Octave Specialty Group Inc (OSG) 2008 Q3 法說會逐字稿

Welcome to the OSG third quarter 2008 earnings conference call. (OPERATOR INSTRUCTIONS) As a reminder this conference is being recorded today, October 31, 2008. I would now turn the conference over to Mr. [Allen Hemelstein], Assistant 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 ordering OSG's prospects including the outlook for tanker and articulated tug barge markets, change and oil trading pattern and anticipated levels of new building and scrapping, prospects for certain strategic alliance and investments, prospects for the growth of the OSG gap transport business, estimated TCE rates and synthetic TCE rates achieved for the fourth quarter of 2008, estimated TCE rates and synthetic timecharter rates for 2009, projected dry bulk and repair schedule, timely delivery of new buildings and conversions of vessels and prospects of OSG's strategy of being a market leader in the segments in which we compete and the forecast of world economic activity and world oil demand.

Factors risks and uncertainties that could cause the actual results to differ from the expectations projected in these forward-looking statements are described in OSG's annual report on Form 10-K for 2007. For this conference call we have prepared and posted on OSG's website supporting slides that supplement our prepared remarks. This supporting presentation 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. Morten.

Thank you very much. That was Allen Hemelstein you just heard from, our assistant General Counsel. Also joining me this morning is Captain Bob Johnson head of Worldwide Shipping Operations who is joining us from our Manila office and Jonathan Whitworth, head of our US Flag. He joins us from our Tampa office. With me here in New York are Jennifer Schlueter, head of IR and Corporate Communications, Lois Zabrocky, head of our product tanker SBU, Mats Berglund, head of our crew transportation SBU, and Myles Itkin, Executive Vice President and Chief and Chief Financial Officer. Now I'd like to begin the presentation, so please turn to slide 3.

Let me preface my remarks by saying that it is actually a change of pace to be able to have some good news to talk about in a financial economic environment which has been dominated by lots of bad news stories. The financial results for the third quarter was the best in OSG's history. TCE revenues were $435 million, up $181 million quarter-over-quarter. EBITDA was $256 million, up 175% from $93 million. Net income was just under $200 million, up from $27 million in the third quarter of 2007. The only quarter in OSG's history with higher income was the fourth quarter of 2004.

EPS was $6.69 a share up from $0.83 in the third quarter of last year. Adjusting for the sale of two non-core assets generating gains of $55 million, impairment charge on two US Flag vessels and the effect of the mark-to-market unrealized FAA positions, EPS was a strong $4.47 a share. Indeed, it was a very strong and very volatile third quarter. Average spot rates for VLCCs were $113,000 a day. The Aframax has tremendous performance at $53,000 a day and Panamax is another steady performance at $39,000 a rate driving crew revenues up 132% to $295 million. Our run rates were strong and rates of $41,000 and Handysize rates $31,000 drove product tank or TCE revenues of 20% to $81 million for the quarter.

Year-to-date TCE revenues are ahead of fiscal 2007 TCE due to an exceptionally strong market so far this year. TCE revenues in the first nine months were up 52% to $1.2 billion. EBITDA was up 51% to $585 million. Net income was up close to 110% to $397 million and adjusted EPS of $11.22 was up more than 150%.

Looking ahead, the fourth quarter bookings are strong. In crude 47% of our VLCC spot days are fixed at $70,500 a day. 44% of head VLCC days are in at $64,000 a day, and 32% of Aframax spot days have been booked at $47,000 a day in the fourth quarter. In the products, 20% of Panamax spot days are fixed at $40,000 a day and 33% of the MRs at $25,000 a day and US Flag bookings are in line with what you would expect. All in all, we are well on our way to having the best financial year in OSG's history.

Please turn to slide 4. Turning to some of the business and fleet highlights. During the quarter we repurchased 2 million shares of OSG's stock at an average price of $70.26. Under the current program which the Board authorized in June, we have $96 million remaining. This is the third buy-back program during the last three years. Altogether, we have purchased 29% of the total shares outstanding while 11.4 million shares at a total cost of just under $770 million. We remain committed to returning capital to shareholders as we execute our balance growth strategy. Earlier this month we announced financing for FSO project. This joint venture project with [Uronev], our partner in [TI], is converting two ULCCs to FSOs, floating storage off loading service vessels which have been chartered to (inaudible) Qatar for eight years.

These vessels will begin offshore operations next year in (inaudible) field in Qatar. The $500 million syndicated loan facility was put together in June and terms agreed to well before the current credit market melt down. It was through the work of our treasury group and our strong bank relations the deal closed in the fourth quarter on terms that would be deemed favorable today. We also just repurchased over 500 shares of OSG America in October. The result of a reversed inquiry by an institutional investor who was seeking liquidity in the chaotic market conditions. This brings our stake in OSG America to 77.1%. I want to emphasize that this was a one-off transaction reverse inquiry. We remain committed and very excited about our US Flag business today and its prospects going forward.

