Executive Summary / Key Takeaways

• Contractual Fortress with Rate Inflection Potential: KNOP's fleet operates under long-term charters providing 96% coverage through 2025 and $963 million in fixed backlog averaging 2.6 years, yet the shuttle tanker market is structurally tightening across Brazil and the North Sea, positioning the partnership to capture significant rate increases as contracts renew and charterers exercise options in a supply-constrained environment.

• Fleet Rejuvenation Through Sponsor Drop-Downs: The partnership has grown from four vessels in 2013 to 19 by September 2025, with recent accretive acquisitions like the Daqing Knutsen ($95 million) reducing average fleet age to 10 years while adding seven years of guaranteed higher rates, demonstrating a capital-efficient growth model that competitors cannot replicate.

• Capital Allocation at a Critical Juncture: Management is balancing prudent debt repayment ($95+ million annually) with opportunistic unit buybacks ($3+ million executed at an average $7.87/unit) and accretive investments, signaling conviction that units trade at a substantial discount to intrinsic value while maintaining financial flexibility.

• Sponsor Buyout Offer Creates Uncertainty: An unsolicited $10/unit offer from sponsor KNOT NYK, while representing a premium to recent trading levels, raises questions about fair value realization for public unitholders and could limit upside if the Conflicts Committee accepts what may be a lowball bid amid improving market fundamentals.

• Market Dynamics Support Long-Term Demand: Petrobras's pre-salt production growth and North Sea FPSO ramp-ups are driving a projected medium-term shuttle tanker shortage, with all known newbuild orders backed by firm charters, suggesting KNOP's existing fleet and sponsor pipeline will become increasingly valuable as supply struggles to meet demand.

Setting the Scene: The Pure-Play Shuttle Tanker Operator

KNOT Offshore Partners LP, founded in 2013 and headquartered in Aberdeen, Scotland, began operations with a fleet of four specialized shuttle tankers. The partnership's strategy has centered on accretive fleet investment and maintaining long-term sustainable distributions, a model that has delivered 19 vessels by September 2025 with an average age of 10 years. This is not a general tanker operator dabbling in offshore; KNOP is a pure-play shuttle tanker specialist serving the North Sea and Brazilian markets, where it transports crude oil from offshore FPSO units to onshore terminals under long-term time charters.

The shuttle tanker industry operates as an oligopoly with formidable barriers to entry. Vessels cost $150-200 million each, require specialized dynamic positioning technology that takes years to develop, and must meet stringent regulatory approvals for harsh environment operations. KNOP's fleet features advanced DP2 and DP3 systems enabling operations in severe weather conditions where conventional tankers cannot safely load. This technical capability translates directly into economic moats: higher utilization rates, lower insurance costs, and the ability to secure decade-long contracts with major oil companies like Equinor (EQNR), TotalEnergies (TTE), and Petrobras (PBR).

The partnership sits within a value chain where it provides the critical link between offshore production and onshore refining. Unlike spot-market tanker operators who chase volatile daily rates, KNOP's business model prioritizes cash flow visibility through fixed-rate, long-term charters. This positioning creates a fundamentally different risk-reward profile than diversified peers like Tsakos Energy Navigation (TNP), Frontline (FRO), Teekay Tankers (TNK), or Scorpio Tankers (STNG), who compete across multiple segments with varying degrees of spot exposure.

Technology, Products, and Strategic Differentiation

KNOP's core technology is not software but specialized maritime engineering embodied in its shuttle tanker fleet. These vessels integrate dynamic positioning systems, turret mooring capabilities , and advanced offloading equipment that enable safe, efficient crude transfer in harsh environments. Why does this matter? Because it allows KNOP to operate in the North Sea's winter storms and Brazil's pre-salt fields where conventional tankers face prohibitive downtime and safety risks. This operational reliability translates into 96.5% utilization rates (99.9% when accounting for scheduled drydocking) and the ability to command premium rates for long-term contract security.

The economic impact of this specialization appears in the partnership's margin structure. Q3 2025 gross margins reached 64.37% and operating margins 31.66%, levels that reflect the scarcity value of shuttle tanker capacity and the efficiency of KNOP's operations. These margins are not cyclical artifacts but structural features of a business where customers pay for operational certainty. When Petrobras or Equinor commits to a five-year charter, they are buying insurance against supply chain disruption in critical production fields.

