“As all of us were taught, but most of us have long since forgotten, economic change occurs at the margin, where the action takes place… individuals who can think on the margin always have an advantage over those who cannot.”
I have seen a lot of press coverage regarding the McDermott/ Amazon deal. The word “steal” has even been used. I’m not convinced. Let’s take the upper limit price of USD 80m. For that you get a big, a really big (200m), ship with enormous deckspace and two 400t cranes. I take it from the McDermott comments that they are ditching the G-lay spread and going for a straight J-lay spread. I don’t know how much of the Huisman system they can raid for the new system, but I bet not much, and a new system is likely to be in the USD 75m-100m range. On that basis they didn’t get the vessel at an 80% discount to new they got the vessel at c.50% to new. But as I said the other day the world is a very different place from when the order was placed, which tautalogically is of course why they got the fire-sale price. But USD 50-80m isn’t scrap value and this vessel has a very high operating cost which is essentially fixed.
As a heavylift vessel it’s clearly cheap. McDermott have enough work in the Gulf and Africa to utilise a mutlipurpose vessel like this, and if the market recovers put a J-lay spread on it, and they will have had a cheap option on a deepwater lay vessel. Over a 30 year period it will have been a good buy, and even if the market doesn’t recover they didn’t overpay, so its clearly a sensible transaction.
But since I got involved in offshore in 2005 no segment of the market has changed more than pipelay. In 2005 there were only two vessels that could lay rigid reel pipe (the Technip Apache and the Seven Navica) with the Acergy Falcon and its ancient S-lay system making up a triumverate of possible lay contractors in the North Sea. Vessels such as the Deep Pioneer roamed the Golden Triangle, but they were more riser installation and Allseas and Heerema were serious forces but only did risers and flowlines. There were a few options for spooled flexibles, but these were a niche product and these vessels could generally perform flexlay more efficiently for anything other than short jobs. And these vessels were essentially global assets that returned to the North Sea over summer after completing projects elsewhere.
Globally it was different, and there were options, but mainly because environmental conditions were different. For example in shallow water you could use a barge in Asia, UAE, Africa and the US or use more S-Lay. But the bigger specialist vessels were global assets (the Apache went to NZ at about 8 knots once to build the Maui field!) and made a ton of money off a couple of jobs a year and then spent the rest of the year operating in a sub-optimal operational fashion (maybe doing small tie-ins or flexlay) to keep utilisation up an spread the OPEX cost.
Over the past 10 years however no class of asset has been built up more proportionally than pipelay, and for all the work these vessels used to do on a marginal basis there is now at least one (and often more) specialist assets. Not only that, modular spreads from Aquatic, MDL, and others, have become increasingly large and compete with dedicated spreads for small flowlines/risers and all sorts of umilical and cable lay jobs. If you doubt this check out the size of this MDL kit on the North Sea Giant.
This is a really complicated way of saying that there has been a massive increase in the supply of pipelay vessels and just as importantly an increase in the supply of competitive products at the margin which reduce the utilisation potential of said pipelay vessels. This at a time when the demand for their core services has plummeted. Since 2005 Technip has built a new Apache II (a replacement but with the old lay spread) and Deep Energy in addition to the Deep Blue; it also went out and brought Global Industries to get 2 x s-lay vessels to lay even more pipe (2011). In 2013 Deep Orient joined the Technip Asia fleet, in Africa the Skandi Africa (2015), and four vessels for Brazil with 2 more to come to join the Deep Pioneer. The are geographic assets to reflect the combination of flexlay and risers in the region. Subsea 7 has been just as extreme: Seven Oceans (2007), Seven Seas (2008), Seven Waves (2014), Seven Rio (2015), Seven Sun (2016), Seven Cruziero (2016). All 25 year assets on eight year contracts at best.
Yes there are few of the really utlradeepwater lay vessels around, but they all used to do less complicated work to keep up utilisation. At the margins now are the Normand Vision (Ocean Installer), the Normand Maximus (Saipem), and the Lewek Express (presently chartered by EMAS Chiyoda but soon to be owned by the banks and clearly going cheap). Yes, I get it, they all have their niches and can do things differently, but the number of jobs where they have a competitive advanatge on an asset basis is small, whereas the number where they overlap is large… not to mention Allseas and Heerema.
