A technological revolution in Houston…

[The graph above show US Auto prices hedonically adjusted for quality over the period 1906-1982. NBER].

A couple of great stories from the Houston Chronicle recently on shale production. The first questions whether watching rig numbers is a valuable activity given the increase in productivity?

For example, the number of frack stages in a well are expected to increase 14 percent this year to an average of 28.5, more than double what explorers were able to do in 2014. And the total amount of sand crammed into wells this year is expected to grow 20 percent to more than 100 million tons…

At 7,500 feet, the average lateral length of a well is 50 percent longer compared to three years ago. And a rig can drill 25 wells a year, compared to 15 just two years ago…

And then this on Big Oil displacing Wildcatters, but is really about the how large E&P companies are turning shale into a mass production technique:

Chevron’s frack factory is a choreographed exercise in efficiency. Computer algorithms identify drilling sites. Geologists map out well lengths and locations. Teams of contractors, roughnecks and engineers mount 800,000-pound drilling rigs that cost tens of thousands of dollars a day.

The rigs drill one 10,000-foot lateral, slide over a few feet, and then drill another. Computers automatically chart progress, and drill operators, sitting in a glass box on the rigs, constantly monitor the process, watching for the first indication the pipe is straying out of the shale sweet spot.

Every 12 hours each drilling team reviews its work, comparing progress to the most efficient performances in Chevron’s fleet, and makes corrections to their own drilling, to catch up.

At Shell, the process is so digitized and automated, geologists and engineers guide Permian rigs from the 11th floor at Shell’s Woodcreek campus in Houston, allowing them to drill and monitor 24 hours a day, seven days a week. They didn’t even stop when Hurricane Harvey hit this summer.

Shell’s future, Gerges said, will increasingly rely on automation and mechanization: wireless sensors to check well levels, pressures and temperatures; drones to travel to pipelines, pump jacks and drill pads. Such technologies would automatically report broken equipment, and match contractors to jobs, much as ride-hailing services match drivers with passengers.

I am clearly not a geologist but I repeat here that it seems clear this is an industry undergoing a huge investment cycle that is leading to rapid technological change and productivity enhancement. This is not a new phenomenon of the modern American economy, indeed writing in 1990, at a time when the US was insecure about its economic position Gavin Wright looked at the origins of American industrial success and noted “whether resource abundance reflected geological endowment or greater exploitation of geoglogical potential. It was mainly the latter”.

Shale isn’t going to be all conquering but it is going to be a constant and important part of the energy mix. For offshore there is no comfort in saying shale is “uncompetitive” and cannot produce the volumes required as the entire economic model has changed now E&P companies need less reserves and have more available sources of short-term production increase.

Offshore needs technology and innovation to lower unit costs and compete with short cycle production: not just for production levels but for capital allocation from E&P companies. Greater standardisation, lower cost components, less asset intensive installation etc will all form a part of it which will make it more attractive as E&P profit margins increase to reflect the length of the investment cycle. Offshore industry recovery ,with straight volume increases that lead to higher day rates and utilisation, might well be part of the story but to pretend they are all of it is ignoring the scale of change undergoing in the shale industry and E&P company thinking (and ultimately capital allication). The days of building more assets, at ever higher numbers, as the price of oil increased have gone for good.

What will recovery looks like?

I came across the chart above the other day while starting to think how to write a post the other day about how 2018 will look (I have been really busy on an FLNG project so have not had much time lately), the reason I like it is I think it sums the two eras we are dealing with: Before Crash (2014 and earlier) and the After Drop. The chart is for Ocean Rig Q3 2017 and is just a very simple illustration of the scale of the drop in day rates the entire industry is facing.

Quite simply ORIG was banging out rigs at $500-600k per day and now they are going out at ~$150-170k, when they can get work. I am no rig expert (I think the best commentary is at Bassoe for rigs) but it’s no different in the vessel market where discounts of a similar percentage (~70%) have been common since 2014. Not only that but whereas before the utilisation was near 100% now it is patchy at best.

