OVERSEAS SHIPHOLDING GROUP INC - Quarter Report: 2012 June (Form 10-Q)

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(Mark One)

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2012

OR

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

YES x NO ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (Section 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

YES x NO ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “accelerated filer”, “large accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

YES ¨ NO x

APPLICABLE ONLY TO CORPORATE ISSUERS

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practical date.

Common Shares outstanding as of August 3, 2012– 30,909,605

OVERSEAS SHIPHOLDING GROUP, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

DOLLARS IN THOUSANDS

See notes to condensed consolidated financial statements

OVERSEAS SHIPHOLDING GROUP, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS

(UNAUDITED)

See notes to condensed consolidated financial statements

OVERSEAS SHIPHOLDING GROUP, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

DOLLARS IN THOUSANDS

(UNAUDITED)

See notes to condensed consolidated financial statements

OVERSEAS SHIPHOLDING GROUP, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

DOLLARS IN THOUSANDS

(UNAUDITED)

See notes to condensed consolidated financial statements

OVERSEAS SHIPHOLDING GROUP, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY

DOLLARS IN THOUSANDS

(UNAUDITED)

See notes to condensed consolidated financial statements

OVERSEAS SHIPHOLDING GROUP, INC. AND SUBSIDIARIES

Note 1 — Basis of Presentation:

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. They do not include all of the information and footnotes required by generally accepted accounting principles. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair statement of the results have been included. Operating results for the three and six months ended June 30, 2012 are not necessarily indicative of the results that may be expected for the year ending December 31, 2012.

The consolidated balance sheet as of December 31, 2011 has been derived from the audited financial statements at that date, but does not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements.

Dollar amounts, except per share amounts are in thousands. For further information, refer to the consolidated financial statements and footnotes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2011.

Note 2 — Earnings per Common Share:

The computation of basic earnings per share is based on the weighted average number of common shares outstanding during the period. The computation of diluted earnings per share assumes the exercise of all dilutive stock options and restricted stock units using the treasury stock method. The components of the calculation of basic earnings per share and diluted earnings per share are as follows:

There were no dilutive equity awards outstanding as of June 30, 2012. Awards of 2,395,209 and 1,786,731 shares of common stock for the three months ended June 30, 2012 and 2011, respectively, and 2,392,797 and 1,814,510 shares of common stock for the six months ended June 30, 2012 and 2011, respectively, were not included in the computation of diluted earnings per share because inclusion of these awards would be anti-dilutive.

OVERSEAS SHIPHOLDING GROUP, INC. AND SUBSIDIARIES

Note 3 — Debt and Liquidity:

Debt consists of the following:

The weighted average effective interest rate for debt outstanding at June 30, 2012 and December 31, 2011 was 3.4% and 3.6%, respectively. Such rates take into consideration related interest rate swaps.

Financial Covenants

Agreements related to long-term debt provide for prepayment privileges (in certain instances with penalties). As noted below, certain of the Company’s debt agreements contain loan-to-value clauses, which could require the Company, at its option, to post additional collateral or prepay a portion of the outstanding borrowings should the value of the vessels securing borrowings under each of such agreements decrease below their current valuations. In addition, the financing agreements impose operating restrictions and establish minimum financial covenants, including limitations on the amount of total borrowings and secured debt and provide for acceleration of principal payments under certain circumstances, including failure to satisfy certain financial covenants. Failure to comply with any of the covenants in the financing agreements could also result in a default under those agreements and under other agreements containing cross-default provisions. The Company was in compliance with all of its financial covenants under all of its debt agreements as of June 30, 2012. Given the possibility of continued depression of market values in the International Flag segments in the near term as well as the adverse affect that a continued depression of spot rates would have on the Company’s operating performance, the Company's forecasts for the twelve months ending June 30, 2013, indicate significant reductions in the headroom that the Company has under the financial covenants in its debt agreements. The Company believes, however, that it will maintain compliance with all of its covenants over the twelve months ending June 30, 2013, including those associated with the $900,000 forward start facility, which do not become effective until December 31, 2012, through the use of cash on hand and the execution of one or more of the liquidity raising options discussed below. Additional information with respect to unsecured and secured long-term debt agreements to which the Company is a party follows below:

Unsecured Revolving Credit Facilities

In 2006, the Company entered into a $1,800,000 seven-year unsecured revolving credit agreement with a group of banks, which matures on February 8, 2013. In accordance with the terms of the credit agreement, the maximum amount the Company can borrow under its unsecured revolving credit facility decreased to $1,500,000 in February 2012. Borrowings under this facility bear interest at a rate based on LIBOR.

OVERSEAS SHIPHOLDING GROUP, INC. AND SUBSIDIARIES

At June 30, 2012, the Company had unused unsecured credit availability of approximately $343,854, which reflects $10,146 of letters of credit issued principally in connection with collateral requirements for derivative transactions and certain arbitration proceedings. In July 2012, the Company borrowed an additional $343,000 under the unsecured revolving credit agreement for general corporate purposes.

The Company has taken steps to replace the borrowing capacity under the unsecured revolving credit facility, including entering into a $900,000 unsecured forward start revolving credit agreement on May 26, 2011, with a bank lending group that matures on December 31, 2016. Under the terms of the agreement, OSG may begin borrowing under the forward start facility on February 8, 2013, the date on which OSG’s existing unsecured revolving credit facility expires. Financial covenants under the forward start facility, which are more restrictive than those contained in the $1,800,000 unsecured credit facility (due principally to differences in definitions between the two agreements) first become applicable on December 31, 2012.

The excess of the amount outstanding plus letters of credit issued under the unsecured revolving credit agreement as of June 30, 2012 over the $900,000 capacity of the replacement forward start facility of $256,147, has been included in the current portion of long-term debt in the accompanying consolidated balance sheet. The Company currently intends, to the extent necessary, to use cash on hand to reduce amounts outstanding under its unsecured revolving credit agreement by December 31, 2012.

The Company is evaluating how best to increase liquidity and how to bridge the estimated $100 million gap between the amounts that it anticipates may be outstanding under the existing unsecured revolving credit facility as of February 8, 2013 and the amounts that will be available under the forward start credit facility. These options include increasing the borrowing capacity of the forward start credit facility; obtaining incremental bank financing; raising debt or equity capital using the Form S-3 shelf registration that was filed on February 13, 2012; selling or entering into sale and leaseback transactions for one or more vessels; or a combination of these or other options, some of which may be difficult to execute. The Company intends to market in the third quarter of 2012 one or more ships for sale or sale and leaseback and is also currently in discussions with its main banks while pursuing each of the other options listed above. The Company believes that it will be able to execute one or more of these liquidity raising options. If market conditions, however, continue to remain weak, OSG may be unable to enter into suitable vessel sale or leaseback transactions, raise additional equity capital or obtain debt financing on acceptable terms, which could have a material adverse impact on the Company’s business, operations, financial condition and liquidity.

Secured Loan Facilities

As of June 30, 2012, 15 vessels representing approximately 29% of the net book value of the Company’s vessels, are pledged as collateral under certain term loans maturing between 2018 and 2023.

On January 18, 2012, the Company prepaid the outstanding principal balance of $49,000 associated with term loans maturing in 2016 with borrowings from its unsecured revolving credit facility. The two vessels that were pledged as collateral under these term loans are no longer encumbered.

Interest paid, excluding capitalized interest, amounted to $11,869 and $9,184 for the three months ended June 30, 2012 and 2011, respectively, and $40,992 and $36,979 for the six months ended June 30, 2012 and 2011, respectively.

OVERSEAS SHIPHOLDING GROUP, INC. AND SUBSIDIARIES

Note 4 — Business and Segment Reporting:

The Company has three reportable segments: International Crude Tankers, International Product Carriers and U.S. vessels. Segment results are evaluated based on income/(loss) from vessel operations before general and administrative expenses, severance and relocation costs and gain/(loss) on disposal of vessels. The accounting policies followed by the reportable segments are the same as those followed in the preparation of the Company’s consolidated financial statements. Information about the Company’s reportable segments as of and for the three and six months ended June 30, 2012 and 2011 follows:

OVERSEAS SHIPHOLDING GROUP, INC. AND SUBSIDIARIES

Reconciliations of time charter equivalent revenues of the segments to shipping revenues as reported in the consolidated statements of operations follow:

Consistent with general practice in the shipping industry, the Company uses time charter equivalent revenues, which represents shipping revenues less voyage expenses, as a measure to compare revenue generated from a voyage charter to revenue generated from a time charter. Time charter equivalent revenues, a non-GAAP measure, provides additional meaningful information in conjunction with shipping revenues, the most directly comparable GAAP measure, because it assists Company management in making decisions regarding the deployment and use of its vessels and in evaluating their financial performance.

