Anecdote is not the singular of data…

“As regards the scope of political economy, no question is more important, or in a way more difficult, than its true relation to practical problems. Does it treat of the actual or of the ideal? Is it a positive science concerned exclusively with the investigation of uniformities, or is it an art having for its object the determination of practical rules of action?”

John Neville Keynes, 1890, Chapter 2

Music journalists know a lot about music… if you want some good summer listening I would advise taking them seriously. However, as a general rule, their knowledge of finance and economics is less sound… ‘Greatest Hits’ have for example included complete confidence that EMAS Chiyoda would be recapitalised right before they went bankrupt… or that the scheme from Nautilus to put ancient DSVs in lay-up wasn’t stark raving mad because the Sapphire couldn’t get work either… I digress…

On a logical basis it is very hard to argue that a majority of companies in an industry can consistently be under margin pressure and and that they will exist indefinitely regardless of cash flow losses. It might make a good album cover but as economic reasoning it leaves a lot to be desired.

Let me be very clear here: if the total number of firms in an industry are operating at below cash break-even only one of three things (or a combination of) are possible:

  1. Some firms exit the industry. Capacity is withdrawn and the margins of the remaining firms rise to breakeven (a supply side correction).
  2. The market recovers or grows (a demand side correction).
  3. An external source injects funds into the loss making companies or they sell assets (a funding correction).

There are no other options. I write this not because I want people to lose their jobs, or because I hate my old company, or because I didn’t like the Back Street Boys as much as the next music journalist in Westhill, I write it because it is an axiomatic law of economics. To write that firms, backed by private equity companies, who have a very high cost of capital, will simply carry on funding these businesses indefinitely is simply delusional.

A deus ex machina event where a central bank provides unlimited liquidity to an industry only happens in the banking sector generally (in the energy space even Thatcher made the banks deliver in general on their BP underwriting commitment). Subsea appears to flushed out the dumb liquidity money, convinced of a quick turnaround, and being turning toward the committed industrial money now.

The real problem for both York and HitecVision, or indeed any private equity investor in  the industry isn’t getting in it’s getting out (as Alchemy are demonstrating). Both have ample funds to deploy if they really believe the market is coming back and this is just a short-term liquidity issue, but who do they sell these companies to eventually? It was very different selling an investment story to the market in 2013 when all the graphs were hockey sticks but now anyone with no long-term backlog (i.e. more than a season) will struggle to get investors (even current ones). The DOF Subsea IPO, even with their long-term Brazil work, failed and the market is (rightly) more sceptical now. Every year the market fails to reover in the snap-back hoped for each incremental funding round gets riskier and theoretically more expensive.

Private equity firms have a range of strategies but they generally involve leverage. Pure equity investment in loss making companies in the hope of building scale or waiting for the market to develop is actually a venture capital strategy. Without the use of leverage the returns need to be very high to cover the cost of funding, and if the market doesn’t grow then this isn’t possible because you need to compete on price to win market share and by definition firms struggle to earn economic profits, yet alone excess profits, that would allow a private equity investor to profit from the equity invested. For private equity investors now each funding round becomes a competition to last longer than someone else until the market recovers. In simple terms without a demand side boom where asset values are bid up significantly above their current levels the funding costs of this strategy become financially irrational.

In this vein HitecVision are trying to exit OMP by turning it into an Ocean Yield copy. The GP/LP structure will be ditched if possible and the investment in the MR tankers shows the strategy of being a specialist subsea/offshore vessel company is dead. Like the contracting companies it isn’t a viable economic model given the vintage year the funds all started.

Bibby Offshore may have backlog but it is losing money at a cash flow level. The backlog (and I use the 2013 definition here where it implies a contractual commitment) it does have beyond this year consists solely of a contract with Fairfield for decom work. This contract is break-even at best and contains extraordinary risks around Waiting-On-Weather and other delivery risks that are pushed onto the delivery contractor. It is a millstone not a selling point.