Turning to fleet activity on the upper right on this page. Two vessels delivered in the quarter, the overseas Kimolos, a newly built 50,000 dwt Handysize product carrier and the Overseas Texas City. The Texas city is the 5th in a 12 ship series under construction with (inaudible) Philadelphia is the third US Flag new build that BP has chartered from us in this series. We further expanded the Suezmax International Commercial tool with our partner (inaudible) shipping from Italy through six ships by chartering in the Hellespont Trinity for one year. We have a 50% interest in that timecharter.

We further expanded the Clean Products International Commercial Pool adding Korea Line also a tanker international partner. The pool, focused on trading in the Americas, now totals eight operating ships with two new builds set to deliver in 2009. Turning to asset sales and sale lease specs at the bottom of the page. The sale of subsidiaries that time chartered in two Capesize (inaudible) generated $55.5 million. We continue to be active in the SMP market. Since January 2007 we have generated $505 million in proceeds in asset sales. Further asset sales detailed earnings release totaled another $500 million in the next three quarters and include two LR-1s and two Aframax's to be sold and chartered back. These four ships, these transactions were prudently arranged when the vessels were contracted close to one and two years ago precisely so we could retain flexibility, shift residual risk and raise cash. We planned for this.

More on our plans for cash on the next slide. Please turn to slide 5. Now you've heard this before. Over the last few years we have consciously sought a balance between own vessels and chartered in with close to 50% for total fleet charted in today. This enables us to leverage our commercial platform in strong markets while providing flexibility in weak markets. This balance has also been achieved in our new building feet. 13 of 37 new builds are chartered in regarding no capital up front from OSG.

Information on this slide and the next slide was put together as many of you have been asking about our capital commitments and credit standing. The kind of fundamental questions that are turning equity analysts into credit analysts in these uncertain times. 65% of our new build fleet is on the international side, many of which are replaced vessel deliveries while others are intended to join one of our five commercial pools in order to meet cargo commitments and demand requirements. Flexibility is critically important to us from how we manage our fleet. Moving to the table at the bottom. Out of 38 new bills by includes the overseas [Acadia] that just delivered only 23 vessels are owned. This number reduces to 19% or 50% if you exclude four vessels subject to sale leaseback arrangements that I referred to earlier. The next three lines in this table tell a very compelling story. Our new build capital commitments are entirely funded and then some through 2009, the end of 2009 by asset sales and the capital construction fund, money allocated for certain construction of certain US Flag assets. Put it another way, we expect to end up with at least a strong liquidity position at December 31, 2009, as we have today while meeting all our commitments. Please turn to slide 7.

Earlier this month we put something together for our Board detailing our liquidity position and projections for next year. We thought doing something similar on today's call, without the projections unfortunately, would be useful and give us an opportunity to highlight elements that differentiate OSG from more highly leveraged less well capitalized competitors. We are predominantly and unsecured borrower, a rarity in the shipping world, with less than 27% of net book value pledged as collateral. In addition, this means we are not confronted with ugly loan to value calculations that the vast majority of shipping companies are struggling with today and will continue to struggle with in the coming year. Annual principal payment obligations are less than $30 million a year through 2011.

We have one of the lowest debt to capital ratios in the industry and ample liquidity of $1.5 billion available to us. We have about $940 million available on our $1.8 billion unsecured credit facility another $122 million available on a $200 million secured facility put in place last year for OSG America. Dividend payments stock repurchases and operating lease obligations round out uses of cash from operations which is very strong given our mix of fix and spot business.

Please turn to slide 7. Our fixed portfolio positions us well for 2009. The investment and growth in our products in US Flag fleet and their time charter book of business coupled with contacts of freight, time charter to the pools and FFA positions is paying off. In addition, we have a full year of gas earnings in 2009 and the FFO project coming on line in the second half of the year.

As a bottom, a compelling forward picture of fixed revenues including $516 million in 2009 of non-cancel bookings and hedge positions. Of the $560 million locked in in TCE revenues, 61% is from timecharter and 22% from US Flag [COAs], the balance from FFA position, and pool timecharters. Joint venture revenue from the FSO project and from the gas fleet announced another $77 million. Let me take this one step further in how fix revenue set us up for next year.

Please turn to slide 8. Contracted revenue in 2009 covers a significant portion of cash expenditures. In crude, 60% of cash expenditures, and this includes operating, dry bulk, charter obligations, allocated G&A, debt amortization, and interest expense are covered requiring the balance fleet to earning $18,000 a day on unfixed or open days to cover the balance of cash expenditures. These charts further show this relationship and the products in the US Flag segment and further breaks down crude. On products if we remove the pre 1990MRs, all which will be returned to their owners by July of next year, we earned $18,000 a day on the open days. For VLCC in 2009 we need to earn just $10,000 a day to cover cash expenditures. I'm confident that is reasonable to achieve. The message we want to convey to you is that OSG is in a solid position.

Capital commitments are covered by asset sales and require no borrowing. Financing commitments and operating cash expenditures are substantially covered from locked in revenues leading us to achieve a certain level of earnings on the balance of open days. We have ample liquidity and borrowing available to us.