OVERSEAS SHIPHOLDING GROUP, INC. AND SUBSIDIARIES

Reconciliations of income/(loss) from vessel operations of the segments to loss before income taxes, as reported in the consolidated statements of operations follow:

Reconciliations of total assets of the segments to amounts included in the consolidated balance sheets follow:

OVERSEAS SHIPHOLDING GROUP, INC. AND SUBSIDIARIES

Note 5 — Vessels:

Purchase and Construction Commitments

As of June 30, 2012, the Company had remaining commitments for vessels to be wholly owned by the Company of $46,452 on non-cancelable contracts for the construction of two Aframaxes. These vessels are scheduled for delivery in 2013.

Vessel Impairments

The Company performed an impairment test on all of its owned operating and newbuild International Crude and Products vessels as of December 31, 2011. Based on tests performed it was determined that the estimated undiscounted future cash flows expected to result from the use and eventual disposition of the International Crude and Products vessels exceed each of the vessels’ carrying values as of December 31, 2011. The Company gave consideration as to whether events or changes in circumstances had occurred that could indicate that the carrying amounts of the vessels in the Company’s International Flag fleet may not be recoverable as of June 30, 2012. The Company concluded that no such events had occurred to warrant a change in the assumptions from those utilized in the December 2011 impairment tests. Furthermore, the Company believes that given the relatively long remaining useful lives that its International Flag vessels have to generate sufficient cash flows to offset their carrying values, it is unlikely that any of the vessels in its International Flag fleet is impaired as of June 30, 2012.

In September 2011, Sunoco, a core customer of the Company’s Delaware Bay lightering business, announced that it will make its Marcus Hook and Philadelphia refineries available for sale. Subsequently, in December 2011, Sunoco announced that it would begin idling the Marcus Hook facility immediately while it continued to seek a buyer and also pursue options with third parties for alternate uses of the facility. Sunoco also announced that it intended to continue to operate the Philadelphia refinery as long as market conditions warranted. However, if a suitable transaction could not be implemented, Sunoco would permanently idle the main processing units at the Philadelphia refinery no later than August 2012. On July 2, 2012, Sunoco announced it had entered into a joint venture agreement with a third party to take over the operations of the Philadelphia refinery. On July 3, 2012, Sunoco tendered a six-month notice of reduction of minimum volumes under its long-term lightering contract with the Company. The lightering contract provides for rights and obligations of the parties when a notice of reduction is tendered. The Company is currently in discussions with Sunoco regarding the notice and the terms of the reduction. The announced plans of the Delaware Bay refineries to source increased volumes of crude oil from North America (versus imported crude) coupled with the amendment of the lightering contract could result in the Company’s redeployment of one or both of the two new ATBs to other locations with possible reductions in revenues earned. These two ATBs, the OSG 350 and the OSG 351, are recent newbuilds with relatively high cost bases and redeploying one or both of these vessels into the clean products trade would require modifications to be made to the vessels. Based on the tests performed in December 2011, it was determined that the estimated undiscounted future cash flows would exceed the carrying values of each of the vessels under two different scenarios – one assuming the Sunoco refineries are purchased and continue to operate as refineries that require lightering services, employing the two ATBs for the remainder of their lives, and a second assuming the refineries are closed and the two ATBs enter the U.S. Gulf of Mexico clean market after necessary modifications are made, earning spot rates. The Company does not consider the receipt of Sunoco’s notice of reduction to be new information since such receipt was considered possible based on Sunoco’s announced intention to idle the Philadelphia refinery by August 2012 if a buyer couldn’t be found. Further, the Company does not believe that either of the two ATBs referred to above was impaired as of June 30, 2012.

OVERSEAS SHIPHOLDING GROUP, INC. AND SUBSIDIARIES

Management will continue to monitor developments, which could result in a change in the above conclusions.

Vessel Sales

There were no vessels sold during the six months ended June 30, 2012. However, on June 28, 2012, the Company entered into an agreement for the sale of its Car Carrier, the Overseas Joyce, which is expected to deliver to buyers by the end of October 2012. At that time the Company expects to recognize a gain on such sale. The Company recognized aggregate gains of $391 during the period principally from the sale of equipment as well as property sold in accordance with the Bender Shipbuilding & Repair Co., Inc. (“Bender”) bankruptcy liquidation plan.

During the six months ended June 30, 2011, the Company delivered its two remaining single-hulled U.S. Flag Tankers to buyers. Also, the remaining chartered-in single hulled International Flag Aframax in which the Company had a residual interest was delivered to buyers. The Company recognized a gain of $2,117 on these transactions. The gain on disposal for the six months ended June 30, 2011 period also includes approximately $3,400 in proceeds received in connection with property sold in accordance with the Bender liquidation plan as well as a loss of approximately $4,357 related to the cancellation of an order with an equipment supplier and the retirement of vessel support equipment.

Vessel Acquisitions and Deliveries

During the six months ended June 30, 2012, the Company completed construction of a VLCC and an International Flag Handysize Product Carrier. During the six months ended June 30, 2011, the Company completed construction of a U.S. Flag ATB, an International Flag Panamax Product Carrier and a tug boat.

Note 6 — Equity Method Investments:

Investments in affiliated companies include joint ventures accounted for using the equity method. As of June 30, 2012, the Company had an approximate 50% interest in two joint ventures. One joint venture operates four LNG Carriers. The other joint venture converted two ULCCs to Floating Storage and Offloading Service vessels. In addition, the Company has a 37.5% interest in Alaska Tanker Company, LLC that manages vessels carrying Alaskan crude for BP.

Floating Storage and Offloading Service Vessels (“FSO”) Joint Venture

Maersk Oil Qatar AS (“MOQ”) awarded two service contracts to a joint venture between OSG and Euronav NV to provide two vessels, the FSO Asia and the FSO Africa, to perform Floating Storage and Offloading (“FSO”) services in the Al Shaheen field off shore Qatar. The Company has a 50% interest in this joint venture. The joint venture financed the purchase of the vessels from each of Euronav NV and OSG and their conversion costs through partner loans and a long-term credit facility, which was secured by the service contracts. Approximately $270,779 and $294,937 was outstanding under this facility as of June 30, 2012 and December 31, 2011, respectively, with the outstanding amount of this facility being subject to acceleration, in whole or in part, on termination of one or both of such service contracts. In connection with the secured bank financing, the partners severally issued guarantees. As of June 30, 2012 and December 31, 2011, the carrying value of the Company’s guaranty, which is included in other liabilities in the accompanying balance sheet, was $67 and $122, respectively.

OVERSEAS SHIPHOLDING GROUP, INC. AND SUBSIDIARIES

The joint venture entered into floating-to-fixed interest rate swaps with major financial institutions. The interest rate swaps, covering notional amounts aggregating $374,796 and $396,993 as of June 30, 2012 and December 31, 2011, respectively, pay fixed rates of 3.9% and receive floating rates based on LIBOR. These agreements have maturity dates ranging from July to September 2017. As a result of the delays in the completion of conversion and commencement of the service contract for the FSO Africa, the joint venture concluded that it was no longer probable that the forecasted transaction applicable to the FSO Africa swaps would occur. Accordingly, as a result of the de-designation of the FSO Africa swaps, all changes in the market value of the swaps have been recognized in the joint venture’s statement of operations. The Company’s share of amounts recognized in equity in income from affiliated companies were losses of $994 and $2,308 for the quarters ended June 30, 2012 and 2011, respectively and $1,091 and $2,373 for the six months ended June 30, 2012 and 2011. As of June 30, 2012 and December 31, 2011, the joint venture had a liability of $30,752 and $33,040, respectively, for the fair value of the swaps associated with the FSO Africa and FSO Asia. The Company’s share of the effective portion of such amounts, aggregating $7,184 and $7,790, at June 30, 2012 and December 31, 2011, respectively, is included in accumulated other comprehensive loss in the accompanying balance sheet and is associated with the FSO Asia swaps only, since the swaps associated with the FSO Africa have been de-designated and deemed to be ineffective.

