Octave Specialty Group Inc (OSG) 2007 Q4 法說會逐字稿

Good morning ladies and gentlemen, and thank you for standing by. Welcome to the OSG fiscal 2007 earnings call. During today's presentation, all appears will be in a listen-only mode. Following the presentation, the conference will be open for questions. (OPERATOR INSTRUCTIONS) This conference is being recorded today, February 27, 2008. I would like to turn the conference over to Mr. Jim Edelson, General Counsel. Please go ahead, sir.

Thank you. Before we start, let me just say the following. This conference call may contain forward-looking statements regarding OSG's prospects, including the outlook for tanker and articulated tug barge markets, changing oil trading patterns, anticipated levels of new building and scrapping, prospects for certain strategic alliances and investments, prospects for the growth of the OSG gas transport business, estimated TCE rates achieved for the first quarter 2008 and estimated TCE rates for the second, third, and fourth quarters of 2008, projected dry duct and repair schedule, timely delivery of new buildings, and prospects of OSGs strategy of being a market leader in the segments in which it competes, the projected growth of the world tanker fleet, and the forecasts of world economic activity and world oil demand. Factors, risks and uncertainties that could cause the actual results to differ from the expectations reflected in these forward-looking statements are described in OSG's annual report in Form 10-K in 2006.

For this conference call, we prepared and posted on OSG's website supporting slides that supplement our prepared remarks. The supporting presentations can be viewed and downloaded from the investor relations webcast and presentation section on osg.com. With that out of the way, I'd like to turn the call over to our Chief Executive Officer and President, Morten Arntzen. Morton?

Good morning. Joining me on the call today from Mexico, Myles Itkin, our CFO; Bob Johnston, our Head of Ship Operations; Mats Berglund, who runs our crude SBU; Lois Zabrocky, who runs our products SBU; Jonathan Whitworth, who runs the U.S. Flag business for OSG; and Jerry Miller, our Controller; and Jim Edelson you've heard from; and then Jennifer Schlueter, our head of IR and Corporate Communications.

We'll start with slide three. OSG delivered solid financial and operational results in 2007, overcoming a challenging global energy environment and meeting the tough operational expectations of our customers. EBITDA to pick on one number in 2007 was $476 million on $1 billion of PC revenues, yet another year of strong cash flow generation from OSG despite the difficult freight rate environment that existed last year. I will leave the rest of the financial details for Myles' review in his remarks.

OSG today is a well capitalized, well funded, large scale, diversified shipping company. 4.2 billion in total assets. $1.8 billion in liquidity. $502 million in cash and with a fleet whose market value is significantly in excess of its book value. This results from an execution of a balanced growth strategy we put in place four years ago and it leaves us with very few direct public market competitors. Financial stability and strength in a volatile uncertain market will continue to create opportunities for OSG and provide support for our share price.

Looking today, we have leading positions in each of the primary markets we trade proving that the platform we have built is working and is scalable. Our commitment to recruiting, retaining, and motivating the best shore and sea staff available is a competitive advantage in an industry that's clamoring for cleaner, safer, more reliable and incident free shipping. Unless you have a real demonstrable and measurable commitment to quality, you will not succeed in tomorrow's shipping world. That is why we have made this the cornerstone of our strategy as we continue building scale in the segments in which we compete.

Looking at the key segments, our crude tanker fleet, including new buildings as of last week totaled 64 tankers up from 53 last year. Mats Berglund and his team continue to expand this business in traditional as well as creative ways buying, building, chartering and selling ships and making corporate acquisitions like Heidmar Lightering. At the same time, we continue to focus on fostering relationships with customers and partners that expands our cargo contracts, a key part of our strategy in this sector. And a key differentiator between OSG and most of our competition. This is the main reason our spot earnings significantly outperform the market every quarter.

On the products side, ably led by Lois Zabrocky has done far more than just rest on the laurels of the Stelmar acquisition. Our MR new building program will leave us with 100% double hull fleet by the middle of next year and will enable us to significantly lift earnings in this segment. At the same time, with an eye to the long term and the expected rapid growth in the long haul products, as in Middle East and Asia we have committed to building a major presence in the R1 market, the market for coated Panamaxes.

Headed by Jonathan Whitworth, the U.S. Flag unit perhaps has been the busiest of all of them. Notable achievements this year include the two-ship contract awarded OSG by Petrobras under which OSG will be the first operator, the first operator, of Jones Act shuttle tankers in the U.S. Gulf of Mexico bringing ultra deepwater oil to the U.S. Jonathan also spearheaded the successful IPO of OSG America, now Masted Limited Partnerships.

To our shareholders, you can expect more of the same from us in 2008. We have ambitious operating and financial goals for 2008 and if we achieve them we will move closer to our aim of being the most respected and valuable energy transportation company in the world. We remain committed to outperforming our care group on an annual basis at the same time as we continue to build for the long term. We are not just sitting around waiting for opportunities to fall from the sky. We are making them happen ourselves.

Move to the next slide. Looking at some of the business highlights. On November 15, 2007, we completed the IPO of OSG America a massive limited partnership. Issuing 7.5 million common units at $19 per unit. The IPO generated $129 million in net proceeds which we used to pay down debt. We retained a 75.5% interest in the Company including a 2% general partner interest. The fundamentals of the Jones Act market in which OSG America ships trades are strong. We are confident that the new build fleet delivers over the course of the next four years, that OS will be rewarded with premium valuation reflecting its leading position in the Jones Act market and the more dependable nature of its largely long-term contract revenue.

Our buyback program. Since our initial announcement in June 2006, we have spent $570 million repurchasing approximately 22% of the total outstanding shares of OSG. Now in the fourth quarter last year, confronted with the worst credit markets since the Latin American debt crisis in the mid-1980s, we cautiously scaled back active repurchases. The deterioration in the credit markets continues and we are watching this carefully and prudently. However, we remain committed to completing the program.