Let's talk a little bit about the market, what happened in the third quarter. The strength of the market in the third quarter was due to very simple formula, limited tonnage increases, 8 additions and 13 deleases in the VLCC fleet plus OPEC production increased by 1.4 million barrels a day over the third quarter of '07 resulting in the highest third quarter rates seen in the past decade. There was no shortage of volatility in the (inaudible) with freight rate high of $196,000 a day and lows of $7,000 a day in the VLCC market. Hurricanes disrupted the market, 15 refineries totaling over 7 million barrels a day of capacity were impacted sharply reducing refining utilization in the Gulf of Mexico. This impacted our product MR fleet with heavy concentration in the US Gulf as ships waited for refineries to reopen and restart after shut downs.

Looking forward, long oil trades and single hull discrimination continue to factor into the market. 21% of the world's VLCC fleet is single haul and the list of companies that refuses to use single haul ships for spot movement is growing. This single haul discrimination and the growth in longer haul trays continues to provide support for the market. On the negative side, OPEC cut production by 1.5 million barrels a day on October 24 despite oil prices. Further cuts are possible.

Now on the positive side, the global financial crisis could cause delays and/or cancellations of new deliveries, although it will probably not have a significant impact in 2009. Summing up, we think 2009 will be weaker than 2008 but will remain at healthy levels for operators of double haul tankers. The same thing we said in 2005, 2006, 2007 and 2008 and we'll repeat it for 2009. Before I turn the mike over to Myles, I want to leave you with my thoughts on what I believe to be the most compelling about OSG as an investment. Our balance growth strategy has positioned us well in a challenging environment in which we live today. Our longstanding commitment to maintaining a strong balance sheet in the face of high dividend payout [sheet] has put us in the position of being able to folks on running the Company for profits rather than for cash while still being able to consider new opportunities.

Our shareholders will be comforted by a company with a real board process and a real commitment to openness and transparency. Finally and most important of all, we have the human resources at sea and on shore that can focus on the issues at hand, no distractions, no hobbies or other dabbling other businesses. Instead, you get a group of professionals focused on building and running the best energy transportation company in the world. With that, I'll turn the mike over to Myles.

Thank you, Morten, and good morning. May I ask you to turn to slide 11 please. The results for the quarter ended September 30, 2008, reflect an exceptionally strong rate environment as well as OSG's earning power, our ability to deliver superior returns. TCE revenues increased by 71%. Our operating margins stood at 45%, and our net profit margin at 46%. The increase in Q3 revenues is largely attributable to a 221% increase in VLCC spot rates to $113,000 a day, a 160% increase in Aframax spot rates to $53,000 per day and 837 additional revenue days across all sectors. Of the quarter's $435 million of TCE revenues and $194 million of income from vessel operations, the Crude sector contributed 68% of TCE revenue and 85% of income from vessel operations. The Product sector, 18% of TCE revenue and 11% of income crude vessel operations and the U.S. Flag sector 13% of TCE revenue and 3% from income of vessel operations. For the quarter, 64% of the Company's TCE revenues were derived in the spot market and 36% in physical and synthetic timecharter markets. The positive impact of increases in spot rates and revenue days was partially offset by higher voyage expenses which increased by $15 million from Q3, 2007 principally due to higher fuel cost.

Vessel expenses for the entire fleet increased by $9 million for the quarter to $79 million. We continue to experience industry wide upward pressure in all areas of OpEx, but especially in the area of crew wages. We also incurred higher cost on seven tankers which operate under fixed rate management agreements with DHT Meritime, a one-time subsidiary. These agreements terminate in January 2009, eliminating our exposure to excess cost on these vessels estimated at $12 million for full year 2008. Charter higher expense increased to $115 million in the current quarter, up by $46 million or 67%. The increase was attributable to approximately 12 more vessels over a thousand days being charted in during the third quarter of 2008 compared with the prior year's quarter. The profit share component of charter higher for the current quarter totaled $22 million, $19 million higher than the prior year's quarter reflecting higher earnings generated on VLCC and Aframax's. As a result of our focused efforts, the Company's G&A expense continues to moderate registering $32.4 million in the quarter with full year G&A now estimated at between $145 million and $150 million.

During the quarter we sold the charter end contracts, including purchase options for two 1997 built cape size dry bulk carriers for an aggregate gain of $55 million. This was offset by vessel write downs of $24 million on two older US Flag vessels employed in the Delaware [lightering] trade. We decided not to put these vessels through expense of dry dockings which would have been required for the vessels to continue trading. Accordingly, the vessels will be placed in lay up pending sale and have been classified as held for sale on our balance sheet.

Other income increased by $1 million quarter-over-quarter. The impact of settlements and changes in fair value of economic hedging instruments that do not qualify as cash flow hedges are reflected in other income. During the current quarter such results were favorable and reduced the previously recorded mark-to-market unrealized loss at June 30 by $21.7 million. This was offset by settlements of $13 million resulting in a net gain of $8.6 million for the quarter or an improvement of $10 million quarter-over-quarter.

