Waiting for Godot: Nor DSVs

In a previous article, I outlined why I believe the market for North Sea class DSVs is as structurally unattractive as could possibly be designed. The investors backing Nor/Harkand are Waiting for Godot. With their own Vladimir and Estragon, parked quayside at Blyth, they don’t know when Godot is coming, and they don’t exactly know what it looks like apart from an unexpected increase DSV days in the North Sea, but at the moment they can’t agree to leave either. This is totally unsustainable given the running costs and there is clearly an oversupply of North Sea class DSVs, a situation that hasn’t existed since 2002. I believe the offshore industry (globally) will only reach back to a new equilibrium when a focus on economics forms the core of decision-making, and at the moment we appear to be some way off that.

One of my real (and clearly biased) issues with offshore has always been the dominance of engineering and operations people who were feted as their skills became so scarce in the boom. Offshore contracting isn’t at a base level a complicated industry, the execution can be, but the economics is relatively simple. Yet for years the “black magic” of operations has been allowed to obfuscate the economic issues, engineering could dominate all other disciplines because there was no cost pressure. First oil mattered to the exclusion of everything else.

But in order for the industry to move ahead, financial investors need to face reality as well. How low could subsea vessel prices go? Look at the rig market: Ocean Rig purchased Cerrado at c. 10% of cost and the Deepwater II cost NOK 7.3bn (USD 870m) and sold for USD 210m.  Subsea 7 sold the ROV vessel Petrel for c. 7, maybe 1/3 of book value. A wave of bankrupt OSVs are coming to market and some sales are close to being announced which may set new benchmarks. OSVs in general are a classic case of asset specificity. But what gives them such high values in a boom market also works in a counter-cyclical way on the way down. That’s a complicated way of saying if you build a ship that’s really good at one thing, and that thing isn’t needed anymore, it’s not worth a lot regardless of how much it cost to build.

Nothing seems more financially irrational than the behaviour of the Nor/Harkand bond-holders. Having taken re-delivery of the vessels from the Harkand administrator in 2016 they then proceeded to move the vessels to Blyth in hope of getting work. The fact that no consultants were engaged to provide some guidance on the regulatory requirements and operational realities of getting work shows how truly out touch these investors and advisers were. Even a basic knowledge of the North Sea DSV market shows that there are only five serious companies and all were too long on tonnage, with massive (non) utilisation issues of their own fleet, and therefore these vessels were simply going to be tied-up quayside. There are enough data providers out there for this not to have been missed.

Apart from Technip, who had used the Da Vinci before, anyone wanting to use these assets would have had to invest in bridging documents from the vessel dive operating system to their company HSE system and then get HSE approval. Its not impossible, ISS did it with the Polaris when they brought it to the North Sea, but its probably 4-5 people taking at least 4-6 weeks. It’s time-consuming, process oriented, work. Then you need to get HSE approval which needs a few weeks best case scenario. And that’s before you tender for work because no one is going to award you work on the off-chance something goes wrong on your approval process. And more importantly, why would you bother? There are five companies in the market with really good assets and track record and they don’t have enough work for their own boats and are bidding at less than OPEX just to get the vessels away from the quay? Economists call this market an oligopoly: a few firms dominate it. In a period of oversupply it leads to an efficient market where there are no economic rents to be made by these firms. In plain English it means they compete on price and there is no economic room for new entrants.

For this reason there has never really been a spot market for DSV charters in the North Sea, it’s actually the opposite, you need to control an asset before being seriously considered for work. So in reality there was never any chance of the Nor/Harkand assets getting any work at all in 2016 as any independent party could have pointed out (saving millions in transit and operational costs).

But what the Nor/Harkand investors lack in humility and foresight they make up for in intractability. These vessels, having sat around for the better part of 9 months without any work, raised USD 15m in November last year giving them more time to pursue exactly the same strategy for longer. Like Haig at the Somme, no amount of money is too great to commit to proving their point, against the face of all evidence to the contrary, that the North Sea market is going to bounce back. The Nor/Harkand vessels, like Vladimir and Estragon, wait in Blyth to take advantage of a break-out of demand so extreme all the current dive contractors are going to suddenly go-long on two more vessels and allow the whole crazy cycle to start again. [And it’s actually more than that because with the Vard new-build and a couple of other you could add 20% capacity to the market almost instantly.]