We ended 2007 with $1.8 billion in locked in revenue. This is 9.5 times what we ended 2004 with. 9.5 times increase. In fact, 38% of fiscal year '07 revenues were derived from time charters up from 31% in 2006. We are committed to increasing this number and expect to do so over the course of 2008. On a negative note, Standard & Poor's lowered our credit rating at the end of last year from BB plus to BB. They say the increase in our chartered in fleet, the increase in our dividends and stock buybacks are the main reasons for doing so.

Moving to slide five. A lot happened in our fleet last year. One of the more exciting things was we chartered in to Suexmaxes, the Overseas Newcastle and the Overseas London are now in our fleet and we are the only Company that now is actively trading ULCCs, VLCCs, Suezmaxes, Aframaxes, and Panamax. We cover the full gamut of the crew transportation market.

We have already talked about acquiring Heidmar Lightering, and now we have two of our older Aframaxes, our smaller ones, the Overseas Beryl and the Overseas Eliane have been dedicated to the crude oil lightering trade. We also stationed a work boat on the West Coast to go after that market which we think will be the most rapidly expanding lightering market in the U.S. You look at that picture, you can see the size of the fenders we use in these operations, they're very impressive pieces of equipment. We exercise options to build two additional LR1 coated Panamaxes towards the end of the year. So we now have six LR1s being built at SPP, that's in addition to the two we bought last year and the two we already have on the water. So we are building for the product business for the future.

We did a sale leaseback of the Overseas Rimar, a 1998-built tanker. Why am I mentioning that in particular? One of the things we have done here is very active asset management. The older ships today tend to have higher value to the newer ships. So we have been selling these ships to take advantage of the highest second in value today, shifts in the residual value exposure to third people but taking the ships back so we will continue to trade them. That gives us a lot of financial flexibility as we move forward. The Overseas Serifos joined the product carrier fleet. The Overseas Los Angeles, the third of our ships joined the fleet and now we have for LNG carriers on the water all operating on 25-year charters.

So let's talk -- move to the next slide and talk a little about the market. And the first question, what happened last year? Was it the end of the world, the end of the crude world as some analysts were forecasting or was this a short-term shift in the market? We think it is the latter. So what happened last year? Crude went from $7 contango to $7 of backwardation. That led to significant stock drawdowns, the Atlantic Basin and Asia. There was lower refinery utilization. It was high bunker prices not fully recoverable rates. In the beginning there was a steady inflow of new buildings and very low scraffing and there were no catastrophic events. We had a weak market.

On the last call, prior to the market picking up, I said that we continue to believe that the market was very tightly balanced. That that was not an extra surplus of double hull ships and that the market continued to be a two-tier market. So the market did improve. Then why was that? OPEC increased production by 500,000 barrels. Just 500,000 barrels. This led to sudden increase in Middle East cargoes right basically on Thanksgiving day. Very significantly, a lot of those cargoes went West. That meant that you needed to have double hull tankers in action. There was a very tight balance and rates went up. This was not a surprise. This is what we talked about in the last call. There have been somewhat better refinery margins. We expect those to improve more this year. We expect to see replenishment of stocks in the Atlantic Basin from which we began then. Then we also saw the fleet growth slowing due to conversions to drive. I'll come back on that. We had normal winter demand and then you had the Hebei Spirit.

One of the things that we have told you over the last couple of years that we don't forecast in catastrophic events or incidents like hurricanes and such in the shipping world, but they do happen. And they did. As a result of that, an already tight market, a single hull tanker spilled 11,000 tons of cargo on the beaches and shoreline of Korea and the market and the differentiation between single hull and double hull tankers took off.

Moving on to the next slide. This is a very simple slide. If I'd done this slide any time during the '70s, '80s, or '90s, the growth in production would have been in the areas next to the high consumption areas, the North Sea, Mexico, Venezuela, U.S., Europe. That is no longer the case. The incremental supply is coming coming from long haul sources, the Middle East, West Africa, Brazil, the FSU. This is one of the fundamentals that's improved our business. This leads to ton mile demand growing faster than the underlying demand for crude itself.

Moving to the next slide. The VLCC, this is showing the development of the VLCC fleet from September through the end of August this year projected. The fleet will actually shrink during this period. We see 44 Vs leaving the market. 39 for conversions to dry bulk. This is more than just chatter and five FPSOs. We estimate today roughly 40 going out in the course of this year of 2008. That number you can never be 100% certain of the number. We think these are pretty good statistics. What it means is that the VLCC fleet could shrink at max will grow 1 to 2% this year. So you have demand going up for oil. Ton mile demand going up even faster and the fleet shrinking. Then you have the other big wild card, and that is the commercial obsolescence of the single hull fleet.

I have been arguing for four years that there is a two tier market in the tanker world, the market between singles and doubles. That gap has been widening, and that the commercial obsolescence of single hull tankers will occur sooner than the IMO mandated. phase outs.

Now you have the Korea factor. 40% of all single hull VLCC cargo movements are to Korea. Look at the numbers. about 33% of the world VLCC fleet is single hull. That's 172 ships. There are 182 tankers on order right now to replace those.

What's happening so far? Bigger charters are likely to reconsider the use of single hulls. We know that one of the big oil majors from the beginning of this year stopped carrying crude oil in single hull tankers. We expect more to follow. Conversions could actually accelerate because your window for trading a single hull tanker is shrinking and the areas and dry bulk continue to be attractive. This is without forecasting any other exogenous events. Other incidents can happen. We're not counting on them. Korea has already accelerated the single-hull phase out by five years and may do so earlier and one of its major refineries has already said they will.

Where does this lead us to 2008? VLCC remains flat or grows maximum 1 to 2%. Ton mile demand increases by approximately 6%. No inventory drawdown forecasted in 2008 versus approximately 400,000 declined in 2007. Oil demand forecast up 1.9%. And an increase in worldwide refinery throughput from higher utilization rates and an increase in capacity of 1.4 million to 1.5 million barrels per day. Where does this lead? The freight rates in all the crude sectors, notably the VLCCs expected to be well above 2007 levels.