Interest income in the current income declined by $9 million to $2 million as a result of both lower interest rates and the reduction in cash and capital construction fund balances. As the Company used $545 million repatriated in the second quarter of '08 to repay a portion of our outstanding long-term revolving credit debt. Interest expense is down as a result of the 220 basis point rate decline on floating debt, the repatriation of $545 million in cash and the redemption of $176 million of our 8-1/4 senior notes also done in the second quarter. This redemption reduces interest expense by about $7 million per annum through 2010.

Please turn to slide 12 for a discussion of various balance sheet line items. Cash and cash equivalence go to $343 million at September 30. The decrease in the cash balances from December 31, '07 repayment of off debt by cash generated from operations. Shareholders equity increased by $143 million from year end '07 through the addition of $397 million of net income offset by $199 million spent for stock repurchases, $45 million in dividends and a $19 million increase in unrealized derivative expenses being deferred in OCI.

As a result of recent developments in financial markets we monitor the strength of our financial institutions on a daily basis. Where we felt it was necessary or desirable, we have moved cash deposits and recalled excess margin deposits related to the derivative activity. Also, we monitor charter counterparty risk at regular intervals.

Please turn to slide 13. The Company enters into freight derivatives with a primary objective of using them as economic hedging instruments to reduce volatility. The Company's VLCCs are deployed and are in revenue through commercial pools that operate on multiple routes whereas the related hedging instrument, TD3, is tied to a single route; therefore, the FAA and bunker hedges that qualify us cash flow hedges for accounting purposes have some degree of basis risk. Because of this basis risk on a quarterly basis the synthetic TCE rates achieved will fluctuate within a range around the targeted level. The degree of fluctuation around the targeted level increases in periods of high volatility. Third quarter VLCC rate ranges from $70,000 a day to $196,000 per day.

In the third quarter the TI pool performed better than the long-term historical relationship between the VLCC pool performance and the FAA market that was expected, explaining why the synthetic positions achieved $78,000 per day versus the notional targeted rate of $56,000 per day. For the 239 hedged days in the fourth quarter of 2008 for which the TI rate has been fixed, we expect the synthetic TCE rate to be $64,000 per day. For the balance of the 301 hedge days in the fourth quarter of 2008, we estimate a notional synthetic rate of $71,000 per day based on historical relationships with actual results falling within a range between $55,000 per day and $83,000 per day with a 95% confidence level. Currently, we are hovering at the lower end of that range.

For 2009, we estimate a notional synthetic rate for nine hedged VLCCs of $62,000 per day based on historical relationships with actual results falling within a range of between $45,000 per day and $76,000 per day also based on a 95% confidence interval. For additional details regarding FAA and TCE correlations, you can refer to page 18 in the appendix.

Full year 2008 guidance. We have updated the annual guidance reflected on page one of the appendix but would like to direct your attention to two individual items charter higher expense. The guidance provided for the time and charter expense is updated and now anticipated to be between $420 million and $430 million reflecting higher level of profit share principally in the third quarter and additional chartered and vessel since the last update. Capital expenditures. We have updated our 2008 full year guidance for capital expenditures from $403 million to $612 million mainly due to two new VLCCs that were ordered in July, the acceleration of the delivery of one Panamax from 2009 into the fourth quarter of 2008, and project costs for the FSO conversion.

In conclusion, we believe the Company is well positioned to optimize shareholder values in all shipping markets. We have a diversified portfolio of assets, including both owned and chartered vessels that provide optionality and reduce our risk. Known asset sales and sale leaseback transactions will generate proceeds that more than fund our 2009 new build program. Our continued fleet modernization program provides competitive advantage through customer preference, fixed revenues in COA contracts provide for solid earnings in cash flows and our strong liquidity position balance sheet and predominantly unsecured debt profile enables us to attract high margin projects and puts us in a position to see opportunities that may not be available to more highly leveraged competitors. With that, operator, we will now take questions.

Thank you, sir. (OPERATOR INSTRUCTIONS) Our first question comes from the line of Natasha Boyden with Cantor Fitzgerald. Please go ahead.

Thank you, operator. Good morning, ladies and gentlemen.

Good morning.

Hi. Given the market we are seeing your stock trading at a discount to [NAV], given this, are you really focused now on spending your cash on purchasing shares versus more acquisitions at this point?

I think we are going to continue with our balance growth. We are going to look at always to maintain a strong balance sheet and ample liquidity, and we will weigh the alternatives of continuing to buy back stock with opportunities that come up in the market. Is there obviously a disconnect between the value of OSG today and the share price, yes, but I think you can say that practically of every company listed on the stock exchange today. But we will continue to operate the company the same approach we have up to now, and we think we are in a good position to do so. No change.

Great. Myles I think you touched on this briefly in your remarks, but talking about counter party risk, obviously it's been a huge issue in the dry [bulk] market. A) Have any of your (inaudible) Indicated that they may not be able to fulfill their obligations? B) How do you go about maintaining your relations with them and obviously monitoring them? Can you just sort of touch on that a little further?

There's been no indications of renegotiations or inability to obligations. We are in constant contact with our major charters, many of whom are major oil companies and trading companies. So based both on personal contact and typical credit analysis, we get a good sense of their current positions.

