A recent article by an Bloomberg analyst in London makes a case for the over supply of oil tankers, with orders for an equivalent of nearly a third of the existing fleet.

The spike in crude oil prices has sent a flurry of orders in for more hauling capacity as demand from China is still in the sights of the market.  Grant Smith foresees these new tankers hitting the seas about the time demand starts to fall off due to high commodity prices.

Naturally, this scenario is the largest risk to my potential Frontline (FRO: chart, web) position.  While I’m not necessarily looking to get into FRO for a price appreciation play, but rather for a dividend play, the future dividend payout is based heavily on crude oil demand.

Naturally, this is only one analysts opinion, and the speculation on whether we’ve seen the peak of the oil prices or not is still running rampant on The Street.  But an over supply of vessels will drop earnings significantly from their present levels, meaning a cut in dividend payout will be warranted, regardless of oil prices.

While I think global demand for oil is still very strong, every new ship that is brought to market increases the hauling supply for black gold.  On the flip side, though, the United Nations is mandating that all single-hull vessels be scrapped by 2010.  Tighter regulations from the environmental sector may keep earnings tracking higher.

I think FRO is still a good play, and is safe for the short term.  We’ve still got plenty of time before new tankers start hitting the market to see which direction the crude market will turn.

I believe high oil prices are here to stay (and let’s not forget that by high I mean over $50/bbl), demand in Asia will keep the demand for supply high, and environmental regulation will continue to thin the fleet.

Disclosure: I do not own shares of Frontline

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