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.

The Nemean lion of debt in offshore supply…

The slaying Nemean lion was the first of the twelve labours of Heracles. The lion had an indestructible skin and it’s claws were sharper than mortals swords. I sometimes feel that the first task in getting some normality into the offshore supply market is to find a Heracles who can begin to slay the debt mountain built up in good times…

In Singapore Otto Marine and Pacific Radiance appear all but certain to enter some sort of administrative process as their debt burden divorces from the economic reality of their asset base. The best guide to what they need to achieve, and the enormity of the task, come from the recent MMA Australia capital raising. I think MMA is a company that understood the scale of this downturn, and reacted accordingly, but they still have a tough path to follow, but at least they have an achievable plan.

The MMA plan involved raising AUD 97m new equity (AUD $92 cash after AUD$ 5m in fees, which is steep for a secondary issue and shows that this wasn’t easy) compared to bank borrowings of AUD $ 295m i.e. 33% of the debt of the company, or over 100% of the equity value (at AUD 88m) was raised in new capital in one transaction in November 17. In order to do this the lending banks involved had to agree to make no significant dent in the debt profile before 2021, reduce the interest rate, and extend the repayments. “Extend and pretend” as it is known in the jargon. All this for a company that in the six months ending 31 Dec 2017 saw a revenue decline of 22% over the same time last year (AUD $119m to AUD $92m) and generated an EBITDA of only $7.6m (which excluding newly raised cash would give a Debt/EBITDA of 14.3x when 7x is considered high).  I’d also argue the institutions agreed to put the money in when the consensus view (not mine) was that 2018 would be a better year, raising money now looks harder. (Investment bankers can sometimes come in for some stick but this, in my opinion,  was a really good deal for the company and the banks earned their money here).

The fact that MMA’s Australian banks have far less exposure to offshore supply than the Singaporean banks made them more pragmatic (while still unrealistic), but this shows what needs to be achieved to bring in new, institutional quantities, of money to back a plan. As a portfolio move from large investors, making a small bet on a recovery in oil prices leading to linear increase in offshore demand, I guess that is sensible. I don’t think it will work for the reason this slide that Tidewater recently presented shows:

TDW OSV S&D.png

There is too much latent capacity in an industry where the assets, particularly the MMA ones, are international in operational scope. By the time the banks need to start being repaid these 20-25 years assets will be 3 years older, 7 since the downturn, yet expected to bear an unmarked down principal repayment schedule. It’s just not realistic and requires everyone else but you to scrap their assets. It maybe worth a punt as an institutional shareholder… but I doubt that few really understand the economics of aging supply vessels.

This contrasts with Pacific Radiance where this week the bondholders refused to agree to accept a management driven voluntary debt restructuring and management seem to be relying on the industry reaching an “inflection point”. As soon as you hear that you know there is a terrible plan in offing that relies on the mythical demand fairy (friends with the Nemean lion I understand) to save them.

I would have voted against the resolutions this week as well had I been a bondholder, but mainly because of the absurdity of agreeing to a plan without the banks being involved or new money lined up. The bond was for SGD 100m… have a look at the debt below on the latest Pacific Radiance balance sheet (Q3 2017)… can anyone see a problem?

PR Balance Sheet Q3.png

Pacific Radiance has USD 630m in debts. Even writing off the bond would mean you are in a discussion with the banks here. I have no wish to take people through the math involved in what the bonds are worth becasue in reality all anyone owns here is an option on some future value, and if you are not the bank you don’t even have that. In order to bring the plan into line with MMA, Pacific Radiance would be looking at presenting an agreed plan with the banks, and ~USD 220m capital raise, an amount that is real money for a company that is still losing money at an operating level.

