The Economics of Constraints and (Really) Deepsea Diving…

It’s a poor sort of memory that only works backwards.

Lewis Carroll, Alice in Wonderland

In historical events what is most obvious is the prohibition against eating the fruit from the tree of knowledge.

Leo Tolstoy, War and Peace

One of my frustrations with offshore/SURF is that despite the mathematics of engineering and economics being the same, both are really optimisation problems, there is precious little of the latter influencing the former in offshore. A classic case of this came in Frontrunner today where there was an attempt at a serious discussion about diving below 300m. Now I accept that this is technically possible, lots of things are technically possible, for a billion dollars you can probably get NASA to take you on holiday to the moon, but because not that many people want/are able to spend a billion dollars on such a holiday there are very few companies offering this as an economic choice. If money is not a constraint then you have few constraints, but in economics and business money is always a constraint.

Diving at up to 600m is definitely technically possible, but it would be economic lunacy. Don’t get me wrong if I was an equipment supplier I would want to believe it was possible as well, but that doesn’t make it viable. There are so many realistic economic and organisational constraints on this I can’t be bothered going into them all, but here are a few, all of which are complete showstoppers:

  1. There is no market: the list of marginal field developments that could be made viable between 300-600m of water if a DSV could be used is minimal, even on a global basis. Most shelves drop off completely below 300m and there simply no proof that there are suitable reserves that could be tapped by this technology
  2. In order to service this (non) market you would have to build a 600m capable DSV completely at risk (which is admittedly what UDS claims to be doing), budget $160-185m, then prove the technology and procedures, which will be months of testing and practice dives etc, and only then be ready to sell it, all the while burning vast amounts of risk capital. Then you would need to get a bunch of global oil companies to change their entire HSE approval process, which will take years, and get this to coincide with a project approval process. This strikes me as an enormous barrier because even if you could prove this worked there is no demonstrable evidence of the long-term health effects on the divers and you risk creating an abestos like residual legal claim on the oil companies (as the diving contractor may be bankrupt) for approving this. And then, and only then, years after building a 25 year asset and burning through working capital you might, just might, win a project competitively tendered against an ROV solution. That is without going into IMCA, class, various regulatory agencies etc. All this for a project whose financial upside must by definition be capped at what a comparable ROV service could deliver the project for. So a venture capital investor has no possible way of making a returns in the 100s of % to cover the risk. Literally nuts.
  3. ROVs are currently oversupplied and operating below their capital cost, and are likely to for an extended period, so not only would this harebrained plan have to compete for work against the above constraints it would have to with competitors who will be selling at below economic cost

If you speak to divers who go below 250m they will tell you the joints hurt and they really notice the pressure. It is not a popular depth to dive at. Subsea 7 and Technip now have special dive procedures in place for anything over 200m and there is enormous resistance to diving over this depth level even if you could prove what it costs. Changing this organisational inertia for marginal benefits only just don’t represent a viable economic time/cost trade-off.

This is just a classic case of someone trying or thinking of doing something because it is technically possible not because there is any economic rationale to it. The idea is so DOA from an economic perspective it doesn’t bear serious analysis.

SOR also make the following highly questionable claim:

Sources close to the scene, suggest BP’s huge west of Shetland Quad -204 redevelopment might have cost a third of the total bill if the project could have used divers. [Emphasis added].

Now the best estimate of the costs I have is £4.4bn ($5.7bn), but that includes drilling, fabrication, control modules, a FPSO etc. Traditionally the SURF installtion scope is 10-15% of the total project budget, so at best what I think SOR mean is they could have saved 1/3 of this… so maybe 5% of the total budget. But that is a pretty minimal saving in the scheme of things and exposes the installation to a lot more weather and other operational and contractual risks. For a 5% saving on the overall cost you would have exposed yourself to having a minimal choice of assets to complete the task and run the risk that all future OpEx operations would have to be done by divers (i.e. no ROV handles) and that needs to be factored in to the total economic cost.

[But if I am wrong I am happy for SOR to publish some more detailed information to correct my erroneous logic and I will happily publish a correction having been suitably educated].

But again the Quad 204 cost statement avoids the economics of this situation: if Quad 204 was going offshore in 2014, when every North Sea class DSV was operating at capacity the job would probably have cost more because DSV rates were at a premium. Re-bid the job now and you might get a different answer. Markets are dynamic not static. So there “might” have been a saving, but there is a much smaller North Sea class DSV fleet than ROV fleet that “might” have been busy, or it might not, and the saving would have been dependent on that. And surely the losing contractor would have gone back and offered to make such a substantial saving? But whatever the situation it would not have transformed the economics of a project the size of Quad 204 as suggested.

Interestingly the whole Frontrunner is relatively bullish on diving. Although, frankly any previous investors in vessels backing MEDS would be amazed if their ability to get hold of a vessel should be seen as a sign of confidence in  the market given the losses they have suffered on the Altus Invictus and Altus Extertus (disclosure of interest: I was a Director of one such company). I don’t think SAT diving is going to go away, that isn’t what I am arguing at all, but until significant CapEx projects involving DSVs return to the North Sea then the market on any reasonable basis remains over-supplied and day rates and utilisation levels will remain under huge pressure.

SOR has been at the forefront of reporting the creditors involved in the rescue of Bibby Offshore and I’d be interested to know if they have a consulting relationship with any of the bondholders who they have named? Either someone very close to the deal is speaking to them or they are working on this deal… And you would really have to believe in a degree of bullishness about diving that isn’t grounded in current market reality to buy into the Bibby deal at current value levels…. And frankly any financially rational actor would be more than a little nervous now Boskalis have the Nor vessels… contracts for small DSVs in Brazil won’t save the North Sea market…

I am wondering if a lack of clear economic thinking has permeated the deal for the investors, maybe they have been blinded by perceived benefits such as 600m diving, because when you have to get management to warrant that:

  • Within the next 7 days, Bibby Offshore will appoint an independent consultant on behalf of the noteholders to support management on the ongoing cash flow management and transition of the business to the new shareholders.

you clearly don’t have a great handle on the business or what you plan to do with it. This could well be a classic situation of the “Winners Curse” in M&A.

At the time I had worked with two seperate hedge funds who were also looking at the deal. We valued the business at ~.08 – .15 of the outstanding bonds (£14.0 – 26.5m) reflecting the new working capital required. Different people have different perceptions of value and therein will lie the answer to who makes money on this deal. A 2 x North Sea DSV operation, focused only on being a low cost operator, was the plan. In order to get to a bigger number you need to back a platform business to expand. No one outside of the large contractors has made diving work on a global basis as there are no economies of scale and procurement is all regional and follows different standards. So in order to recover £115m Enterprise Value York & Co., are backing a subscale, loss-making business, in an industry that is consolidating with large competitors, in a market with huge cost pressures. Traditionally that has been a poor route to value creation… but it is also true that counter cyclical investments generate huge returns. The hard part here is that because of the lead times for projects (which are well documentted), and Bibby’s own investment documents show, this is a market forecast to grow at CAGR c. 7%… roll the dice…

2 thoughts on “The Economics of Constraints and (Really) Deepsea Diving…

  1. Exceptionally thorough, J. You’ve come at this bottom up – literally – economic long term viability of >300m sat diving. Haven’t read FrontRunner of late but they obviously haven’t woken up and smelled the ☕️ At macro level (supply side), Russia has 700k square miles of territory which reputedly will yield shale oil & gas – another giant nudge that’s on the way!

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