Aside from the cost base another major issue for Bibby is the Polaris. Polaris will be 20 years old next year and in need of a 4th special survery: only the clinically insane would take that cost and on if they didn’t already own it (i.e. buy the company beforehand). Not only that but at 10 years the vessel is within sight of the end of her working life. Any semi-knowledgeable buyer would value her not as a perpetuity but as a fixed-life annuity with an explicit model period and this has a massive impact on the value of the firm. In simple terms I mean that the vessel within 5-10 years needs to generate enough cash to pay for a replacement asset (to keep company revenues and margins stable) that costs new USD ~165m and for a spot market operator might need to be paid for with a very high equity cheque (say ~$80m). Sure a buyer can capture some of this value, but not much and they don’t need to give this away.

In order to fund her replacement capital value the Polaris needs to bank ~USD 22k per day on top of her earnings. Good luck with that. When I talk about lower secular profits in  the industry and the slow dimishment of the capital base that is it in a microcosm: an expensive specialist asset that will be worked to death, above cash flow breakeven in a good year, with no hope of generating enough value in the current economic regime to pay for a replacement. This is how the capital base of the industry will shrink in many cases, not the quick flash of scrapping, but the slow gradual erosion of economic value.

Ocean Installer also have limited work although it is installation work and firmly grounded in Norway. Like everyone else this is not a management failing but a reflection of market circumstances.

McDermott and OI could not reach a deal on  price previously. MDR realised they could just hire some engineers, get some vessels (and even continue to park them in an obscure Norwegian port if needed by Equinor), and recreate OI very quickly. All OI has worth selling is a Norwegian franchise the rest is fantasy. An ex-growth business with single customer risk and some chartered vessels has a value but nowhere near enough to make a venture capital strategy work in financial terms.

Now at both companies there are some extremely astute financial investors are doing the numbers and they must either send out letters to fund investors requiring a draw down to inject funds into these businesses, explaining why they think it is worth it, and putting their reputations on the line for the performance. It may have been worth a risk in 2016, and 17, but really again in 18? Really? [For those unaware of how PE works the money isn’t raised and put in a bank it is irrevocable undertaking to unconditionally provide the funds when the investment manager demands. Investors in big funds know when the money goes in generally and what it is being used for.] And again in 19? And the more they draw down now the higher the upturn has to be to recover. (In York’s case I think it’s more subtle as the investment exposure seems to have moved from the fund to Mr Dinan personally given the substantial person of interest filings).

But whatever. If they do this all the firms do this forever then they will all continue to lose money barring a significant increase in demand. And we know that this is not possible in the short-term from data supplied to the various regulatory agencies. And for the UK sector we know production starts to decline in two years (see graph). So in the UK two years just to keep the same available spend in the region the price of oil will have to go up or E&P companies will have to spend more proportionately on the service companies. This is not a structurally attractive market beset as it is with overcapacity.

Aside from the major tier 1 companies are a host of smaller companies like DOF Subsea, Maersk, Bourbon, and Swire, long on vessels and project teams, and with a rational comnmitment and ability to keep in the market until some smaller players leave. I repeat: this is a commitment issue and the companies with the highest cost of capital and the smallest balance sheets and reources will lose. These companies don’t need to win the tie-backs etc. that OI (and Bibby) are really aiming for: they just need to take enough small projects to ensure that the cost base OI and Bibby have to maintain for trying to get larger projects is uneconomic and expensive in short-term cash costs. It is a much lower bar to aim for but an achievable one.

So the private equity funded companies are left with option 3 as are the industrial companies. The problem is that the industrial companies have a Weighted Average Cost of Capital of ~8-15% and private equity companies who like to make a 2.5x money multiple have about a 25-30% (including portfolio losses) The magic of discounting means the nominal variance over time is considerably larger.

