The North Sea DSV Market: no deus ex-machina forecast…

I have been asked by request for my opinion on the North Sea DSV market (that’s you Mr Cappalletti). At the moment I appear to be nothing but a catastrophist on here,  but I have only one word for my prediction: Grim. The following is from a presentation I have given to a small number of people in the market.

A near 40% reduction in the UKCS DSV fleet in 2016 still saw poor utilisation and very low day rates.

ukcs-dsv

(Source: Stamford Maritime)

New vessels are arriving in 2017 for Subsea 7 and Technip. I predict low profitability as a result of excess supply and weak demand.Why such a grim forecast? There are basically two reasons for this that point to a structural decline in the market and it is not easy to see what will make it reverse:

  1. CAPEX work at shallow water depths has all but disappeared. This was major driver of DSV utilisation taking Technip and Subsea 7 out of the Inspection, Repair, and Maintenance (IRM) market and leaving it for Bibby and Harkand (to a lesser extent who still traded their DSVs a lot in Africa).
  2. The decrease in OPEX/IRM has been far more dramatic than many people, including myself, ever thought possible. But the facts are clear.

UKCS DATA.png

The CAPEX cut back is most serious for Bibby Offshore. Despite having made major strides in becoming a construction contractor, like Icarus, they flew too close to the sun; prior even to the bond issue Bibby committed to the Olympic vessels, ultimately moving from specialist vessels to commodity vessels at the top of the market. I understand this move, in the subsea Dark Ages (c. 2012), vessels with large back decks and 250t cranes were unavailable unless lengthy charter commitments were taken. Not only did Technip and Subsea 7 have access to the pipelay assets but for much of the year they had others locked out of the heavier tonnage required for complex ROV-based interventions. Accessing this work, inevitable once the commitment to ROVs had been made, the fateful journey began. Bibby dialled up the risk without increasing the equity to anything like the extent of the financial commitments made.

Then they doubled-down! A GBP 175m bond for a dividend re-cap, a general purpose bond, that essentially withdrew equity from the business. While the operational effect of the moves was different the net balance sheet result was the same: a highly leveraged bet on the North Sea oil price and a management team executing flawlessly in an international expansion strategy. No one is criticising the management here, most of whom I have a great deal of time for, but the balance sheet made this impossible. The time-honoured, and well-tested instrument for pure risk, which is what this was, is equity. That beautiful part of there balance sheet that can expand and contract as cyclical markets move without shattering the other constituent parts. And the Bibby balance is as bereft of this as I was of girls as a teenager.

There is no doubt Bibby, aware of their predicament, must already talking to the largest bond investors about the situation they are in (the only logical strategy to try and preserve some value for Group). Difficulties abound and there is no certainty of success. I don’t think Group will make a significant contribution (as a minimum I would be demanding the 20m taken out this time a year ago but that maybe unrealistic now), and it certainly won’t be at current equity levels, because that equity is worthless. The bondholders face the terrible prospect of getting redelivered two North Sea class DSVs, some of the most specific and costly shipping assets in the world to maintain, or making a complete shambles of it as the Harkand bondholders did as financial investors. Clearly neither is an appealing option and the Bibby bondholders will have to choose between kissing their sister or the dog.

Because, if everyone is honest, Bibby isn’t going to be a major construction contractor with activity at these levels. The majority of the construction work that is being done in the North Sea is deep-water and requires rigid pipelay, or floating bundles, for flowlines that Bibby do not have the asset base for, and these projects use very little DSV days (if any being significantly deeper than 300m but maybe some riser hook-up). Technip and Subsea 7 have this to themselves, but to add insult to injury, as they are so quiet they have now moved in to significantly take market share off Bibby in the IRM market. In the old days (c. 2013) smaller E&P companies with a USD40-50m construction project would be lucky to get a call-back from Technip or Subsea 7. Now they are all over these companies for even 10 days diving, and like the ugly duckling at the school ball who suddenly finds the cool guys chasing her, the nice guy isn’t getting a look in.