Pipes and risers need to be replaced infrequently and umbilicals perhaps more so. But nothing like construction demand. So if these vessels aren’t working on construction what can you do with them? They make expensive ROV vessels.
In the new world of pipelay, integration with subsea equipment manufacturer is also crucial. Technip-FMC-Heerema, and Subsea 7- Aker are clearly the two strongest alliances. McDermott-Petrofac just isn’t in the same league. A market only needs two serious competitors to keep margins down, three just keeps the pressure on. Meanwhile Saipem and and OI wait in the wings to keep margins down on less complicated jobs. The TechnipFMC and Subsea7/Aker alliances are spending serious money integrating subsea processing equipment with vessels to ensure that offshore installation (and therefore future vessel days used offshore) is reduced materially to lower project cost and execution risk. Again this adds to the capacity problem in the industry.
… and just when you thought I was getting over the bad news there is Brazil. Petrobras is redelivering some of the flex lay vessels it has gone long on. These will have to go somewhere. At the margin they compete with a large heavylift vessel with a modular installation system, despite costing 1.5x as much, these vessels will globally drive installation costs down. I don’t know if the number redelivered will be 2 or 4, worst case maybe 5, but relative the size of the market its a material number.
I get it: these are not comparable to J-Lay work. But few vessels work in J-lay mode for 365 days and they used this sort of work to split the cost base. Now the day-rates for this sort of “ancillary” work will remain low for years. This will drive lay costs down, and encourage projects that would have been marginal, but this will be cold comfort for you had you invested in a lay vessel in 2013 as the financial returns are likely to struggle to keep the debt holders whole.
So while McDermott may have got the vessel for much less than it cost it to build that cost is almost irrelevant. The assets simply don’t generate the cash they used to, or even likely have the potential to, so they must be cheaper to any rational buyer.
The other thing about pipelay that EMAS Chiyoda (“EMASC”) have shown is that not everyone can do pipelay well. McDermott have huge intellectual heritage, and long term are a credible tier 1 contractor, Technip, Subsea 7, Heerema, and Saipem didn’t wake up one day and have the ability to drop Steel Catenary Risers at 3000m: they have followed a path dependent process to develop what economists call dynamic capabilties:
Dynamic capabilities, unlike ordinary capabilities, are idiosyncratic: unique to each company and rooted in the company’s history. They’re captured not just in routines, but in business models that go back decades and that are difficult to imitate. Lynda Gratton and the late Sumantra Ghoshal called them “signature processes.” They are “the way things are done around here.”
It has taken these companies years, trial and error, and organisational learning to ensure that they can profitably and reliably do this, day-in and day-out. I mention this to highlight that McDermott still has a long and costly process to go through before it can do this. Not only does it need the ship and lay system, it needs systems and processes, it needs to win customers (will the first customer need to be brought?), and in all likelihood it will make a few (affordable) mistakes along the way. Subsea 7, and I am only picking on them here as it has happened to every contractor, lost hundreds of millions on Guara-Lula by underestimating the weather complexity around the final stage of the riser installations in Brazil and the ability of the Seven Waves to perform the hook-up. EMASC are likely to have the dubious honour of never having made money off the Lewek Express for their entire (short) existence. Chances are McDermott will have a few similar issues should it compete in the ultradeep J-Lay segment.
Simply jumping into a market, even an adjacent one, where there are a small number of extremely high risk/ return (and maybe not even that given the competitive dynamics I have outlined above) projects is full of Knightian Uncertainty (i.e. an immeasurable risk). You can de-risk that by buying cheap but I’m not sure that makes it a bargain in terms of risk-adjusted returns.
So McDermott have clearly been smart buyers but very few people actually could credibly put themselves on a path to utilise the vessel and have the balance sheet to do it. If I owned a share on the mortgage of the Lewek Express I would be starting to accept the size of the writedown coming.