One of the top analysts in the transportation sector starts every piece he writes about the tanker trade with the following comment. We view the long-term outlook for the crude and product tankers we believe as attractive; however, we remain cautious in our outlook for 2008. I really do think it's time to smell the coffee. This market in 2008 is strong, it is likely to stay strong. In fact, 2008 is going to be a very good year for the tanker industry. I think you need to reassess that.

Moving on to page 11. It's not just about when you order ship, though that's very important. It's not just about having the best hardware, and we think we have about the best hardware. Above all else, shipping is about running ships safely, incident free, reliably without putting things in the water or injuring people on the ships. Our strategy is (inaudible) of that, our balanced growth strategy will not succeed without getting technical operations right. This is what our customers care about. They bet our ships, our crew, our office operations, our IT, our shore side of the sea staff, our training. The key performance indicators that we measure report they do matter and our customers look at them very carefully. Therefore we have to invest across all ship operations and people and maintenance and safety, and quality, and environmental programs, and assurance. The old formula of short-term savings in operations is a guaranteed recipe for long-termed failure in the tanker world. We are committed to being a quality provider. We've seen a 20% increase in our operations staff since 2006 and that is delivering the important improvements in our key performance indicators.

We have internal audit group that visited -- made 206 visits in 2007 to make sure things are being operated according to the law and the following OSG policies and procedures. What happened after Korea? As anticipated, the discussion on quality is getting even greater and greater emphasis. We are committed to this and this will be one of the key differentiators for OSG going forward. With that, I'll turn the speaker over to Myles Itkin. Who will do a financial review of the Company.

Thanks, Morten. Good morning. Please turn to slide 13. For the quarter ended 2007, TCE revenues were [$150] million, a 4% increase over the same period of 2006. The increase in TCE revenues reflects a 20% or 1600 day increase in revenue days across all segments of the Company's fleet. The impact of this increase in days was substantially offset by higher fuel costs and a significant weakening in spot rates for the Company's VLCCs, Aframax's and handy sized product carriers. Accordingly, for full year 2007, 62% of the Company's TCE revenues was derived on the spot market compared with 69% in the prior year, and 38% of TCE revenues was derived from time charters.

Vessel expenses increased for the quarter in comparison with prior years quarter principally as a result of an increase in operating days from vessels. Average daily vessel expenses for the year, however, remained essentially flat. The increase in charter hire expense was mainly attributable to the acquisition of Heidmar Lightering which added $37 million in charter hire expense for full-year 2007 and $13 million for the fourth quarter. The balance of the increase reflects the greater number of operating vessels that were chartered in during 2007 relative to 2006. The $2 million increase in depreciation and amortization expense for the quarter relative to the immediately preceding quarter reflects increased levels of dry dock amortization.

In comparison with the prior year's quarter the $13 million increase in D&A reflects three factors. One, the inclusion of Maritrans fleet for the full quarter compared with only one month in the fourth quarter of 2006. Two, the inclusion of Heidmar Lightering in 2007. And three, increased amortization as a result of dry docks incurred. Although for the quarters presented, G&A expense remained relatively flat. Full-year G&A expenses increased to $127 million from $100 million in 2006. Of this $27 million difference $24 million is attributable to the expenses of both the Manila office, which was established as part of a crewing strategy to retain qualified Filipino-based crews as well as the increased G&A expense for the Tampa, Philadelphia, and Houston offices associated with the Maritrans and Heidmar Lightering acquisitions.

The drop in equity and income affiliate companies is due to our selling our remaining 13.4 million shares of DHT in the first six months of 2007 as well as the required expensing of Ballast Voyages for our first two LNG carriers in November. Each of which has commenced 25-year time charters. These reductions were offset in 2007's fourth quarter by higher levels of incentive hire for Alaska Tanker Company.

The combined effect of these changes was that EBITDA for the quarter decreased 48% to $89 million from $170 million in the comparable period of 2006. Net increment in the period decreased to $21 million and diluted earnings per share decreased to $0.67 compared with $113 million or $2.86 per diluted share for the same period a year ago.

If you'd be good enough to turn to slide 14, we can review certain balance sheet items. Cash and cash equivalents stood at $500 million at December 31, compared with $540 million September 30. The reduction in cash balances reflected first of all the vessel acquisitions net of proceeds from sale of vessels and funds withdrawn from the capital construction fund. Secondly, the retainment of revolver and other obligations with IPO proceeds from the sale of a 24.5% limited partnership interests in OSG America. Thirdly, the continued repurchase of OSG stock although at a lower pace than in the third quarter.

During the fourth quarter of 2007, we withdrew an additional $24 million, $176 million year-to-date from the capital construction fund to satisfy payments on the three new ATBs currently being build in U.S. shipyards. We expect to withdraw an additional $109 million over the next two years from the CCF, bringing our total qualified funds withdrawal to $285 million. Vessels and deferred dry dock increased by over $200 million to $2.8 billion at 12/31/07. Vessels and other asset additions for the year amounted to 550 million while new dry dock charges totaled $70 million. These additions were offset by vessel disposals of $234 million and depreciation and amortization of $178 million.

The reduction in investments in affiliated companies to $132 million from $275 million at year end 2006 principally reflects the sale of our position in DHT. On November 8, 2007, a subsidiary of the Company, OSG America LP completed its initial public offering of 7.5 million common units at a price of $19 per unit, representing the 24.5% limited partner interest. At year end, the minority interest in the limited partnership amounted to $132 million.

Slide 15 highlights how future revenue stability underscores the actions we've taken to increase fundamental shareholders value by increasing our level of locked in revenue and associatively our earnings stability. Details regarding this ninefold increase are locked in revenue in days per sector are included in the appendix at the end of this slide presentation.