LNG Joint Venture

In November 2004, the Company formed a joint venture with Qatar Gas Transport Company Limited (Nakilat) whereby companies in which OSG holds a 49.9% interest ordered four 216,200 cbm LNG Carriers. Upon delivery in late 2007 and early 2008, these vessels commenced 25-year time charters to Qatar Liquefied Gas Company Limited (II). The aggregate construction cost for such newbuildings was financed by the joint venture through long-term bank financing that is nonrecourse to the partners and partner contributions.

The joint venture entered into floating-to-fixed interest rate swaps with a group of major financial institutions pursuant to which it pays fixed rates of approximately 4.9% and receives a floating rate based on LIBOR. The interest rate swap agreements have maturity dates ranging from July to November 2022 and cover notional amounts aggregating $775,717 and $790,946 at June 30, 2012 and December 31, 2011, respectively. These swaps are being accounted for as cash flow hedges. As of June 30, 2012 and December 31, 2011, the joint venture recorded a liability of $137,016 and $148,699, respectively, for the fair value of these swaps. The Company’s share of the effective portion of the fair value of these swaps, $68,295 and $74,133 at June 30, 2012 and December 31, 2011, respectively, is included in accumulated other comprehensive loss in the accompanying balance sheet.

OVERSEAS SHIPHOLDING GROUP, INC. AND SUBSIDIARIES

A condensed summary of the results of operations of the equity method investments follows:

Note 7 – Variable Interest Entities (“VIEs”):

As of June 30, 2012, the Company participates in five commercial pools and three joint ventures. Two of the pools and the FSO joint venture, described in Note 6 above, were determined to be VIEs. The Company is not considered a primary beneficiary of either of the two pools or the joint venture.

The following table presents the carrying amounts of assets and liabilities in the balance sheet related to the VIEs as of June 30, 2012:

In accordance with accounting guidance, the Company evaluated its maximum exposure to loss related to these VIEs by assuming a complete loss of the Company’s investment in these VIEs and that it would incur an obligation to repay the full amount of the VIE’s outstanding secured debt. The table below compares the Company’s liability in the consolidated balance sheet to the maximum exposure to loss at June 30, 2012:

In addition, as of June 30, 2012, the Company had approximately $27,977 of trade receivables from pools that were determined to be VIEs. These trade receivables, which are included in voyage receivables in the accompanying balance sheet, have been excluded from the above tables and the calculation of OSG’s maximum exposure to loss. The Company does not record the maximum exposure to loss as a liability because it does not believe that such a loss is probable of occurring as of June 30, 2012. Further, the joint venture debt is secured by the joint venture’s FSOs. Therefore, the Company’s exposure to loss under its several guaranty would first be reduced by the fair value of such FSOs.

OVERSEAS SHIPHOLDING GROUP, INC. AND SUBSIDIARIES

Note 8 —Fair Value of Financial Instruments, Derivatives and Fair Value Disclosures:

The following methods and assumptions were used to estimate the fair value of each class of financial instrument:

Cash and cash equivalents—The carrying amounts reported in the consolidated balance sheet for interest-bearing deposits approximate their fair value.

Short-term investments—The carrying amounts reported in the consolidated balance sheet for short-term investments, which consisted of interest-bearing time deposits or marketable securities held for trading purposes, approximated their fair value.

Debt—For publicly-traded debt, estimates of fair value are based on market prices. For unsecured revolving credit facilities and secured term loans, fair value is estimated based on a model-driven approach using U.S. forward swap interest rate yield curves.

Forward freight agreements and bunker swaps—The fair values of forward freight agreements and bunker swaps are the estimated amounts that the Company would receive or pay to terminate the agreements at the reporting date, which include an adjustment for the counterparty or the Company’s credit risk, as appropriate.

Interest rate swaps—The fair values of interest rate swaps are the estimated amounts that the Company would receive or pay to terminate the swaps at the reporting date, which include adjustments for the counterparty or the Company’s credit risk, as appropriate.

Foreign Currency Contracts—The fair values of foreign currency contracts are the estimated amounts that the Company would receive or pay to terminate the contracts at the reporting date, which include adjustments for the counterparty or the Company’s credit risk, as appropriate.

The estimated fair values of the Company’s financial instruments, other than derivatives and marketable securities that are not measured at fair value on a recurring basis, categorized based upon the fair value hierarchy, are as follows:

OVERSEAS SHIPHOLDING GROUP, INC. AND SUBSIDIARIES

Since the Company's publicly-traded debt is not actively traded, their fair value is categorized within Level 2 of the fair value hierarchy.

Derivatives

The Company is exposed to certain risks relating to its ongoing business operations. The risks, managed by using derivative instruments, are volatility with respect to spot (voyage) charter rates, fuel prices, interest rates and foreign currency exchange rates.

Spot Market Rate Volatility Risk

The Company enters into Forward Freight Agreements (“FFAs”) and bunker swaps with an objective to utilize them as (i) economic hedging instruments, some of which qualify as cash flow hedges for accounting purposes that reduce its exposure to changes in TCE revenue earned by some of its vessels operating in the spot market; and (ii) from time to time for trading purposes to take advantage of short term fluctuations in the market. The FFAs and bunker swaps involve contracts to provide a fixed number of theoretical voyages at fixed rates, which generally range from one month to one year and settle monthly based on a published index. As of June 30, 2012, the Company was party to FFA contracts entered into for trading purposes. These contracts, representing aggregate volumes of 240,000 metric tons (“mts”) of cargo and 6,000 mts of bunkers, expire in December 2013 and do not qualify as cash flow hedges for accounting purposes.

Fuel Price Volatility Risk

The Company enters into standalone bunker swaps to protect the Company against future increases in fuel prices in the normal course of its International Crude Tankers lightering business, which includes a number of fixed rate Contracts of Affreightment. As of June 30, 2012, the Company is party to four bunker swap agreements, the details of which are as follows:

OVERSEAS SHIPHOLDING GROUP, INC. AND SUBSIDIARIES

These contracts settle on a net basis at the end of each calendar month, based on the average daily closing prices, as quoted by the Baltic Exchange, of the commodity during each month. These swaps do not qualify as cash flow hedges for accounting purposes.

Interest Rate Risk

The Company uses interest rate swaps for the management of interest rate risk exposure. The interest rate swaps effectively convert a portion of the Company’s debt from a floating to a fixed rate and are designated and qualify as cash flow hedges. The Company is a party to seven floating-to-fixed interest rate swap agreements with various major financial institutions covering notional amounts aggregating approximately $220,412 at June 30, 2012 pursuant to which it pays fixed rates ranging from 3.3% to 4.7% and receives floating rates based on three-month LIBOR (approximately 0.46% at June 30, 2012). These agreements contain no leverage features and have various final maturity dates ranging from December 2012 to August 2014.

Foreign Exchange Risk

The Company seeks to reduce its exposure to fluctuations in foreign exchange rates related to recurring monthly foreign currency denominated general and administrative expenses through the use of foreign currency forward contracts and through the purchase of bulk quantities of currencies at rates that management considers favorable. At June 30, 2012, the notional amounts of the foreign currency forward contracts aggregated approximately CAD$2,400, settling monthly through December 2012. Such contracts were not designated as cash flow hedges for accounting purposes.

Tabular disclosure of derivatives location

Derivatives are recorded in the balance sheet on a net basis by counterparty when a legal right of setoff exists. The following tables present information with respect to the fair values of derivatives reflected in the balance sheet on a gross basis by transaction. The tables also present information with respect to gains and losses on derivative positions reflected in the statement of operations or in the balance sheet, as a component of accumulated other comprehensive loss.

