MPV Everest for sale…

If you had been paid the contracted SGD 265m for the MPV Everest I am not sure it would appear on LinkedIn as in the recent photo above? I love this statement:

MPV Everest can carry out subsea repair and construction activities at 3000 metres of water depth, well intervention, diving support services with an 18-men twin-bell system, fire-fighting and emergency rescue operations, as well as towing and the provision of supplies in Arctic terrain.

Having a DSV that can operate at 3000m is like having an aeroplane that can also fly to the moon, interesting but dramatically over-specified, given that divers are limited to 300m (and more commonly 200m now)? Yes, I get the crane and ROVs can be used at that depth… but why hire a DSV then? And quite why you would need an 18 man SAT system for the provision of supplies to the Arctic is beyond me?

Incidentially, if I had paid SGD 265m for a vessel I also would want it to be slightly better looking? Personal taste I guess…

But then again I am pretty sure no one has paid more than the progress payments for this vessel yet… If they get half the contract value I will be impressed (see here).

These types of assets that were ordered in the boom to do everything seem the most exposed in value terms while the market remains chronically oversupplied. If Keppel cannot get rid of this, and there are a very limited number of buyers, before the UDS vessels start arriving next year then all that beckons is a race to the bottom in day rates as supply  continues to outpace even a modest recovery in demand.

Looks a lot like this:

White Elephant

I still remain surprised at the lack of public comment on this from Keppel. The relevant SGX continuous disclosure requirements would appear clear:

SGX Cont Disc.png

Not getting paid for a SGD 265m asset, that is in all reality worth significantly less, would appear to “materially affect the price or value”? Nine figure write-offs, even for a company the size of Keppel, tend to have that effect?

Who knows? Maybe PWC as auditors for Vard and Keppel could ask them to park the DSVs at the same location? That way they could save money as once a year an audit junior could go out, inspect the DSVs, confirm they were there and in good condition, hadn’t worked for a another year, but were still worth nearly exactly what someone had agreed to pay for them before they went bankrupt, and despite day rates for comparable vessel dropping somewhere between 40-60%?

Given it is now April this vessel will have no regular work, of any of substance, in  the 2018 calender year as the schedules are now effectively secured. Combined with the fact that this is by an order of magnitude the most expensive DSV in Asia (in cost terms) things are not looking good for Keppel here. The strategy of building the most expensive DSV in the world and seeing if it will force companies to upgrade their tonnage is getting a  pure natural experiment here before more similar vessels arrive. Serious buyers can be very patient here… the sellers? Maybe not so much.

“This time it’s different…” … But it really is…

I sometimes think the brief downturn of 2008/2009 in oil prices and offshore demand has a lot to do with how the downturn that started in 2014 is interpreted. I was there, got the t-shirt, and it was brutal, but it was short and there was an asset base that was vastly smaller than the current active (or potentially) rig and vessel fleet of today.

The graph above show’s the EIA forecast for US crude oil production by grade (that includes onshore and offshore). Unless you believe this graph to be completely wrong you would have to accept there has been a significant structural change in the industry… as a comparison have a look at the US production levels leading up to the 2008/09 downturn:

US oil production 1986 -2010.jpeg

US domestic oil production was on a downward trend at 5m barrels a day, slowly rising in 2009, before its meteroric 2010 rise. In 2009 the logical dominant narrative, both in investment terms, and operational terms, was that offshore production had to be increased: there was no alternative. Shale was expensive, companies were still thinking oil sands production was a viable technology within current constraints to keep pursuing, and although the investment dip was brutal it was a single season, and the spot price recovered quickly as well.

Now the graph at the top is the dominant logic. There is a self-reinforcing cycle here that is leading investors at the margin to use shale as the swing production method of choice. From 5m barrels a day to 10m and realistic scenarios involve this being 12m. Not only this as a marginal production technology shale is shorter cycle and uses much less initial capex, the trade-off being lower overall profitability. But on a risk-weighted and time-commitment basis it is a far less intensive production technology. As I keep saying here everything Spencer Dale wrote is coming to fruition here over the shale doubters. The force of economics triumphs over engineering constraints of the current technology curve yet again!

