Free money in offshore and Hoyle’s Fallacy…

During a boom, the expansion of debt-financed investment spending causes initial “robust” financial structures to evolve into “fragile” financial structures, and it is this evolution that ultimately brings the expansion to an end. In the subsequent contraction, typically some fragile financial structures collapse while others are refinanced into more robust financial structures, thereby creating the preconditions for renewed expansion.

Perry Mehrling

There is an old joke in economics (really!) about two economists walking down the street, one of them notices a $20 bill on the pavement and says, “look there is a $20 bill”, and the other one says “no it can’t be, someone would have picked it up by now”… (control yourself I know).

In a way it’s a geeky, very dry, insiders joke about the nihilism of neo-classical economics, and its inability to explain well the endogenous nature of economic change. I mean how do you explain the success (in product development and capital raising rather than financial return terms) of Tesla? Surely electric cars as a business model would already have been invented before Elon Musk if there was a real opportunity? But the (sic) joke also points to a deeper economic truth about innovation: that there is generally a very good reason why something isn’t being done, and that free money, ideas that haven’t been thought of before, are a very rare commodity. Which is why of course innovation can be so rewarding.

I say this, as yet again, I have read a claim about a company building a fleet of the world’s most sophiticated DSVs, that has miraculously, in the worst OSV/DSV market ever, managed to bag it’s second long-term contract for a new build DSV. Details are scarce, but the Americas is mentioned.

Now it is highly unlikely for a tornado to rip through a junkyard and assemble a 747, even if all the constituent parts are there, an idea commonly known as Hoyle’s Fallacy. It is just as unlikely in this market, that a company, would manage to find two counterparties, in two differing geographic locations, willing to sign an economic charterparty, for a multiyear period, when no one else in the industry had heard of these contracts or been given the chance to bid for them, and that these have real substance.

I could spend hours here writing about how impossible this is: Why would a contracting company give free money away (by paying a higher than market dayrate) by not using a shipbroker to get various bidders into an auction process? Does the vaunted fuel economy of these new vessels, which could be no more than 2 or 3 cubes a day in DP, so max $3000 a diving day, really cover the capital cost of a $150m new build when a near identical unit sold second-hand for $60m (and lower on a blended price)? Who are the oil companies willing to pay above market rates for a new DSV which offers no operational advancement on current functional technology? Who are these small companies that have so much DSV work they are going long on assets while established players lose money running high-end DSVs?

Or I could mention that the current charter announced has gone to a 4 year old Malaysian company, with limited operational experience, in a market where people have been lucky to get OpEx or above for years, and the leading buyer in the market has encouraged vessels like the Stephaniturm? Have Petronas really decided to pay above market rates just to have a shiny DSV? Anyone who has had to negotiate a contract with them, and been through the extraordinary lengths they will go to in order to save minimal costs, will find this idea fantastical in  the extreme. Who is this company in the Americas with the financial resources to charter one of the worlds most advanced DSVs but without the commercial skills to get involved in a competitive auction? I’d almost bet my house that this will emerge as a Mexican company, in which case satire is dead.

But then I would simply be playing the same game… And as I am going skiing on Saturday I am time constrained and it’s boring. Because these things go back-and-forward without looking at the bigger picture: which is that clearly it can’t be true that these are economic deals or a charter party like a 365 BIMCO time charter as the statements imply. The only thing I know for certain here is someone is getting less money out of this than they thought: if it’s the yard, then they are not getting the full build cost of these vessels on delivery, or at any point in the future (on a real basis); if it’s investors then they are not getting a charter that covers the investment cost, or any mixed scenario of the two or some other third scenario I haven’t thought of.

It is simply not possible in a market with such informed buyers, and as many shipbrokers working, who make the market structure for assets with such a high degree of specificity nearly perfectly competitive in a down period, that one company could assemble a veritable 747 of contracts from the primordial soup of DSV demand. The only question is here: who is going to take the financial hit and when?

This is one of those situations where a business model cannot stand serious economic scruntiny. It appears in essence to involve delivering the most expensive assets, without long-term and fixed time-charters charters (that reflect financing cost) into an over supplied market, with extremely high running costs, and lacking credible counterparties. People like to say nice things about start-ups, and I understand why, it’s a hard thing to do (as I can personally attest), but just like Enron, Railtrack, and countless other examples, if something is too good to be true it is (not a 747 or a $20 note).

I am going to write my predictions for 2018 while I am skiing (I don’t think I did a bad job of 2017 if you want a look here, pessimism was warranted), but one of the things I am convinced of is that in 2018 substance will count. Companies that claim they will grow 50% in this market are simply dreaming, and companies that claim they can find work that no one else is bidding for, or can deliver on are just as delusional. Unlike late 2016 (going into 2017) people are now aware there will not be an elastic bounceback for the offshore fleet, and as the cash running costs are so high, as the pay-off so uncertain, funding costs will increase dramatically, and the Demand Fairy will not save everyone despite a better market.

To everyone who sent me nice wishes about this blog thanks. I have sometimes wondered where I am going with it, and it hasn’t always gone the way I planned, but it has involved a fair bit of work so I appreciate the positive feedback. Have a safe and merry festive season.

5 thoughts on “Free money in offshore and Hoyle’s Fallacy…

  1. Morning Jeremy

    Hope this reaches you. I wanted to give you some positive feedback on your blog. It is excellent and in my opinion very perceptive. A big well done.

    We never did catch up a few years ago. You were involved then in that Red 7 charter. So pre oil industry collapse maybe. I cannot remember exactly when.

    Are you still in Twyford? If so when I get back to Southampton on a visit (I grew up there if you can vaguely remember) I will buy you lunch at The Bugle if it suits. We can exchange views.

    Happy Skiing and all the best for 2018.

    Festive wishes

    Mark

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  2. Shock and awe ! Thats what i went through when these UDS DSV stories surfaced. Either somebody is living in fool’s paradise or they have the balls of an elephant and of course, an obscenely wealthy sugar daddy. Beats me anyways.

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  3. Thanks for your precious comments Jeremy and sorry for reading them like a parasite and not witnessing my appreciation as often as I should 🙂
    Having been so long in the diving industry I share your concerns and I think that rather than rain-dancing for the industry recovery we should try to diversify our product range and to bring innovation to the business.
    Nevertheless it is curious to see how people in the same situation have different reactions, and some of them seem to continue double-betting of the DSV table.
    I also ask myself if the appearance of these “charters” you are tracking is a tentative of some people to convince their own investors? Or clients? Or to convince themselves?
    In all cases, even the smallest players in the industry have access to the specialized press on-line or cannot consult with third parties, to verify the seriousness of these odd commercial proclamations.
    Except ….

    … if you are a local Chinese investor who doesn’t speak English? Working with China for long time I have personally learned there are many.

    If you need to buy time with some Chinese money who doesn’t know the offshore industry and you want to bring the vessels far from China could this be a strategy?
    I don’t understand how to bring this further, or I don’t want to make groundless assumptions here, but could a Malaysian or any other unconventional flag help to get rid of the investors in case of bankruptcy?
    Or buying time is simply better than not having time left?
    We can continue the discussion over the email, happy new year and thanks for sharing your precious knowledge and intuitions.

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