OVERSEAS SHIPHOLDING GROUP, INC. AND SUBSIDIARIES

Fair Values of Derivative Instruments:

OVERSEAS SHIPHOLDING GROUP, INC. AND SUBSIDIARIES

The effect of cash flow hedging relationships on the balance sheets as of June 30, 2012 and December 31, 2011 follows:

OVERSEAS SHIPHOLDING GROUP, INC. AND SUBSIDIARIES

The effect of cash flow hedging relationships on the statements of operations for the six months ended June 30, 2012 and 2011 are shown below:

OVERSEAS SHIPHOLDING GROUP, INC. AND SUBSIDIARIES

The effect of the gain/(loss) recognized on derivatives not designated as hedging instruments on the statements of operations for the three and six months ended June 30, 2012 and 2011 are as follows:

Fair Value Hierarchy

The following tables present the fair values, which are pre tax, for assets and liabilities measured on a recurring basis (excluding investments in affiliated companies):

Cash Collateral Disclosures

The Company does not offset fair value amounts recognized for derivatives by the right to reclaim cash collateral or the obligation to return cash collateral. The amounts of collateral to be posted are defined in the terms of respective master agreements executed with counterparties or exchanges and are required when agreed upon threshold limits are exceeded. At June 30, 2012, the Company did not hold collateral related to its derivative transactions. At June 30, 2012, the Company has a $1,000 letter of credit issued in relation to its derivative activities.

OVERSEAS SHIPHOLDING GROUP, INC. AND SUBSIDIARIES

Note 9 — Taxes:

On October 22, 2004, the President of the U.S. signed into law the American Jobs Creation Act of 2004. The Jobs Creation Act reinstated tax deferral for OSG’s foreign shipping income for years beginning after December 31, 2004. Effective January 1, 2005, the earnings from shipping operations of the Company’s foreign subsidiaries are not subject to U.S. income taxation as long as such earnings are not repatriated to the U.S. The Company intends to permanently reinvest these earnings, as well as its share of the undistributed earnings of its less than 50%-owned foreign shipping joint ventures, in foreign operations. Accordingly, no provision for U.S. income taxes on the shipping income of its foreign subsidiaries or its less than 50%-owned foreign shipping joint ventures was required to date in 2012 or at any time in 2011. As of June 30, 2012, undistributed earnings on which U.S. income taxes have not been provided aggregated approximately $2,200,000, including $119,000 earned prior to 1976; the unrecognized deferred U.S. income tax attributable to such undistributed earnings approximated $770,000.

The components of the income tax benefits/(provisions) follow:

At December 31, 2011 the Company had a reserve of approximately $4,804 for benefits attributable to tax positions taken during the current and prior tax periods for which the probability of recognition is considered less than “more likely than not.” There was no material change in the reserve during the six months ended June 30, 2012.

Note 10 — Capital Stock and Stock Compensation:

On February 13, 2012, the Company filed a Form S-3 shelf registration with the SEC that will allow it to issue common stock, preferred stock, debt securities, warrants or units (as defined) up to an aggregate of $500,000, from time to time as market conditions permit.

OVERSEAS SHIPHOLDING GROUP, INC. AND SUBSIDIARIES

Restricted Common Stock, Performance Related Grants and Options

During the six months ended June 30, 2012 and 2011, the Company awarded a total of 401,409 and 82,544 shares, respectively, of restricted common stock at no cost to certain of its employees, including senior officers. Restrictions limit the sale or transfer of shares of restricted common stock until they vest, which occurs over a four or five-year period. During the restriction period, the shares will have voting rights and cash dividends will be paid if declared. The weighted average fair value of the restricted stock issued during the six months ended June 30, 2012 and 2011 was $10.09 and $34.90 per share, respectively (the market price at date of grant).

During the six months ended June 30, 2012, the Company granted certain of its senior officers performance awards valued at an aggregate of approximately $1,307 on the grant date. Each performance award represents a contingent right to receive cash or, at the Company’s option, shares of common stock of the Company, based upon certain market related performance goals being met and the covered employees being continuously employed through the end of the three-year period over which the performance goals are measured. The performance related grants were valued using a Monte Carlo pricing model that takes into account the market related performance goals described in the grants. It is the Company’s intention (but not an obligation) to settle the awards in shares of the Company’s common stock to the extent such shares are available for issuance under the 2004 Stock Incentive Plan (the “2004 Plan”) on the settlement date. To the extent sufficient shares are not available for issuance under the 2004 Plan or the Compensation Committee of the Board of Directors determines not to settle the awards in shares, the awards shall be paid in cash. As a result of the current and expected availability of shares under the 2004 Plan and the Company’s intent to settle these awards in shares of the Company’s common stock if such shares are available, these cash based performance awards are being accounted for as equity awards. The Company will evaluate at each reporting date, the sufficiency of shares available under the 2004 Plan to settle the awards in shares. If at any reporting date in the future the shares available under the 2004 Plan are not sufficient, these awards would be bifurcated into the portion that can be settled in shares and the portion that would have to be settled in cash, with the latter portion being classified as a liability award.

In the first six months of 2012 and 2011, the Company granted a total of 45,000 and 45,192 restricted stock units, respectively, to its non-employee directors. At the date of the awards in the first six months of 2012 and 2011, the fair market value of the Company’s stock was $10.00 and $26.55 per share, respectively. Each restricted stock unit represents a contingent right to receive one share of common stock upon the non-executive director’s termination of service as a board member. Such restricted stock units vest ratably over a four-year period, which period may be accelerated provided that the director has served until the earlier of (a) the first anniversary of the grant date or (b) the next annual meeting of the Company’s stockholders. The restricted stock units have no voting rights and may not be transferred or otherwise disposed of while the non-employee director is a director. The non-employee director is entitled to dividends in the form of additional restricted stock units at the same time dividends are paid on the Company’s common stock in an amount equal to the result obtained by dividing (i) the product of (x) the amount of units owned by the non-employee director on the record date for the dividend times (y) the dividend per share by (ii) the closing price of a share of the Company’s common stock on the payment date, which restricted units vest immediately on the payment date for the dividend.

OVERSEAS SHIPHOLDING GROUP, INC. AND SUBSIDIARIES

There were no performance related restricted stock units awarded during 2012. During the six months ended June 30, 2011, the Company granted a total of 54,329 performance related restricted stock units to certain of its employees, including senior officers. Each performance unit represents a contingent right to receive shares of common stock of the Company based upon certain market related performance goals being met and the covered employees being continuously employed through the end of the period over which the performance goals are measured. The performance units have no voting rights and may not be transferred or otherwise disposed of until they vest. Dividends will be paid when the performance period expires and are conditioned upon the attainment of the performance goals. The estimated weighted average grant-date fair value of the performance stock units awarded during the six months ended June 30, 2011 was $40.19 per share. The performance related grants were valued using a Monte Carlo pricing model that takes into account the market related performance goals described in the grants.

Stock Options

During the six months ended June 30, 2012 and 2011, options covering 377,653 and 176,312 shares, respectively, were granted at or above the market price at the date of the grant. Such options were valued using the Black-Scholes option pricing model and expire ten years from the grant date. The exercise price of options granted during the six months ended June 30, 2012 and 2011 was $12.50 and $34.90 per share, respectively. The grant date fair value of options granted during the six months ended June 30, 2012 and 2011 was $3.83 and $10.04 per share, respectively.

Note 11 — Accumulated Other Comprehensive Loss:

The components of accumulated other comprehensive loss, net of related taxes, in the consolidated balance sheets follow:

Included in accumulated other comprehensive loss at June 30, 2012 are the following amounts that have not yet been recognized in net periodic cost: unrecognized transition obligation of $23 ($15 net of tax), unrecognized prior service costs of $1,554 ($1,010 net of tax) and unrecognized actuarial losses of $21,445 ($13,939 net of tax).

OVERSEAS SHIPHOLDING GROUP, INC. AND SUBSIDIARIES

Note 12 — Leases:

1. Charters-in:

As of June 30, 2012, the Company had commitments to charter in 45 vessels. All of the charters-in are accounted for as operating leases, of which 21 are bareboat charters and 24 are time charters. The future minimum commitments and related number of operating days under these operating leases are as follows:

The future minimum commitments for time charters-in have been reduced to reflect estimated days that the vessels will not be available for employment due to drydock because the Company does not pay time charter hire when time chartered-in vessels are not available for its use.

