In this report, Pat McKeough discusses how an oil tanker company may fare when the price of oil is low. The stock in question is Nordic American Tanker, owner of 23 vessels that ship crude oil. The company’s shares have done well over the past year, even as the price of oil was falling. For one thing, lower oil prices cut the cost of fuel for tankers. In addition, changes in the oil futures market create a demand for greater storage facilities, which tankers can fulfill. Looking ahead, Pat considers the highly cyclical nature of the industry, and whether the company can sustain its dividend, which yields a high 10.4%.

Nordic American Tanker (symbol NAT on New York; www.nat.bm) operates 23 Suezmax vessels that ship crude oil. Suezmaxes are the largest tankers able to go through the Suez Canal.

In July 2015, Nordic American announced the purchase of two more Suezmax vessels. The first joined the fleet in September, and the second will be delivered shortly. In addition, the company signed a deal for the construction of two more Suezmaxes in December 2014 that are slated for delivery in August 2016 and January 2017.

Nordic’s shares moved up recently, despite lower oil prices, for two main reasons:

First, the oil-price drop has cut the cost of fuel, and that boosts profit margins: fuel represents about 70% of a tanker’s voyage expenses.

Second, the tanker market is driven by the supply of available ships and demand for oil shipping—but it’s also driven by the storage of oil.

Energy stocks: Oversupply of vessels appears to have worked itself out

As oil prices fall, what often happens is that changes take place in the oil futures market. The price of oil delivery now tends to fall below the price of oil for delivery, say, 12 months in the future.

This creates a potential profit opportunity. By buying cheap oil today and agreeing to deliver it 12 months from now, traders can lock in a profit. But they need a place to store that oil for the next year, and tankers can provide such storage. It’s not the typical use for a tanker, but in special situations like today’s depressed oil markets, it can make tankers’ day rates rise dramatically.

Under normal conditions, tanker companies make a profit as long as the market isn’t oversupplied with vessels. A few years ago, these firms were making so much money that too many new ships were built, resulting in an oversupply. Today, much of that imbalance appears to have worked itself out, and tanker rates have moved up again.

The total global Suezmax fleet now stands at 452 vessels, up seven from last year. The current order book stands at 78 vessels from now through late 2017. Nordic has one of the oldest fleets, with an average age of 13.2 years. However, the company does not have any vessels over 20 years of age, and a ship’s average life is around 25 years.

Nordic has a high 10.1% dividend yield, and its payout appears sustainable, at least in the near term. However, the global shipping industry is highly cyclical, and the company’s dividend would likely fall if its profits declined.

The stock is okay to hold, but only for highly aggressive investors.

TSI Network recommendation: HOLD for highly aggressive investors.

For a recent report on one Canadian energy stock we regard as a safety-conscious buy, read Diversified Operations give Imperial Oil top spot among Canadian energy stocks.

For our view on the wisdom of holding a selection of resource stocks even when commodities are down, read Why resource stocks are a good investment.