net cash consistently, we will then consider returning cash to shareholders. We would take it in stages and decide the optimal approach when we have sustained improvement. We're not going to assume it in advance.

Fair enough. On the market side, refinery closures have been happening since late last year. Has that finally run its course or do you see additional impact from realignment of global refineries?

Hey, Liam. I think we're seeing the impact now. Lars mentioned increased volumes to places like Australia, and I think there will be a second leg as product demand picks up and exports increase. That will magnify and accelerate the effect of refinery closures. Most closures have occurred but there are still a few left and we'll need to replace lost production through increased exports and imports.

Great. Thank you very much.

Thank you.

Thank you.

Thank you. There are no further questions at this time. Mr. Emanuele Lauro, please continue.

We have no further remarks. Thanks very much for attending the call today and we look forward to speaking soon. Thanks very much.

Thank you. This concludes today's conference call. Thank you for participating. You may now disconnect.