It’s all well and good talking about a recovery, and clearly as the oil price increases work for offshore will come back, but the scale of a comeback here needs to be kept in context, and the best way to do that is to look at historic utilisation and day rates. It is also well worthwhile remembering the subsea value chain and being honest that if the rig market is struggling with such onerous day rate decreases to make projects “economic” for the E&P companies then even these projects are a long way off hitting those with vessel exposure, and will they even be economic for offshore contractors?

The definition of economic on this blog is economic profit not simply surviving. That means consistently earning returns the actual cost of capital. I think the industry will be better from a demand perspective in 2018 the question is really at what price point the surplus capacity soaks up demand? Unfortunately I can’t see anyway that a marginal increase in work doesn’t simply encourages some companies to stay in the market and keep profits weak for everyone else. Individually economically rational, but collectively destructive. Nothing will make the E&P companies happier than to watch the contracting industry burn through their equity while projects are de-risked for them with the resulting cost reductions.

The North Sea PSV market is a classic case where as soon as day rates pick up someone buys another distress sale PSV for around what it costs to operate at cash breakeven and lures investors with the unrealistic proposition that if asset values recover to previous levels they will make supernormal profits. If anyone other than the project promoters and the operating company make money then I will be very surprised and the situation is being replicated across a range of asset classes. The Seadrill restructuring plan for example requires a heroic belief in day rate increases and utilisation:

Seadrill RP day rates.png

It is a very rare market where both the quantity and price of work increases at the same time so aggressively when there is so much excess capacity. You can argue that the industry is at an unaturally low levels but I struggle to see the commissioning of rigs and projects on a scale to make these numbers realistic.

In 2017 the problem for the offshore industry was over confidence in demand. Move too early and you lost money, and because there is so much distress money looking at the sector, people feel they have to do something or lose out regardless of how unrealistic the plan (i.e. the Nor liquidity issue). But the market dropped lower than people thought, maintenance demand was more elastic than presumed, and new Capex virtually dried up. The problem in 2018 is going to that same level of supply for only marginal increases in work. Good for workers as job losses abate but offering no respite in profit terms and asset valuations.

New FID’s will take years to flow through to offshore execution. Literally two seasons for most of them under a best case scenario by the time the engineering and financing has been arranged. So you need to last until 2020 under best case scenarios. Also not every asset class will benefit from a straight increase in the oil price as E&P companies are being far more selective about the types of fields they develop. All the data I have seen point to large scale, high flow, developments being the focus for development: that will favour large contractors with bigger balance sheet and a more complex asset base.

Vendor financing is becoming a big issue. For example Premier and Rockhopper are trying to finance the Sealion development with nearly 100% vendor financing – paid on installments following first oil. In earlier years these companies would have gone to the capital markets for financing and paid cash. It is another sign of the broken financing market that this vendor financing is being considered large scale: contracting companies have limited ability to assess downhole risk, and if these deals ever go really wrong then this will be very messy as the creditors fight it out. There is also a limit to the number of deals contracting companies can absorb like this.

A common thread in this (that I will talk more about later) is that in addition to the price of oil needing to be high financial markets need to recover as well to help companies take advantage of the opportunities, and we appear to be a long way off that happening. E&P companies are concentrating on paying down debt and prioritising dividends, and when you can sell 100% of your output, and your shareholders have been scared by the volatility in your price level, then you have less incentive to spend to keep market share that other types of companies (i.e. supermarkets) might worry about. The longer E&P companies want to be cash rich, or distribute it, then the harder it will be for offshore.

Smaller E&P companies that focus on offshore need to be able to raise debt and equity for the industry to improve – these were called marginal producers for a reason and they created marginal demand for the offshore contractors. Until some degree of access comes back for these companies then the global fleet is simply too big as the supermajors refocus on shale.

Don’t get me wrong offshore isn’t going away, and for the vessels not in lay-up 2018 is likely to be busier than 2017. But I think it will be utilisation, not day rates, where the majority of the pick-up will be felt, and a vessel doesn’t pay for itself with 4-5 months work (unless you buy it super cheap), a fact that won’t help financial markets open up for offshore as the same banks are behind the pull-back in the vessel and offshore market as were often behind the offshore E&P companies.

