The annual “Investor Day” event is a major production for any large public company. It’s all-hands-on-deck for investor relations teams and top management. PowerPoint slides and speeches are fine-tuned, responses to predicted questions rehearsed, thematic takeaways honed.
The big day for ocean shipping’s Teekay Group was set for Wednesday, October 2, at the Grand Hyatt in midtown Manhattan, steps away from Grand Central Terminal. Invitations were sent. Flights were booked. Then, at the eleventh hour, on September 30, the event was indefinitely postponed. Teekay executives rebooked their plane tickets and headed to China instead.
The Teekay Group, through no fault of its own, had just been caught in the crossfire of an escalating triangle of tension between the U.S., Iran and China. In Byzantine fashion, U.S. sanctions targeting Iranian crude oil aboard Chinese ships traversing the Indian Ocean unwittingly ensnared a Canadian-headquartered, New York-listed owner of Bahamas-flagged vessels carrying Russian cargoes via the ice-choked Arctic Sea.
The curse of the 50% rule
When the U.S. sanctioned China’s COSCO (Dalian) on September 25, the crude oil tanker market experienced immediate side effects – and it still is – in the form of higher spot rates. Teekay’s travails show how sanctions fallout could overflow into the liquefied natural gas (LNG) shipping segment as well.
COSCO (Dalian) – a subsidiary of China COSCO Shipping Corp, the world’s largest ship owner – has ownership interests in multiple projects outside of the oil tanker space. Among those is a 50% stake in China LNG Shipping Holdings Ltd. (CLNG). CLNG in turn owns 50% of a joint venture (JV) with Teekay LNG (NYSE: TGP) that owns so-called “Arc 7” ice-breaking LNG carriers. These ships serve the massive Yamal LNG export project in the Russian Arctic, bringing cargoes to Asia via the North Sea Route that has become increasingly passable as temperatures rise.
The Arc 7 fleet serving Yamal output is comprised of six vessels owned by the CLNG-Teekay LNG JV costing an aggregate $2.1 billion (four on the water plus two newbuilds soon to be delivered); one ship owned by Russia’s Sovcomflot; three owned by a Chinese JV with Japan’s Mitsui OSK Lines (MOL); and five owned by a Chinese JV with Greece’s Dynagas LNG.
Under the so-called “50% rule” of the U.S. sanctions regime, if an entity is placed on the “blocked” list – meaning that any individual or company deemed a “U.S. person” cannot do business with it – then any company that’s at least half-owned by the blocked entity is likewise blocked.
When the U.S. sanctioned COSCO (Dalian), CLNG became blocked under the 50% rule. When CLNG was blocked, the 50-50 joint venture with Teekay LNG also became blocked.
According to Argus Media, the MOL JV partner is not COSCO (Dalian) but another COSCO subsidiary, while in the case of the Dynagas JV, the COSCO (Dalian) stake is only 25.5%, thus it doesn’t trigger the 50% rule.
The definition of a U.S. person encompasses American citizens and companies, as well as non-U.S. entities that either have subsidiaries in the U.S. or a material presence in the country. According to its annual report, Teekay LNG has a U.S. subsidiary, which appears to confirm that it is now blocked from doing business with its own Yamal LNG subsidiary.
This begs the question of how the Teekay LNG Yamal vessels can practically continue to operate and move cargoes without special “carve out” permission from the U.S. Office of Foreign Assets Control (OFAC). Vessel positioning data shows all four of the Teekay JV ships are at sea and underway as of October 1.
If OFAC permission is not granted, it raises the further question of whether a portion of Yamal LNG export flows could be temporarily constrained. If that happens, it would have implications for spot LNG commodity pricing, LNG shipping spot rates and U.S.-listed companies with exposure to spot shipping rates.
Teekay CEO changes his travel plans
On September 30, Teekay Corp (NYSE: TK) conducted a hastily scheduled conference call with comments from its chief executive officer Kenneth Hvid. Teekay Corp is the general partner of Teekay LNG LP, owns 32% of the partnership and obtains a substantial amount of its earnings from its LNG limited partnership.
Hvid said he was prevented by “legal advice” from answering any questions, and explained that he and other executives had been enthusiastically prepping for Investor Day for several weeks, but instead “must attend meetings with CLNG, COSCO and our customer [Yamal LNG] and focus our attention on finding a solution to the COSCO sanctions.”
According to Hvid, “We are in close dialogue with CLNG and COSCO to resolve this issue and minimize any disruption to Teekay LNG’s business. It is important to note that the vessels owned and operated by our JV with CLNG are purpose-built and therefore a critical part of the infrastructure to lift gas from the Yamal LNG project in Northern Siberia to end customers, most of which are in China. So, all parties are aligned to resolve this issue as quickly as possible.
“Our vessels account for 40% of the total shipping capacity servicing the Yamal project, which produces approximately 5% of the world’s LNG and supplies not only China but also Europe and the global markets,” added Hvid. Argus Media estimates that Yamal’s output is 16.5 million tons of LNG per year.
Analysts speculate on fallout
Russian natural gas producer Novatek, the majority owner of Yamal LNG, insisted in a statement that “the Yamal LNG project has all the necessary capacities to ensure supplies of LNG produced to customers in accordance with contractual obligations within the agreed timelines.”
Nevertheless, the four ships linked to Teekay LNG could be temporarily removed from service. Hvid expressly stated during the conference call that “the Teekay Group, including the Yamal JV, has not and will not…act in contravention of any trading sanctions.”
Analysts at Deutsche Bank cited the possibility of market disruptions. According to Deutsche Bank transportation analyst Amit Mehrotra, “The sanctions could restrict Novatek’s ability to ship LNG from its ultra-large Yamal export project. Chinese buyers would likely need to replace Yamal LNG volumes with longer-voyage exports, driving [shipping] ton-mile demand.”
According to Deutsche Bank shipping analyst Chris Snyder, “While Yamal will continue to pump out LNG, there are now critical questions as to how the production will be transported. The potential supply bottleneck could provide a much-needed boost to the LNG commodity price, which has languished for most of 2019.”
Snyder continued, “The developments could also have positive implications for the broader LNG shipping universe as the sanctions could remove [vessel] supply from the market for a period of time. In this context, Golar LNG [NYSE: GLNG] and GasLog [NYSE: GLOG] would benefit. There are several moving parts and these developments deserve close watching over the next several weeks.” More FreightWaves/American Shipper articles by Greg Miller