Affirming the consequent: Standard Drilling and vessel recovery…

A ship is at best an opportunity and at worst a liability.

Anon.

If you wanted to pick on one company to highlight how diminished expectations are of the offshore sector SDSD, down 66% for the year, would be a good candidate.

I think its great that if investors want a counter-cyclical investment vehicle they have one, but I just don’t think there is any industrial strategy here at all, and it is really hard to see how this can ever make money without some sort of extraordinary market movement. Depreciating 2007 and 2008 built PSVs, some of which required upgrades to DP II,  must be the ultimate “have faith in offshore” investment. Let’s have a look at the SDSD strategy:

Strategy.png

The thing is that Standard Drilling sold all the KFELs units prior to delivery, so maybe its been lost a little in the translation: but quite why buying assets in a booming market and selling them prior to delivery illustrates the success of buying minority shares in PSVs and putting them in lay-up in the worst downturn to hit the offshore vessel sector is beyond me? Just because I am good at rugby is unlikely to make me good at cricket (and the company isn’t called Jeff Wilson Drilling). The logical error is I believe called affirming the consequent.

It doesn’t mean you can’t make make money from this: but you are taking not only asset risk, on the vessel prices, but market risk on the stock price as well. So it’s not ideal (although you would think in this case they are highly correlated).

My broader point is that offshore supply is probably at the absolute nadir for demand. The PSVs working are supporting working operational infratsructure, or the few rigs working, and it probably cannot get any lower. But as Maersk Supply reported this week there remains an industry characterised by revenue at opex levels and huge oversupply. The SDSD are primarily older and/or in layup. The original plans to operate the vessels at cash break even, or above, and try and pay dividends. Even if one or two projects manage to achieve this there is no chance of this happening at a corporate level. Quoting historic vessel values I also think is a little absurd given the whole point of accepting the scale of the current downturn must mean they want revert to their previous implied value?

Look I don’t have an issue with this: SDSD has allowed the public a show of the price discovery mechansim that is identical to how many distressed funds viewed these types of investments. The fact is at this time last year, when the world seemed a different place, people thought the market couldn’t get any worse, and the plain fact is that it has. Substantially both at an asset value level and an operational level.

In specialty vessels Nor Offshore raised USD 15m almost to the day at this time last year. Now the reports are Fearnleys is basically trying to get them out completely as you can see from the SDSD share price graph that the cost of equity financing these vessels without visible backlog must have materially increased.

Longer term I don’t really get though how European companies, burdened with bank debt that the banks are reluctant to write-off, are going to compete with the likes of Tidewater and Gulfmark? SolstadFarstad must be the most worried of all the European companies given their commodity tonnage exposure. Sitting on a bunch of Asian built AHTS and PSVs from DeepSea Supply with inflexible European banks and no Chap 11 possibility must seem like a Sisyphean challenge at this point in the cycle.

But in the Tidewater’s case all the investors had an incentive to save the operational company to maximise value, whereas in the SDSD case the asset manager is paid regardless and isn’t making the returns required to back the assets.

Bassoe noted this week that they expect nearly 340 rigs to leave the market permanently. If you assume that supply vessels now are serving the base load of work on production assets and maintenance associated with them, and that a meaningful part of the E&P rig fleet that drove demand  will be scrapped, you need a real good story to explain a recovery play in offshore supply. There is more pain to come for investors before the market stabilises I feel.

 

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