Change at the margin it is occurring every day when investment managers at either E&P companies, or fund managers/PE investors, decide to back a shale project over an offshore project. No one is saying offshore is going away, but at the margin the total volume of decisions made one way or the other will dictate what a “recovery” for offshore looks like. There is no doubt this summer will be busier than last summer for work, particularly for IRM where the spending taps have been loosened a little, but the supply situation is such that no one is reporting increased rates it’s all about utilisation.

My point with this, as I constantly stress, isn’t that offshore is going to zero, but that any recovery in offshore is going to look very different to any prior to 1986, because there is now a viable swing producer with a very different commitment profile. Offshore will be part of the energy solution not THE solution, and that is a very different dynamic.

Up until 2010 offshore was the only viable solution so there was a reasonable belief that this was cyclical pause in investment driven by a cash flow issues oil companies were having with the spot oil price. I am just not sure that is a reasonable assumption now?

Frac spread count

The Frac Spread Count is the equivalent of the BH rig count for frac spreads. You can see the tremendous growth in onshore capital equipment utilised that has occurred in a fairly short space of time. This process of capital deepening will not go away, this equipment, which is getting more efficient, will need to be traded even if the price of oil drops. Like vessels it will price at marginal cost if required to keep utilisation high.

And shale appears to be getting ever more efficient:

Now a second revolution is on the horizon as operators prepare to re-enter those wells that launched the first revolution and implement secondary recovery projects. That can consist of operators reinjecting gas into the reservoir to restore pressure and then producing the additional crude and natural gas…

the Permian Basin has been producing for close to 100 years and “we’re not even close to getting all the oil.”

Which led the IEA to issue this graph this morning with the byline “US shale oil growth is set to see the largest sustained rise in history matching the huge expansion seen in Saudi Arabia in the 1960s and 1970s”

IMG_0445.JPG

And as a topic for another day gas is becoming so cheap that for bulk energy it will take market share off oil eventually. There is growth in offshore as Brazil and the GoM show:

Brazilian production forecast.JPG

There might well be another bull market in oil… but whether it leads to one for rig and vessel companies is altogether a different question? There will be profitable companies in offshore they will be just look, and in some cases be, different from those in 2013/2014.

There is an interesting parallel in shale infratsructure to offshore infratsructure providers in investment terms:

That fate has just arrived for the pipes and plants connected to some of the first great shale-gas plays in Barnett, Woodford and Haynesville. In September, Wells Fargo analysts estimated that four pipelines serving the original boom areas would be re-contracted for much lower volumes. Recurring operating costs and lower prices create distressing leverage on those declines.

According to Wells: “We estimate the four pipelines will see a median tariff decrease of 39 per cent and ebitda [earnings before interest, tax, depreciation and amortisation] decreases of 66 per cent, once legacy contracts expire.”…

This is not the end of the world for the midstream business. Other, better informed sources of capital can replace MLP money. However, the oil and gas infrastructure bubble is over. An American Petroleum Institute study in 2017 estimated “pipeline and gathering capex” would decline from an annual average of $31.3bn in 2013-16 to $20.8bn in 2017-35.

That is still a lot of pipeline but the ongoing returns appear to be weighted in the E&P companies favour, not the infrastructure providers. Offshore investors probably have some sympathy for pipeline owners.

Any offshore reovery scenario needs to be realistic about how the “new demand” will play out on the current and future asset base. Demand will vary by region, asset class, and type of project at the margin, but an overall contraction in the supply side of the market is a certainty as US shale production continues to grow faster than overall oil demand.

Random DSV write-off Friday …

The map above, in the yellow circle, shows the MPV Everest parked right outside Keppel in Singapore (this morning)… which is an odd place to park a SGD 265m vessel you have “delivered”. I mean you have literally delivered it, but normally in shipping terms it means to someone who has paid for it. Sooner or later Keppel is going to have to front up and admit they haven’t been paid for this. I am surprised that as a listed company they haven’t had to already, but they will also need to come up with a realistic impairment value here which will be interesting?

