Greece, Solstad Farstad, and other restructurings…

The recent Greek debt deal is proof that when no other option exists lenders will sometimes do the right thing. Greece it should be remembered was a banking crisis as well as a sovereign debt crisis, and although the Greek banks are recovering five years after the first major ructions they are still on life support from the ECB. This should provide both some degree of hope and reality for Solsatd Farstad when they announce where they are on the latest restructuring this week. I understand that as part of the process the Farstad name will be dropped in October/ November and the Farstad’s will sell out and not be associated with the company.

The banks and investors now seem to be aware of the scale of the problem here and realize that a booming market isn’t coming and isn’t going to save anyone. The high-end AHTS have even had disappointing day rates relative to expectations (hopes?) and the Q2 numbers will simply not bank enough for a long idle winter to give anyone real comfort. And all the while the Deep Sea Supply fleet festers like a cancer on what healthy tissue remains in the body. Now only an agreement with the banks can  provide any long term solution.

Offshore companies remind me of banks in a funding sense, hence why I mention Greece, as the debt dynamics and issues are broadly similar. Offshore vessel operators fund themselves in charter markets that are significantly shorter than the economic life of the assets they buy. Charter periods dropped from 5-8 years in the early 2000s to complete spot market/ at risk vessels by 2013/14. That is complete market risk funding the purchase of a 25 year asset.

Banks also borrow-short and lend-long, in simplistic terms they borrow money as deposits and lend them to businesses for significantly longer periods of time, and while the deposits can be drawn down as requested the loans cannot. There is in effect a funding mismatch called “maturity transformation” which creates value.

This same sort of duration mis-match between the vessels owned and the charter market created huge value for offshore vessel and rig companies in a booming market. Vessel owners committed to 25 year assets, with 10 year loans on 12-15 year repayment profiles, and funded this in some cases purely in the spot market. In trading terms it was a carry-trade with the high yield short term market being funded by a long term lending market. This was a totally procyclical financial phenomenon that meant the short-term market had a pricing premium compared to the long term cost to anyone who took the risk to commit assets to the short-term market. Now, just like a banking crisis, there has been a freeze in the short-end of the market and this is impacting their ability to meet long term commitments. As Paul Krugman stated “if you borrow short and lend long you are a hedge fund and should be regulated like one”, and that is in effect the embedded funding profile of many offshore operators prior to 2014.

That model is now dead, although not completely, but I think this is the most important, and maybe the least discussed, part of the industry change. And there will be change, not through any grand initiative, but eventually as the market recovers and banks lend on offshore assets again they will force the counterparty to have a longer term contract, and gradually the time/duration risk will be more equitably split than it currently is in an oversupplied market. But I think that is going to take a long time.

It will also mean for smaller E&P operators, marginal producers, their costs could increase significantly for assets on the spot market… and they should! Building assets in the tens-to-hundreds of millions and relying on the spot market to clear them just isn’t rational, as is currently being shown. Being able to call up a jack-up PSV, AHTS, CSV or whatever at a moment’s notce and get it delivered in a few hours or days is currently proving to be a terrible business model for asset owners. Longer term the industry should move to larger operators with a series of longer contracts that roll off in a time efficient way rather than everyone thinking they can clear excess capacity in a short-term market. Larger E&P companies will commit to longer contracts and get a much lower margin as a result. Those providing short term assets will have to charge a substantial premium for this given the risk involved but it will be a smaller, risker part of the market, with substantial amounts of equity to cushion the cyclicality required. It is this factor that I think will drive consolidation far more than any cost savings: how much idle time can your business model handle?

The solution is therefore going to look like banking resolutions in Europe. Traditionally that has meant either a) bankruptcy/insolvency (and there is still more of this to come), or; b) a good bank/ bad bank split (e.g. Novo Banco). Solstad I think could eventually go this way: Solship 3/ Deep Sea Supply was an early attempt at this but failed. More radical solutions are needed now but the final solution will end up more like this. In order to compete with Standard Drilling and others in the North Sea the banks behind Solstad would need to equitise their entire expsoure to the PSV fleet and the most likely new “bad bank” starts here. The “bad bank” they already own, Deep Sea Supply, needs to be cauterised. All the banks have with these assets anyway is a claim to some future value when the market recovers and they want someone else to pay the OpEx to get there. It might have worked in 2016 but the investment narrative has changed since then.

These are moves that take months not weeks and not all the stakeholders are in the same place. A cold winter with lots of tied up vessels is likely to bring these groups closer together. Resolution is some way off. Eventually, when all the other options have been exhausted, the banks are likely to do the right thing here.

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