Please turn to slide 16 for 2008 full-year guidance. With a view towards providing guidance for 2008 we expect vessel expenses to range between 305 million to $330 million. Operating days will increase by approximately 1700 days. The passing days for crude and 700 days for products in 2008. Adding close to 17 million to $20 million to total vessel expenses. Daily vessel expenses are also expected to rise during the year and will account for the balance of this increase.

Time and charter hire expenses are estimated between 370 million and $390 million, including $36 million of profit sharing on certain vessels. Depreciation and amortization is forecasted between 200 million and $220 million reflecting among other items depreciation for a full year of two LR1s that delivered in the third quarter of 2007, a full year of intangible amortization relating to crude lighting and a shortened dry dock amortization period for our pre-1990 chartered NMRs that redeliver before June 200. General and administrative expenses are estimated at 145 million to $160 million reflecting the impact of Manila and Houston offices for the full year, and an increase in amortization of noncash stock compensation. Please note that noncash stock compensation in 2008 will proximate $12 million.

Equity and income of affiliated companies will range between 8 million and $12 million reflecting results from our interest in Alaska Tanker Company and our four LNG carriers during 2008. Other income in 2008 is forecasted at 27 million to $35 million and consists primarily of interest income. Other income in 2007, as you'll recall included a gain of $41 million on the sale of our holdings in DHT. Interest expense of 85 million to $95 million reflects a higher level of average outstanding debt than in 2007 and CapEx for the year will amount to $410 million. $370 million of payments for new buildings and $40 million for dry dockings. Of this amount, an estimated $87 million represents qualified withdrawals from the CCF in 2008.

Please turn to the next slide. Slide 17 lays out our view of OSG's net asset value in comparison with our share price. Each of the categories of NAV are included in an appendix to this presentation. We are currently trading at approximately $70 per share compared with net asset value of $108 per share. We believe the combination of this valuation gap, the creation of the Master Limited partnership for OSG's U.S. Flag business, our expansion into sectors characterized by long-term stable cash flows, our program of active asset management, and our continued distribution of capital to shareholders makes us a compelling investment. At this point, we'd like to open it to the floor for questions.

Thank you. (OPERATOR INSTRUCTIONS) Our first question comes from the line of Doug Mavrinac of Jefferies & Company.

Just have a few questions. First, Morten in your presentation, you mentioned the VLCC asset class, as voice of experience very limited fleet growth in 2008 if any at all. My question for you all is do you guys believe the VLCC fleet can outperform the Suezmax and Aframax asset classes over the course of this year without drawing competition from some of those vessels which are likely to experience significantly more fleet growth than the VLCC fleet?

Doug, the long term historic correlation between the various crude sizes. However, what you're seeing in this year is somewhat a departure from that. And what we said at the end of last year we thought the VLCC class would relatively outperform the other segments but there's no doubt at the end of the day that the presence of Suezmaxes in certain areas will always prevent VLCCs from departing two far from the other asset classes. But because the fleet dynamics of ships coming in and going out in the VLCC are relatively belter than the others, we think that that gap will widen this year but it can never run away from the rest of the crew segments because charters will just take advantage of the cost overcharges.

Right, right, right. That's kind of what we were thinking. Then shifting gears a little bit, rather than talking about the various asset classes, just talking about what we think is somewhat of a game-changing event that being a Korean oil spill which you all touched on. We recently came across some reports that there was a single hull VLCC being circulated for scrap last week which would mark the first one since July of 2005 by our estimates. Do you have any color that you can add on that? And do you think that 2008 is a year that not only could you see some conversions but also some accelerated scrappings?

I think this year would be more focused on accelerated conversions. There are more FSO and FPSO projects that are in those numbers that we give but we don't give out an FSO number in our numbers until it's firm, the ship has been given a contract and has a contract with a shipyard. But I think you guys are familiar with the offshore segment, the number of projects there, there will be forthcoming. What I've been saying for about five years, Doug, is that as you approach 2009, and as the new building doubles come in and the percentage of the fleet represented by single hulls falls to 10 to 15% that the commercial market is going to discriminate them to such a degree that you will have accelerated scrappings. I don't think that'll happen this year but it doesn't really have to happen this year because the fleet is going to be relatively flat. In 2009, we would expect that we would not be surprised if both Japan and China come up with announcements that they will put in place the IMF phaseouts early. I think you'll see more oil companies doing that. That'll either accelerate conversions or have more of the older babies to scrap.

I think 2009 is the year that people are pointing to as far as seeing the order book and the number of ships that are going to be delivered. So that would certainly help. Then my final question for you all, Morten, you mentioned during your comments about the credit environment and how that has impacted your decisions when considering pursuing additional share repurchases. We note that you guys have over $500 million of cash in the balance sheet and that's not to still trace our NAV by our estimates and it sounds like yours as well. Do you think at some point once the credit crisis is behind us and assuming your share prices are still about where they are that not only could you exhaust that remaining authorization but that you could potentially bump it up? And then at what point do you consider your available float and any liquidity issues in the shares and whatnot? That's my final question.

You answered the question for me, so I don't need to answer that one, the first one. If the credit crisis ended and our share price didn't move, considering all the cash we're doing, I think that you can expect that OSG and OSG's Board will assess that and behave in a way that's consistent with maximizing shareholder value. I have to say it's very scary when you read about banks that have already written off 18 billion, $20 billion worth of assets, talking about doing that again in the first quarter. This environment, I think it behooves us to be somewhat careful and prudent. And the last thing I'd say is for the first time in probably a number of years, we're seeing some fairly big fleets, particularly new building fleets circulating. I think that's really a sign of difficulties that are starting to occur with people financing ships, new buildings they have and you just want to keep your eye on that. More than anything, it's just this is a very scary external financial environment and we want to be smart about how we manage the balance sheet.

Congratulations once again on a truly great fourth quarter.

Thanks, Doug.

Our next question comes from the line of Scott Burk of Bear Stearns. Please go ahead.

Just a couple of follow-up questions. I wanted to -- first of all, can you tell me the number of FPSOs that you've got built into your conversion number? You said 39 conversions dry bulk and what was the number you had converting to FPSOs?