Okay. Great. Thank you. Maybe this one is for Jonathan. We heard reports that US Gulf oil production was fairly significantly affected by hurricane season and there is still some capacity offline. Does this have any effect on your US operations?

Good morning. Correct. In the third quarter there was a dramatic decrease in refinery output thanks to Gustav and Hurricane Ike. Fortunately for OSG, we have very little exposure to the spot market. So the vessels that we did have during that period were actually all term chartered out. So we really saw no financial and also, more importantly, saw no operational distress from those events and we have also seen the utilization of those refinery outputs increased to somewhere about 88% within the fourth quarter. So it has come back strong.

Okay. So didn't really, A, have any impact whether production comes back on line doesn't have an impact you going forward?

That's correct. The refinery outage was relatively small despite the hits both in Houston and New Orleans took. They did come back online by the beginning of the fourth quarter.

Great. Morten, can you talk a little bit about the single haul issue? I know last quarter and maybe in the quarter before the VLCC -- conversion to VLCC was such a hot topic, and I don't think that's happening now, but you were fairly bearish 2009 I think previously. Can you just talk about single haul, the issue and the order book and going forward especially with oil demand going down and OPEC cut, what you see going forward and then for 2010 with the IMO -- the IMO cuts coming in, how you see spot rates going forward?

Let me make one correction. We were never bearish in 2009.

Maybe I was very --

We said it would be weaker than 2008 but still a good year. So we will continue to generate significant cash flow from our crew fleet, just not as strong as 2008, which is one of the reasons we took the hedge positions. The single haul discrimination continues to accelerate. A week ago there was a single haul VLCC that grounded in Singapore. It was controlled by a Korean refiner. There were no spills, but I guarantee you that people in Singapore and Korea lost a lot of sleep that following week and it led to the Korean charter in that case not accepting a single haul next time around. If you look at the top ten charters of single haul VLCCs in the world in 2008, every single one has reduced its usage of single hauls in the course of the year. The trend is down and hangs towards zero.

If you look forward into 2009, I mentioned the OPEC production cuts not a good thing. There's actually a silver lining in that in that if you honor those production cuts, because of the nature of the field and the oil equipment, they will continue to run the field and they will put crude in storage. If you go back to this year, the VLCCs that Iran uses for storage were all double hauls. If they have to do their cuts, which I think is it's estimated about 160,000 barrels a day, they are going to need 9 double haul VLCCs for storage. That's a possibility. You have three of the oil majors now have put 15-year maximum levels on any ships they use for spot voyages, so that again takes out some of the older double haul VLCCs. The trend is very clear.

The Singapore incident, which is just a week old, was a close one and we think by 2010 the single hauls will be completely obsolete. There's also the possibility of Japan and China outright banning them next year. So while the order book is large, in fact the actual fleet growth, if you factor out the single haul VLCCs and take into account some of the other things like the Iran storage possibilities, we think there's five double haul (inaudible) for (inaudible) in the next two years, you actually have a fairly normal fleet growth. And 2010 we believe will be a very strong year for our industry as a result of that and hopefully at the same time then the world economy is starting to improve. So we feel good about 2009 and we think 2010 could be significantly better. Myles, do you want to supplement that?

I think you got most of it there earlier. Insensitive with the discrimination on how even harder people needing cash and we'll choose to scrap their ships. Also, there will be a reduction in the long-term order book which will have a positive effect with people considering canceling orders, not to disagree with being in the dry (inaudible) side, but tanker orders will get to canceled more and more as we see the financial crisis develop.

Great. Thank you very much. That was really helpful.

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

Good morning. Morten, I want to dig a little deeper on the opportunities in the industry vis-a-vis your balance sheet. Obviously cash is king a lot more today than it was even 12 months ago. Did the returns based off current asset prices and the charters you can get in the market today justify maybe levering up a little bit or taking less cash off your balance sheet today as you see the market over the next 12 months.

John, if you, I look forward to meeting with you off line. If you can tell me what assets are actually worth today, then I can do that mathematical calculation. I think it's a little early in the game for the tanker market to rush in and do deals today because we don't know what the levels of asset decline have been. They certainly haven't gone up. In the tanker space you still have a good market and people are earning good money. New building prices have not come down yet, though the yards are offering somewhat better payment terms.

You have seen some cancellations of VLCC so far, but what you are mainly seeing are owners trying to find buyers, joint venture partners, this, that and the other, as they need to finance or their cash squeeze gets tighter, things will change. We fully expect to see a lot of opportunities. You recall, John, about a year ago I (inaudible) banking crisis was going to impact the industry and a lot of people laughed at me. The banking crisis is impacting the industry I think more materially than it did in the mid '80s when there were a lot of problems. I think you'll see a lot of bankruptcies across the industry and there will be people that will have to look for stronger partners to take ships.