Fleet rejuvenation through sponsor drop-downs represents KNOP's strategic differentiator. The partnership's relationship with Knutsen NYK Offshore Tankers provides access to a pipeline of younger vessels with firm contracts, avoiding the speculation and construction risk that plagues competitors like Tsakos Energy Navigation, which has ordered 12 newbuilds costing billions. The recent Daqing Knutsen acquisition ($95 million, $25 million cash component) added a vessel with seven years of guaranteed higher rates, immediately accretive to distributable cash flow while reducing fleet age to 9.7 years. This sponsor-backed growth model enables KNOP to expand its revenue backlog without diluting unitholders or taking on speculative construction risk.

Financial Performance & Segment Dynamics

KNOP's Q3 2025 results provide compelling evidence that the strategy is working. Revenue of $96.9 million, up from $87.1 million in Q2, was driven by the full-quarter contribution of the Live Knutsen (acquired March 2025) and the Daqing Knutsen (acquired July 2025). Operating income of $30.6 million and net income of $15.1 million demonstrate operational leverage as new vessels contribute without proportional increases in administrative costs. Management explicitly noted no material increase in G&A expenses despite fleet expansion, highlighting the scalable nature of the partnership's operating model.

The balance sheet tells a story of disciplined capital allocation. Debt repayment continues at $95+ million annually, a pace management considers prudent for a depreciating asset base. Yet this deleveraging does not constrain growth. The partnership assumed $73 million in debt with the Live Knutsen acquisition and still increased available liquidity to $125.2 million by September 30, 2025, comprising $77.2 million in cash and $48 million in undrawn credit facilities. This financial flexibility enabled the concurrent execution of a unit buyback program, repurchasing nearly 385,000 units for approximately $3 million at an average $7.87 price—well below the current $10.70 market price and the $10 sponsor offer. This activity was part of a larger $10 million authorized program.

Cash flow generation remains robust. Annual operating cash flow of $137.15 million and free cash flow of $136.20 million support a price-to-free-cash-flow ratio of 2.44, a figure that suggests either severe market skepticism or a compelling value proposition. The partnership's 0.98% dividend yield and 7.72% payout ratio indicate substantial capacity for distribution growth, though management has prioritized accretive investments and buybacks over immediate distribution increases. This capital allocation discipline reflects a board focused on long-term unitholder value rather than short-term yield.

Outlook, Management Guidance, and Execution Risk

Management's outlook is unequivocally positive, grounded in observable market tightening. The shuttle tanker market is strengthening in both Brazil and the North Sea, driven by FPSO start-ups and ramp-ups that are delivering ahead of schedule. Petrobras's five-year plan for 2026-2030 shows pre-salt production volumes meeting or exceeding prior expectations with marginal capex reductions, indicating efficient execution that supports shuttle tanker demand. As management stated, "from the shuttle tanker owners' perspective, there is a lot to like about what Petrobras is saying and importantly, in what they're putting into action."

The contractual backlog provides both visibility and optionality. As of September 30, 2025, KNOP held $963 million in fixed contracts averaging 2.6 years, with 93% of 2026 vessel time covered by fixed charters and 69% of 2027. If all relevant options are exercised, coverage rises to 98% in 2026 and 88% in 2027. This rolling coverage matters because it demonstrates the partnership's ability to continuously renew its revenue base. Management increasingly expects charterers to exercise options given market strength, noting "the economic rationale for exercising these options has been strengthening, and we increasingly expect these options to be taken up."

Execution risk centers on debt refinancing and contract renewals. Four refinancings were completed in 2025, including a $71 million loan for the Synnøve Knutsen and a $25 million revolving facility rollover. Management expresses confidence, stating "we feel quite confident about these maturities in the years ahead, particularly after seamlessly addressing similar maturities in recent years amid materially less rosy market conditions." However, they acknowledge that "nothing can be taken for granted" and that negotiations proceed slowly due to early engagement with lenders. The average margin on floating rate debt is 2.2% over SOFR, a reasonable spread that reflects lender comfort with KNOP's asset base and contract quality.