Because according to AIS the two UDS DSVs (Lichtenstein and Picasso) are also in lay-up effectively in Singapore. With three more being built having 0% utilisation on the first two in the fleet must be a minor concern?

Jumeirah Offshore ST.jpg

And now into the mix comes the Jumeirah Offshore DSV being built at Huangpu… At least the yard here is being honest and admitting that the buyers have defaulted. But in the next breath you are told they will only sell at 100% of book value… And the vessel is c. 80% complete apparently: just enough to have purchased all the expensive long lead items but not enough to recover their value. This is a nice vessel on paper, 24 man Drass system, ST design, 250t crane, and a fairly generous power capacity etc.

In fact it is possibly as nice as the Vard DSV, speaking of unsold DSVs (although without the build quality one suspects), that will also only be sold at book value. So when looking at the size of the financial write down that these yards will have to take why not look there given Vard have just published their accounts? It is not completely clear how much value Vard are acribing to the vessel as they hold it in inventory with another vessel, but amazingly the write-off for all their vessels is only NOK 54m, or around $7m!

Given the discounts going around in offshore at the moment for completed offshore vessels, and the price Boskalis recently paid for the Nor vessels, to pretend that the Vard 801 only lost a maximum of $7m on it’s build cost (Vard use realisable value) is really unbelievable. Preposterous in fact. Surely a discount of 50% to cost would be needed to actually sell the vessel in this market? The scale of the loss here is massive for Vard, not quite a solvency event but not that far off and hence their desperation to hold an unrealistic value, but this is really a case where it is hard to see how the auditor has been objective here? There is enough market intelligence to suggest that a North Sea Class DSV that cost c. $150m to build would need to be marked down more than 5% to sell in this market? Good news for Keppel because they are audited by PWC as well I guess?

The fact is there are a host of very high-end DSVs mounting up in yards now with no realistic buyers and yet somehow we are meant to believe these vessels are worth close to what they cost to build? This despite the fact that UDS has made a business out of offering to commercially market very similar vessels and apart from a small job in Iran, and short-lived contract with a company without an office or phone, has managed to get close to zero utilisation. I am going to share with you an extremely insightful piece of economic thinking: if a boat isn’t being paid to work then it it isn’t worth a lot of money (generally speaking).

And still they come… three more from UDS alone… will they really be finished or cancelled like the Toisa vessel in China?

Quite where all these vessels end up is a great unkown. Only a maximum of 2 could ever end up in the North Sea given current demand levels and replacement requirements, and more likely one, and just as likely Technip and Subsea 7 just decide to replicate their last DSV new builds with export financing and attractive delivery terms… in which case none are worth the North Sea premium.

That means these vessels are likely to end up in the Middle East and Asia where day rates have never supported North Sea class DSVs for a host of very good economic and environmental reasons. So either there are a whole pile of USD 150m DSVs sitting around idle, with no buyers, that are all worth nearly exactly what they cost indefinitely, or someone is going to start losing some real money soon, even if the auditors allow them to pretend they won’t for a while longer.

Changing of the North Sea guard in Leith…

Pictured this week are two stalwarts of the North Sea subsea market in Leith on their way to be scrapped.

The Seven Navica above has arguably gone earlier than envisaged when she was upgraded in 2014, but her replacement is a global asset for longer tiebacks and pipe-in-pipe projects and it reflects how much offshore development types have changed in a few short years. Not that long ago there were only two options for rigid-reel pipelay in the North Sea (excluding the s-lay Falcon) and that guaranteed Technip and Subsea 7 a substantial business where on they could integrate DSVs and rigid reel, which was the development methodology of choice. Now there are at least five options I can think of, flexibles technology has improved, and UKCS CapEx has shrunk so much the market doesn’t need dedicated assets but rather more flexible global ones.