We will wait patiently and do that, and we will be in a position to do things if and when they come and they are going to be done at levels based on what ships can earn going forward. Going to (inaudible) point, we've been trying to get a count on how many doubtful orders there are in the VLCC space, the tanker space. It's much easier in the dry bulk space actually. In 2010, '11 we think about a third of the order book is doubtful, a third, and that is just a range, and in 2012 we think it's as high as 40%. Right now we count 28 specific VLCCs that we think are highly doubtful of being built, but this is early in the game.

This is all happening so quickly, but what I do expect because the banks would be leveraging more than the shipping industry, once they get new asset values they will enforce their loan-to-value calculations, their loan-to-value covenants across the industry, wet-dry container, you name it, and that will create opportunities for those in a position to capitalize on it and we will be.

Do you think there might be opportunities on the public side that may already be flushing out in that type of negative scenario?

Without question.

You mentioned before that every stock is technically trading below their net asset value right now.

I think there are a number of companies that could realistically consider their options. They have more upside in their stock or they would be better off putting their fleet in to OSG and I think they would have a lot more upside, a lot more earning potential for their assets and a lot better chance of a recovery. I think some owners will reach that conclusion.

Particularly fleets that might have already been part of OSG?

No comment. We have built strong commercial and technical platforms so we can do that and I've said so many times, we actually have people that can manage it. We are a team here.

Okay. Two more. Is there any way to gauge the length of the charter-in fleet charters? I'm trying to get a sense of what the charter end cost might be going into '09.

Yes. Sure. We average over the next couple of years both timecharters at about $400 million.

Okay. And then the final thing is on the G&A front. Given the guidance in the back of the packet, it would look like the fourth quarter would be up $8 million sequentially just to make the low end of the range. Are there bonus accruals that are going in to the fourth quarter G&A estimate?

It's accruals through the year with performance as determined at the end of the year having somewhat of an effect, but the guidance range should hold if not be somewhat improved.

Okay. Great. Thanks.

Thank you, sir. Our next question comes from the line of Scott Burk with Oppenheimer. Please go ahead.

Good morning. I just wanted to know if you are seeing in your VLCC operations any impact from the OPEC cut yet terms of actual charters that people are trying to arrange for say November, December time frames?

Hey Scott, it's Mort. We've seen charters holding back a lot recently both after the results of OPEC holding back and as a result of fall in the oil price. We do believe it will come back and the end are we will see a bounce back in rates.

In the fourth quarter time frame you are talking about or next year?

In the short-term. In the short-term in the fourth quarter. Have to kind of go back in oil prices. We have a more stable oil price. We've also seen the oil major take a bigger stake of the market again. The traders have reduced activity and the likes, Shell and the big companies are back doing a proportionately higher percentage of the fixtures out there.

What's the implication there? Is that because the traders are having a tough time getting letters of credit or what's the implication?

Likely also the fact that oil price has been dropping during the last period. They haven't been incentivized to trade on it. They need a more stable environment which I think we are getting into now.

More stable trading environment going forward. Okay. And then, Myles, one for you. You talked about the FFA hedging on the VLCCs. Is there anything beyond that or is that basically the full scope of your freight board agreement?

Products are essentially down a diminimus amount.

I'm sorry.

A diminimus amount of Aframax hedging and (inaudible) are completed.

And the products in US Flag and gas we have timecharters.

Great.

One thing. The Aframax, we have the fix rate lightering contracts which we built up over the last period, and we also have some fixed rate within Aframax international. We've been able to do a physical market in the smaller ships.

Okay. And so looking into next year, just with the FFAs, how much total do you have hedge for the overall fleet in terms of hedge revenue versus spot revenue?

A little more than half the revenue in the VLCCs for 2009.

And then, Morten, I had a question for you. If you can put on your banker hat and you mentioned the 1980s that you lived through the banking crisis back then. When do you think the bankruptcy, the fed and governments are on the roll just pump a ton of liquidity in the market. When do you think it will make its way through and start impacting vessel values and impacting banks willingness to maybe open up loans to shipping companies again?

I think it's a different environment. If you went back to the '80s at that point and it's really from '84 to '86. It was before the Latin America debt crisis hit. In fact the banks themselves were in very good financial condition during the shipping crisis in the mid '80s and the world economy was in relatively good shape.

It was the shipping industry as a result primarily of over building the late '70s and over building in Japan in '80, '81 was in horrible shape. Today is different. It's the banking community that is in horrible shape and the world economy is in horrible shape. I think we've entered a period of sustained deleveraging for the industry, for the banking industry. I think a number of the specialized ship flood institutions that have relied from borrowed money from other banks, I don't think that model is sustainable at the volumes they have done going forward.

I see a much reduced capacity for the industry to lend, and the banking industry has less products from which to make money today than they had a year ago. They are going to have continued sustained credit losses in their mortgage portfolio as well as in yesterday cards and in other areas. So I see them being very strict in their enforcement of loan-to-value covenants and such. I see a number unable and unwilling to increase their lending and they are going to be selective about who they deal with. I don't see a quick surge in liquidity bailing out owners in this sector. It will be survival of the fittest here and a number of companies are going to have to retire and turn their assets over to stronger well capitalized companies. This is a different ball game now.

The bankers I know, most of the bank shipping banks have their work out teams being organized.

