The market isn’t coming back anytime soon… Asset values will suffer.

“It’s not the despair, Laura. I can take the despair. It’s the hope I can’t stand. ~ Brian Stimpson, Clockwise ”

I have been struck over the last couple of weeks by the contrast between the rig market and the subsea market. OceanRig, Seadrill, Vantage, all seem to be realistic that the equity is nearly gone and the previous business model was unsustainable. Borr Drilling has shown that with a clean balance sheet, and access to assets at potentially “low point” pricing, and a clear cash runway to 2020, you have something investible. It’s a punt, but at least one with a plan. Subsea and offshore seems some way away from this reality, Rigs lead the market in terms of creating demand and it seems the sheer scale of their financial needs has made them face economic reality to a greater degree as well. At least the rig guys have a plan, which is not something you can say of subsea yet (apart from sitting around until the market recovers).

I haven’t had a lot to say on the EZRA/ EMAS situation since Chapter 11 mainly because I don’t have anything constructive to add apart from the fact I think it is good for the industry to have this supply side capacity reduced. US Chap 11 is a court run process, and not one I know much about, the only thing I am sure here is that there is a very complicated problem coming regarding the Lewek Express. In order to frame it properly I ask the question can you be a boatless contractor?

The banks now own this asset, although Bibby was in court a few days ago trying to spread the cost of arresting the vessel with the fellow court participant Waksey Bridges, but I expect eventually the banks to have this asset returned, and then, what do they do with it? Even if the US judge returns EMAS Chiyoda to the market free of onerous charters, like that of the Lewek Express (and everything else) then all that remain is a project management company with perhaps the ability to charter ships? But the new owners aren’t going to put enough capital into the Newco to charter the Lewek Express, and without this asset there is no real point to the company. The reason subsea construction companies own vessels is because they have an asset specificity issue: it is cheaper once all the integration and contractual costs are included to own one.

If you try and charter a deepsea pipelay asset who pays for the liquidated damages if it arrives on the site late? Who pays if you buckle the pipe? Who pays if the vessel doesn’t lay at the speed forecast? These issues go on ad infinitum. And yes you can solve them all contractually, but the whole point is it’s cheaper to own the vessel than do this contractually. In the boom days you also needed the vessel to actually have access to one, and for the sort of work EMAS Chiyoda was chasing that is still the case: Technip and Subsea 7 aren’t going to charter them high-end vessels to do deepwater lay. Saipem might as it starts to get desperate enough, but actually they will just bid lower and cross-subsidize the engineering with sub-economic vessel costs. Without access to a vessel EMAS Chiyoda is just a project management house without a boat, no sane investor in this market would create more capacity by injecting equity in a company that would have to charter a vessel off a bank that requires years of tendering before it could win any project work. Remember the cash cost of running the Lewek Express is at least USD 15k per day, so someone might buy it for 100m but they are not buying it at anything like a level that will keep the banks whole.

I see no future for EZRA, EMAS, or EMAS Chiyoda. The first two were too long on vessels and the third simply isn’t viable as a boatless contractor and the market doesn’t need one. A court can’t change an economic reality. The only real question of interest is what percentage recovery rate the bondholders get and what the assets go for?

But at least the drama for this is in its final stages. The North Sea DSV farce continues. I don’t know who should be more terrified of the Bibby results: Bibby or the Nor Bond holders?

The Bibby results were as bad as feared, they actually could not have been any worse, a GBP 10m write-off to EMAS Chiyoda being the real low point of the US expansion strategy. A £-52m Operating Profit indicates a business model entered into in much better times and limited ability to change it as the market declines. The profits from leverage are so great in the good times succumbing to the temptation to go too long on vessels is hard to resist. And so it proved at Bibby. With the Olympic charters (Bibby and Aries) having significantly more time to run (late September 17 and June 18) unless the market changes significantly its a question of when, not if, the restructuring process begins. Customers should sign up now because the contracts will be novated across. The real question is why the bonds are still trading in the mid-60’s which implies an Enterprise Value of £105m, which for a business consuming cash at that rate seems extraordinary. Even stripping out exceptionals the business seems to be going back at £100k per day in cash terms.