And for both OI and Bibby the fact is they face a very different market from when they started. Both companies went long on specialised tonnage when there was a shortage, taking real financial and operational risk, and growing in a growing market. That market looks likely never to return and the exit route for their private equity backers therefore becomes trying to convince other investors that they need to go long on specialist assets that operate in the spot the market with little visibility and backlog beyonnd the next six months. As someone who tried raising capital for one of these companies in downturns and booms I can tell you that is a very hard task.

So if you want some easy listening summer music I suggest you take advice from a music journalist. On the other hand if you want a serious strategic and financial plan that reflects the market please contact me.

Shale and offshore… the competition for marginal investment dollars…

Last week the Baker Hughes rig count for the US came in and again it was up. In the graph above Woodmac are highlighting it that Lower 48 US shale production may crack 12m barrels a day.  As recently as 2013, when offshore was starting to go really long on ships, US shale production was ~3.0m per day. It has in short been an industrial phenomena, one as I have noted here before no other economy in  the world could have marshalled as it has required enrmous flexibility in capital markets and the ability to turn a service industry into a manufacturing process.

The narrative has changed as well. Shale has consistently outperformed even optmistic forecasts:

US-Shale-Production-Outlook-Revised-Upward-Repeatedly-20160210-v2.png

As recently as 2016 even BP’s renowned research team were only predicting a fraction of actual demand. Shale now represents an enormous portion of workd output and it’s economic model of short-cycle low-margin is the antithesis offshore but this flexibility around spending commitment is clearly very valuable to E&P companies in an era of price volatility.

So I get as the price declined in 2014/15 you could maybe make a reasonable case for a quick rebound in offshore? 2016 at a stretch, although I think the market signals for offshore were already clear byt then, but I have to say it strikes me as hard now for people ignore the scale of this change and to argue there will be some demand driven boom coming in offshore. E&P companies have stated repeatedly they are sticking to forecast offshore CapEx numbers and they seem to be sticking this.

I still think there are too many business plans floating around which have as a core assumption. This from Ocean Rig:

Ocean Rig Recovery.png

“[F]or the market upturn” (emphasis added)… like it’s a given? I get it’s off a low base but I think we all know when people talk about that sort of recovery they mean a deep cyclical one that flows to rig and vessel operators who will make a ton of money.

But let’s look at the scale in terms of shift at the margin in incremental output:

Long term offshore.png

The last time the oil price dropped and offshore boomed back,whichever cycle you were talking about but especially the quick 2008/09 rebound, that yellow portion of incremental investmnent simply didn’t exist on the graph in a meaningful sense (and since this graph was done shale is more important). A business plan that simply ignores this reality an insists on a change in market conditions as it’s defining principal is simply logically inconsistent to my mind. Clearly offshore is an important part of the energy mix going forward, but in 2009 it was really the only alternative to traditional onshore production and that clearly isn’t the case now.

Offshore used to have very high utilisation rates, that is what made small companies in an extremely capital intensive industry viable, but it is clear that the scale of investment in shale is having a profound impact on utilisation levels and this is changing the entire economic structure of the industry. This point is a prelude to a further few posts that have this logic as there core.

What is an offshore construction vessel worth?

There is an article from Subsea World News here that is sure to have bank risk officers and CFOs choking over their coffee… VesselValues new OCV is launching a new analytics tool for the sector. The ten most valuable vessels in the OCV sector are apparently:

  • Normand Maximus $189m;
  • Fortitude $99 million;
  • Deep Explorer $97 million;
  • Siem Helix 2 $96 million;
  • Seven Kestrel $95 million;
  • Siem Helix 1 $95 million;
  • Island Venture $94 million;
  • Viking Neptun $92 million;
  • Far Sentinel $90 million;
  • Far Sleipner $89 million;

Firstly, look at the depreciation this would imply? As an example the Maximus was delivered in 2016 at a contract price of USD $367m. So in less than 2 years the vessel has dropped about 48% in value. Similarly the two new DSVs the Seven Kestrel and Deep Explorer appear to be worth about 67% of value for a little over two years depreciation.