Whereas this old girl below, caught on the same day, has more than paid for herself over the years and marks the end of what has been a very profitable investment for her owners. Rockwater shows you need to do a lot more than paint a DSV red to make money from it.

Rocky Scrap.JPG

NZ bans offshore oil and gas exploration…

Hardly a move that will cause tremors among the offshore companies of the world, and I don’t think a harbinger of things to come for other places, but I was surprised to see NZ ban offshore oil and gas exploration from today.  But if if you want to understand the NZ pysche behind this seemingly Luddite stance you need to understand this comment:

James Shaw, the New Zealand Green Party’s co-leader and climate change minister, praised the move as “the nuclear-free moment of our generation” – a reference to a 1984 ban on nuclear-armed ships entering New Zealand’s waters.

And if you want to understand that comment there is no finer place to start than David Lange at the Oxford Union in 1985. One of the finest pieces of debating you will ever see, I get goosebumps watching it, and it’s hard to overstate the effect this had on NZers at the time.

Watch the whole video “I can smell the uranium as you lean towards me…”

 

One of the finest pieces of debating ever. Only 6 minutes so watch it.

Seadrill restructuring… secular or cyclical industry change?

There is a cheeky 879 page document that outlines the Seadrill restructuring, agreed this week, if anyone is interested. My only real point of interest is that the business plan that was agreed finally in December 17 contained a significant reduction in day rates and forecast utilisation levels from the previously agreed plan of June 2017.

Seadrill VA Dec 17.png

It seems to sum up something I have said here before that the general consensus  said 2017 would be better than 20 16, and actually as the numbers come in it was not, and therefore 2018 will be another year with only weak growth for offshore. The longer this keeps up the harder it gets to mark the drop in demand in the offshore industry as a purely cyclical change that will reverse. The longer the rigs and jackups keep quiet the longer the boats will be under-utilised as well. Part of this I think is the realisation that the industry has relied in the past on very high levels of utilisation to remain profitable: fixed costs are so high that profit often wasn’t reached on any unit until it has worked 270-300+ days a year, so a future where these levels might not be reached permanently again is almost too much for many banks to accept or even contemplate.

A quick look at the forecast P&L for Seadrill shows that this is a business that requires a rapid recovery for this complex restructuring to work:

Seadrill forecast P&L 2018.png

In 2019 Seadrill needs to grow revenue 65% to lose $415m of cash after turning over $2bn. In 2020 Seadrill then needs to grow 40% again, and only then do they generate $25m after meeting all their obligations. A rounding error. A few thousand short on day rates or a few percentage points in utilisation adrift and they will lose some real money. Sure they start with a big cash pile, but they are still paying off .5 billion debt per annum and it goes up quickly. You don’t need to be a financial wizard to see that there is very little margin for error here. But the real dynamic here is the banks who would have to look at writing off billions if a plan along these lines cannot be agreed. And this is exactly the dynamic that drove the SolstadFarstad restructuring.

Here is a graphic example of “extend and pretend” or “delay and pray” that the Seadrill restructuring has come up with:

Seadrill extend and pretend.png

The banks are hoping that a collection of 32 assets, many  in lay-up, will recover in economic value enough to keep them whole in the next six years. I guess if you are in for this much it is a risk you have to take but is it really realistic?

McKinsey noted in their latest OFS outlook that:

[t]he offshore Baker Hughes rig count managed a tentative rise to 215 in January from a record low of 209 in September – barely reflecting the beginning of what many expect to be a more broad-based recovery in oil and gas project development in 2018 and 2019. Our data show that after showing signs of recovery in Q1–Q2 2017, rig demand actually decreased in the second half of the year (–3 percent for jack-ups, –13 percent for floaters since July 2017). Demand has now stabilized, although it remains more than 30 percent below levels seen in mid-2014. In the next bid round, we anticipate some improvement in rates as a result. [Emphasis added].

