The slow fade to obscurity and Gell-Mann amnesia…

Dum loquimur, fugerit invida ætas: carpe diem, quam minimum credula postero.

(While we speak, envious time will have fled; seize today, trust as little as possible in tomorrow.)

Horace

For this will to deceive that is in things luminous may manifest itself likewise in retrospect and so by sleight of some fixed part of a journey already accomplished may also post men to fraudulent destinies.

Cormac McCarthy, Blood Meridian 

Amid the seeming confusion of our mysterious world, individuals are so nicely adjusted to a system, and systems to one another, and to a whole, that by stepping aside for a moment man exposes himself to a fearful risk of losing his place forever.

Nathaniel Hawthorne

Media carries with it a credibility that is totally undeserved. You have all experienced this, in what I call the Murray Gell-Mann Amnesia effect. (I call it by this name because I once discussed it with Murray Gell-Mann, and by dropping a famous name I imply greater importance to myself, and to the effect, than it would otherwise have.)

Briefly stated, the Gell-Mann Amnesia effect works as follows. You open the newspaper to an article on some subject you know well. In Murray’s case, physics. In mine, show business. You read the article and see the journalist has absolutely no understanding of either the facts or the issues. Often, the article is so wrong it actually presents the story backward-reversing cause and effect. I call these the “wet streets cause rain” stories. Paper’s full of them.

In any case, you read with exasperation or amusement the multiple errors in a story-and then turn the page to national or international affairs, and read with renewed interest as if the rest of the newspaper was somehow more accurate about far-off Palestine than it was about the story you just read. You turn the page, and forget what you know.

That is the Gell-Mann Amnesia effect. I’d point out it does not operate in other arenas of life. In ordinary life, if somebody consistently exaggerates or lies to you, you soon discount everything they say. In court, there is the legal doctrine of falsus in uno, falsus in omnibus, which means untruthful in one part, untruthful in all.

But when it comes to the media, we believe against evidence that it is probably worth our time to read other parts of the paper. When, in fact, it almost certainly isn’t. The only possible explanation for our behavior is amnesia.

Michael Crichton

Fearnley Securities resumes OSV coverage as slow pickup starts to take shape…Analyst Gustaf Amle places buy ratings on Tidewater and Standard Drilling at a time market is experiencing a slow recovery…

Tradewinds

Energy companies and investors are focused on profits and reluctant to boost spending even after crude prices surged to four-year highs, a senior Goldman Sachs banker said on Thursday…

But this time round, the barriers for investments are high, with investors seeking returns of as much as 15 to 20 percent from multi-billion dollar oil and gas projects, Fry said.

“In the near term the focus is on returns as opposed to growth for the sake of growth,”

Big Oil still reluctant to open spending taps: Goldman

I haven’t written much lately a) because I have been busy with an LNG project I am working on, and b) because it’s a bit like Groundhog Day at the moment: a bunch of offshore companies come out with bad results and tell you it’s grim out there and then a bunch of Norwegian investment banks and consultants write reports about what a good time it is to invest. In the same way the relentless expansion of shale continues apace so to does the inevitable decline in value of the offshore fleet and the capital intensity required to maintain it.

Offshore supply is so grim, with such vast oversupply, it is not even worth the effort to rebut some of the more outlandish claims being made. But if you buy Standard Drilling shares expecting the World Wide Supply Vessels to reocver anything like 60% of their historical value I wish you luck, the money would probably be better spent on lottery tickets, but good luck. If you have relied on one of these above-mentioned reports it is likely you are suffering from Gell-Mann amnesia, forgetting the false positives these self-same analysts saw before (this time it’s different…)

On the contracting/subsea side in the North Sea a denouement slowly approaches regarding capacity and the number of firms. I am interested in the North Sea not only because I worked in that market but also as a quite specialised market, with a small number of players and potential assets, it is as close to a natural experiment in economics as you are likely to get. So when you see a load of small firms losing cash, charging rates below what it would cost them to replace capital equipment, and competing against diversified and well capitalised multi-national corporations, the most likely scenario is that sooner or later their private equity owners decide they are not worth putting money into and they are shut down.

It isn’t the only scenario: the investment industry is awash with liquidity, every PE house wants to be the hero that called the bottom of the market right before it boomed. This idea found its ultimate expression in Borr Drilling, but York Capital buying Bibby Offshore was based on a similar sentiment. The problem is that the price of oil has doubled and the amount of offshore work has remained relatively fixed. Next year (apparently?) the oasis in the desert will appear…

Despite the music journalist from Aberdeen claiming that the management reshuffle at Ocean Installer a few months back was just a small thing and all about focus, this week the ex-CEO left to join DOF Subsea. No one would have had more share options in OI than Steinar, and I bet DOF Subsea wasn’t buying any out: when insiders know the shares are worthless you can bet they are. Even a PE house as big as Hitec Vision has to admit sometimes they cannot keeping pumping money into such a marginal venture as OI with such clearly limited upside for an exit? McDermott and OI couldn’t agree on price and unless another bidder can be conjured up to pay more for a business than you could build it from scratch then it’s days are surely numbered?