This highlights the other problem the Bibby bondholders have: if you were recreating Bibby tomorrow it wouldn’t be with the Polaris and Sapphire yet these are the vessels they have a mortgage over. Polaris at 25 years is operationally capable, but in reality probably unsellable, which locks the investors into an irrational course for a long-term business decision. A better bet would be to buy a pre-pack of the management system and IP and merge it with the Topaz and the Vard new-build. If I was Vard I would trade a sale now for an equity stake in a service business, but there are clearly a vast number of complications and agendas to be overcome before a transaction like that could be done.

The news get worse because as many people have noted the UKCS is not going to rebound like Norway. As DNB noted (in a pessimistic market report) this morning:

The outlook on the UKCS does not look as strong, however, and we highlight that only ~GBP0.5bn of new investments was sanctioned in 2016, versus an average of ~GBP8bn in 2010–2015. In other words, we believe the recovery in activity in 2017– 2019 is likely to be limited to the NCS, which is a major difference from the 2010–2013 recovery in this region.

Technip, Subsea 7,DOF Subsea, and Ocean Installer are going to cross subsidise their UK operations with the Norwegian market where Bibby has minute market share and no NORSOK operational DSVs. The cancellation of another Brazilian PLSV for Subsea 7 will only strengthen their determination to get what work they can on the UKCS, and if that vessel isn’t stacked is likely to head North anyway.

Until the construction market returns there will be no sufficient market for an independent IRM focused dive contractors until their asset-base is revalued and expected equity returns and loan profiles subsequently adjusted.

Which leads us nicely to the IRM market:

SSDT.png

The fact of the mater is we were all wrong. No one more than me. E&P companies could, and did, cut back IRM spend more than we thought. There is no reason to believe this isn’t structural as there are currently a large number of wells “shut-in” as operators simply refuse to spend on maintenance and defer production.  If you believe the optimists and think the E&P companies have been storing IRM up you need to explain why the DSV schedules for the major contractors is empty? Economic logic would suggest book work now when DSV contractors will give the vessel for OPEX only? Speak to people in Aberdeen and they will tell you the schedules of all five serious DSV companies are wide open next year. S&P commented on the lack of backlog at Bibby in their recent downgrade.

My views on the Harkand/Nor vessels are well known: sooner or later the grown-ups will take charge and at least one of these assets will leave the North Sea. They don’t have the crane size to compete as heavy-lift vessels, Nor has nowhere near enough capital and infrastructure to compete as a dive contractor, and they will be completely dependent in M2, a start-up, on winning work for them. Unless Technip runs short on vessel days, which would seem unlikely at this stage, I don’t see them working in the North Sea much at all.

Helix will continue to cover their OPEX with well intervention and continue to keep pressure on rates by virtue of having excess capacity and a well regarded delivery capability.

DOF I believe are the real wild card as I have said. DOF Subsea are a serious company with a far stronger balance sheet than Bibby and an ability to cross-subsidise across the fleet.  The Skandi Achiever may only be single-bell but she has worked for Technip and already done some decommissioning work.

The supply side remains of real concern for overall profitability. The Vard new-build has to be delivered and find work. DOF again would make a good home but don’t need the OPEX. Bibby must either strike a deal with the Volstad Topaz bondholders or redeliver the asset which would return to the market. Bibby would have to spend millions removing the dive system something I don’t believe they will do. As an aside, I believe Bibby did the diving for EMAS Chiyoda on Angostura… I hope they got paid because otherwise I think they will take a serious credit impairment there.

I don’t see the UDS vessels making it at all the North Sea: they simply aren’t needed. Norway appears to have about 600 addressable dive days per annum and 2 x NORSOK DSVs already.

These are genuinely epochal times for contractors in the North Sea. The market will adjust to a more normal level, probably higher than now. But there won’t be a deus ex-machina event here that will keep everyone whole.

I hope I haven’t lost you in my verboseness Sergio!

 

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