To be fair I met one of the distressed investors who said to me “if they were going to win work with this strategy they would have done it last year, hopefully we’ll have to so another cash call and I can buy some more when people realise how bad it is”. I get that….It’s not quite as irrational as trying to put the Cal Dive band back together, but its not that far off either.

The Atlantis and Davinci are totally unsuited now to the North Sea market (where demand meets supply as opposed to strictly environmental factors). As DSVs go they clearly have the technical capability to operate in the region but the real question is who would need them and for what? One of problems with DSV is that because you cannot put a diver down more than 300m, the same technological boundary of 30 years ago, newer vessels offer few advantages over old ones, and certainly nothing price cannot fix.

E&P companies buy DSV time on 5 criteria : 1) the operator, 2) the SAT system, 3) the crane, and 4) deck space 5) schedule. A DSV is a compromised vessel on everything compared to a general purpose OSV unless it’s working as dive vessel. If you are not working as a dive vessel what are you?

Obviously as an operator the Nor/Harkand proposition doesn’t make sense. There is no infrastructure, management team, capital or long-term plan that would make someone buy a complex project off them. Using a bunch of subcontractors to replicate a solution that other integrated SAT dive companies could provides a solution for Nor but not for the customers. Nor seemed to have recognised this and have stated explicitly they are not seeking dive work… but then what are they seeking?

As ROV vessels the Atlantic and Davinci don’t work: they are over specified and too heavy on fuel. M2 have ROVs on board, but they have also struck a deal on the Go Electra, and need to build their first year campaign around this vessel (which is a great ROV vessel and full credit to the guys here). Who would cover tendering costs, bid bonds, warranty issues etc? I will write on ROVs soon, but they are shaping up to be an extremely competitive area with everyone from start-ups to established companies having access to a huge variety of custom ROV tonnage these assets simply aren’t needed in the market,

As a heavy-lift vessel they don’t work. The cranes are rated at 140t but that is double fall. More importantly, these vessels have not worked doing lift operations in a long time. Anyone looking to do a decent lift isn’t going to save a few dollars to have a temp crane driver do the lift offshore on an asset that hasn’t worked in a year with an offshore team that has never worked together.

In the current market where every asset type is oversupplied these assets simply have no logical market space. Simply being cheap doesn’t help because everyone is cheap. The Nor bondholders are soon likely to find that their USD 15m bazooka is actually a pea-shooter and simply will not convince potential customers or buyers they are here for a long time. Long-term DSV charters are extremely rare, and at the moment some of the most contested contracts around. Everyone is competing on price so Nor offer nothing. And there are NONE in the North Sea where their vessels are.

Nor have a basic commercial problem: no one wants to buy what they have to sell. Nor need a massive change in strategic direction. However, Maritime Finance Corp, the largest shareholder, appear committed to following this strategy to its logical conclusion (another fundraising round after months of no work) as to pull out now would mean owning up the residual value of the assets being significantly lower than they would like. MFC purchased about 37% of the bonds on issue meaning they put in c. USD 81.4m in 2014. In the current market you would be lucky to get that for both vessels implying that MFC would have to write off c.50m (i.e. 37% of USD 80m is USD 30.1m).

Moving the vessels out of the region means owning up to the fact that they aren’t worth all the extra money above an Asian or US flagged DSV. Keeping the vessels in the North Sea requires an act of faith, a contrarian view, that diving in the UKCS will bounce back. Sooner-or-later this strategy must fail. The core point is this (thanks to DNB):

The UKCS and NCS saw a boom in oil and gas investments post the financial crisis in 2009, particularly the former, where development capex increased by ~125% from 2010 to 2013. The rebound in the oil price made several smaller projects economically attractive, and a sizeable majority of these were developed as subsea tie-backs. In addition, ageing infrastructure needed significant upgrades to accommodate a much longer lifetime than originally envisaged, and new production from smaller fields…

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.

CAPEX is at 1/16 of previous levels. The CAPEX vessels are trading in the OPEX market and will do for a significant period of time given lead times. A small CAPEX project could easily take 180-270 DSV days, that work simply doesn’t exist now, and Technip and Subsea 7 have moved their corporate resources back to IRM. A strategy to add capacity, without infrastructure, in a brutally declining market, against better-capitalised and more committed competitors, is economic madness.

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