No one believes the vessels and the company are worth USD 710m. If the banks really thought they could get even .80c in the dollar here by selling to a hedge fund they would be out tomorrow. A large number of the Pacific Radiance vessels are well below the quality of the MMA vessels and in the real world it would seem reasonable for the banks to have to write down their debt significantly to attract new money. If vessels are sold independently of a company transaction, like MMA, then they go for .10c – .20c of book value, so it would make sense for the banks to be sensible here. However, I fear that so many have told shareholders they are over the oil and gas exposure that major losses here will be resisted despite economic reality. I suspect the write-off number here would need to be at ~50-60% of book value to make Pacific Radiance viable and get such a large quantity of new money, an amount that will have risk officers at some Singaporean banks terrified.

As I keep saying here the real problem is that if everyone keeps raising new money for operational expenditure, on ever lower capital value numbers, then the whole industry suffers as E&P companies continue to enjoy massive overcapacity on the supply side. Eventually without a major increase in demand a large number of vessels are going to have to leave the industry and this will happen when the  banks have no other options, and we are starting to get close to that point.

In reality the Pacific Radiance stakeholders need to sit around the table, have a nice cup of tea, and accept the scale of their losses. Then all the stakeholders can come up with a sensible business plan and the new money for operational expenditure can be found. But the banks here will be desperate to be like the MMA banks and get the new money in without suffering a serious writedown while trying and push the principal repayments out until a later date. I don’t see that happening here and the bondholders may as well sit around with all parties rather than be picked off indepdently. A major restructuring would appear the only realistic outcome here and if Pacific Radiance is to continue in anything like it’s present form there will be some very unhappy bankers.

Investment banking analysts, groupthink, and the space shuttle disaster….

“a mode of thinking that people engage in when they are deeply involved in a cohesive in-group, when the members striving for unanimity override their motivation to realistically appraise alternative courses of action”

Janis, Victims of Groupthink, 1972

The quotes in the graphic above come from an MMA Australia equity placing last year. As a follow on to an earlier post I made regarding equity analysts at investment banks I read this article in the Financial Times Alphaville blog this week which makes essentially the same point:

The problem is that equity research has a famous bias towards positivity. Investment banks seek to do business with companies, which tend to dislike sell ratings. Stock markets spend most of their time rising. Fund managers don’t love to be told their decisions to invest in something is wrong…

So, it is very rare to see more than a quarter of analysts recommend their clients sell a stock

The distribution of ratings bears this out. Goldman Sachs aims to have 10 per cent to 15 per cents of stocks it covers rated as a sell. Morgan Stanley discloses 18 per cent of 3,200 stocks covered are rated underweight/sell. For UBS the global figure is 16 per cent. Investec has just 9 per cent of European and Hong Kong stocks on a sell rating.

How could the offshore analysts of some of the major maritime banks have been so positive when managers in the industry are saying things are very different? And in fact MMA’s latest financial results offer no hope of a market recovery?

Part of the answer I think lies in the psychology of groupthink (a classic article on it is here which applies this logic to the Challenger disaster). Another part of the answer lies in behavioural economics where analysts exhibit a positive confirmation bias, in which they look, and notice, information that accords with their preconceived ideas. This bias comes about understandably because analysts are employed by firms seeking to do business with companies they write reports about (and to be clear analysts who a nicer to managers get preferential treatment). People who want unbiased advice should probably pay for it from someone who owes them a duty of care is my takeaway… but hey I’m biased…

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.

Zombie offshore companies… “Kill the zombie…”

“I’ve long said that capitalism without bankruptcy is like Christianity without Hell. But it’s hard to see any good news in this.”

Frank Borman

“In a business selling a commodity-type product, it’s impossible to be a lot smarter than your dumbest competitor”.

Warren Buffet

The Bank for International Settlements defines a Zombie Company as a “firm whose interest bill exceeds earnings before interest and taxes”. The reason is obvious: a firm who is making less in profits than it is paying in interest is likely to be able to eke out an existence, but not generate sufficient profits to invest and grow and adapt to industry changes. A firm in such a position will create no economic value and merely exist while destroying profit margins for those also remaining in the industry.

