A bank run in offshore…

DOF shares dropped 33% yesterday as the market woke up to the painfully obvious fact that it need a major financial restructuring. In breach of loan agreements at least one bank appears to be accepting reality.

I have said here before, indeed it was the basis of my EMAS predecitions, that you need to think of offshore operators as funding themselves like a bank: they borrow short and lend long. They take mismatched duration risk, or maturity transformation in the vernacular. Offshore operators “borrow” short-term in the contracting market with contracts that are far shorter than the assets they need to fulfill the contracts, and then they use this facility to invest in assets of a longer duration that cannot be redeemed early if the short-end of the market changes. In construction they are a confidence play that requires the customer to believe they will be solvent and deliver the contract next year. With these numbers DOF can’t promise that.

DOF is in short experiencing a bank run. This little paragraph highlights that going into the summer some banks are losing patience (waking up to?) [with] rolling over loans they know will not be paid back at an economic rate and have had enough:

DOF banks 2019.png

DOF has breached the covenants in its loan agreements and the equity is now worth nothing. Another restructuring begins.

Just like in the financial crisis the liquidity crisis starts between financial institutions refusing to roll-over obligations. The summer is coming and some banks have seen that day rates and utilisation levels are not occurring at an economic rate and the internal risk police (and financial regulators) appear to have called time.

My own view is that Solstad and DOF cannot survive. Certainly there is the possibility that someone like DNB Bank back a ‘national champion’ and commbines them (and that will surely be DOF). Or maybe Solstad is allowed to die? But the market isn’t big enough for both now and the industrial logic of having two major Norwegian OSV operators slowly draining cash waiting for the never appearing recovery has moved from the tenuous to the non-existent. It might seem like a big deal in the industry but in economic terms it’s two over leveraged micro caps going out off business at the end of a commodity boom. Move on.

The folly of the offshore strategy of going long on specialised assets with a contract life significantly shorter than their economic value is now painfully obvious; the Skandi Vittoria and Skandi Nitteroi were purpose built in 2010/2011 and were redelivered in 2018 and are now in lay-up. There is no spot market for PLSVs as everyone knows and so DOF either goes really long on flexlay contracting capacity (which I doubt Technip will accept) by building up a really expensive engineering team that will takes years to win work that has a long lead time (and therefore required vast sums of working capital) … or … Or what?

No one needs those vessels. Ever. There used to be 80 floaters driving flexlay demand in Brazil and now there are less than 20. Subsea 7 skipped a bargain and went for the new build Vega and everyone else has excess flexlay capacity. The value of having a short-put on a specialised asset has been gained by Petrobras at the expense of DOF shareholders and creditors.

Those two relatively new vessels are actually worthless at much beyond conversion value but probably have a book value of over $100m. For Seadrill (through Seabras), Subsea 7, and Technip the reality of what lies ahead when their contracts finish is all to obvious.

The only thing that isn’t like a bank run is the customers are staying (at the moment). But that’s because they are getting supplied long duration assets well below their economic cost aided by real banks that would rather push the day of reckoning out than realise real losses now. For Solstad and DOF to be viable economic entities senior (and junior) creditors will have to write-off billions of NOK.

No wonder the banks are reducing their loan books and expsoure to the sector. And if no one lends then asset values drop (one of the major flaws in the Standard Drilling business model for another day).  How exactly you seperate a liquidity crisis from a solvency crises becomes a moot point, but we are about to see more than one practical example.


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