2. Charters-out:

The future minimum revenues, before reduction for brokerage commissions, expected to be received on noncancelable time charters and certain COAs for which minimum annual revenues can be reasonably estimated and the related revenue days (revenue days represent calendar days, less days that vessels are not available for employment due to repairs, drydock or lay-up) are as follows:

OVERSEAS SHIPHOLDING GROUP, INC. AND SUBSIDIARIES

Future minimum revenues do not include (1) the Company’s share of time charters entered into by the pools in which it participates, (2) the Company’s share of time charters entered into by the joint ventures, which the Company accounts for under the equity method and (3) COAs for which minimum annual revenues cannot be reasonably estimated. Revenues from those COAs that are included in the table above, $841 (2012) and $1,682 (2013), are based on minimum annual volumes of cargo to be loaded during the contract periods at a fixed price. The largest COA in the Delaware Bay lightering trade is excluded from the table above because the minimum annual revenues for that contract cannot be reasonably estimated. Revenues from a time charter are not generally received when a vessel is off-hire, including time required for normal periodic maintenance of the vessel. In arriving at the minimum future charter revenues, an estimated time off-hire to perform periodic maintenance on each vessel has been deducted, although there is no assurance that such estimate will be reflective of the actual off-hire in the future.

Note 13 — Pension and Other Postretirement Benefit Plans:

The net periodic benefit cost for the Company’s domestic defined benefit pension (for which the benefits have been frozen) and postretirement health care and life insurance plans was not material during the six months ended June 30, 2012 and 2011.

The Company expects that its required contributions in 2012 with respect to its domestic defined benefit pension plan will be approximately $1,832, of which $1,114 was funded during the six months ended June 30, 2012.

Note 14 — Other Income/(Expense):

Other income/(expense) consists of:

OVERSEAS SHIPHOLDING GROUP, INC. AND SUBSIDIARIES

Note 15 – Severance and Relocation Costs:

In the first quarter of 2012, the Company announced the relocation of the technical management of its conventional International Flag crude oil tanker fleet from its Newcastle, U.K. office to its Athens, Greece office. In connection therewith, approximately 50 employees have been or will be terminated in Newcastle. In connection therewith, the Company expects to record approximately $3,100 in costs related to severance and transfer of vessel management during 2012. As of June 30, 2012, the Company has recognized severance and relocation related costs totaling $2,213.

Note 16 — Contingencies:

The Internal Revenue Service (“IRS”) imposed penalties totaling approximately $3,500 against certain U.S. Flag vessel owning subsidiaries of the Company due to alleged delinquent excise tax registration applications and delinquent filing of information returns. The Company has denied the applicability of the penalties in question and is vigorously contesting the matter with the IRS. As a result of certain administrative protocols, the Company had to pay the assessed penalties in order to formally file suit for a refund. The court case is scheduled for September 2013. As of June 30, 2012, the Company has paid $3,500 in penalties and such amounts are included in other receivables in the accompanying consolidated balance sheet. The Company believes, based on the merits of the case, that the likelihood of an unfavorable judgment is more than remote but less than probable. Accordingly, no provisions have been made in the Company’s financial statements for a potential loss as of June 30, 2012, as the Company does not believe there is any one amount within the range of likely losses (from $0 to $3,500) that is a better estimate than another.

OVERSEAS SHIPHOLDING GROUP, INC. AND SUBSIDIARIES

MANAGEMENT'S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS

General:

The Company is one of the largest independent bulk shipping companies in the world. The Company’s operating fleet as of June 30, 2012, consisted of 112 vessels aggregating 10.7 million dwt and 864,800 cbm, including 45 vessels that have been chartered-in under operating leases. In addition to its operating fleet of 112 vessels, two newbuilds are scheduled for delivery in 2013, bringing the total operating and newbuild fleet to 114 vessels.

All dollar amounts are in thousands, except daily dollar amounts and per share amounts.

Operations:

The Company’s revenues are highly sensitive to patterns of supply and demand for vessels of the size and design configurations owned and operated by the Company and the trades in which those vessels operate. Rates for the transportation of crude oil and refined petroleum products from which the Company earns a substantial majority of its revenues are determined by market forces such as the supply and demand for oil, the distance that cargoes must be transported, and the number of vessels expected to be available at the time such cargoes need to be transported. The demand for oil shipments is significantly affected by the state of the global economy and level of OPEC exports. The number of vessels is affected by newbuilding deliveries and by the removal of existing vessels from service, principally because of storage, scrappings or conversions. The Company’s revenues are also affected by the mix of charters between spot (Voyage Charter) and long-term (Time or Bareboat Charter). Because shipping revenues and voyage expenses are significantly affected by the mix between voyage charters and time charters, the Company manages its vessels based on TCE revenues. Management makes economic decisions based on anticipated TCE rates and evaluates financial performance based on TCE rates achieved.

Overview

Second quarter average spot fixture rates for crude oil tankers were higher than those in the second quarter of 2011 primarily due to an increase in worldwide crude oil inventories of about 2.1 million barrels per day (“b/d”) during the second quarter of 2012 compared with an inventory drawdown of approximately 400,000 b/d in the second quarter of 2011. Spot rates for Product Carriers were, however, significantly lower than those in the second quarter of 2011 as oil demand declined in both Europe and the U.S. and led to a reduction in transatlantic movements. Additionally, shipowners in Asia, where spot rates were even lower, moved their excess tonnage into the Atlantic Basin, which resulted in an oversupply that further weighed on rates.

The sanctions against Iran that became effective on July 1, 2012 also benefitted tonne-mile demand as countries in the European Union (“EU”) and Asia (South Korea, Japan, Singapore and China) either significantly reduced or eliminated their Iranian crude oil imports and began to source crude oil from more distant sources well before the effective date. Countries such as China also increased its commercial and strategic crude oil inventory reserve levels while Saudi Arabia shipped crude oil to inventory storage facilities in both Asia and Europe, adding to tonne-mile demand growth. A reduction in the Brent-Dubai price differential during the first half of 2012 compared with the same timeframe in 2011 resulted in a significant increase in the movement of crude oil from West Africa to Asia as Asian refiners found it more profitable to run light sweet crudes from the Atlantic Basin areas as opposed to crudes from the Middle East.

OVERSEAS SHIPHOLDING GROUP, INC. AND SUBSIDIARIES

World oil demand in the second quarter of 2012 amounted to 88.8 million b/d, an increase of approximately 870,000 b/d, or 1.0%, over the second quarter of 2011. Oil demand increased by 1.15 million b/d in non-OECD areas but declined by 270,000 b/d in OECD countries. Transportation fuels accounted for most of the increase in non-OECD oil demand, led by increases in Asia of about 470,000 b/d followed by increases in the Middle East, the FSU and in Latin America of 200,000 b/d, 190,000 b/d and 140,000 b/d, respectively.

Reduced OECD oil demand was centered in the Atlantic Basin, as European demand declined by 480,000 b/d and North American demand fell by 230,000 b/d as ongoing economic problems persisted, especially in Europe. The weak demand in the Atlantic Basin was somewhat offset by a 440,000 b/d increase in demand in OECD Pacific areas, specifically in Japan, which imported significant volumes of low sulfur fuel oil and direct burn crudes necessary for power generation purposes as their nuclear power plants remained closed as a result of damage caused by the earthquake / tsunami in the second quarter of last year.

OPEC production during the second quarter of 2012 averaged 31.8 million b/d, about 2.4 million b/d higher than the second quarter of 2011. Production in Libya, which was shut-in during most of the second quarter of 2011 due to its civil war, increased to almost pre-civil war levels and was responsible for approximately 50% of the total increase in OPEC production. The remaining increase of 1.2 million b/d occurred in Middle East OPEC countries as reductions in Iranian production due to pending sanctions were more than offset by increases in all other Middle East OPEC countries, especially Saudi Arabia, Kuwait and Iraq.