The BIS make clear that zombie companies are an important part of the economic make-up of many economies. I am sure sector level data in Europe would show offshore comfortably represented in the data.

Zombie Firms.png

Conversable Economist has an excellent post (from where I got the majority of my links for this post) on Zombie Companies and their economic effects, which timed with a post I have been  meaning to right about 2018 which I was going to call “year of the zombie”. Zombie companies have been shown to exist in a number of different contexts: in the US Savings and Loans Crisis zombie firms paid too much in interest and backed projects that were too risky, raising the overall costs for all market players. Another example is Japan, where post the 1990 meltdown Hoshi and Kashyap found (in a directly analogous situation to offshore currently):

that subsidies have not only kept many money-losing “zombie” firms in business, but also have depressed the creation of new businesses in the sectors where the subsidized firms are most prevalent. For instance, they show that in the construction industry, job creation has dropped sharply, while job destruction has remained relatively low. Thus, because of a lack of restructuring, the mix of firms in the economy has been distorted with inefficient firms crowding out new, more productive firms.

In China zombie firms have been linked to State Owned Enterprises, and have been shown to have an outsize share of corporate debt despite weak fundamental factors (sound familiar?). The solution is clear:

The empirical results in this paper would support the arguments that accelerating that progress requires a more holistic and coordinated strategy, which should include debt restructuring to recognize losses, fostering operational restructuring, reducing implicit support, and liquidating zombies.”

The subsidies in offshore at the moment keeping zombie firms alive don’t come from central banks but from private banks, and sometimes poorly timed investments from hedge funds. Private banks are unwilling to treat the current offshore market as anything more than a market cycle change, as opposed to a secular change, and are therefore allowing a host of companies to delay principal payments on loans, and in most cases dramatically reduce interest payments as well, until a point when they hope the market has recovered and these companies can start making payments that would keep the banks from having to make material writedowns in their offshore portfolios.

Now to be clear the banks are (arguably) being economically rational here. Given the scale of their exposure a reasonable position is to try and hold on as the delta on liquidating now, versus assuming even a mild recovery, is massive because of the quantity of leverage in most of the offshore companies.

But for the industry as a whole this is a disaster. The biggest zombie company in offshore in Europe is SolstadFarstad, it’s ambition to be a world leading OSV company is so far from reality it may as well be a line from Game of Thrones, and a company effectively controlled by the banks who are unwilling to face the obvious.

A little context on the financial position of SolstadFarstad makes clear how serious things are:

  • Current interest bearing debt is NOK 28bn/$3.6bn. A large amount of this debt is US$ denominated and the NOK has depreciated significantly since 2014, as have vessel values. SolstadFarstad also takes in less absolute dollar revenues to hedge against this;
  • Market value equity: ~NOK 1.73bn/$ 220m;
  • As part of the merger agreement payments to reduce bank loans were reduced significanlty from Q2 (Farstad)/Q3 (Solstad) 2017. YTD 2017 SOFF spent NOK ~1.5bn on interest and bank repayments which amounted to more than 3 x the net cash flow from actually operating all those vessels. While these payments should reduce going forward it highlights how unsustainable the current capital structure is.

The market capitalisation is significantly less than the cash SOF had on the balance sheet at the end of Q3 2017 (NOK 2.1bn). Supporting that enormous debt load are a huge number of vessels of dubious value in lay up: 28 AHTS, many built in Asia and likely to be worth significantly less than book value if sold now, 22 PSVs of the same hertiage and value and 6 ageing subsea vessels. The two vessels on charter to OI cannot be generating any real value and sooner or later their shareholders will have had as much fun as they can handle with a loss making contracting business.