Secondly, the methodology. I broadly agree with using an economic fundamentals approach to valuation. And I definitely agree that in a future of lower SURF project margins that these assets have a lower price than would have been implied when the vessels were ordered. I have doubts that you can seperate out completely the value of a reel-lay ship like Maximus from the value of the projects it works on but you need to start somewhere. It is clear that SURF projects will have a lower structural margin going forward and logically this must be reflected in a vessel’s value so I agree with the overall idea of what is being said.

There is a spot market for DSVs on the other hand so their value must reflect this as well as the SURF projects market where larger contractors traditionally cross-subsidised their investment in these assets. A 33% reduction in value in two years might well reflect an ongoing structural change in the North Sea DSV market and is consistent with the Nor/Boskalis transactions on an ongoing basis. This adds weight to the fact York have overpaid significantly for Bibby, who would be unable to add any future capacity to the DSV market in the pricing model this would imply and not even be earning enough to justify a replacement asset. Given the Polaris will need a fourth special survey next year, and is operating at below economic value at current market rates, even justifying the cost of the drydock in cash terms on a rational basis is difficult.

Depreciation levels like this imply clearly that the industry needs less capital in it and a supply side reduction to adjust to normal levels. Technip and Subsea 7 are big enough to trade through this and will realise the reality of similar figures internally even if they don’t take a writedown to reflect this. Boskalis looks to have purchased at fair value not bargain value to enter the North Sea DSV market. SolstadFarstad on the hand have major financial issues and Saipem locked into a charter rate for the next 8 years at way above market rates, but with earnings dependent on the current market, will have to admit that while the Maximus might be a project enabler it will also be a significant drag on operational earnings. The VesselsValue number seems to be a fair reflection of what that overall number might look like.

The longer the “offshore recovery” remains illusory the harder it will be for banks, CFOs, and auditors to ignore the reality of some sort of rational, economic value criteria, for offshore assets based on the cash flows the assets can actually generate.

Market forecasts as structural breaks….[Wonkish]

Not for everyone this post but important if you are involved in strategic planning. The above chart is from the latest Subsea 7 Q1 numbers. The problem I have with these charts is what statisticians call “structural breaks“. Basically if the underlying data has changed then you need to change your forecast methodology. As I have argued here and here (although it’s a general themse of this blog) I think there is sufficient evidence that large E&P companies are commissioning less offshore projects when they become economically viable in the past on NPV basis. I am not sure that all the forecast models reflect this.

This break in the historical patterns has really important forecasting implications because when you see whichever market forecast  it has made an assumption, whether formally through a regression model or on a project-by-project basis, that x number of projects will be commissioned at y price of oil (outside of short term data which logs actual approvals). If there has been a stuctural change in the demand side then y (commissioned offshore projects) will be lower, and on a lower trajectory to x (the oil price) permanently, than past cycles.

E&P companies are not perfectly rational. As the oil price gets to $60 there is no set programme that triggers a project. For sure the longer the price stays high it increases the probability of projects being commissioned but it is a probability and the time scale of has changed I would argue. I think it is why demand has surprised many on the downside because there has been a change in the forecast relationship between offshore projects and the spot price of oil.

 

More for less… Tier 2 contractors is where capacity will leave the market

I don’t get the ROV business. At the small end numerous small firms, often with private equity money, all with exactly the same strategy of getting cheap ROVs and finding  a (desperate) vessel operator to charter them the vessel for next to nothing on a profit share. They all have exactly the same business model and have no ability to differentiate on anything other than price, entry barriers are low, and buyers have a vast array of choice. It is a textbook example of an industry structure designed to produce poor profitability. Against this there are large international contractors who make minimal profit but clearly have enough capital and cash to have staying power. Surely, if demand remains at current levels something has to give?