Not every business model is going to work here and not every asset will have value as the market recovers. I think we will only see the bottom when the banks start accepting the scale of the losses they will have to take, there some indications of this: DZ Bank has appointed Goldman to sell DVB, DNB looks to be setting up a “bad bank” etc. But there are a host of deals across the sector: Seadrill, Mermaid (Australia), SolstadFarstad, Eidesvik ad infinitum where the banks are just delaying repayment and hoping for a miracle. Much like the Euro crisis this will just create zombie companies and banks from which the industry will struggle break free of.

North Sea DSV update… Has the Vard vessel been sold? Will IMR save the world?

We’re eyeball to eyeball, and I think the other fellow just blinked.”

Secretary of State Dean Rusk, during the Cuban Missile Crisis, 1962

It was a little windy (80-100 mph) up the mountain today as you can see from the photo… I thought it was a good metaphor for offshore at the moment anyway…

So in clearing out my emails I have now been told Technip have reached a deal with Vard on the 801. A price of ~$100m, but with no delivery risk and commissioning liability for Vard, has apparently been agreed. Technip is large enough for that to be a sensible risk to take as the Wellservicer needs to be replaced at some point. Unless ordered by SS7 or Technip I think this will be the last North Sea class DSV built without E&P company contract coverage for at least 10 years, maybe ever,  barring some unheard of change in the market. (This isn’t the place to get into why I don’t think any of the UDS vessels will end up North of the Med).

We are watching how an extremely illiquid and asset specific market clears in a huge market downturn. The interesting thing is that Technip and Subsea 7 seem to be making a renewed commitment to IMR having really lost focus during the construction boom, this graphic from Technip makes clear:

Technip Market Growth.png

If you are a smaller IMR contractor expect Technip to come up more often on tenders you are spending money on bidding. A near new DSV fleet fits this theme. It also shows you what sort of percentage/revenue increase on IMR a market leading company thinks it can get and how it is planning on taking market share. Smaller companies should be worried and anyone who publishes documents claiming they can grow organically at 50% in this market just isn’t serious.

I find the pricing of this asset fascinating: to Technip and Subea 7, taking a 25 year asset view it is an asset you could spend some real money on. One needs to replace the Wellservicer and the other the Pelican. But outside of those two companies the asset is almost unsellable at anything like it’s build cost. If you can’t operate that vessel in the North Sea (and it’s not even NORSOK) then it’s just an ROW DSV and you would be lucky to get $50-60m… and only then if you could find a bank to lend against it. So really they are just bidding against each other to take on the asset (not that I think Subsea 7 were)? How long do you make Vard sweat or risk seeing a really good vessel go to a competitor? Other vessels could also have been purchased from distress sellers e.g. How much better is the Vard vessel to the Toisa Pegasus (currently in lay-up)?

Both sides blinked at 100m if you ask me. More compromise than Mexican standoff.

The Seven Kestrel is arguably the best DSV in the world and as soon as construction work starts to pick-up SS7 will just ask the Koreans to build a replica (for less) if the need to relace the Pelican. And at that point that will be the last North Sea class DSV built for a very long time.

Both Technip and SS7 have some pretty new DSVs and both have an old (fully depreciated) one that operates when the market peaks… But as I wrote earlier the only realistic scenario for 2018 is for North Sea day rates to stay low for DSV work, and in this market making a trade off against a low capital cost to lose money on OpEx for a bargain purchase is getting ever harder to make? The lower than expected contract size for the Snorre Extension for Subsea 7 shows how low margins are for awarded work at the moment and how long it may take for day rates to recover. And if, as looks likely,  Boskalis and Bibby start a brutal price war to gain or keep market share, then dropping $100m on a vessel to go out at $100k a day (a cash loss amount in the North Sea) doesn’t seem that clever at the moment. Go back $10m a year for a few years on a DSV, easily possible in this market, and savings in CapEx were illusory.