But change is coming because at some point this year SolstadFarstad management are in for an awkward conversation with the banks about handing back DeepSea Supply (the banks worst nightmare), or forcing the shareholders to dilute their interest in the high-end CSV fleet in order to save the banks exposure to the DeepSea fleet (the shareholders worst nightmare and involves a degree of cognitive dissonance from their PSV exposure). Theoretically DeepSea is a separate “non-recourse” subsidiary, whether the banks who control the rest of the debt SolstadFarstad have see it quite that way is another question? It would also represent an enormous loss of face to management now to admit a failure of this magnitude having not prepared the market in advance for this?

Not that the market seems fooled:

SOFF 0202

(I don’t want to say I told you so).

SolstadFarstad is in a poor position anyway, the company was created because no one had a better idea than doing nothing, which is always poor strategic logic for a major merger. What logic there was involved putting together a mind numbingly complex financial merger and hoping it might lead to a positive industrial solution, which was always a little strained. But it suited all parties to pretend that they could delay things a little longer by creating a monstrous zombie: Aker got to pretend they hadn’t jumped too early and therefore got a bad deal, Hemen/Fredrikson got to put in less than they would have had to had DeepSea remained independent, the banks got to pretend their assets were worth more than they were (and that they weren’t going to have to kill the PSVs to save the Solstad), and the Solstad family got to pretend they still had a company that was a viable economic entity. A year later and the folly has been shown.

Clearly internally it is recongised this has become a disaster as well. In late December HugeStadSea announced they had doubled merger savings to 800mn NOK. The cynic in  me says this was done because financial markets capitalise these and management wanted to make some good news from nothing; it doesn’t speak volumes they were that badly miscalculated at that start given these were all vessel types and geographic regions Solstad management understood. But I think what it actually reflects is that utilisation has been signifcantly weaker than the base case they were working too. Now Sverre Farstad has resigned from the Solstad board apparently unhappy with merger progress. I am guessing he is still less unhappy though than having seen Farstad go bankrupt which was the only other alternative? I guess this reveals massive internal Board conflict and I also imagine the auditors are going to be get extremely uncomfortable signing vessel values off here, a 10% reduction in vessel value would be fatal in an accounting sense for the company.

The market is moving as well. In Asia companies like EMAS, Pacific Radiance, Mermaid, and a host of others have all come to a deal with the banks that they can delay interest and principal payments. Miclyn Express is in discussions to do the same. This is the very definition of zombie companies, existing precariously on operating cash flows but at a level that is not even close to economic profitability, while keeping supply in the market to ensure no one else can make money either. Individually logical in each situation but collectively ruinuous (a collective action problem). These companies have assets that directly compete with the SolstadFarstad supply fleet, with significantly deeper local infratsructure in Asia (not Brazil), and in some cases better assets; there is no chance of SolstadFarstad creating meaningful “world class OSV company” in their midst with the low grade PSV and AHTS fleet.

Even more worrying is the American situation where the Chapter 11 process (and psyche) recognises explicitly the danger of zombie companies. Gulfmark and others have led the way to have clean, debt free, balance sheets to cope in an era of reduced demand. These companies look certain to have a look at the high-end non-Norwegian market.

SolstadFarstad says it wants to be a world leading OSV company that takes part in industry consolidation but: a) it cannot afford to buy anyone because it shares are worthless and would therefore have to pay cash, and b) it has no cash and cannot raise equity while it owes the banks NOK 28bn, and c) no one is going to buy a company where they have to pay the banks back arguably more than the assets are worth. SOF is stuck in complete limbo at best. Not only that as part of the merger it agreed to start repaying the banks very quickly after 2021. 36 months doesn’t seem very far away now and without some sort of magic increase in day rates, out of all proportion to the amount of likely subsea work (see above), then all the accelerated payment terms from 2022 will do is force the event. But still is can continue its zombie like existence until then…

In contrast if you want to look at those doing smart deals look no further than Secor/COSCO deal. 8 new PSVs for under $3m per vessel and those don’t start delivering for at least another 18 months. Not only that they are only $20m new… start working out what your  10 year old PSV is really worth on a comparative basis. There is positivity in the market… just not if you are effectively owned by the bank.

