The International Energy Administration just reported in its Oil Market Report that third-quarter global oil and liquids production has reached 100.3 million barrels a day as the world continues its insatiable demand for energy commodities without any signs of a slowdown -- despite sanctions, trade wars and other geopolitical standoffs.
This means someone has to move all these commodities around the globe to consumer markets. Our top play for that is Frontline Ltd. (FRO) , one of the largest crude oil and refined products tankers in the world.
According to the IEA, the surge in production has been driven by the U.S. shale revolution and supported by big increases in Brazil, Canada and elsewhere. The EIA also sees production from non-OPEC countries increasing another 1.7 million barrels a day in 2019. In the future, the IEA sees that additional supply could potentially come from places like Iran, Iraq, Libya, Nigeria and Venezuela, if their various challenges can be overcome, although we remain skeptical about those particular sources in the near term.
This record output reflects the global demand for energy commodities even as the world is boosting capital to develop renewable sources of energy like solar and wind. The IEA sees no peak in energy demand in the near term. According to an IEA featured report, "The Future of Petrochemicals", the drivers of demand remain powerful with petrochemicals being a major factor -- due to rising living standards, particularly in developing countries.
Frontline is a play not only on crude oil transportation but also on storage. Historically, there is a close connection between oil inventories and freight. When inventories increase demand for freight rises as tanks are filled. When inventories draw, demand for freight slows as oil is released from tanks. In addition, the crude oil structure recently flipped to contango, which means the prices for delivery of crude oil later in the future are higher than the prices for delivery in the near term, allowing a time-related arbitrage usually played by large commodity traders.
Global inventories are expected to build as the structure of crude oil indicates it will. As an example, the Indian Strategic Petroleum Reserves Ltd. (ISPR) is seeking about $1.5 billion in investments from global oil producers and traders to build additional emergency crude reserves that will act as a buffer against the volatility in oil prices. The ISPR's plan is to build underground caverns that can hold a total of 46.5 million barrels of crude at two locations.
Frontline is also at the forefront of marine fuel regulations, in particular the IMO 2020, which is a rule issued by the International Maritime Organization (IMO), the regulatory authority for international shipping. The rule calls for a significant reduction in the sulfur content of the fuel oil used by ships, capping the content at 0.50% m/m (mass/mass) by 2020. That is forcing the industry to switch to cleaner diesel fuel to power ships or to install scrubbers to reduce the amount of emissions from lower quality bunker oil.
For this purpose FRO recently acquired a 20% stake in Feen Marine Scrubers, an OEM manufacturer of Exhaust Gas Cleaning Systems (EGCS) and Inert Gas Systems (IGS), which gives Frontline a significant competitive advantage ahead of the IMO's implementation of new sulphur emissions caps in 2020.
FRO shares are up 37% year-to-date on the back of the recent crude oil rally and, as we mentioned in our earlier column, is outperforming major energy stock benchmarks like the Energy Sector SPDR (XLE) and the SPDR exploration & production ETF (XOP) . This rally is likely to continue as consuming countries reallocate their source of crude away from Iran into West Africa and Latin America, leading to longer shipments.