Optimists point to graphs like this:

North SEa SAt MArket.png

But this ignored Boskalis taking the Nor vessels and Vard vessel replacing the Rockwater 1. [As a methodological point it is also worth noting that each movement on the vertical axis represents 3 DSV vessel years! showing you how easily the forecast could be out here]. It is also worth noting that if those Decom figures are wrong, and they look agressive, the market imbalance is illusory. No one in this market is going to force E&P companies to pay divers to remove mattresses etc off the seabed.. its just not going to happen. Just as importantly, a modest increase in day rates, which would see the DSV fleet operating at below economic cost, could curtail IRM or EPIC project demand as this graph seems to assume constant demand. There is a large amount of latent supply in the market that will come into the market as rates increase (which happened in 2014)… economic change happens at the margin… which is not reflected in a static graph like this.

Ultimately running vessels, even for companies the size of Subsea 7 and Technip, is a utilisation game as the fixed costs are so high that a small drop in utilisation and day rates /project margins can lead to a massive drop in profitability and cash losses. Shareholders would not welcome a cash call if it means they have overpaid for vessels and ultimately been diluted in a down market, and a North Sea class DSV is a very expensive vessel to have underutilised. I am always reminded mentally that Technip looked seriously at acquiring CGG not that long ago… in which case this would be a great bargain…

Let’s wait and see…I still have my doubts… but if the Vard 801 rocks up to the North Sea in April/May under Technip control for the North Sea summer my photo above will be a good reflection of economic conditions for North Sea DSV owners in 2018…

A new industrial revolution…

Pessimism has been the usual response to the Industrial Revolution.

Robert Allen

Tell me there isn’t a new industrial revolution happening in the US at the moment (from The Houston Chronicle)?

U.S. oil production surged to a 46-year record in October.

The Energy Department said the nation’s output of crude oil jumped 1.8 percent to 9.64 million barrels a day. Morgan Stanley said shale drillers pumped at the fastest rate in nearly three years.

And they did it with half the rigs they had in the boom times

I have said many times here I don’t think offshore oil and gas production is going away… but when was the last time someone showed you a project that could be constructed with 50% less boat days? I have seen day rates go down 50%, but that just means once the equity of a boat owner has been lost the bank is taking a hit. I have seen project costs reduced markedly, and some of this is down to standardisation and better scheduling, but much of it is just down to better procurement in an industry plagued with overcapacity. Vessels are running into productivity improvement limits and this has a bearing on costs, which cannot easily be reduced, whereas shale seems to be at the beginning of its technological and productivity journey (see also this post)).

On a volume basis offshore has advantages but the pace of technological improvement here, as the US turns oil and gas production into a manufacturing process, cannot be underestimated. This is turning into a positive feedback loop of increasing profits feeding increasing investment and further productivity improvements for E&P companies investing in shale.

There is a link between these sorts of productivity improvements and declining investment in offshore, especially the high cost UKCS/ Norway. Another good article here on declining investment in the Barents region from the most recent Norwegian licensing round:

“It’s a warning and a cause for reflection,” said Stale Kyllingstad, chief executive officer of IKM Gruppen AS, one of the biggest suppliers to Norway’s oil industry. “The Norwegian shelf isn’t as popular anymore. It’s a concern.” An historic three-year slump in the industry has seen Exxon and BP Plc relinquish their role as field operators in western Europe’s biggest producer. The landscape is changing in the aging North Sea basin in Norway and the UK as companies search for higher margins in projects such as liquefied natural-gas or US shale. Smaller, more specialised companies, some backed by private equity, are stepping in.

The fact is of the 11 companies who bid only 1, Statoil, has both the balance sheet and the technical capability to develop multiple fields in the region, and of a scale and complexity comparable to Africa and the Gulf of Mexico sanctioned projects, and it can’t do everything. The lack of super-major support, and their massive concomittant increases in shale investment is an important market signal.

Long gone are the days when ExxonMobil used to take its PSVs up to the Barents in April so they would be early in case weather conditions were favourable early. I still don’t think the offshore industry is being real about how an increase in the oil price and E&P investment will play out.

