Market equilibrium…

The graph above comes from a recent Tidewater presentation. There is also this slide from the same presentation:

OSV Business Drivers.png

Now Tidewater is a global supply vessel company, rather than a subsea player, but the data cannot be ignored: it is the Jackups and Floaters that generate future demand for the industry. The subsea vessels may not be quite as dependent as the supply vessels on the ratios of JU/Floaters to vessels, but it will be close and directionally similar. There is simply not enough front end work being done for a realistic scenario where anything like the current fleet is saved. Any realistic scenario of market equilibrium involves and increase in demand and a large adjustment in supply.

Demand does appear to have hit rock bottom. However, market equilibrium, which I would define as a situation is which those operating vessels covered their cost of capital, appears to be a long way off.

I would urge you to read the whole of a conference call Hornbeck gave recently (courtesy of Seeking Alpha):

Todd Hornbeck:

Beyond a doubt in nearly every category 2017 was the most challenging year we ever have confronted in our 20-year history. We experienced the full force of the offshore meltdown in all of our core operating regions and across our vessel classes. In the Gulf of Mexico an average of 21 deepwater drilling units were working during the year. We started and finished the year with almost zero contract coverage for our vessels meaning there are financial results reflect a true market conditions with little residual noise from day rates contracted in better times…

So where are we today and what do we believe 2018 holds in store for us?

To begin with, we think that the conditions for recovery offshore will begin to gel and that the necessary elements for improvement in our core markets maybe taking shape. Improved oil prices reflecting a more balanced oil market, improved global economic conditions, and healthy global demand for oil cannot be ignored nor can the significant under investment in deepwater over the last several years by our customers. While we think weak market conditions shaped by a low offshore drilling rig activity at OSV overcapacity will continue in 2018. We also think this year could mark the beginning of the end of this downturn.

Current healthy production from the Gulf of Mexico is unsustainable absent new investment by our customers. Depletion is real. The same is true in Mexico and Brazil. Consider this in 2014 there were 114 floaters under contract across our three focus areas of operation in this hemisphere plus 45 jack-ups in Mexico. Today there are 57 floaters and 20 Mexican jack-ups under contract in our core markets. So the contracted rig counts have been cut in half…

That said, we still expect OSV demand in 2018 to resemble 2017 in which we saw only 21 floating drilling units working in the Gulf of Mexico on average. We can even make a case that the drilling rig count to fall into the teens. As a reminder, there were 39 active floating rigs working in the Gulf of Mexico in 2015… [emphasis added]

James Harp (CFO):

In fact, our effective day rates thus far in 2018 are down substantially for both our OSVs and MPSVs…

Hornbeck is a Gulf of Mexico focused operator with both subsea and offshore vessels. The Gulf of Mexico is still regarded as one of the major investment growth areas in subsea, but it shows off what a low base this is, and how unevenly an industry “recovery” will be spread.

Basically what I am saying is  we are in a recovery phase (and you can agree with analysts who argue this), but as Todd Hornbeck states, it is off such a low base, and with such a vast amount of oversupply in vessels and rigs, that the industry will face low profitability for years. It is clear day rates in some markets and segments will be higher over the summer, some PSVs are being bid at £25k per day in June/July/August, but these rates need to be averaged over a year not a few months.

Any OSV/rig/subsea company strategy that doesn’t reflect the fact that the market will be significantly smaller than it has been previously, and the “recovery” level will be smaller than 2014, just isn’t realistic. Just buying boats and hoping for mean reversion seems to ignore the  data presented above. This time it will not be like the dip of 2009.

MPV Everest at mooring

According to the Marine AIS the MPV/DSV Everest is currently moored in Singapore. It is now over 2 months since Keppel stated they had delivered the vessel. I have always taken delivered to mean “paid for” by the new owner? (Previous thoughts here).

I am pretty sure that hasn’t happened in this instance. But if anyone has any definitive information on it could you PM/email me?

I note with interests the auditors (PWC) made the following statement in 2016:

Downturn in the Oil and Gas industry

The downturn in the Oil and Gas industry has had a significant impact on the financial statements of the Group, in particular over the following areas:

i) Appropriateness of revenue recognition and recoverability of work-in progress balances in relation to Offshore and Marine construction contracts
(Refer to Note 13(a) to the financial statements)

We focused on this area because of the significant judgment required in:

  • assessing whether the Group’s customers will be able to fulfill their contractual obligations and take delivery of the rigs/vessels at the contracted or revised delivery dates; and
  • estimating the net realisable values of stocks for sale.

We reviewed management’s assessment of the risk of customers defaulting on the contracts, and corroborated management’s assessment against our understanding of the industry. We read public announcements and other externally available information that would be relevant to understanding the financial position of the major customers…

We reviewed the terms of each contract as well as the terms of the modifications to assess if management’s judgment on the continued recognition of revenue and associated margin was appropriate.

We also reviewed management’s assessment of the external valuation of each rig/vessel, to assess if the related work-in- progress balances of construction contracts and stocks would be recoverable through sale, in the event that any of the Group’s customers are unable to take delivery of the rigs/vessels at the contracted or revised delivery date.