Back in February Reach Subsea raised money, I didn’t get their logic, or that of people backing it, and I don’t get it now. However, unlike ROVOP, M2, and a host of others, they are publicly listed so you can get access to exactly how they are performing, and I would be really surprised if any of the other smaller companies are doing any differently given their business model and strategy are exactly the same. It is also worth noting that Oceaneering, the worlds biggest ROV company by some margin, has just reiterated its commitment not to pay dividends until the market improves. So with all the benefits of scale that Oceaneering has they still cannot return any cash to investors for all their free cash flow.

Now Reach Subsea are maybe great engineers and operations people, and they may have good relations with Statoil, but here in essence is the problem:

Reach key figures Q4 2018.png

Compared to 2016 in 2017 Reach sold 49% more ROV days, 63% more offshore personnel days, and 35% more vessel days and yet increased turnover by only 10%. It is the very definition of business facing decreasing returns to capital: For every unit of capital they throw at the market they get a decreasing amount of economic value back. (I won’t even get into the EBITDA and operating loss because they brought some equipment during the year and claim to be building up scale, but the turnover number tells you all you need to know).

This is interesting as well:

Reach Operating Profit Q4 2018.png

To get 360m in sales in 2017 cost 387m in direct expenses. Or look at it another way: it cost 387m to sell 360m. That is a totally unsustainable business model. I get they are working their way out of terminating some historic vessel charters but businesses that cannot make an operating profits are axiomatically dependent on external funding eventually. Like everyone else in the ROV space this business is simply keeping capacity going while waiting for other people to drop out of the market and wait for the magical demand fairy to appear and save everyone.

Despite this they are opening an office in Houston, which is a major expense for a company of this size, to offer exactly what everyone else in the market there does: cheap ROVs on vessels with no commitments. Like everyone else they are doing loads of tendering and are in advanced discussions with potential clients. I get the US has the best structural growth characteristics of any ROV market, but there are a lot of companies there doing exactly this,  and firms like Bibby had to pull out despite investing substantial amounts in kit and infrastructure.

I therefore find it amazing that you can get comments like this:

Reach q4 comment 1.png

And then get this:

Reach Q4 comment 2.png

What attractive growth opportunities? The installation market is forecast to be flat next year and the IRM will grow modestly but nowhere near enough to soak up excess capacity. But despite this the obvious answer is to go to Houston, well behind ROVOP, M2 … ad infinitum

But clearly some people disagree because despite everything I have written above look at the Reach share price:

Reach Share Price 06042018.png

Up 42% in the last 12 months. 20% since November. Not only that the company according to Bloomberg is trading 1.6x book value which implies that the asset base can generate signficant value (Tobin’s Q) above its cost. For a company where the operating losses were NOK -17m and the Depreciation charge was NOK 27m that is verging on the astonishing, and definitely on the irrational.

You can say the stockmarket is meant to anticipate forward earnings and I agree, but there is nothing structural in the market that would lead you to believe 2018 is going to be very different from 2017 (as the graph from Oceaneering in the header makes clear). I get Reach have announced over 100 days work recently, but without any information on day rates and margin levels can you believe it is value accretive?

The longer all the ROV companies remain in business and keep capacity high it guarantees that margins will be breakeven-to-low in the best case for everyone in the game. This is an industry that built capacity for 349 tree installations in 2014 and is coping with 243 in 2018 (a 44% decrease), and at the moment the new investors piling in are simply providing a subsidy for the E&P companies who take rates at below economic levels.

It is only a question of which tier 2 companies leave the market if The Demand Fairy doesn’t make a rapid deus ex machina appearence soon. This is an industry with too much capacity and capital relative to demand and the equity market here is sending the wrong price signal about allocating more capital.

Oil prices, speculators, and supply expansion…

An article from the FT here touches on an issue that has been discussed since there was an oil market:

Who trades oil is changing, however. Investors who bother little with details such as inventories and pipeline flows are replacing dwindling ranks of specialist commodities hedge funds. The shift could alter the way prices are formed…
Then who is driving oil positions higher? Newly prominent oil speculators are not necessarily reacting to news about supply and demand or utterances from Riyadh. Instead, they may be buying and selling oil based on moves in currencies, interest rates or the price of oil itself.