Following a 1.3 million b/d increase in inventories during the first quarter of 2012, world inventory levels increased by about 2.1 million b/d in the second quarter of 2012. According to the International Energy Agency (“IEA”), about 15% of the second quarter inventory increase occurred in OECD areas, primarily in the U.S. where crude oil inventory levels increased by about 225,000 b/d. China also imported significantly more crude oil than its refineries required, including record crude imports of 6.0 million b/d in May. Much of this surplus crude oil was used to partially fill China’s recently completed Phase 2 Strategic Petroleum Reserve that has a total capacity of 230 million barrels.

Rates for VLCC, Suezmaxes, Aframaxes and Panamaxes during the first half of 2012 were above those realized in the first half of 2011 while rates for Product Carriers were lower. First half 2012 crude tanker rates reflected an increase in inventory levels of about 1.7 million b/d compared with an inventory drawdown of about 200,000 b/d that occurred in the same timeframe in 2011. Lower product rates reflected the continued oversupply of tonnage in the Atlantic Basin combined with lower oil demand in both Europe and the U.S. that that reduced trans-Atlantic movements.

World oil demand during the first six months of 2012 averaged approximately 89.1 million b/d, an increase of 600,000 b/d, or 0.6%, over the first half of 2011 as demand growth in non-OECD areas of 1.2 million b/d was partially offset by a decline of 600,000 b/d in OECD countries. A significantly warmer winter in the U.S. in 2012 and the continuing financial / economic crisis in Europe during the first half of 2012 resulted in a decline in oil demand in Europe and North America of one million b/d compared with the same timeframe in 2011. Oil demand in OECD Pacific increased by about 430,000 b/d given the increase in oil-fired power generation required in Japan.

OVERSEAS SHIPHOLDING GROUP, INC. AND SUBSIDIARIES

OPEC crude oil production during the first six months of 2012 averaged approximately 31.6 million b/d, about 1.9 million b/d more than the first half of 2011. Saudi Arabia, which has stated that it will supply all the crude required by its customers and fill the void caused by reduced Iranian production due to sanctions, increased its first half production by about one million b/d compared with the same timeframe in 2011. Additionally, higher production in Kuwait and Iraq more than offset the 300,000 b/d reduction in Iranian output. First half 2012 Libyan production was up about 700,000 b/d compared with the first six months of 2011.

The tanker orderbook as of July 1, 2012 now stands at 13.9% of the existing fleet, based on deadweight tons, a twelve year low. The Aframax and Panamax orderbooks are at 7.4% and 8.8%, respectively, while the Suezmax orderbook is at 20%, the highest in the crude tanker sector. Limited new ordering in the crude tanker sector combined with scrapping of single hull and first generation double hull tankers has resulted in a continuous decline in the orderbook over the last few years that has improved the longer-term supply / demand outlook. The Product Carrier orderbook stands at 13.6% of the existing fleet.

The tables below show the daily TCE rates that prevailed in markets in which the Company’s vessels operated for the periods indicated. It is important to note that the spot market is quoted in Worldscale rates, except U.S. Flag, which is based on the American Tanker Rate Schedule and quoted in American rates (“AR”). The conversion of Worldscale rates to the following TCE rates required the Company to make certain assumptions as to brokerage commissions, port time, port costs, speed and fuel consumption, all of which will vary in actual usage. In each case, the rates may differ from the actual TCE rates achieved by the Company in the period indicated because of the timing and length of voyages, waiting time and the portion of revenue generated from long-term charters. For example, TCE rates for VLCCs are reflected in the earnings of the Company approximately one month after such rates are reflected in the tables below, calculated on the basis of fixture dates.

International Flag VLCCs

* Based on 60% Arabian Gulf to eastern destinations and 40% Arabian Gulf to western destinations

Rates for VLCCs trading out of the Arabian Gulf in the second quarter and first six months of 2012 averaged $25,700 per day and $22,900 per day, respectively, which were both more than 100% higher than rates realized in the same periods of 2011. Second quarter VLCC rates were also somewhat higher than those in the first quarter of 2012.

OVERSEAS SHIPHOLDING GROUP, INC. AND SUBSIDIARIES

Long haul crude oil movements increased to both Western and Eastern destinations in the second quarter of 2012 compared with the same timeframe in 2011. Middle East crude oil movements to the U.S. Gulf Coast increased by approximately 400,000 b/d in anticipation of the startup of the Motiva 325,000 b/d refinery expansion at Port Arthur that was configured to process Saudi Arabian crude oil. This expansion was scheduled to begin during the late second quarter / early third quarter timeframe but a mechanical issue forced a shutdown in June. Repairs are now underway to resolve the issue with the full startup of the expansion now forecast to occur in early 2013.

There was also a significant increase in long-haul crude oil movements to Asia, especially to China, South Korea and Japan. Second quarter 2012 seaborne crude oil imports into China increased by 15% compared with the same timeframe in 2011 led by a 40% increase in imports from West Africa (Angola) and Latin America (Venezuela). The reduction in the Brent-Dubai price differential from over $6 per barrel in the second quarter of 2011 to about $2.50 per barrel in second quarter of 2012 led to an increase in West African crude shipments to Asia. The closure in February of the 350,000 b/d Hovensa refinery in the Caribbean, which processed Venezuelan crude oil, resulted in additional Venezuelan crude oil available for long- haul exports.

A change in the free trade agreement between the U.K. and South Korea resulted in the elimination of the 3% duty on crude imports from the U.K. that effectively lowered the price of North Sea crude oil imported into South Korea compared with other crudes that still incurred the tariff. North Sea crude oil exports to Korea have averaged about 100,000 b/d during both the second quarter and first six months of 2012 compared with no imports in 2011. This long haul movement benefitted large tankers over the first half of 2012.

There were also additional long haul crude oil movements into Japan from both the Middle East and West Africa. Middle East exports to Japan in the second quarter of 2012 averaged over 3.0 million b/d, an increase of approximately 300,000 b/d compared with the same timeframe in 2011. Additionally, Japan imported approximately 100,000 b/d of additional crude oil from West Africa. These additional crude imports were used for power generation purposes as Japan’s nuclear power plants remained closed.

The increase in VLCC rates in the first half of 2012 compared with the same timeframe in 2011 was largely due to the increase in tonne-mile demand resulting from a rise in inventory levels and from the sourcing of alternative crudes by refiners as sanctions against Iran became effective at the end of the second quarter. China imported an average of 5.6 million b/d during the first half of 2 012, an increase of 14% over the same timeframe in 2011. These imports, combined with local production of about 4.1 million b/d, resulted in total crude available for processing of 9.7 million b/d. Refining runs in China averaged about nine million b/d over the first six months of 2012 indicating that about 600,000 b/d of crude oil went into commercial and strategic storage during the first half of 2012.

Enforcement of U.S. and European sanctions against Iran has significantly reduced Iranian crude oil exports. Europe, which imported about 700,000 b/d of Iranian crudes during 2011, began to source alternative crudes from other Middle East producers and from West Africa. India, Japan and South Korea also turned to longer-haul crudes from South America and West Africa, as they reduced their imports from Iran. Additionally, the insurance and banking sanctions have marginalized the Iranian crude fleet effectively removing it from the market and forcing Iran to utilize its own tankers for floating storage purposes.

OVERSEAS SHIPHOLDING GROUP, INC. AND SUBSIDIARIES

There have been 28 VLCCs delivered during the first six months of 2012 while six have been scrapped for a net increase of 22 tankers. There was a total of 593 VLCCs (181.0 million dwt) in service as of July 1, 2012, of which 589 tankers are double hull. The VLCC orderbook totaled 95 vessels (30.1 million dwt) at July 1, 2012, equivalent to 17% of the existing total VLCC fleet, based on deadweight tons.

International Flag Suezmaxes

* Based on West Africa to the U.S. Gulf Coast

Rates for Suezmaxes trading out of West Africa in the second quarter of 2012 averaged $18,500 per day, 82% higher than rates in the second quarter of 2011 but about 16% below rates in the first quarter of 2012. Rates during the first half of 2012 averaged $20,200 per day, approximately 60% above rates in the first half of 2011.