Just five.

Okay.

We know that number's going be more because there's projects that are out there being bid and we also know that some will be double hull ships which is even more traffic to the fundamentals of the business.

You went through August of '08 and if you extend that out into '09 just kind of wanted to see what the picture looks like going out into '09?

For -- this is Mats. If it's OFPSO we have that running at anything from five to ten. For conversion to dry it's very difficult to assess. That future book is not longer than 9, 12 months right now. But to assess the number of conversions for '09, will depend on the continued strength of the dry corridor market and a lot of other factors. We have not seen any sign of slowdown in the conversion deals being done, as of yet. That's for sure.

Scott, just to amplify, I would call the conversions to the VLOCs for the single hulls as really commercial obsolescence by other means. This is a reaction of those owners to what they can do with those ships and trading life they have. The window just gets tighter.

Okay. I wanted to ask you about your charted in vessel. You've got quite a few. I counted, I believe 21 in the fleet, somewhere in the 20s. Those that are chartered in right now that are going to be rolling off their charters. What are your plans for those vessels? Do you plan to recharter most of them or are you going to see your chartered in fleet decline towards the end of '08 and '09, or how do you plan to handle that?

Let me have Lois tackle that one. It is a very important thing you should understand about our product mega-business.

Scott this is Lois.

Hi.

We have 13 older product carriers that were built in the late 1980s that are on bareboat. When those vessels redeliver from our fleet this year and in July of -- the remainder being in July of next year, those vessels will not be rechartered, and I think that they will have at that time an increasingly challenging time in the market. So we're actually, we have replaced those vessels throughout the last two years with a lot of long-term charters, bare boats as well as two new buildings. So we've essentially replaced those but those ships will not be rechartered.

So when you say you've replaced them, meaning you don't need to go out and replace them with 13 additional new vessels in 2009? You've already got those in your fleet already?

I think more important than that is the earnings capacity of what the new ones have coming in is significantly higher than what they're replacing. Those older ones for the most part are on longer term charters at rates reflect really the vintage of the ships. We would expect margin expansion from every one of those double hulls that replaces those older ships. So, in fact, Lois' business will be burdened with that for the next 12 months but then once those goes, here earnings basically, get an enormous unleashing I would say.

Okay. Then I guess just one last question for Myles. Thank you for the annual guidance on the expense levels. Is there any seasonality that we should look for, and maybe seasonality in any of the expense items from quarter to quarter?

No, not really. Of course vessel expenses can have some degree of shift depending upon timing of delivery, spares and stores.

Okay. Thanks.

Nothing unusually seasonal.

All right. Thank you.

Our next question is from the line of Jonathan Chappell, JPMorgan.

Lois, on the product tanker fleet, if I remember correctly there was some talk last year about potentially shifting a little bit to more spot market exposure on the product tanker fleet. However, there is still pretty significant time charter coverage. Is this something you would hope to shift eventually or is this a strategic decision because possibly some delays in the long haul refineries being up and running?

John, if we separate the fleet into the vessels that I referenced earlier, on those vessels that are older, we do endeavor to have those completely put away on time charters so that we can have as high as earnings as possible on those vessels. But with our double hull fleet we have over 50% of that fleet on the spot market and they have been earning very well. We have been taking some time charters at very profitable levels over the last 12 months. That provide us with some time charters at very profitable levels over the last 12 months that provide us with some coverage in the current environment that we're in right now.

What are you seeing from the refinery standpoint? Are you seeing delays in construction of some of the export only long haul refineries or do you think that most of it's coming out on track for the end of this decade?

I think that in the longer term the refineries in the Agee are fairly on track. Especially with India coming on with the reliance at the end of the year. So we are still feeling very positive about the LR1 sector and the timing of which we have the vessels entering our fleet?

Myles, if I can ask a follow-up on the timing, variable charter and expense guidance number, does that reflect the fleet as it stands today or does that have some anticipation of more charter in throughout the course of this year? I just don't want to sell you short on the revenue side with the cost.

Only the committed vessel.

Okay. Then one last thing -- go ahead.

I'm sorry. It does include $36 million of profit sharing which is a function of what the prevailing rates would be in the stock market.

Right. Then just one last follow-up to one of Doug's previous questions on buyback versus opportunities, I understand we're in a tough credit environment right now but by our estimates you'll be generating almost $400 million of cash this year, and when you weigh opportunistic acquisition versus buybacks, and Morten, you mentioned there are some big new build fleets out there that may look attractive at $0.67 to the $1, I would still think that the buybacks look a bit more attractive. Is this something that you'd be considering with the Board, credit crunch versus -- potential acquisition opportunities versus buybacks versus dividends. How do you kind of weigh those three things?

The first thing I think you reluctantly can start giving us credit for, we've been pretty disciplined about what we've been buying, how we've been buying it, making sure that in fact the things work in our HP12C and when we can't find things to buy or build we look to chartering options to reduce debt. So I think you will continue to see a lot of financial discipline. We've bought back close to 22% of the stock of the Company so you could hardly say we've been shy about doing that. We had a downgrade from S&P and that's certainly not the end of the world but we would not want to see a significant deterioration in our credit rating because one of the reasons we can charter in ships from other owners in the market is because we are very strong. That has to be balanced in there. I think we're going to be patient on anything we look at and we'll do things that work with our numbers. Our Board will look very carefully at the options. We'll also look at -- part of this will also be our long-term tax strategy. All those things will be taken into account. I can assure you it is a topic at every single Board meeting and will be again be a topic next week.

Very good. I will reluctantly give you credit for your discipline.

Our next question is from the line of Urs Dur, Lazard Capital Markets.

Great quarter. All of my questions really been asked I guess. What I'd like to see on the front page of your release, though, is the quick discussion of contango, backwardation. Was wondering, do you guys have a view as to when and how this might shift? Are you looking at that in your strategy going forward in terms of contango, backwardation, and oil pricing this year ? Do you have any view on

Let me -- do we look at this -- we actually have a pretty strong economics group here that looks--.