Namely, are speculators affecting the price of oil? You can see from the graph above that the exponential growth of Brent Ice futures contracts, which is cash settled and does not require physical product delivery, bears no relationship to the relative steady increase in the demand for oil. Some demand for these futures clearly reflects increasingly sophisticated financial risk management techniques, but some clearly represents purely speculative capital trading on price moves (often with large amounts of leverage).

There has been an entire industry in trying to ascertain the economic effects of speculators in oil markets. The IMF view is that they have no effect, but reputable economists at institutions such as the St Louis Fed disagree. A good summary is here.

My own (simplified) view, that accords to a well researched positions, is that speculators affect the volatility of the oil price but the not the final price over the long run.  Basic economic logic alone should dictate that if there is an increased amount of capital being invested in an asset class it will cause the price to rise, but when combined with leverage it adds huge volatility (quite simply if you have borrowed money to buy something and the price drops you tend to liquidate quickly to minimise loses). Which is why you see such huge swings in oil investment positions with a clear procyclical bias:

The big long.png

But the major point for those involved in service industries to my mind is that this is part of the explanation why there is not a linear relationship between the oil price and demand for oil field services. Directors at E&P companies make decisions about the long term price but ultimately the market for physically delivered product is more important when investing in production infrastructure, despite the large trading arms of the supermajors,  because they obviously do have deliver in the physical form eventually. They also benefit from miscalculating demand on the upisde through rising prices and a higher ROE on invested capital, so although they give up some amount of market share it’s a fairly small downside for erring on the side of caution.

Too many models that forecast the demand for oilfield services work are based on the forecast oil price rather than physical volume required. Too many management teams in offshore are using a rebound in the oil price as “proof” the “market” will eventually recover in demand terms when it is clear there is no linear relationship. As shale becomes the swing production method of choice offshore demand in particular should be relatively easy to forecast because in the new environment it will be supplying a baseload of physically demanded production while short-term changes in demand are managed by tight-oil. If someone in oil services tells you their business model is fine because the price of oil will rise I would suggest examining things a lot more carefully.

The shale productivity revolution in context…

“[W]e can see the computer age everywhere but in the productivity statistics”

Robert Solow

 

A great article in the FT today (behind paywall) on the boom in shale being driven by productivity increases (a near facsimile earlier version appears here). Readers of this blog will notice a consistent theme, as Krugman said, “productivity may not be everything, but in the long run it’s nearly everything”. The importance of this is that the US is turning shale into a manufacturing industry, small incremental improvements day-in, day-out, that cummulatively dramatically lower overall per unit costs:

In 2015, shale oil producers on average used 3,300 tons of sand per well, according to Petronerds, a consultancy. By last year, that had almost doubled to 6,100 tons per well. Delivering that much sand to the well site can require 250 truck movements. Other techniques for shale production have also been refined to increase the amount of oil that can be extracted. Modern rigs can drill faster, further, and more accurately than their predecessors. The process of hydraulic fracturing is being split up into more “stages”, allowing effort to be focused more precisely on oil-bearing rocks.

Innovations using the latest computing and communications technology, including remote operations, are also starting to be used more widely. Schlumberger, the oilfield services group, says that in 2014, 13 per cent of jobs it worked on at US onshore wells were supported by technical experts watching from its Houston campus. By 2017, that was up to 31 per cent.

This coincided with the IEA forecasting that the US will become the world’s largest oil producer by 2023 (graph above). [It is well worth having a look at the 13 slides at the bottom of the page of the IEA link]. Investment remains depressed in all but tight oil and the comment at the bottom of this slide regarding offshore is telling:

IEA Upstream Spending.png

The IEA is worried:

that despite falling costs, additional investment will be needed to spur supply growth after 2020. The oil industry has yet to recover from an unprecedented two-year drop in investment in 2015-2016, and the IEA sees little-to-no increase in upstream spending outside of the United States in 2017 and 2018.