I have to be honest and say I don’t think the solution here is to borrow more… The solution proposed seems to be that Bibby Line Group put £10m into the revolver and Barclays open it up for £20m more. If Barclays really follow through and increase their borrowing limits to fund this then they are braver than most commercial bankers; by putting the money in at the revolver level Bibby Line Group would guarantee themselves a seat at the creditor restructuring table, something Barclays and the bondholders are unlikely to welcome. One bondholder has already asked why the BLG £10m (50% of the dividend they took in January 2016) contribution to the revolver wasn’t put it as equity? The answer is BLG has enough accountants not to be that stupid: it’s a risk-free loan (given the revolver has seniority over the bonds) or nothing at this point from Group for Bibby Offshore.

But Bibby got DSV utilisation up to 77% which is impressive. I have put a little comparison in with the Nor vessels:

Bibby DSV Utilisation:      77%

Nor Atlantis Utilisation:    0%

Nor Da Vinci Utilisation:   0%

The problem isn’t that there isn’t any work out there the problem is no one wants to buy what Nor are offering, and this despite the fact The Contracts Department (“TCD”) claimed that they had a plan for the vessels and they were the first point of call people would naturally go to for the vessels and associated work (or so I was told by AMA Ca[ital the bondholders financial adviser). It is hard to know if TCD actually believed this, in which case they aren’t close enough to the market to know what they are doing, or if it was a cynical ploy to extract some money from a dispersed group of clueless financial investors. Most rational people would think sitting at Blyth for well over a year, waiting for the mountain to come to you, was not the most cunning plan, and as sometimes happens the madness of the crowds was right in this instance. The Nor vessels have turned into a rort for contractors and service providers, the dive systems are being maintained by a company whose previous strength was in mobilising Ampleman systems, the Contracts Department are fighting with them now (no doubt to try and get their friends at Rocksalt on the vessels), and there is no economic incentive for any party to actually save the Nor bondholders money because they don’t know when this gravy train will end, so just front load the returns everyone figures. The only work, for one vessel only, appears to be in the Middle East where Nor are one of 18 bidders. Nor Offshore remains a salutary reminder that financial investors can continue to get taken to the cleaners by Ops personnel who realise how limited the general financial investors’ knowledge of the asset is. Any serious charterer or buyer for the Nor DSVs  just needs to sit around until November now, when the owners will be nearly through their USD 15.9m, without having worked a day, and get the firesale price they demand or force them into another complicated fundraising (given the last USD 15 was “super senior”). Given Subsea 7 fired up a DSV for 200 days for Apache the logic of this strategy has really been laid bare for all the risks it entailed.

But unfortunately for Bibby they have got utilisation up by getting real on price (and it’s a credit to the operational managers who have got utilisation this high). Day rates for DSVs have been as low as GBP 75-100k for SAT diving (and the divers/ project crew are £50k of that), there is precious little in the mob fees etc. All that is happening is that equity is being eroded (or is gone), and older DSV operators, who have depreciated the vessel, are at an advantage over newer owners, who must at some time try to recover their capital. Scale and scope count at this point which benefits Technip, Subsea 7 and DOF.

Everyone is chasing wind farm work, but as all those involved in the industry know it is hugely margin dilutive, even if it gets you utilisation, it comes with greater contract risk. Civil contracts are used (not LOGIC), variation orders are hard to get through, there is a greater reliance on free issue equipment etc, and because production doesn’t bring “first oil” there just isn’t the ability for a contractor to make as much money.