If you thought North Sea DSV rates were cheap last year…

Next week Bibby Offshore is shutting down the US business Bibby Subsea Inc. completely. It’s the right move as the business is subscale, lacks a competitive position or asset, has a very high cost base, and has no booked work at all for next year. However, it does mean the new owners, only three weeks in, have given up on the £130m revenue target for 2018 management had been promoting to potential investors in November. The gulf between the new owners and management would appear to be huge and it is a total repudiation of the past management strategy and actions. The new strategy is clear: create a small UK DSV business and sell as quickly as possible to minimise losses.

The new owners of the business, clearly outlined in the Scheme of Arrangement document here, now own a 2 x North Sea DSV business, one chartered and one operational, and the Bibby Sapphire in lay-up. Norway, Singapore and the US have gone, dreams of building an international contractor have collided with the cash cost and risk of building one. This is going to be a much easier business to get into than get out of and the consequence of this will be a very competitive North Sea DSV market for 2018 as the new owners are forced to try and build up the order book at any cost in order to get out of the business before next winter.

The closure of the US means the new owners have to sell and make profitable a 2 x DSV  North Sea business. There is an entire layer of corporate management now that is surplus and it doesn’t take a genius to see what will happen here. In all likelihood a strong Executive Chairman will be brought in above the current UK management to help sell the business. M&A advisers will be brought in, and as soon as the order book has some substance, and some costs reduced, look to get the investors out of this position before the company consumes too much of the £40m cash that has been pumped in.

This will not be an easy business to run or sell. The new owners only have a year to use the Bibby name, and won’t want to spend money on an expensive rebranding exercise, so use the branding as an external sign of how confident they are of selling the business.

The question is how long the £40m can last?  This isn’t a project management business it’s a hotels like business, only one thing matters for a small boat owner: days utilised * day rate. I suspect the new owners have now done some downside calculations based on air dive work and a forecast cost base and are horrified at how much cash they could burn through by June, hence they taking no risk at all on sticking with the US business. The UK business needs the vessels in SAT, at fairly high utilisation levels, or it simply isn’t an economic entity. It is very hard to see any more money going in now the strategy is clear and the only thing being sold is a small UK focused contractor, so it has to last until a sale.

The asset base is the weakest now of any North Sea contractor. The Bibby Sapphire (a vessel I feel a strange emotional attachment to as the first ship I ever transacted) is likely never to return to the North Sea I believe, but even  lay up costs are likely to be $1200-1500 per day + 500k to get it there (e.g. a lot will need to be spent on the dive system procedures to make sure reactivation is possible, humidifiers). The problem is that outside of the North Sea DSV rates are low, driven by oversupply (unless your ship is painted red), and there is a binary price difference between a North Sea DSV and one that isn’t (although the Boskalis transactions blurred that boundary). Brokers I have spoken to think USD 10m is reasonable and even that could take time to achieve. No one needs the boat for the same reason Bibby couldn’t get her utilised: there is no work unless it is bid very cheaply. There might be an interesting discussion between the auditors and investors on vessel values in the last accounts coming up.

The 1999 built Bibby Polaris is a generation behind the other DSVs in the market. The vessel is popular with customers but the awkward forward bell arrangement means no one would go out of their way to buy it, but it is working and a core UK asset. The Topaz is on charter with minimum committed spend and a charter that de-risks cash spend but lowers margin as the vessel works in SAT mode.

The Olympic vessels are a smokescreen: they are total commodity vessels in the current market. Every single small ROV contractor out there has access to similar tonnage and on pay-as-you-go charters the margin is minimal. No one is giving Bibby a real construction contract until their financial position is sorted, and they if don’t have one for 2018 now (which they don’t) then it isn’t real anyway. James Fisher recently used one of the Olympic vessels and even put their own ROV crew on. Access to the Olympic vessels might move the revenue needle a little but in reality they add nothing to the economic cost base. The only question is if the current Olympic charter is continued for whether the creation of the new TopCo allows for its legal termination? The cost of this charter is material as it is significantly above market rates.