Okay. We certainly see the stresses on the dry bulk side. Tanker values have hung in quite a bit better. Are you kind of seeing, do you think that same kind of scenario will play out on the tanker side as well?

I think this tanker market, as I said, you and I agreed on it more than some of the other analysts. It still has very strong structural support. Oil demand can fall by 1% in the year, but it's not the same thing happens when China stops importing iron ore for a period period of time and we have a single haul replacement which is certainly going to provide good support for rates in the next couple of years.

There is a number of owners both dry and wet that are exposed. There are a number of newcomers to the wet space who are exposed. It's not going to be as big as the dry bulk space where I think you can lose 40%, 50% of the order book, I think that's now a pretty realistic number, but I think looking at 30% of the order book in to 2010 and beyond is what we scoped out today which I think is very good for the long-term fundamentals for this business, and I don't see a huge recovery in the banking space in two or three years that is going to change that, and we are also certain that there's going to be a significant reduction in ship building capacity. If you look at people's projections the capacity in the world through to 2012 it varies steep hockey stick. It's now likely to peak in 2009 and is to decline or stay flat. And that is a big, big change for the business.

Yes. We said that the siller lining is that the number of ships gets cancelled but sure is a dark cloud on the way.

I think and give use little credit. We started focusing on G&A in 2007. We didn't wait until now. We started unlocking more revenues in 2009 a year ago because we were concerned about that. It's been a challenging and volatile environment for everybody, so it's how you came prepared for all of these unexpected events that will be the difference and we feel fairly prepared. Don't get me wrong. We are not cocky and this is a challenging environment and I'm sure we'll get some surprises.

Scott, to put a little bit more color on fixed revenue, one of the slides in the presentation reflects north of $500 million worth of fixed revenue. It excludes revenue derived from fixed COAs which aggregates another $100 million. So fixed revenue for 2009 is in excess of $600 million.

Morten touched on the fundamental of the tanker business. (inaudible) China, (inaudible) for the last three months is 20% above 2007 levels including the month of October. New refineries coming on early next year and throughout the year and that, in our view, will not stop. We will continue to see increase number of VLCC cargos into China, a lot from west Africa and some from the Venezuela supporting (inaudible).

Okay. Thanks.

Thank you. Our next question comes from the line of Urs Dur with Lazard Capital Markets. Please go ahead.

Good morning, guys.

Good morning.

Ladies and gentlemen, actually. I note that at least I don't see in the release and we have gone over this many, many times already in today's call, the valuation situation. I do not see an NAB calculation in there. Is that based on the drastically changing and swiftly changing environment?

We find a number of third party sources have stopped publishing values because of limited liquidity.

Right.

In the market in terms of number of transactions, and we prefer to provide something that was third party factual base than our own determination.

Fully understood. It's an interesting illustration and that's very interesting that nobody is publishing. And I would presume then that it makes it very difficult no matter how cheap stocks intellectually appear depending on how you value ships, that it's very difficult to see what is available on the public front at least at this point in this quarter. Would that be a proper assumption?

I think we always look at what we first of all what we can earn with the vessels. That's been our practice with this timecharter new builds, second-hand purchases, but I would just say OSG trading at 2.77 times nine months earnings, that's cheap.

Well, my valuation tends to agree as well. But it is a challenging time nonetheless to even work on an [NAV] possibility. Interesting. One point of clarification. I know that you have mentioned that you are not exposed to LTV or VMT clauses, which is great, and I probably know the answer to this but I think it would be interesting for all of us to hear. Are there any requirements, any clauses, any capital lease requirements that are market related that could potentially raise your operating expenses going forward, not to ship operating expenses, the corporate operating expenses, is there any that are market related that could hurt you?

None whatsoever.

Great. Great. And one last question. In regards and you touched a lot on this anymore, but more on a macro market, OPEC interpretation, we see that VLCC rates, in particular spot rates out of the Arabian Gulf are very sensitive to OPEC production if the Arabian Gulf and then of course we always have the common discussion about cheating with OPEC. What is your overall opinion about the effectiveness of an OPEC cut going forward? Do you have any more general views on this and how it may affect your business? I am aware that you are conservative going forward and appreciate that but any further color on that?

I think the OPEC cut already introduced when they announced it. They've just been holding back because of the market. I don't think it is as big impact on the shipping as it might sound. We are heading into the winter and people will need to heat their homes and stocks are low. In the short-term you talk to the guys on the (inaudible). They see possibilities for rates to improve. Rates are weaker than than west Africa. We have seen B rates go up of 45 and roughly [NAG].

Yes.

West Africa is 65, 70, and, as always, we encourage people to do the math and they can increase their return if they (inaudible) .

Sure.

And again we see improvement more likely than a decrease right now in spite of the announced OPEC rate cut.

Okay. Excellent. Very informative and highly appreciated. Thank you, gentlemen.

Thank you. (OPERATOR INSTRUCTIONS) Our next question comes from the line of Justine Fisher with Goldman Sachs. Please go ahead.

Good morning.

Good morning.