I know.

Looks at it very carefully.

Yes.

Predicting what OPEC is going to do on production is really difficult. There's no question that they're cutting back on production in 2007 had an impact to shift in the market from contango to backwardation. We keep a lot of flexibility in the way we trade the ships so that we can adjust to that. One of the reasons we built up the big TC book is we know we can't predict it. What I would say, last year, the end of the third quarter, we made the decision to keep all our VLCCs in the spot market because it was very clear it was a very tight market, we continue to think that the market is very tight, but that we are going to have to manage volatility. We do have a paper hedging that is pretty active at OSG. And the extent that we look forward and think that it makes sense to take some cover we might do that. We have the tools available. We also know we can't call what OPEC is going to do. We have to manage around that uncertainty or volatility. I think we're doing a pretty good job on that. Having said that, you expect to us keep our VLCCs in the spot market for the time being and that will be a very good strategy. As it has been for the last five years

Sure, if we roll into contango that's good. Excellent. Thank you very much. Then I guess one other thing, and I guess this has been asked before but maybe you could review your position on possibly doing further spin-offs, further MLPs and in general it's a nice superior valuation. Any view there?

I don't think we have any immediate plans now. We have four LNG carriers on the water earning money. Four LNG carriers does not an MLP make. We built up a gas business that we were successful in some of our initiatives in CMG and LNG. Is that something we'll consider? Yes. But in the short term, we love our collection of assets and chartering ships and OSG and the cash flow they're generating we're hoping that you all will recognize that and give us credit for it.

Understood. Thank you very much. Good quarter and thanks.

Our next question comes from the line of Justine Fisher of Goldman Sachs. Please go ahead.

Good morning.

Good morning.

My first question is one about single hulls. Maybe this is a tough one to answer but I'd love to get your opinion. If you guys still had any more single hull VLCCs left in your fleet, what would you do with them now?

If I had them?

Yes.

I would convert them to a VLOC as quickly as I could. I would be bidding on every FSO project if I could. To the extent that you had anybody who would give me a time charter which I think a number did last year, I would take it. Then I would go right to the scrap yards and scrap the thing for your 25 million or $30 million because it's a hell of a lot better than putting 11,000 tons of oil on the beaches of anywhere.

Given that there are a lot of -- well, probably half of the singe hull VLCC fleet's relatively young, are there options for these vessel owners to either retrofit their tankers to be double hull to keep them operational? Obviously if it's 25 years old, you've got to get rid of it. Is there more optionality for the younger ships?

There's somewhat more optionality. The technical risk of double hulling a single hull VLCC is one that I wouldn't take but there are people that are comfortable doing that. There still will be a lot of reluctance among a number of charters to take them so it's a pretty big gamble. I think the best thing you can do with a VLCC is make it into razor blades. That's what I would do.

Okay. The other question that I have is on the hedging. You said that you'd keep your VLCCs on the spot market but would you put on paper hedges on your VLs or would you only hedge the Aframaxes and the smaller ships?

We would hedge the same way -- we would look at hedging any of all of our asset classes if the result of that hedge is that we will lock in returns that are significantly above our short term, medium term and long-term positions. Excuse me, forecasts. That's why we have a desk in place to do that and of course we're doing that. But we keep that to ourselves obviously.

Okay. So you are doing paper hedges on your VLs even though they're operating in the stock market? You're not going to disclose it or are you not doing paper hedges at all for your lighter ships?

I'm saying we look at paper hedges for all our asset classes, and we manage that along the lines of what we see is the long-term outlook for the segments.

Okay. Then a couple of questions for Myles. First of all I know you have $370 million of new book (inaudible) payments to make for '08. Do you have a dollar amount for the total new build payments that you'll have to make over the next five years or whatever the order book is?

Sitting in Mexico now, but if I can give you a call, I'll let you know. The number strikes me as circa 700 million or $800 million but I'll clarify that with you when I return.

Then the last question and I've got to ask this for all of the debt people on the phone. Given the fact that the credit environment is a little bit shakier than it has been and that your debt to EBITDA at the end of '07 is four times, granted that will go down in '08 and '09 probably, with improved rates, why wouldn't you consider using some of your free cash flow to repay some debt?

Myles, you want to answer that one?

Yes, yes, sure. We do evaluate all of our options. We view it in terms of what our immediate commitments are during the 12 months we sensitize it against what an optimal tax repatriation would be. But it's certainly one of the things that we consider.

Okay, thanks.

Our next question comes from Greg Lewis, Credit Suisse.

I guess my first question is more of a general question. Given the fact that a significantly strong balance sheet and you haven't really gone out and purchased any vessels, are you in the market to potentially sell vessels over the next couple quarters?

The only vessel that we have technically held for sell is a ship that already is committed to be sold which is the Overseas Donna which is a VLCC that has been sold forward to an FPSO and the buyer can take the ship any time between now and (inaudible) and we will at that point get about a 75 million to $85 million dollar book gain on sale. The price has already been fixed. Right now, double hull ships are scarce. We are not looking to unload. We have done -- we will continue to do sale leasebacks on our older ships. That's been a pretty consistent program and we expect we would do that. We might sell some of our older U.S. Flag units if we didn't have alternative uses for them. But nothing being actively shopped right now. If you look at the table in the back, and what we're earning with these various units, and keeping in mind that we have a very low book value fleet for the most part. We're doing pretty well with these units.

Moving forward, you talk about the significant opportunities in the FPSO business. Is there any thought that OSG might entertain entering that space?