“The United States is set to put its stamp on global oil markets for the next five years,” said Dr. Fatih Birol, the IEA’s Executive Director. “But as we’ve highlighted repeatedly, the weak global investment picture remains a source of concern. More investments will be needed to make up for declining oil fields – the world needs to replace 3 mb/d of declines each year, the equivalent of the North Sea – while also meeting robust demand growth.”

The real questions here revolve around how much capacity is being replaced annually, and it is simply not true that 3mb/d are not being replaced at the moment. The producutivity improvements in shale above are part of the solution. Other questions are what sort of price increases would crimp demand? etc. There appears to be no change in investor expectations that they want E&P companies, certainly large ones, to reduce debt and increase shareholder payouts, and therefore capital projects will remain subdued. There is also a strong feeling in the investment community that reserves can be run down.

Without wishing to sound like a broken record the “Demand Fairy” isn’t saving anyone in offshore. Offshore needs to re-engineer it’s business model to compete. The IEA is clear that this weakness will be felt from 2020 onwards, so even if you accept their reasoning, that is a long time to keep burning OpEx if your business model cannot even breakeven in the current climate.

I view shale as a technological revolution and believe that no economy is better suited to maximising its potential. Perez defines the major economic technical revolutions since 1770 into five categories, and the US is dominant in the last three:

Tech Rev 1770 -2000s.png

Revolution is an overused word. But according to Perez’s definition, that I agree with, the shale industry is a Technological Revolution (TR):

Tech Rev Definition.png

This to me is the most interesting part of economic history, because while there are nuances the broad economic development of industrial patterns are really well understood. A classic article here compares the development of the computer industry to electric dynamo. Like shale it is a story of how US capital markets funded ambitious companies, vast economies of scale, manufacturing efficiency gains, and the slow initial diffusion of producitivity gains (think tight-oil 2007).

How long can this positive productivity feedback loop, where innovations throughout the system positively affect other inputs, continue? A long time I suspect. Shale may not be subject to the same volume effects as the PC industry but it still makes an interesting comparison (Allen):

Computers deflator.png

(For those who can’t remember logarithmic maths from school all the left hand bar of the top graph means is “this is a really big number… so big we have a formula to make it shorter”. And the bottom graph just means that even though the price dropped really quickly a lot of new features were added as well). This is a hallmark of the US economy and a manufacturing industry based on constant productivity improvements.

An earlier, and slightly different technical revolution, can be seen with the invention of Corliss Steam Engine,  which allowed America to break free from the constraints of water power in the 19th century (Rosenberg and Trajtenberg). Like shale this was an energy revolution, one that changed the structure of the US economy and allowed manufacturing and urbanization to begin in earnest. Corliss Steam Engine.png

Everytime I write about shale I want to write something about the incredible economic period of the 1930s: How US mass production techniques, a revolution in both managerial skill and capital formation, led to the creation of the economy that created Victory Ships and transformed the Ford factory at Willow Run (YouTube watch this, seriously) into the manufacturer of the B-24 (“the Liberator“), innovations that arguably changed the course of the WWII, and ultimately the post-war global economy. There are surprisingly (and disappointingly) few journal and web references to this, and all are about the mathematics of productivity, when this is really a story to be told at the company level. However, economic development is path dependent and these processes and learnings today are being applied in the shale basins every day, even if unwittingly. (For a broader read about what an incredible period the 1930s was in microeconomic terms this the best I have turned up so far).

So although I don’t understand the individual impact of every innovation listed on this slide I understand where they came from and the process driving this:

Nabors Rig.png

Once upon a time a PSV went for the low-to-mid USD 20ks a day. At the time of writing the BHGE rig count hit 800, the revolution therefore continues…