My first question is on the mechanics of shipyard orders when maybe a buyer may not be able to finance the vessel. So if there is a slot and it's been taken up in either the vessels partially I guess less than 50% build. If that owner has to cancel or wants to cancel the order either because they can't obtain financing, does the yard continue to build the vessel and try to sell it to someone like an OSG that may be better capitalized and better to afford it? If so, is there flexibility on that price, like can the yard operate to a larger company like an OSG at a lower price to try and move that vessel out of the burst?

There's an enormous amount of possible outcomes. Keep in mind, it takes less than 12 months to build a VLCC. So there was a cancellation two VLCCs by a Turkish owner last week. I believe they had 20% deposit and they got some of that back. It's unclear whether that vessel will be built. If the yard ordered all the parts, steel, and equipment and well into it, they may reach an accord with the owner. The owner may walk away and the yard certainly may discount that order and try to sell it to somebody like us. I believe we have had one product tanker already proposed to us on that basis.

Go ahead.

When you get to 2011, 2012, I think it's a boom for the legal industry. Publicly traded law firms --

Someone has to benefit from this, right?

There are some owners that are exposed who have significant orders at some of these greenfield yards that will get in trouble where they have partial refund guarantees but not all the refund guarantees, and when shipyards go bankrupt, they go bankrupt, and those that have committed to that have issues. So it's really a whole range of outcomes, but if something is already underway and it's (inaudible) or one of the big Japanese yards, it's likely to get finished.

So I guess as a follow on then, do you think we may see some of the companies with purchasing power? This clearly goes down to OSG. Do you think we may see some companies try and pick off the vessels that are completed if they have the balance sheet to do so?

Absolutely. The stronger are going to be taking advantage of the opportunities. The yard will have to find other takers for them. The yard learned during the '80s taking ownership stake in ships was a one way ticket to bankruptcy. I think you will see some of that.

I know that everyone is pointing to the credit crisis as a major, major hamstring on some of the supply grow we are going to see across the board in commodities, but I guess the one thing to me that is interesting is that whether you look at the iron ore market or the coal market or the shipping market, we also have five years of strong commodity prices that have left us with very large, very well capitalized companies who still have the wherewithal to paper orders like OSG does. To what degree do you think this might offset some of the smaller companies cancellations? Is there in way we can think about that now?

There was a high dividends payout sheet that we had in the industry. So they were building up equity but they were giving it back. We gave a reasonable and growing dividends but we continue to build a strong balance sheet so we will be around for the long term. A lot of equity has in fact disappear. If you put down payments down in the yard and no refund guarantees and that yard gets in trouble, and for the record we think practically all the greenfield yards in China and Korea are going to get in trouble, you may have a problem. Are there strong well capitalized companies out there, yes. Absolutely. But if you have unfinanced new buildings, you need to first prioritize that before you go start picking up other people's bargains and because this credit crunch came so quickly and abruptly, even some strong companies are faced with that.

And then another question just because I haven't heard really what is going on with these vessels. What is happening to all the vessels that will be converted to VLCCs? Like people are trying to scrap them or are the scrap yards having issues because of credit as well? What are the companies who were going to convert to VLCCs doing now with rates as low as they are?

I think if you bought a single single haul VLCC for conversion, if you didn't, you are sitting there scratching your head and worrying because you have a single haul ship and you probably don't have a commercial operation to trade it and you have an unresponsive market, so you have a problem. You really got to determine do you lose more money scrapping it or trading it as a single haul tanker, or do you have a conversion. You have a difficult choice.

Okay. Then last question.

Position Justine.

I think it's a really interesting position for those players because you can't do the one and you can't do the other either. That's a tough spot I just wanted to know if you had any other color on it.

No.

And then the last question I have is just on the vessel financing for 2010. It's impressive that the company can finance its 2009 commitments and the rest of '08 commitments with asset sale proceeds and cash but there's $46 million for 2010 and I'm wondering, first of all, whether you expect to fun those with additional drawing on your unsecured or additional secured facilities and then, second, whether or not you may look for free cash flow to repay debt in '09 in order to better prepare the balance sheet for 2010 if you do have to finance a decent amount of that $486 of debt?

As it related to 2010 as you know we have over $1 billion, $1.1 billion worth of credit availability under various facilities as well as a remaining balance under the [CCS] to complete the construction of certain ATVs. The net amount is below the stated amount. Yes, we continue to utilize free cash flow to pay down debt as appropriate. We will do that as we move forward in to the future. We have swaps on some of that debt that will influence our immediate choice to pay down or not, but we have full financial flexibility. Cash flow from operations even under a break even is very strong.

Thanks very much.

Thank you ma'am and at this time there are no further questions. I'd like to turn the conference back to Mr. Arntzen for any closing remarks.

Well thank you for joining us today. If you have further questions about any issues please contact Jennifer Schlueter or Myles or myself, Lois, and we look forward to working with you in the coming weeks, months, years. Thank you.

Ladies and gentlemen, this concludes the OSG third quarter 2008 earnings conference call. Thank you for your participation. You may now disconnect. Have a pleasant day and a good weekend.