And the conclusion (for year end 2016):

Based on our procedures, we found that management’s judgment around the recognition of revenue, including associated margin on the Group’s Offshore and Marine projects for the financial year was appropriate. We also found that the work-in-progress balances on construction contracts and stocks were appropriately assessed to be recoverable.

So I guess it would be embarrassing for all concerned if there was a major event of default here? You would think an SPV set up to purchase a SGD 250m vessel, with no underlying charter and pre-arranged take-out financing, would therefore have warranted some special attention from the auditors?

This is not a “farm burner” for a company the size of Keppel, but it is also pretty serious if the counterparty can’t pay, because there are a host of these high-class DSVs building up now. The Everest is BV classed which also surely limits her resale potential? I have no idea what would be required to get her DNV or Lloyds classed but surely any other buyer would expect this to be to Keppel’s account?

Frankly, I would have expected Keppel to provide slightly more information regarding this vessel. It is a material transaction for the Group and it is very hard to believe they have simply delivered the vessel, been paid for it, and the new buyers have left her at anchor in Singapore? And if the contracted buyer cannot fulfill their obligations then any value to Keppel of this assets will be tens of millions lower than the contracted build price.

Surely Vard are (even more) worried now? I heard again last week that their DSV had been sold (this time the rumour was to a smaller company), but this ship has a clearing price (as eventually do the UDS vessels). With Technip scrapping the Wellservicer they have a host of options on replacement tonnage should they choose to invest in what is turning into an oversupplied sector.

OSV reality…

Some great footage on Youtube here of vessels in lay up in Batam. Sometimes I think it is only by watching such scenes visually the scale of the drop in demand in offshore, and the concomitant oversupply, can be appreciated.

I heard a lot of talk at the OSJ conference last week that it isn’t as simple as putting companies out of business, as these assets will simply come back at a lower price and compete against you, or they may be worth more in the future, but really that just means their economic worth is less than you care to accept.

I’ll write more about this later but the obvious point is that unless something structural is done here the vast quantities of latent capacity make any sort of recovery in offshore supply unlikely. Not wishing to pick on any particular company here, but as a follow-up to this, it shows what a huge problem SolstadFarstad has with the commodity DeepSea fleet.

New ship Saturday…

Yet again UDS seemed to have pulled off an amazing feat, right after becoming the greatest DSV owner and charterer in the world, with a record 4 out of 4 (or maybe 5) DSVs on long term charter, they appear to have Technip, McDermott, and Subsea 7 quaking with fear as they look at helping a company enter the deepwater lay market:

UDS Lay vessel.png

This is a serious ship. Roughly the same capability as the Seven Borealis.

Seven Borealis

Although the Seven Borealis  can only lay to 3000m, not the 3800m UDS are looking at. As depth is really a function of tension capacity then I guess they will have a significantly bigger top tension system than the Seven Borealis as well?

I can see why you would go to UDS if you wanted to build a pipelay vessel significantly more capable than any that the world’s top subsea contractors run. Sure UDS may never have built a vessel of such complexity, and actually haven’t even delivered one ship they started building, but they have ambition and you need that to build a ship like this. Not for this customer the years of accumulated technical capability, knowledge building, and intellectual competency, there is nothing an ex-diver can’t solve.

UDS is building vessels the DSVs in China. The closest the Chinese have come (that I know of) to such a vessel is HYSY 201:

HAI-YANG-SHI-YOU-201.jpg

But that only has 4000t system? No wonder this new mystery customer, who I assume is completely independent of the other customers that have chartered their other vessels, wants to up the ante. The HYSY 201 cost ~$500m though, which is quite a lot of money to everyone in the subsea industry, apart from UDS.

The last people I know who went to build a vessel like from scratch were Petrofac. There is a reason this picture is a computer graphic:

Petrofac JSD 6000.jpg

To do this Petrofac hired some of the top guys from Saipem, a whole team, with years of deepwater engineering experience… And when the downturn hit Petrofac took a number of write offs, and even with a market capitalisation in the billions, didn’t finish the ship. To be fair though, they hadn’t engaged UDS.

But I think the reason you go to UDS “to explore the costs”, you know instead of like a shipyard and designer who would actually build it, is because they appear to have perfected the art of not paying for ships. So if you go to them and ask for a price on an asset like this chances are you get the answer: the ship is free! It’s amazing the yard just pays for it. Which is cheap I accept but ultimately the joy-killing economist in me wonders if this is sustainable?

Coincidentally I am exploring the costs of building a ship. I have just as much experience in building a deepwater lay vessel as UDS. On Dec 25th 2017, with some assistance from my Chief Engineer (Guy, aged 9), we completed this advanced offshore support vessel, the Ocean Explorer,  from scratch!

Ocean Explorer.jpg

Ocean Explorer Lego.jpg

Not only that I had take-out financing for the vessel in place which is more than UDS can claim at this stage!