The only thing in the M&A bankers arsenal is the cost synergies a new owner could get from taking over this 2 x DSV operation and further reducing the costs. Pretty quickly, if the US office example is anything to go by, the unescessary costs will go from the business and a small 80-90 person business will emerge. But it will be hard for any buyer to reduce that dramatically in cost terms because you still need three project crews per DSV and a certain number of commercial personnel. But it is the only financial incentive to buy beyond the contracted revenue, which is all short-term.

The need for synergies means that only an industrial buyer makes sense here. Bokalis may want the service agreements but it has two better boats now so won’t want the assets. DOF Subsea? No cash to buy and won’t want the DSVs, but it may make sense to take the infrastructure and get the Achiever working (although what they really want is for the market to pick up and Technip to take her back) and get the Vard newbuild. DeepOcean? Triton as the controlling shareholder will not be bailing this deal out and won’t want Polaris or Sapphire. McDemott? Just done a large deal and don’t need a loss making DSV operation to win work. Ocean Installer? The sellers will be getting shares only in another subscale business. It is a depressingly small list for a sell side adviser.

If you were going to recreate the business from scratch really you’d just take the Vard DSV and the Topaz and not bother with Polaris. But for the current owners that isn’t an option… but for anyone else as a buyer it is? Splitting the operational and asset base makes perfect sense for any buyer here but almost none for the seller as if the Polaris leaves the North Sea she too will see her limited value drop by a quantum.

Another problem the Bibby owners face is that to get out quickly all the cost savings and new operational model will not have any operating history. When you sell completely on pro-forma accounts you take a big discount though, and worse a discount combined with paper/shares not cash normally, because it’s all just a promise. However, stick with this until next summer and the business will in all likelihood need another cash injection and a special survey for Polaris beckons. The bankers will earn their money on this.

So the new owners have to sell SAT days: now. They need an order book.  Working as an air dive contractor at 90k a day won’t even cover the new reduced cost base. A sale requires market share in SAT, and the only way to guarantee that is to drop the rates and build backlog. A sale by June, when hopefully the burn rate has slowed, and there is some SAT order book, is now the imperative.

Unfortunately there is the competition: three multi-billion market capitalisation companies with open DSV schedules. Boskalis has just taken delivery of two North Sea class DSVs and needs to get them working. Technip and Subsea 7 also realise now there is a chance to finish off a fourth player in the market and can flood the market with cheap capacity. The new shareholders cannot cross subsidise from other business lines and have a much higher cost of capital. It is a very weak strategic position to be in for a company with such a high fixed cost base, something the competition is only too aware of.

Therefore every single one of these companies will be calling on the Aberdeen market with once-in-a-lifetime pricing on DSVs next year. If you thought rates were low at the start of 2017, at £90k for a fully kitted out DSV with a 15 man team, you can expect them to be there again now for periods and won’t rise above last year’s peak of £130k

Demand won’t save anyone for 2018. The planned increases in spend are marginal and relatively fixed now and there is very little DSV construction work. Platform shutdown plans and schedules have been made. Engineering capacity for the 2018 summer has been locked in E&P company budgets with only small increases possible. Only unplanned outages, or rates so low work is brought forward, offer room for increases in planned work now. And the reason Bibby and others don’t have much work now is the E&P companies believe they will have ample options in the new year… and they are right. 2018 promises to be another grim year to be a DSV owner in the North Sea.

Free money in offshore and Hoyle’s Fallacy…

During a boom, the expansion of debt-financed investment spending causes initial “robust” financial structures to evolve into “fragile” financial structures, and it is this evolution that ultimately brings the expansion to an end. In the subsequent contraction, typically some fragile financial structures collapse while others are refinanced into more robust financial structures, thereby creating the preconditions for renewed expansion.

Perry Mehrling

There is an old joke in economics (really!) about two economists walking down the street, one of them notices a $20 bill on the pavement and says, “look there is a $20 bill”, and the other one says “no it can’t be, someone would have picked it up by now”… (control yourself I know).