Rates in the second quarter of 2012 were influenced by higher Angola production, an increase in Libyan crude oil movements to China and the switching by refiners in Asia from Iranian crude to alternative sources (West Africa and Latin America) many of which were longer-haul. Production in Angola during the second quarter of 2012 was 200,000 b/d more than that produced during the same timeframe in 2011 due to the ramp-up in new production. Imports of Libyan crude oil into China increased from an average of about 25,000 b/d in the second quarter of 2011 to approximately 160,000 b/d in the second quarter of 2012, boosting demand for Suezmaxes.

For the most part, the increase in first half 2012 freight rates reflected the same factors that positively impacted rates in the second quarter. Improvement in the VLCC market and rebuilding of the world oil inventory levels were also favorable contributing factors.

There was a net growth in the Suezmax fleet of 19 tankers during the first half of 2012 as 30 deliveries were offset by 11 scrappings. The world Suezmax fleet stood at 460 vessels (71.0 million dwt) at July 1, 2012. The Suezmax orderbook was 92 vessels (14.2 million dwt) at July 1, 2012, representing 20% of the existing Suezmax fleet, based on deadweight tons.

OVERSEAS SHIPHOLDING GROUP, INC. AND SUBSIDIARIES

International Flag Aframaxes

*Based on Caribbean to the U.S. Gulf and Atlantic Coasts

Rates for Aframaxes operating in the Caribbean during the second quarter of 2012 averaged $13,600 per day, more than double rates in the second quarter of 2011 but 21% below rates in the first quarter of 2012. Rates in the first half of 2012 averaged $15,400 per day approximately double average rates for the first half of 2011.

Aframax rates benefited from additional demand in the Mediterranean as well as Asia. Production in Libya in the second quarter of 2012 and the first six months of 2012 averaged 1.4 million b/d, significantly above 2011 production levels that averaged just 120,000 b/d in the second quarter and 600,000 b/d in the first half. This incremental volume from Libya provided additional opportunities for Aframax movements of crude oil to Europe.

The Aframax market in the Pacific was supported by additional demand in Japan for oil-based power generation that includes direct burn crude oil and low sulfur fuel oil. Japan’s fuel oil imports increased by about 150,000 b/d in both the second quarter and first half of 2012 compared with the same periods in 2011. Due to strict regulations, most of the fuel oil was primarily imported from Korea, Malaysia and Indonesia. Direct burn crudes are required to have a sulfur content of 0.1% or less and Japanese utilities prefer to run crudes from Indonesia, Vietnam, West Africa and Australia. Crude oil imports into Japan from Southeast Asia and Australia increased by approximately 70,000 b/d in the second quarter of 2012 and 100,000 b/d in the first half of 2012 compared with the same timeframes in 2011. Crude oil imports into Japan from the Russian port of Kozmino also increased (by 50,000 b/d in the second quarter of 2012 and by about 30,000 b/d in the first half of 2012).

A new Aframax port began exporting Russian crude oil from the Baltic Sea port of Ust Luga beginning in March, 2012. Exports from the Baltic Sea area have increased by 24% since the port opened providing additional opportunities for Aframaxes and supporting rates.

Refining utilization levels in the U.S. averaged approximately 88.8% during the second quarter of 2012, an increase from the 85.8% in the second quarter of 2011. While the increase in domestic production in the U.S. from Eagle Ford and Bakken oil shale met most of this demand increase, the need for additional feedstocks in the second quarter of 2012 helped to support the Aframax market.

Somewhat offsetting these positive factors were a reduction in North Sea crude oil production. North Sea crude oil production during the second quarter of 2012 was estimated to be about 3.5 million b/d, or some 350,000 b/d below levels in the second quarter of 2011. Technical problems and unplanned maintenance at fields in both the U.K. and Norway sectors and a strike by Norway’s oil workers in mid-June that shut-in about 160,000 b/d of crude oil were key factors that resulted in the lower production.

OVERSEAS SHIPHOLDING GROUP, INC. AND SUBSIDIARIES

There were 28 Aframax tankers added to the fleet since the beginning of 2012 while 14 vessels were scrapped, resulting in a net increase of 14 tankers during the first half of 2012. The world Aframax fleet reached 911 vessels (97.2 million dwt) at July 1, 2012, including 18 single hull tankers. The Aframax orderbook was 65 vessels (7.15 million dwt) at July 1, 2012, representing 7% of the existing Aframax fleet, based on deadweight tons.

International Flag Panamaxes 

*Based on 50% Caribbean to U.S. Gulf and Atlantic Coasts and 50% Ecuador to U.S. West Coast

Rates for Panamaxes that move crude and residual oils averaged $16,300 per day during the second quarter of 2012, 75% above the corresponding quarter in 2011 and 50% higher than the first quarter of 2012. First half 2012 average rates were 12% higher than those in the first half of 2011.

The main factors contributing to these higher rates, both for the second quarter and first six months of 2012, include an increase in fuel oil exports from Brazil to the West Coast of South America, damage to a crude receiving multi buoy mooring in Chile that resulted in tanker delays and from planned maintenance activities on the Panama Canal that created a bottleneck and also caused delays. Rates were also supported by additional movements of residual feedstock from the Caribbean to the U.S. Gulf Coast. These heavy feedstocks are required as a quality balance to offset the additional volumes of light sweet oil shale, primarily from Eagle Ford, that are now being run by U.S. refiners. Somewhat offsetting these positive factors were a reduction in exports from Colombia.

The world Panamax fleet at July 1, 2012 was 453 vessels (32.0 million dwt), including 14 single hull tankers.  The Panamax orderbook was 38 vessels (2.8 million dwt) at July 1, 2012, representing 9% of the existing Panamax fleet, based on deadweight tons.

International Flag Handysize Product Carriers

*Based on 60% trans-Atlantic and 40% Caribbean to the U.S. Atlantic Coast

Rates for Product Carriers operating in the Caribbean and trans-Atlantic trades averaged $4,900 per day during the second quarter of 2012, about 55% below those in both the second quarter of 2011 and the first quarter of 2012. Rates in the first half of 2012 averaged $8,000 per day, 25% below rates in the first half of 2011.

Lower Product Carrier rates in both the second quarter and the first six months of 2012 relative to the comparable 2011 time periods were primarily due to reductions in product movements to the U.S. East Coast from both Europe and the Caribbean, as the motor gasoline arbitrage window between Europe and the U.S. East Coast effectively closed. The closure of the Hovensa refinery in St. Croix in February of 2012 reduced product imports into the U.S. East Coast by approximately 130,000 b/d in both the second quarter and first half of 2012 compared with the same periods in 2011. During this time, the Asian spot market remained very depressed, well below the weak rates available in the Atlantic Basin. This led to an influx of tonnage into the Atlantic Basin that increased competition in a region that was experiencing reductions in demand. In addition, Product markets were also in backwardation during this period, which limited trading opportunities for Product Carriers.

The U.S. Gulf Coast continued to be an important product export center as product exports in 2012 exceeded 2011 levels. Finished product exports from the U.S. Gulf Coast averaged over 2.0 million b/d in the second quarter of 2012, an increase of approximately 15% from the comparable period in 2011. Product exports from the U.S. Gulf Coast during the first half of 2012 were about 10% over the same period in 2011. The U.S. Gulf Coast is forecast to remain a key exporter of product to both Latin America and West Africa given its cost advantage of being able to use lower price natural gas to run its refineries versus international competitors who must rely on higher priced fuel oil.

The world Handysize Product Carrier fleet in the 29,000 to 53,000 dwt range (includes Product and IMO III Chemical tankers) reached 1,561 vessels (68.1 million dwt) at July 1, 2012. The Handysize orderbook amounted to 196 vessels (9.3 million dwt) at July 1, 2012, equivalent to 14% of the existing Handysize fleet, based on deadweight tons.

U.S. Flag Jones Act Product Carriers and Articulated Tug Barges ("ATBs")

Rates for Jones Act Product Carriers and ATBs during the second quarter of 2012 averaged $57,800 per day and $36,000 per day, respectively, 79% and 77% higher than those in the second quarter of 2011, respectively, and 12% higher than first quarter 2012 rates. Rates during the first half of 2012 were approximately 60% above those in the comparable 2011 time period for both Product Carriers and ATBs.