I stand by my previous statements that unless there is a substantial pick-up in construction activity this is the new normal in the North Sea DSV market. IRM has reached its lower limits and will not drop more. But Subsea 7 and Technip have introduced new tonnage, and USD 50 oil just isn’t enough to get new projects launched that are based on the “small step-out/ infield” model that drove previous construction booms. Both Bibby and Nor seem to be like rabbits stuck in headlights just pretending that if they wait in the middle of the road long enough, and with enough determination, the good old days will return. Unfortunately for the rabbit it takes a road a very long time before the road returns to it vegetative state, normally longer than the rabbit can last.

 

These cases are just microcosms of a bigger problem which not enough people in subsea have realised in my humble opinion: the fabled recovery, the great hope that everyone holds out for doesn’t seem to have a good economic foundation: supply has increased, demand dropped dramatically, and the “constant” of maintenance work proved to be illusory. At some point asset values are going to have to reflect the fact that OpEx has remained constant (these costs have “nominal rigidity” due to the high labour input), and therefore it is an identity that the asset values must be lower when overall expenditure is capped. Getting there strikes me as a painful journey that has just begun.

DSVs and pipelay vessels have in common that in the old days (c.2014) banks and bondholders would lend against them and that made asset values higher. This downturn has shown how illiquid these assets are, and in the worst case scenario even running them while waiting to recover the costs can entail significant cash expenditure. This means quantitatively the assets are worth less: they will be financed with less gearing (if any) and the payback period will need to be shorter. The biggest change in offshore finance going forward will I believe be the realisation of this factor creeping across the industry: smaller players will struggle to come close to matching the financing advantages of larger companies, a situation that has never before existed in offshore. On any rational basis, the industry will be financed with a significantly higher degree of equity than people were used to in the past and that pool of equity will be chasing more limited financial returns from projects. This will lead to significantly lower equity returns for an extended period that will dry the investment market for all but the best companies and business models, and the slow, inexorable, correction process will continue… just like the rig market, only slower by the look of it.

4 thoughts on “The market isn’t coming back anytime soon… Asset values will suffer.

  1. Welcome back Mr Jeremy Punnett, I wonder if you have time or inclination to write a more few words on the subject of Mr Fredriksen’s and Mr Troim’s recent activity. I see you have just now written that it’s a punt, but can we read anything from the prices paid to acquire the new Northern Drilling and Borr Drilling assets about future cash flows or expected or achievable rates-of-return? Both companies appear to have drummed up an amount of equity participation, I suppose this echoes what you have written about equity participation. Where might this money be coming from in these cases? Wealthy Norwegian people? Institutional or sovereign sources? Or somewhere else? I believe Schlumberger has become involved, possibly in some kind of joint arrangement or as some kind of associate. Beyond this, what does it mean to be letting down Seadrill with one hand while lifting up a new venture with the other? Also what does it mean for other existing offshore drillers. I don’t mean to imply that Mr Fredriksen knows more about where the price of oil will be in the future than anyone else does. But I think you have written somewhere on this blog that it’s better to buy with him than from him. Maybe there is a minefield in speculating about this stuff online, I don’t know

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  2. No comment on the asset value shown in Bibby’s accounts? Most vessel-owing businesses have been reporting huge asset impairment charges and yet Bibby still has tangible assets of £110M That seems a bit unrealistic for two older DSVs and a fleet of ROVs.

    The balance sheet values may have been sense-checked by an independent broker before the accounts were signed off. They will have cited a lack of transactions as the main difficulty in establishing a market price. But there was a recent transaction for a similar fleet of ROVs (ex Harkand) which is at least a 50% discount on the pre-slump valuation . And only an eternal optimist would value Sapphire and Polaris at a sum significant enough to justify their carrying values.

    I suspect this is why the bonds are trading at current prices. The reality of asset values is not yet reflected in the published accounts.

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    • I agree entirely. The FMV for those assets is well below that level. I didn’t comment for space and other reasons. But the main one is that the market for those assets is so illiquid it’s very hard to get a realistic number. As you say it’s certainly not 110m. I meant to draw that to my point about lack of knowledge in the investor base but I forgot.

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