In a way it’s a geeky, very dry, insiders joke about the nihilism of neo-classical economics, and its inability to explain well the endogenous nature of economic change. I mean how do you explain the success (in product development and capital raising rather than financial return terms) of Tesla? Surely electric cars as a business model would already have been invented before Elon Musk if there was a real opportunity? But the (sic) joke also points to a deeper economic truth about innovation: that there is generally a very good reason why something isn’t being done, and that free money, ideas that haven’t been thought of before, are a very rare commodity. Which is why of course innovation can be so rewarding.

I say this, as yet again, I have read a claim about a company building a fleet of the world’s most sophiticated DSVs, that has miraculously, in the worst OSV/DSV market ever, managed to bag it’s second long-term contract for a new build DSV. Details are scarce, but the Americas is mentioned.

Now it is highly unlikely for a tornado to rip through a junkyard and assemble a 747, even if all the constituent parts are there, an idea commonly known as Hoyle’s Fallacy. It is just as unlikely in this market, that a company, would manage to find two counterparties, in two differing geographic locations, willing to sign an economic charterparty, for a multiyear period, when no one else in the industry had heard of these contracts or been given the chance to bid for them, and that these have real substance.

I could spend hours here writing about how impossible this is: Why would a contracting company give free money away (by paying a higher than market dayrate) by not using a shipbroker to get various bidders into an auction process? Does the vaunted fuel economy of these new vessels, which could be no more than 2 or 3 cubes a day in DP, so max $3000 a diving day, really cover the capital cost of a $150m new build when a near identical unit sold second-hand for $60m (and lower on a blended price)? Who are the oil companies willing to pay above market rates for a new DSV which offers no operational advancement on current functional technology? Who are these small companies that have so much DSV work they are going long on assets while established players lose money running high-end DSVs?

Or I could mention that the current charter announced has gone to a 4 year old Malaysian company, with limited operational experience, in a market where people have been lucky to get OpEx or above for years, and the leading buyer in the market has encouraged vessels like the Stephaniturm? Have Petronas really decided to pay above market rates just to have a shiny DSV? Anyone who has had to negotiate a contract with them, and been through the extraordinary lengths they will go to in order to save minimal costs, will find this idea fantastical in  the extreme. Who is this company in the Americas with the financial resources to charter one of the worlds most advanced DSVs but without the commercial skills to get involved in a competitive auction? I’d almost bet my house that this will emerge as a Mexican company, in which case satire is dead.

But then I would simply be playing the same game… And as I am going skiing on Saturday I am time constrained and it’s boring. Because these things go back-and-forward without looking at the bigger picture: which is that clearly it can’t be true that these are economic deals or a charter party like a 365 BIMCO time charter as the statements imply. The only thing I know for certain here is someone is getting less money out of this than they thought: if it’s the yard, then they are not getting the full build cost of these vessels on delivery, or at any point in the future (on a real basis); if it’s investors then they are not getting a charter that covers the investment cost, or any mixed scenario of the two or some other third scenario I haven’t thought of.

It is simply not possible in a market with such informed buyers, and as many shipbrokers working, who make the market structure for assets with such a high degree of specificity nearly perfectly competitive in a down period, that one company could assemble a veritable 747 of contracts from the primordial soup of DSV demand. The only question is here: who is going to take the financial hit and when?

This is one of those situations where a business model cannot stand serious economic scruntiny. It appears in essence to involve delivering the most expensive assets, without long-term and fixed time-charters charters (that reflect financing cost) into an over supplied market, with extremely high running costs, and lacking credible counterparties. People like to say nice things about start-ups, and I understand why, it’s a hard thing to do (as I can personally attest), but just like Enron, Railtrack, and countless other examples, if something is too good to be true it is (not a 747 or a $20 note).

I am going to write my predictions for 2018 while I am skiing (I don’t think I did a bad job of 2017 if you want a look here, pessimism was warranted), but one of the things I am convinced of is that in 2018 substance will count. Companies that claim they will grow 50% in this market are simply dreaming, and companies that claim they can find work that no one else is bidding for, or can deliver on are just as delusional. Unlike late 2016 (going into 2017) people are now aware there will not be an elastic bounceback for the offshore fleet, and as the cash running costs are so high, as the pay-off so uncertain, funding costs will increase dramatically, and the Demand Fairy will not save everyone despite a better market.