It doesn’t feel like a deep recovery that will lead to increased day rates. Certainly not on the scale that would lead to huge increases in day rates and utilisation. Borr Drilling recently used this data point:

Borr Activity Levels.png

Tender volumes might be rising… but surely if the price goes up some tenders will be withdrawn because the work will come in above budget? The longer oil stays rangebound at $70 surely the less likely, and longer, and these high utilisation and day rate scenarios become? Borr also have a whole presentation that essentially argues for a degree of mean reversion in day rates which is really just an argument that this is a cyclical downturn. For large portfolio investors Borr might make a sensible hedge in case it is true, but I don’t think it reflects the profound nature of the change going on in the industry at the moment.

The second Borr chart simply ignores the fact that in every other upturn mentioned shale was a non-existent market force, not the marginal producer of choice it is now. And look at the most recent 2011 recovery cycle: a very shallow recovery, and the fleet increased significantly since then. But the Borr presentation does highlight the scale of the upside if this is purely a cyclical downturn. My doubts are well known here.

The other unresolved issue in the restructuring is the fate of Seadrill/ Sapura JV flexlay vessels. In Europe everyone concentrates on the DOF/Technip and Subsea 7 vessels but the Sapura/Seadrill JV also own six PLSVs operating on long term contract. The huge drop in Brazilian floater and jack-up work directly imperils the long term demand for all the PLSVs in Brazil, and it is impossible to see Petrobras renewing such long-term and rich contracts for all these vessels.

Seadrill is going to be a very public bellwether of what an industry recovery looks like in the rig market and whether this is a cyclical or structural change in industry demand. The restructured Seadrill will have to hit the run rate very quickly this year or it will rapidly become apparent that, not for the first time in this downturn, projections of a broad industry recovery have been far too optimistic.

 

A really big boat, asset specificity, and Chinese finance….

The picture above is a purpose built vessel, a deepsea mining unit for Nautalis Minerals, currently being built in China at the Mawei yard. It is undoubtedly an amazing piece of engineering, enormous as can been seen: 227m x 40m . A few more shots here:

The problem of course is who is going to pay for it. This is a deal that has been kicking around the market for years, a complex vessel, with few other potential buyers, ordered in the boom times with no takeout financing. Surely, yet again, like the DSVs floating around at the moment the yard is going to be stuck with this?

The economics of this argues that a charter is not the right option for Nautalis here. The vessel is the perfect example of asset specificity where it has a higher value to Nautalis than any other owner, and logic would dictate that Nautalis should raise the capital to pay for it. But Nautalis may get lucky here that the yard knows this and will simply have to charter them the vessel to avoid a firesale for an asset that has few other natural buyers. Delivery date is approaching here and it will start to get interesting.

When you read about the Chinese credit bubble it isn’t all in real estate (although a fair proportion is). This asset is one of number where it seems fairly clear that the losses, or at least the risks in the case of this vessel, will be taken by a semi-private entity at some point, maybe moved to a state bank leasing arm. The question is how systemically important the number is overall for all the Chinese yards? Rumours in China abound that the UDS may end up with the Chinese Navy or Coastguard.

At some point, as the German banks discovered, lending money to make ships that people can’t pay for, even as great short term job creation scheme, has an enormous economic cost.

There is a good article here summarising the Chinese push to become far more active in ship finance as part of a broader strategic plan. I have no idea what the bad loan capacity is for China Inc. as a whole in shipping, in offshore the Chinese lease houses appear to have paid top dollar for some average assets, but so did everyone in the boom and staying power will be important the longer demand stays depressed. In general shipping they may have missed the worst and be coming in at a good time.

Regardless, quite what happens to this vessel will make an interesting case study of how these issues get dealt with. Ship building is a relatively low margin industry that takes massive risks to get orders in the door, often with tacit or explicit state support, but when it goes wrong the potential losses seem so much larger than the upside ever offered. Hopefully the number of speculative new builds for such specific assets, without take-out financing, will drop going forward because it is so economically inefficient. But I doubt it.