Subsea 7, Ingleside, and excess capacity…

Mankiw’s third principle: Rational People Think At The Margin.

Thanks to all those who pointed out the “363″ sale in the DIP documentation of Ingleside to Subsea 7. I still think this agrees with my last post. Quite how this fits with a Helix repossession is one for the lawyers. But it would appear Subsea 7 is buying the Ingleside spoolbase, superior to its own in the region, but also leasing, for a minimum of 2 years, the site on a co-lease arrangement back to an EMAS Chiyoda subsidiary. So yes Subsea 7 gets a better spoolbase, but it also helps keep a competitor and the Lewek Constellation (“LC”) remain in the market. In a world of excess capacity that strikes me as a poor strategic move.

Thanks also to the people who pointed out that Subsea 7 doesn’t have a vessel like the LC in the market. I get they may not have an exactly capable vessel (deepwater reel-lay), but you don’t take on ownership a vessel for one project; and more importantly Subsea 7 should want this vessel to leave the market permanently. Chartering the vessel for BP Mad Dog, and allowing access to Ingleside, which keeps the LC in the market, is just allowing someone entry in the market. Buy Ingleside without a lease, or allow the banks to own the LC and Ingleside, sooner or later they will crack, and just sell it for what they can get. After Ceona I imagine the number of private equity buyers for a subsea business, with a complex asset base and no work, is small. The LC without a decent spoolbase is worthless and the banks, who would really have been in trouble without this agreement, must feel they have a get-out-of-jail card. It will take years to get a sale and some work for the vessel if it can be done. Back yourself to win market share instead of committing resources to help others out.

There might be the odd project each year where Subsea 7 could have won it with the LC in the fleet, but are there really enough to take ownership of the boat when the backlog is declining so much? The good Susbea 7 results today were a virtue of projects tendered in better times and supply chain costs coming down in the final delivery phases. Don’t expect this trick to carry on indefintely.

Subsea 7 may lose the odd big project against TechnipFMC/ Heerema (Aegir), but they were not going to win 100% of the possible work anyway.  One of the problems with subsea is the lack of standardisation, so if an E&P company wants the option of a project that can only be done with deepwater reel-lay, then they expect more than one company to tender. But what if there is a natural monopoly?

A natural monopoly is a distinct type of monopoly that may arise when there are extremely high fixed costs of distribution, such as exist when large-scale infrastructure is required to ensure supply. Examples of infrastructure include cables and grids for electricity supply, pipelines for gas and water supply, and networks for rail and underground. These costs are also sunk costs, and they deter entry and exit.

In the case of natural monopolies, trying to increase competition by encouraging new entrants into the market creates a potential loss of efficiency. The efficiency loss to society would exist if the new entrant had to duplicate all the fixed factors – that is, the infrastructure.

It may be more efficient to allow only one firm to supply to the market because allowing competition would mean a wasteful duplication of resources.

What if the number of projects only supports one such vessel on a rational economic basis globally? Then TechnipFMC/Heerema would bid at a level that would force E&P companies to look at other technical solutions better suited to another contractors fleet and skills and prices would magically adjust. If the E&P companies are so convinced they want more than one deepwater reel-lay system in the market ask them to have a whip around and buy the LC and operate it on a pool basis? Or underwrite the OPEX and dry-dock costs for a few years for a reduction in day-rate when they get a project?

This is economic change at the margin where all the real action takes place. Substitution when prices get too high, and new economic actors finding new solutions. The fact is EMAS Chiyoda could not make the LC work in the current economic environment. Not through lack of effort but through lack of demand. That capacity needs to leave the market and Subsea 7 need to be doing everything in their power to assist that not helping potential competitors stay in the market and depress margins.

You simply cannot see the scale of CAPEX reductions coming from E&P companies for further offshore investment and argue all the large assets need to remain. It is simply illogical at the macro level. If the big five contractors simply refuse to help EMAS Chiyoda here, and there is no rational incentive for any of them to move here given they all have extreme excess capacity, the LC is worthless as a pipelay vessel and the banks will have to sell the spoolbase at its fair market value. This DIP provided by Subsea 7 merely delays inevitable restructuring and may peversely keep industry margins depressed for longer than necessary. If I was a shareholder I would be furious.

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