I think we have been very clear in our expansion strategy that we will enter the markets that are contiguous to the ones we're in. Because there we feel the execution risk is much lower and our technical compensability take on number's higher. Very clearly moving into FSOs or FPSOs considering the technical know how we've built up in the Company, the fleet we have is something we consider. Keep in mind, we have shuttle tanker operations to come on in the U.S. Gulf. We have Lightering in the Delaware Bay, Lightering in the Gulf of Mexico, Lightering in the West Coast. We're involved in an awful lot of parts of this business already, so yes, that would be a logical jump for us. But, one thing about all the FPSO projects up to now, if you look at the returns on that they have been a lot poorer than what we make trading these tankers as tankers. We will exercise the same financial discipline we do when we buy ships. We will probably factor in that there is some technical risk we would take but we would be comfortable doing that. So yes, it's a long winded yes to your question.

Great. Myles, I guess this last question is for you. It looks like quarter over quarter, SG&A expenses were down. What do you contribute that to?

There were expenses incurred in the 2006 quarter, the legal expenses regarding the Departments of Justice settlement.

I was talking about Q3 of '07.

Okay. Well, there's additional compensation expenses that come in, in the fourth quarter.

Okay. Thanks. Thank you for taking my calls.

Our next question comes from the line of John Kartsonas, Citigroup.

Couple questions I guess. One for Morten, one for Myles. First of all, on the realized rate obviously we have on the one from (inaudible) out there to judge form. But it seems that you're '07 VLCCs are much lower than last year compared to -- from mine. First of all, how should we think about that given the pool that you have. Why do you take the expectations forward?

Let me have Mats answer that one.

I think what you're referring to is the Q4 comparison with front line.

I'm talking about the whole year actually.

But the whole year is primarily explained by a difference in the fourth quarter and as you know, spot rates went from $20,000 per day to $200,000 per day at the end of the fourth quarter. So how you come out of that depends very much on how your positions are lined up against those dates. The difference between us and Tankers International is that we are servicing a large amount of cargo contracts much more so than Frontline who doesn't really have any contracts. And as a result of that, we tend to fix earlier ahead of the loading, ahead of the lake hand than front line does. So they were able to take quicker and larger advantage of the spike in the fourth quarter of 2007. On the other hand, as rates have substance in the fourth quarter, Tankers International will likely benefit a bit longer from the good rate since they fixed a little bit earlier and hence will hang on the higher rates a bit longer. That's the main explanation for that difference in rates for '07.

Would you say over time this tends to offset Southern looking at the market rates going forward?

I think the -- John, I think the -- there's no question that Tankers International and Frontline. They are the two biggest operators of VLCCs. If you compare our results with theirs over a two or three year period which is more appropriate, I think some quarters they beat us. In more quarters we beat them. They're the two leaders. The real comparison should be against the overall market. I'll give credit for Frontline for running a very good chartering strategy. I like our cargo strategy much better. So far, both have resulted in superior performance overall to the market. In the long run, I would rather have a big look at cargo to take this business in the future with than not. So that's the difference. You'll have to choose. But relative to the market, we both do better.

Then for Myles. Actually, I just want to go back to this tax repatriation issue. From the free use of cash you have obviously paying back stock and dividend, if you decide to, like, do let's say a 700 million or 1 billion of share buyback, let's assume that that's the case, how much of this comes back (inaudible) and how much do you have to pay tax on that? Or is there a difference on the use of cash?

Jerry, do you have a specific number on repatriation and tax implications?

We have about, at the end of the year we have about $550 million of earnings on which we previously paid tax. So theoretically, we could bring back $550 million without any further tax consequences.

And the tax of that is 35%?

No. There would be no taxes.

No, over that?

The amount of the excess, yes.

Is there any difference from treatment between let's say asset sales or time chartering meaning that if you generate revenue from time chartering to tax at the same rate or?

No. You're not taxable until you repatriate.

Revenues you generate from owned vessels and from time chartering vessels is the same, right?

That's right.

Yes.

Finally on the LNG front, do you have a rate that we can use going forward for the LNGs, or approximately what kind of--?

We are under the strictest confidentiality agreement that I've ever seen, and I think I'd go to jail or debtor's prison or something if I violate it, so I can't.

Okay. Then I don't want an answer. Thank you.

We don't want him to go to jail, either.

Our next question comes from the line of Terese Fabian, Sidoti and Company.

Good morning. I don't know whether you addressed the tax credit in the fourth quarter. If so, I'm sorry, but can you talk a little bit about that what it came from?

Myles, you want to take it?

Jerry, if you take it.

All right.

The level of taxes that we end up paying is due to a large degree by what's called foreign personal holding company income so it's the earnings on the cash that is sitting offshore. That level was higher at the beginning of the year due to the sales of DHT stock. In a normal situation the income that you generate on the domestic side also takes into account placement of the debt that the corporation has. And for the most part, the debt sits on the U.S. side. So the reason for the credit is that you had lower foreign nonshipping income and level amounts of interest expense on the domestic side.

Are there implications for 2008 in terms of your guidance?

Well, we think that everything else being equal, we don't expect taxes to be very high in 2008. We don't -- the tax rules basically allow you a two-year carryback. From a taxable income perspective, we haven't had a taxable income in the U.S. in 2005 -- 2006 or likely in '07. So we don't expect taxes to be very high in 2008.

Okay. That's helpful, thank you. A question on the slowdown in the Florida economy. Is this affecting your Jones Act product spot market rate?

Hi, this is Jonathan. It's funny because there certainly has been a lot of press about the downturn in the housing market and Florida's perhaps one of the states leading it. I have to tell you the sun is certainly shining there today, and it's still an extremely popular place to live, to retire, to visit, and to travel. I believe the numbers last year was that the state grew by 800 people per day. What's more important to us is not necessarily the effect on the housing market as much as the effect on the demand for clean petroleum. As of today, we have yet to see a downturn.

Thank you.

Our next question comes from the line of Stephen Williams of Simmons. Please go ahead.

Yes. Just another question about your existing assets. You suggested you might continue the sale and leaseback of some of the older vessels but you weren't generally in the market to dispose of any tonnage. Can I infer from that your views on the price of the secondhand vessels at the moment? I think you suggested in Q3 they might soften a bit. Is that still your view? Or is secondhand tonnage priced about right at the moment?