To everyone who sent me nice wishes about this blog thanks. I have sometimes wondered where I am going with it, and it hasn’t always gone the way I planned, but it has involved a fair bit of work so I appreciate the positive feedback. Have a safe and merry festive season.

A well intervention/lay-vessel or a DSV?

I’ve missed something with this… is it a Dive Support Vessel or a lay-vessel? News that UDS is building a new vessel left me confused:

The Salt 310 design vessel will be capable of well intervention, flex lay and rigid pipe lay operations in 3,000 m of water.

The vessel will be fitted with first-of-its-kind ‘3 in 1’ tower designed by Huisman in the Netherlands. It will also be fitted with a Huisman 600-1,000 tonne crane which can work in depths of up to 3,000 m and a 650 m hydrogen saturation diving system along with two integrated hydrogen refineries.

Either it’s the worlds most advanced DSV, capable of diving at an incredible 650m (no info on the Hs at that depth), and therefore it will need to travel and be a global asset as those jobs are so rare, or it’s a deepwater well intervention and lay vessel? In either mode of operation it will be overcapitalised, with one part of its functionality redundant? But it would still require dive techs etc even in pipelay mode and vice versa? I am perplexed… Questions abound… A 1000t crane is a monster… Who does 1000t lifts? How often? How much does this crane cost? How many days does it have to work to pay for itself? How much strengthening of the deck was required for the payload? This vessel will clearly be an astonishing technical achievement.

The economics on the other hand look more challenging: If you made the assumption that the dive system was worth $100m, not unreasonable comparing a CSV to a DSV price, then the dive system is depreciating at 11k per day (365 over 25 years), regardless of whether it is being used, and excluding OpEx (about 15% of a working DSV day rate in Asia). The lay system/well intervention system, at say $150m, would be depreciating at $17k per day (365 over 25 years), again excluding running costs. And I have a feeling this j-lay/ flexlay system is closer to $200m, with the tower giving you the well intervention capability for free (with another expensive Lego set).  This effectively adds that to the cost of diving or lay each day depending on what you aren’t doing? And that is without OpEx? I am struggling to see how that is economically efficient.  An economic value calculation would substantially increase those numbers. On a more realistic assumption of 270 days utilisation, given schedule gaps and transit, those numbers rise by a quarter.

Are UDS planning on being a EPCI contractor for rigid lay? There is no spot market for rigid lay vessels? Or do they have a charter for this vessel? Surely for a core delivery asset, such as this, a charterer would be intimately involved?

I could be wrong but this reminds me of the CSS Derwent. It could do almost everything possible (in the right region and water depth), and nothing economically efficiently. At a cost of USD 110m it ended up in Angola once Hallin folded, where I doubt the collective value of offshore shipping assets is USD 110m, and certainly caused a massive loss for the yard (STX).

CSS-Hallin Derwent

In an industry which requires standardisation and cost reduction I struggle to see this as the future. I have voiced concerns before about the willingness of the offshore industry to do something because it can, not because it is economically viable, hidden in a boom market it is a real issue now. But the great thing about capitalism is it’s not my money, and I don’t know everything.

Don’t get me wrong, I have huge admiration for UDS. They are delivering and ordering, by an order of magnitude, a DSV fleet bigger than Subsea 7, a company with a market cap of USD 4.8bn! It is an astonishing organisational and financing achievement, and when  the history of this period is written this will be one of the more interesting stories. By any rough calculation UDS must have ordered, and/or taken delivery, of ~$1bn in vessels.

This is all happening at a time when very good DSVs are underutilised or going into lay-up (Toisa Pegasus) and there is massive over capacity in the lay fleet. If I owned a DSV I’d be dreading seeing UDS pop-up in my LinkedIn feed, as they start delivering these vessels it will almost be call for an asset impairment review everytime. This is turning into a countercylical bet so large it will deserve a place in financial history whichever way it goes.