One of my themes here, highlighted by the graph at the top, is that there has been a structural change in the market and not a temporary price driven change in demand. Sooner or later, and it looks likely to be later, the banks are going to have to kill off some of these companies for the industry as a whole to flourish, or even just to start to undertake a normal capital replacement cycle. Banks, stuffed full with offshore don’t want to back any replacement deals for all but the biggest players, and banks that don’t have any exposure don’t want to lend to the sector. In an economy driven by credit this is a major issue.

I don’t believe recent price rises in oil will do anything for this. E&P budgets are set once a year, the project cycle takes a long time to wind up, company managers are being bonused on dividends not production, short cycle production is being prioritised etc. So while price rises are good, and will lead to an increase in work, the scale of the oversupply will ensure the market will take an even longer time to remove the zombie companies. At the moment a large number of banks are pretending that if you make no payments on an asset with a working life of 20-25 years, for 5 years (i.e. 20-25% of the assets economic life), they will not lose a substantial amount of money on the loan or need to write the asset down more than a token level. It is just not real and one day auditors might even start asking questions…

I don’t have a magic solution here, just groundhog day for vessel owners for a lot longer to come. What will be interesting this year is watching to see the scale of the charges some of the banks will have to make, a sign of the vessel market at the bottom will be when they start to get rid of these loans or assets on a reasonable scale.

Kill the zombies for the good of the industry, however painful that may be.

A market recovery? Not in the data…

Danish Ship Finance have just published their latest report. As usual it is thorough and measured, and frankly not uplifting if you are long on vessels or rigs. The graph above really covers a lot of things I have blogged about here, it’s all well and good coming up with graphs showing how offshore MUST get more investment, as if it were a divine economic law, but that isn’t what companies are ACTUALLY planning on spending.

Another great graph is this one:

DSV Charter Rates DSF.png

What the commentary in the report omits, and I think is very important, is the fact that the divers costs, which are c. £50k for a 15 man team, have not dropped. So for the vessel owner the rate hasn’t dropped 50% it has actually dropped 67% because the labour cost of the dive crew is fixed (again I have blogged about the Baumol effect here). This is probably more pronounced on DSVs than any other asset class but it is a real problem for offshore because the industry isn’t getting more productive (just cheaper which is different). Removing 67% of the revenue for any business is bad, in an industry that had binged on debt, as can be seen, it is beyond a disaster.

DSF also note that while spending on Subsea Production Systems is rising this because smaller step out developments are being done, which require less vessel days, than larger greenfield developments. Again I have discussed this before here.

DSF SPS.png

Finally, it highlights again the scale of the pullback in offshore and why any recovery will not be a repeat of the past. The speed at which contractors are working through backlog is a real concern. Subsea 7 won work recently on the Johan Castberg field that was valued at c. USD 2.0 – 5.0m per well, a 75% decline from the peak. So even an increase in the volume of work awarded will not help the industry recover to previous levels.

Big Three Backlog.png

Subsea Contract Awards.png

This matters because offshore used so much leverage to purchase assets in the past. Now the companies revenues and profits are materially smaller and they are struggling to pay the banks back leading to a credit crisis in the industry. Debt is a fixed obligation that must be paid back for firms to have value and that is much harder to do when the industry is in a deflationary cycle. This is no different to a banking crisis without a central bank.  It is this credit crisis that when combined with the demand crisis makes this so serious. DVB Bank, a specialist lender to the sector, went bankrupt! Indeed I have discussed this many times and it is one my one recurring theme.

Last year probably was the low point in terms of demand. But as the first graph makes clear there is not a wave of investment coming here, just a long slow increase in spending.

Read the whole thing. Many business plans simply don’t reflect this reality yet. Not everyone will survive. 2018 promises to be another tough year for asset heavy companies.