Risks and Asymmetries

The most material risk is not operational but structural: customer concentration. Approximately half of KNOP's revenues derive from Brazilian operations tied to Petrobras. While Petrobras's pre-salt growth trajectory appears robust, any slowdown in offshore investment or shift to alternative export solutions (such as subsea pipelines) could materially impact demand. This concentration risk is amplified by Tsakos Energy Navigation's aggressive expansion in Brazil, where its 12 newbuild shuttle tankers will increase competition for available charters. KNOP's pure-play focus, while advantageous for operational efficiency, leaves it more exposed to regional demand shifts than diversified peers like Frontline or Teekay Tankers.

Debt maturities present a second-order risk. While management has successfully refinanced all 2025 maturities, the partnership's debt-to-equity ratio of 1.56 indicates meaningful leverage. Rising interest rates could increase debt service costs on floating-rate facilities, though management has historically hedged interest rate exposure through swaps. The bigger concern is covenant compliance if vessel valuations decline. Management uses broker mark-to-market valuations for loan-to-value covenants, and while valuations "have held pretty level," a sustained downturn in shuttle tanker asset values could trigger covenant breaches that force asset sales or equity raises.

The sponsor buyout offer introduces asymmetric risk. At $10 per unit, the offer represents a premium to recent trading but may undervalue the partnership's prospects in a tightening market. The Conflicts Committee's evaluation process could result in a higher bid, but acceptance at $10 would cap unitholder upside just as market fundamentals improve. Management's own buyback activity at $7.87 average cost suggests they believe fair value materially exceeds $10, creating tension between sponsor interests and public unitholder value.

Valuation Context

Trading at $10.70 per share, KNOP presents valuation metrics that appear compelling for a profitable, cash-generative partnership. The price-to-free-cash-flow ratio of 2.44 and price-to-operating-cash-flow ratio of 2.44 reflect market skepticism about either the sustainability of cash flows or the partnership's governance structure. Enterprise value of $1.28 billion represents 3.56 times revenue and 6.35 times EBITDA—multiples that are modest compared to broader tanker peers and particularly attractive given KNOP's contract-backed revenue stability.

The price-to-book ratio of 0.68 suggests units trade at a substantial discount to net asset value, a disconnect that management's buyback program explicitly targets. With book value per unit of $15.72, the market implies a 32% discount to asset value despite a fleet of 19 specialized vessels with an average age of just 10 years. This discount appears anomalous given that vessel valuations "have held pretty level" and newbuild costs continue rising, factors that should theoretically support higher asset values.

Comparative metrics highlight KNOP's relative attractiveness. Tsakos Energy Navigation trades at 4.41 times earnings but carries execution risk from its aggressive newbuild program. Frontline commands 23.41 times earnings with heavy spot market exposure that creates earnings volatility. Teekay Tankers and Scorpio Tankers trade at 5.97 and 8.89 times earnings respectively, but lack KNOP's long-term contract protection. KNOP's 7.92 P/E ratio sits in the middle of this range, yet its cash flow multiples are substantially lower, suggesting the market either distrusts reported earnings quality or applies a structural discount to the MLP format.

Balance sheet strength supports the valuation case. With $77.2 million in cash, $48 million in undrawn credit facilities, and manageable debt service requirements, KNOP maintains ample liquidity to execute its strategy. The partnership's 0.28 current ratio reflects the asset-heavy nature of vessel operations rather than near-term solvency concerns, as long-term charters provide predictable cash generation that covers fixed obligations.

Conclusion

KNOT Offshore Partners has built a contractual fortress that generates stable cash flows while positioning to benefit from a structurally tightening shuttle tanker market. The partnership's pure-play focus, sponsor-backed growth model, and disciplined capital allocation create a compelling risk-reward profile that appears mispriced at current levels. Trading at a discount to book value and generating free cash flow at multiples that imply market skepticism, KNOP offers exposure to offshore oil production growth with downside protection from long-term charters.

The investment thesis hinges on two variables: the Conflicts Committee's handling of the $10 sponsor buyout offer and the partnership's ability to capture rate increases as contracts renew in a supply-constrained market. Acceptance of the sponsor bid would crystallize value at what may be a cyclical low point, while rejection could unlock substantial upside as market tightening translates to higher charter rates and expanded distributions. With Petrobras's pre-salt production growing, North Sea FPSOs ramping up, and a projected medium-term shuttle tanker shortage, KNOP's existing fleet and sponsor pipeline represent increasingly scarce assets that should command premium valuations in the years ahead.