Now having watched Elon Musk launch a car on a rocket into space (largely it would appear to detract some appalling financial results, although far be it for me to suggest a parallel here) we (that is myself and my Chief Engineer) have designed a ship: It will be 9000m  x 2000m, a semi-sub at one end to drill for oil, a massive (the biggest in the universe) crane to lay the SPS,  j-lay, s-lay, c-lay, xyzzy lay in the middle, and two (Flastekk maybe?) sat systems at the other end in case we forgot something, and to make it versatile. Instead of launching a car into space we are having a docking station for the space shuttle in order to beat the Elon Musk of Singapore. It is also hybrid being both solar powered and running on clean burning nuclear fusion. Not only that the whole boat works on blockchain and is being paid for with bitcoin. The vessel is also a world first having won a contract forever as the first support vessel for Ghawar field. We are also committing to build a new ship every week forever.

I expect to bask in the adulation on LinkedIn forever once I announce this news, and it will feel like all the hard work was deserved at that point. I am slightly worried about the business model as my Chief Engineer asked “Won’t we have to get more money in for the boat than we paid for it?”. When I have an answer for that trifling problem I will post the answer.

The oil market…

I am not an oil forecaster, if merely use of the word isn’t a misnomer, but I am interested in the psychological effects the market has on the physical and pricing of offshore services. Only last week Goldman called $80 oil, coincidentally when they called oil going to $20 in 2016 (when it was $36), it marked the low point in the market, now it seems this maybe the high as the price dropped yesterday.

To put these daily fluctuations into perspective there is a good article here on the swings in the oil price since 1973 until 2014. The story of shale gets a passing mention but remains to be written.

I have also noticed a lot of commentary mocking the market analysts from investment banks for their inability to predict accurately the turns in the market. I would note firstly if you think analysts at an investment bank have a job to do beyond helping the firm sell securities then you are wrong. IB analysts fall under the remit of marketing and that is their job, not to provide independent, and free, research to the community at large.

And even if they are trying to be accurate, say a firm with a limited corporate finance arm, one should remember Alfred Cowles. Cowles was the inheritor, and investment advisor, to a large Chicago newspaper fortune, as well as being a statistician and economist. In 1929 he was long on stocks and lost a great deal of money and set out to find the answer to a question made famous when asked by the Queen to LSE academics in 2008, namely “Why did nobody notice it?” (as in the Global Financial Crisis). Specifically, Cowles wondered why the big Wall Street brokerages didn’t see the crash of 1929 coming? Did they know any more than their customers? (I mean The Great Vampire Squid was keen on Ceona when anyone with a modicum of pipelay knowledge knew the Amazon lay system was a busted flush?)

In a famous paper “Can Stock Market Forecasters Forecast?”, published in Econometrica in 1944,  Cowles proved that they can’t. I urge you to read the whole article (aside from anything the language is beautiful), for example Cowles found:

Cowles.png

The answer would be exactly the same for the oil market today if replicated I would wager. This comes up time again in mututal fund research and other areas of finance, where essentially the outcome is random and cannot be predicted with accuracy (a statistical theory known as “Random Walk“). In case you think technology has improved things this paper was published recently “Do Banks Have an Edge” … and the answer is no… you would be better off buying a portfolio of treasuries than going to all the effort of taking a complex mix of loans and securities that banks do. And that is when the bank is acting as a principal not even trying to sell the stuff!

So when you read that someone is calling the oil market, or whatever, you need to treat it with the scepticism it deserves, and not be surprised when it is wrong.

#hubris

“Political language is designed to make lies sound truthful and murder respectable, and to give an appearance of solidity to pure wind.”

George Orwell

If you borrowed money off a bank to buy a car, and then couldn’t pay the bank back, and they repossessed your car, would you claim this as a relocation success? I personally would have used the word “recent” not “successful”.

Expect big changes.

Bibby Success 2.png

 

Data versus insight…

An interesting report from EY Norway on the OFS sector in 2017. I’d have to say some of the data left me somewhat perplexed. I think they need to go back to the drawing board with this because they appear to have taken pure numerical data without looking to see if it even makes sense:

Subsea Top 5.png

I could almost let them have this because I think they are trying to show the activity of companies in Norway and the scale of their operations, but mixing an on onshore manufacturer of subsea production systems with offshore vessel delivery contractors seems to lose any insight in the data for me.

We then delve into the bizarre in “offshore logistics”:

Top 5 logistics.png

In case no one noticed, because it isn’t mentioned in the accompanying commentary at all, the top 3 companies run helicopters and the bottom 2 vessels? An explanation of why they have been grouped together would be good? I find it very unlikely the industrial dynamics of these two services are similar? And clearly given the data the financial performance of the  helicopter companies is distorting the vessel data?

And then this the “production” segment, which includes:

companies active in production, supporting equipment and services, such as floating production storage and off loading (FPSO) units, facility management, waste management, communication and production operations.

Why? FPSOs and waste management? Communications? How on earth did someone think that was a logical mix of companies? If you are using an SIC coding system then you need to make modifications here because the results are not relevant:

Top 5 production.png

Last time I looked Inmarsat supplied phone services? APL is an intermodal freight company? How on earth would their margin and revenue development, unless you could separate out the OFS component, be relevant?

A basic lesson of data analysis is to check the output makes sense and if not re-think. Either EY need to change their categories here, or change the analysis, because the output is meaningless (even if some of the commentary is okay).