No, in fact, we're going to talk about double hull assets because that to us is the only thing that counts.

Yes.

Double hull vessels, new building prices have continued to go up, and steel plate is now going to be going over $1,000 ton. So prices continue to go up for new buildings. Order books continue to be long so that has an effect. New build secondhand prices for all classes of double hull ships, product and crude continue to strengthen. There's a report today of a ship being fixed. A VLCC new build 2009 delivery at $163 million which means a delivered cost of $170 million. This is a report not a verification but the market is continuing to trend up. It's there are a lot more buyers than sellers. And people's outlook on the medium term outlook for the tanker market, '08, '09, '10 and '11 has turned decidedly positive and that is pulling vessels up. The yards are full, their costs are going up. They continue to raise prices so the asset support for the public tanker companies has never been higher. You could probably argue that that number that Myles shared with you may be conservative.

Okay. So the secondhand prices are being dragged up by kindness in the new build market. That makes sense. How's your own sort of internal view of the strength of the tanker market over the next few years in step with that? So from your own economic perspective do these vessels look equally attractive as they did before?

Yes, is the answer I think I've been pretty consistent. Fortunately I've been able to say this for several years that we see the outlook the next three or four years that we would expect during the same amounts we did the last three or four years and that environment we're generating tremendous margins and return on the capital we have invested in this fleet. It would be very difficult to find a lot of industries where it would be better. So yes, you're right happy which is why we have none of our modern units up for sale.

So you're (inaudible) of the market is much stronger than it was a year or two years ago?

Correct.

Thank you.

Our next question comes from the line of Omar Nokta, Dahlman Rose.

We know the VLCC market has been quite strong the past few months. We know that OPEC production has been higher, and that VLCC has been falling. But also Saudi Aramco has been offering their crude at big, big discounts especially to the U.S. buyers the past couple months or so. Do you think that's been really the main reason for the huge uplift in rates? And do you think that needs to continue for the next few months to support the market?

It certainly was one of the triggering factors was the Saudis lowering the price at Thanksgiving. It's certainly not the only factor. The underlying factor is tightness as Morten has described between supply and demand. And the big number of ships going out of the fleet combined with the demand. We do not see that that needs to continue for the tightness to remain. The current situation is for strengthening rates. Certainly in the (inaudible) and the smaller crude segments.

We know that product tanker rates have obviously lagged the VLCCs, why is there such a separation and do you think that the gap can tighten a bit going forward?

I think you can see an increased differentiation on the medium term basis. The longer term even the product rates are affected by the crude rates. It all spills over. We're seeing a situation where crude has had stronger short-term growth due to the convergence to dry. You don't see the same thing happening on the product side. But long term we're very positive, as Lois mentioned, on the product segment as well.

Do you think it's more of a supply reason why the VLCCs have outperformed the product versus say demand?

I think that's one of the important factors, yes.

Our next question is a follow-up question from the line of Justine Fisher. Please go ahead.

Hi. Sorry. I just have one question on the taxes for Myles. When you say that there's approximately $500 and change million of cash that you could repatriate without being taxed on it, is that potentially how much you can use to repay debt without facing any negative consequences?

Yes.

Then one more for Morten. If you guys aren't considering converting to FPSOs because the returns for those conversions have been lower than a lot of people may have expected and you would make more money trading them do you think that other people who were going to convert to FPSOs are facing the same type of decision calculus and may not? Maybe dry docks a different story but for FPSOs?

If you look at the main players out there in the FPSO market and you look at the returns of invested capital they have generated year-to-date. It is considerably less than the operators known as tankers have generated. I am told there's an expectation that -- that people expect some repricing in that market, and that remains to be seen. I would expect that margins will expand. A lot of the players that own double hulls that are looking at projects are just really looking to sell. And primarily probably because they don't have the technical capability or staff to take on that risk. And I said FSOs and FPSOs, an FSO while it has a fair amount of technical risk, not to be underestimated is not the same as an FPSO which has a higher degree of technical risk. Same thing. We would be comfortable taking on the technical risk but we wouldn't do it if we could not earn superior returns to what we would operate the tankers in the spot market. It's that simple. We have the capacity to consider and operate both. There's very few that have that.

Thanks very much.

One second Myles, you wanted to add something? I just wanted to add again, some of our large crude tankers have some unique features that make them possibly very suitable for FSO, FPSO service which is one of the reasons why we are looking at that. That could enable to us get more attractive projects and return that what the general market is paying.

Our next question is a follow-up question from the line of Urs Dur. Please go ahead.

Hi. Just a real quick thing on page 16 of your release. I think it's a little bit interesting and maybe you have a comment or not, but why are Suezmaxes being outperformed by spot Aframaxes in this quarter?

There's a very simple explanation which I'll have Mats give you. Straight forward.

I'm sure it's easy, but your comment would be great. You're referring to the fourth quarter or you're referring to the first quarter?

Yes. So far, so far this quarter on page 16 of your release.

The two ships on the Suezmax side that are doing their maiden voyages. You don't have the same vesting approvals. You don't have the same system built up as you do on the Aframax side which is an enormously well established system.

So it's not a market-wide issue or something you're experiencing?

No.

Excellent. Thank you very much.

Ladies and gentlemen, that does conclude our Q&A session. I will turn the call back over to Morten for closing remarks. Please go ahead.

Well, before we sign off, we want to extend an invitation to our upcoming investor event here in New York. Two weeks ago, we sent out invitations to the March 27, event taking place here in New York. All who attend can expect to gain a better understanding of each of our primary segments and the markets in which we operate. You will also have opportunities to get to know the broader management team in more depth and ask any and all questions that you have. We hope you'll be able to join us. We'll all be there and please contact Jennifer Schlueter at 212-578-1634. This invitation-only event. We look forward to seeing you there and we thank all of you for joining us today. Have a good day.

Ladies and gentlemen, that does conclude the OSG fiscal 2007 earnings call. We would like to thank you for your participation. Have a pleasant day. You may now disconnect.