The increase in rates in the second quarter of 2012 compared with the same quarter of 2011 reflected both an increase in demand and a reduction in U.S. Flag tanker supply. There were 54 large ocean-going vessels engaged exclusively in the coastwise trades during the second quarter of 2012 compared with 61 at the end of the second quarter of 2011. Additionally, the closures of the St. Croix Hovensa refinery eliminated a source of product supply for Florida but increased employment opportunities for U.S. Flag ATBs that move product from the U.S. Gulf Coast to Florida.

It was recently announced that two refineries on the U.S. East Coast that were either closed or on the verge of closing were to be acquired by companies that are committed to upgrading and operating these refineries. Delta Airlines has agreed to purchase ConocoPhillip’s 185,000 b/d Trainer refinery (closed since September 2011) and will perform maintenance and upgrade work that will allow it to commence fuel production by the end of 2012. The Carlyle Group has agreed to purchase the 335,000 b/d Sunoco Philadelphia refinery with the intent of upgrading the refinery and sourcing lower cost feedstock and refinery fuel from gas reserves in the U.S.

OVERSEAS SHIPHOLDING GROUP, INC. AND SUBSIDIARIES

The total Jones Act fleet of Product Carriers, ATBs and ITBs (“Integrated Tug Barges”) remained at 54 vessels during the second quarter of 2012 as there were no additions to or removals from the fleet. Since the beginning of the year, there has been a decrease of one vessel through demolition with no newbuilding deliveries. There were no idle Jones Act fleet vessels at the end of the second quarter of 2012.

At June 30, 2012, the Jones Act Product Carrier orderbook consisted of five tankers and ATBs in the 160,000 to 420,000 barrel size range scheduled for delivery through 2015. These additions will be partially offset by the deletion of one vessel that is expected to be retired in accordance with OPA 90 phaseout regulations.

Outlook

According to the IEA, world oil demand in 2012 is expected to average 89.9 million b/d, an increase of 0.9%, or 800,000 b/d, over 2011. Oil demand in the third and fourth quarters is forecast to increase by 1.0% and 1.2%, respectively, from the third and fourth quarters of 2011. Oil demand in the fourth quarter of 2012 is forecast to reach a record level of 90.9 million b/d.

It is estimated that oil demand in the third quarter of 2012 will reach 90.4 million b/d, an increase of approximately 1.7 million b/d over the second quarter of 2012. Second half 2012 oil demand is forecast to increase by about 1.6 million b/d compared with demand in the first half of 2012 and by about 1.2 million b/d compared with the same timeframe in 2011.

Non-OPEC production in the third quarter of 2012 is forecast to be the same as in the second quarter of 2012. Ongoing turmoil in Syria, Yemen and Sudan is expected to continue to shut-in about 600,000 b/d of production through the end of the year. The increase in demand in the third quarter of 2012 over the second quarter of 2012 will therefore likely be met by a combination of higher OPEC production and possible inventory drawdowns.

Additions to refining capacity in the U.S. and Asia will contribute to stronger year-on-year growth in refining runs. Refining capacity and runs will increase by more than 500,000 b/d in Asia primarily as new distillation capacity comes on line, primarily in China and India. The increase in oil demand in the third quarter of 2012 will result in higher refining runs in the U.S. and Europe and the startup of refining capacity on the U.S. East Coast during the fourth quarter will boost runs. The startup of the Motiva refining expansion that is now forecast to occur in late 2012 / early 2013 will result in higher refining runs on the U.S. Gulf Coast with corresponding incremental long-haul crude movements from the Middle East. This, in turn, will allow for an increase in products available for export. The larger Gulf Coast refinery output could also provide clean products that could be moved on U.S. Flag tankers to meet demand in Florida and other South Atlantic States that previously relied on imports from the Caribbean. Additional capacity from the startup of incremental refining capacity in India will exceed its domestic oil demand growth and allow it to export additional products to Europe, the U.S., Africa and other Asian countries.

OVERSEAS SHIPHOLDING GROUP, INC. AND SUBSIDIARIES

The impasse between the world community and Iran with regard to its nuclear program will likely continue to affect world trade in crude oil. Exports from Iran are forecast to decline by approximately one million b/d following the EU embargo that went into place on July 1, 2012 and as Asian customers reduce their imports of Iranian crud as well. Additional banking and insurance sanctions against Iran also limit its ability to export crude and utilize spot tankers to move and / or store their crude oil. It appears unlikely that sanctions will be lifted anytime soon and that tensions could continue to escalate in light of Iran’s threat to close the Straits of Hormuz through which about 25% of the world’s oil production moves to customers in Asia, Europe, Africa and both North and South America.

Approximately 35% of the total 2012 tanker orderbook has been delivered thus far through the first half of the year. It is likely that, in a repeat of the pattern experienced in the last couple of years, slippage will occur as tankers scheduled for delivery over the remainder of 2012 are delivered in 2013 instead while other orders could be cancelled or converted to other vessel types such as LNG Carriers.

The world fleet is expected to grow between 4% and 6% in 2012, depending on the number of single hull tankers that are scrapped and the number of scheduled deliveries that are delayed into 2013.

Freight rates remain highly sensitive to severe weather and geopolitical events. Hurricanes in the Gulf of Mexico during the second half of 2012 could have a pronounced effect on freight rates for both crude oil and product movements depending on the extent to which upstream and downstream facilities are affected. Geopolitical events, such as the tensions in African countries and the Middle East, could also cause changes in supply patterns that could significantly impact rates. The rate of economic recovery and pace of restructuring activities in Japan and decisions concerning its nuclear power plants could also influence trade flows.

Update on Critical Accounting Policies:

The Company’s consolidated financial statements are prepared in accordance with accounting principles generally accepted in the U.S., which require the Company to make estimates in the application of its accounting policies based on the best assumptions, judgments and opinions of management. For a description of all of the Company’s material accounting policies, see Note 1 to the Company’s consolidated financial statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2011.

Results from Vessel Operations:

During the second quarter of 2012, results from vessel operations decreased by $6,393 to a loss of $30,439 from a loss of $24,046 in the second quarter of 2011. During the first six months of 2012, results from vessel operations decreased by $4,194 to a loss of $54,081 from a loss of $49,887 in the first six months of 2011. These decreases primarily resulted from period-over-period increases in depreciation expense relating to eight newbuild vessel deliveries in 2011 and early 2012, partially offset by growth in TCE revenues and reductions in charter hire expense period-over-period. Decreases in charter hire expense in each of the 2012 periods are primarily related to the redelivery of loss making chartered-in VLCCs and Aframaxes discussed below.

During the second quarter of 2012, TCE revenues increased by $2,670, or 1%, to $210,001 from $207,331 in the second quarter of 2011 primarily due to (i) the strengthening of the overall Jones Act market, which resulted in the U.S. segment’s Jones Act ATBs and Product Carriers providing improved results and (ii) increased average spot rates earned in the VLCC and Suezmax fleets. These positive factors were partially offset by decreases in the average blended rates earned by International Flag Aframaxes and Handysize Product Carriers.

OVERSEAS SHIPHOLDING GROUP, INC. AND SUBSIDIARIES

During the first six months of 2012, TCE revenues increased by $10,137, or 2%, to $424,030 from $413,893 in the first six months of 2011. This increase reflected the strengthening U.S. Flag market discussed above, along with deliveries of a newbuild Jones Act Shuttle Tanker and a newbuild Jones Act Product Carrier, which are employed on time charters at attractive rates. The growth in the U.S. Flag segment was partially offset by a decrease in TCE revenues in the International Crude Tankers segment, which resulted from substantial idle time for the Company’s ULCC as well as a decline in average daily TCE rates for the smaller Crude vessel classes (Aframaxes and Panamaxes).

See Note 4 to the condensed financial statements for additional information on the Company’s segments, including equity in income of affiliated companies and reconciliations of (i) time charter equivalent revenues to shipping revenues and (ii) loss from vessel operations for the segments to loss before income taxes, as reported in the consolidated statements of operations. Information with respect to the Company’s proportionate share of revenue days for vessels operating in companies accounted for using the equity method is shown below in the discussion of “Equity in Income of Affiliated Companies.”

International Crude Tankers