OI is a subscale business with a few chartered vessels and is exposed to their charter rates rising if the market booms. The downside is limited to zero for equity and but the upside effectively capped. It is no one’s fault it is just a subscale firm in a remarkably unattractive industry from a structural perspective. Eventually, just as with M2, the grown-ups take charge and face reality. As my shore-based offshore engineering guru reminded me: only a well-timed exit from the Normand Vision kept the business open as long as it has been in all likelihood.

But in the long-run OI has no competitive advantage and will be lucky to earn a cost of capital beyond Reach or other such comparable firms, certainly not one to move the needle on a PE portfolio for Hitec. Is there a market in Norway big enough to keep OI as a Reach competitor? I doubt that despite it being a favoured Equinor outcome.

DOF Subsea revealed in it’s most recent numbers that it only makes a ~9% EBITDA margin on projects (excluding the long-term pre-crash Brazil boats).

DOF pre-post.png

That one graphic shows you the scale of the change in the industry: contracts signed pre-2014: profitable, business post that? Uneconomic. No firm in the market will be making much more than DOF Subsea in IMR  and that is loss making in an economic sense: a signal to the market that there is severe excess capacity in contracting.

The Chief Strategy Officer of Maersk Supply recently went public and admitted even an oil boom won’t save them (a relatively frank admission for a company seeking a buyer whose only interest must be seeing MSS as a leveraged play on an oil boom!). For Maersk Supply the future is charity projects (waste collection), decom (E&P forced waste collection), deepsea mining, and a crane so clever it will make windfarms more than a zero sum game for the vessel provider. The chances of that being as profitable as helping an oil company get to “first oil” are zero. But still with a big corporate parent Maersk remain there supplying capacity at below economic cost and ensuring “the great recovery” remains an elusive Loch Ness styled creature.

A slow descent into obscurity would seem the best case scenario for OI while the worst case is clearly a suddent stop in funding when the investors realise 2019 will just be another drain on cash. Something the ex CEO and CFO have acknowledged in their career choices…

I fear the same thing for Bibby. Clearly York are delaying spending on the re-branding (required by their acquisition) because they were hoping to sell the business before the year was out. The financial results released make it clear how hard that will be. Not only did they overpay to get into the business they then, despite Bibby having spent £6m on advisers, had to pump in £15m more in working capital. When you have to put 30% more investment into working capital don’t believe the line about customers paying slowly: it was a simple, yet dramatic, complete misundertsanding about how much cash the business could generate and would therefore need. If you really believed Polaris, Sapphire, and the ROV fleet were worth 80m you would take the money and run…

Like OI the most likely, but not the only scenario, is that Bibby is simply ground down by Technip, Subsea 7, and Boskalis. At the moment North Sea DSV day rates are such that they do not come close to covering the funded purchase of a new DSV (likely to be USD 170m), and yet Bibby have a relatively old fleet. The 1999 built Polaris for example only has 10 years life left in her: on a DCF valuation model that means she has a finite life and not a capitalised value. In all probability Polaris simply cannot earn enough money in the next ten years to pay for the deposit on a new-build to replace herself (particularly given the dearth of bank financing). When I talk of capital leaving the industry this is a classic case of how this will happen. Boats can be chartered now but then the value accrues to the owner, a situation Volstad are only too aware of and will take advantage of when the Topaz charter comes up for renewal.

A quiet winter and a couple of dry-docks later in June 2019 and it is going to be hard to convince an investor to put another £15m because the customers just keep paying slowly (sic). A bidding competition to renew the Topaz charter would in effect render the business worthless.

There are other scenarios for these firms. I sometimes think optimism is a mineral in Lofoten. A veritable army of Norwegian investment bankers are no doubt trudging around with pitchbooks and research reports showing that if you just pay them a transaction fee in cash these contracting companies will bring you untold wealth (next year). But the most likely scenario is that a dramatic reduction in demand is followed by a large reduction in supply and at the moment only the first of these outcomes has occured as the previous cyclical nature of the industry has encouraged hope for a demand led revival. “It’s not the despair, Laura. I can take the despair. It’s the hope I can’t stand” as John Cleese famously remarked.

But it is starting to feel like the end of the road… Solstad has become a national embarrasment, OI a vanity project, and Bibby simply a mistake (to name just three examples). Eventually, when all the other possibilities have been exhausted mean reversion and cash needs will begin dictate economic reality.

One of the most bullish offshore data firms recently published this forecast:

IMG_0992

Just remember as a general rule: the larger the orange bar at the bottom (particularly in a relative sense) the less your offshore asset is worth.

[Graph in the header from this Seadrill presentation. Not a graph I suspect that will appear in one from Borr Drilling soon].

One thought on “The slow fade to obscurity and Gell-Mann amnesia…

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out /  Change )

Google+ photo

You are commenting using your Google+ account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s