Productivity and capital reduction in offshore …

“Bank executives, believers in sound money to a man when other sectors of the economy were in trouble, became less keen on monetary purity when it came to their own survival…”

Philip Coggan, Paper Promises

From the $FT on Monday:

This has helped boost UK oil and gas output from 1.42m barrels of oil equivalent per day in 2014 to 1.63m boepd in 2017, a 14.8 per cent increase…
But the industry has now managed to lower costs from an average of £19.40 a barrel in 2014 to an estimated £11.80 a barrel this year, according to the UK Oil and Gas Authority, while total expenditure on investment and exploration has fallen from £15bn to £5bn over the same period.

Let’s be clear about what this sort E&P company productivity means in terms of market and price deflation for the offshore supply chain over a four year period: OpEx -39% and CapEx down 66%%! £10bn has been taken from a market of £15bn in revenue terms for the supply chain supporting “investment and exploration”! It is an extraordinary number for an industry supported by a large amount of leverage in the supply chain and represents a fundamental structural shift.

Yes the CapEx number is variable by year, and Clair Ridge and other fields had massive expenditure last year, but this is the future of offshore in the UKCS. The gross figure is probably a good proportionate proxy for all those in market, with the most oversupplied segments perhaps taking a bigger hit, but if you are a UK focused business this is the scale of the reduction in the market. And this in an environment when the oil price rose 44%! As anyone close to the E&P companies will tell you cost pressure is still relentless. A near 13% decline in the price of Brent over the last few weeks only adding to CFO determination to keep OpEx in check.

If you take Bob Dudley’s assertion that you get 40% more volume for your value offshore the market is at £7bn in 2010 terms i.e. more than a 50% decline and a smaller installed base in the future to maintain. The sanctioning of Tolmount yesterday was good news but it doesn’t change the macro statistics: this is a rapidly shrinking basin in market expenditure terms. There is simply no linear relationship between the oil price and the demand for offshore services in  the North Sea now.

There is a reason the Vard 801 has not been taken out by Technip or Subsea 7 and that is clearly in this environment the UKCS is a very difficult place to make money.  It is not sensible to invest in fixed assets for a market facing such steep declines in size. For UK focused contractors there is simply no way to remove that volume of revenue from the market and under any realistic assumptions and expect the same number of firms to survive or profitability levels to return to past averages. The industry must contract to reflect this but the high perceived asset values of the vessels and rigs have slowed this contraction.

If you took on debt in the good times your market has shrunk rapidly but your creditors expect to be paid back from a market that was in percentage terms vastly bigger. If you don’t think offshore has any hot air left to come out then take a look at the accounts of Nordic American Offshore: a North Sea PSV ‘pure play’.

NAO in 2017 (or materially in any other year) decided not to impair the value of their PSVs because they think they will earn their value back. NAO has 10 PSVs, debt of $~140m, ~$12 in cash, and having largely spent the $47.5m raised in 2017. In 2017 it spent ~$22.5m in costs to get ~$18m in revenue and it made another loss (obviously) for H2 2018, resorting to sending non laid-up PSVs to Africa to work. There is no realistic future for this company as a standalone enterprise and no industrial logic for this company to exist at current market demand levels. The vessels are worth less than the bank debt and their market is in a steep contraction. These PSVs are on the books at over £30m each!!! Sooner or later the facts of this market contraction with their cash position will collide.

There is simply no place for these supply companies with 10-20 vessels. Sooner or later the banks will have to forclose here and simply get what they can for the vessels or they will have to write off some of their claims to encourage yet another round of investment in a loss making company whose assets are held at book value at significantly more than could be realised in a sale process. NAO fleet Value.png

That last comment above is based on using a 10 year average of PSV rates and utilisation levels. At some point the reality of needing new cash to pour into operating losses is going to collide with their “beliefs” as NAO don’t have enough cash to last until (if?) rates return to 10 year historic averages. It is very hard to see the upside for any potential investor here even if the banks wrote off 100% of their claims, something they are clearly unlikely to do.

Not that there is room at the survivors table for all the medium-sized companies either. Bankers for Maersk Supply Service have also been taking soundings for a buyer. They are seeking top dollar for a company unfortunate enough to order the Starfish class of vessels just before the market peaked, but even more unfortunate enough to have a parent able to honour the group guarantees to pay for the vessels on delivery. In 2017 they stopped posting financial results on the website but are well understood to be losing significant amounts of cash at an operating profit level.

Maersk Group are listing Maersk Drilling as they have been unable to find a buyer, but they were able to organise banks willing to back the company with debt facilities. It is very hard to see a similar situation arising with Maersk Supply where no realistic path to profitability can be plotted and creditors would remain exposed to large operating losses.

Maersk Supply has also been trying to build a contracting business when the market for projects in the UKCS has reduced by 66%. They have no competitive advantage and nothing to offer an oversupplied market. All that will happen here is they will burn OpEx trying to do this and eventually, when all the other options have failed, they will do the right thing and shut the contracting business down. While all the tier 1 (and 2) contractors have significant excess capacity there is no room in the market for a new tier 2 contractor whose sole purpose is to cross-subsidize utilisation from their vessel fleet. A JV with Maersk Drilling to work on decommissioning is unlikely to yeild anything of scale that someone with outside capital would find value in paying for.

Maersk Supply is at the upper end of the adjustment band of companies that are unlikely to survive without some sort of dramatic and unforecast change in market circumstances. Protected in better times by a massive corporate parent, and with a similar proptionate cost base, it is now exposed as a massive cash drag as its owner tries to protect its investment grade credit rating. MSS offers insignificant scale in the market, ongoing cash losses, and a very high cost base reminiscent of better times in a geographic location where this is hard to change. Maersk Supply simply isn’t a viable standalone business at the moment without a massive equity injection.

AP Moller-Maersk have vowed to do whatever it takes to protect their investment grade credit rating, at some point the material losses being generated in MSS will force their hand here. As more disparate parts of APMM are divested the trading performance of MSS will become something that will need to be cauterised.

The future of offshore supply can be seen in Asia where small nimble  companies with very low costs make money on wafer thin margins. Traders. Vessels are worked to death and meet minimum local standards but nothing more. If Standard Drilling/ Fletcher can bring ex-DP I vessels to the North Sea to compete against NAO then welcome to the future of the North Sea supply market because that is how you drive OpEx down 40%.

NAO and Maersk Supply, like a lot of other companies in the industry, found investors over the last couple of years (one external and one internal) who believed that the market would return to previous levels and it was worth funding the interim period. At each round of fundraising this becomes an ever more unlikely outcome and the costs of this rise. Slowly but surely some companies will be unable to convince potential investors that they will be the one who makes it through to the (mythical?) recovery. This slow grinding down of capacity and capital is how the industry looks set to rebalance.

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