When group think and economic incentives collide …

I’m never sure with this whether it’s a collective case of Norwegian thinking that refuses to accept the scale of the change taking place in the offshore industry or simply the desire to try and get investment banking fees? Maybe a little of both.

Either way it’s clear the market has realised Seadrill is headed for restructuring way before the analyst community…

Seadrill yesterday:

Down 23%. Analysts yesterday morning:

Look at the price targets! And it’s not like anyone didn’t see it coming (Seadrill over 6 months):

There is a liquidity squeeze coming in offshore as all these crazy asset play deals, that were nothing more than momentum trades, have no momentum. The fact is Seadrill is performing miles behind the restructuring plan of only a few months again. Yet again the promised summer hasn’t come and financial markets know it.

The address that never was…

“Not all barrels are created equally,” she said. “60 per cent of our cash flows are not coming from our upstream business. There shouldn’t be a correlation with our reserves or capital expenditure in upstream. It’s not tied to that.”

Jessica Uhl, CFO Shell


Money is not the value for which goods are exchanged, but the value by which they are exchanged.

John Law, Money and Trade (1705)


Roughly a year ago this week I gave an address at the OSJ Conference where I was pretty gloomy about the future for offshore. I was invited back this year but unfortunately a change of work circumstances mean it is no longer really the thing for me to do. Having said that I don’t think it is a bad time for a State of the Union speech.

You can guess where this is going…

Last year we had a mini-rally in offshore mid-year. Some of the more outlandish ideas raised more money and invested more capital in an industry already suffering an excess of capital and the share prices of all these public investments are seriously underwater. The banks also continued to pretend things could only get better, when in fact they were clearly getting worse. Solstad and Pacific Radiance are the two most prominent examples of this philosophy but there are a slew more in offshore supply and drilling.

And all the while shale simply grows in scale and scope. I am actually bored now with the really complicated theories about how and why the shale revolution will die. The offshore optimists who touted this theory have been comprehensively wrong in the past and will continue to be so in my opinion.

A few data points show the scale of the infrastructure being used to grow the shale fields:

That folks is your offshore recovery: prices above breakeven at best and lower utilisation as the prices are just high enough to keep zombie companies in business. Welcome to the new normal.

Shale growth may be slowing down,  but it will still grow over 1 million barrels a day in 2019. This slide from Exxon Mobil is reflective of the huge amounts of capital going into Lower 48 production and the continuous productivity immproveents creating the virtuous feedback loop:


So you can believe some really complicated story about this “offshore recovery” and how it has to happen because reserves are low, or demand will outstrip supply, or shale production isn’t economic, or you can look at what is happening in the US now and accept the logical conclusion: this is the offshore recovery.

Just like the steel industry in the US when it was hit with Asian competition so offshore now has a serious competitor for production investment at the margin. Offshore production isn’t going away but nor is there a boom in store. Projects at the margin are being delayed or cancelled and never coming back. The fleet built for 2014 is still too large by an order of magnitude and operating well below economic break-even. Only a massive increase from the demand fairy can save the current industry structure and that isn’t happening. There are too many boats and rigs with too many operators and this year will bring the start of the slow rationalisation needed. We will end the year with less companies and less tonnage and still the job will remain incomplete.

The most likely scenario at this point is years of oversupply with grindingly poor margins, struggles to get to economic profitability, and a gradual reduction in the fleet as ever so slowly those with less commitment and cash drop out of the race to stay alive. Eventually prices will have to rise to pay for new investment in the offshore supply chain but that looks years away and most firms don’t have the liquidity to wait. Raising new money is getting near impossible for all but the most serious candidates: hedge funds who piled in last year are underwater and look unlikely to wade back in unless the terms are extraordinary, and long-term investors are rightly terrified at the losses the Alternative fraternity have suffered calling the recovery far too early.

The interesting thing is why? In this paper “The elasticity of demand with respect to product failures” by Werner Troesken (pdf) shows that while markets are selection mechanisms they don’t always choose the best products. People continued to buy snake oil in the US long after its efficacy could be argued for.  Maybe the offshore crowd waiting for the boom can comfort themselves with this fact?

However, I see however that in an era of mass production, and rapidly increasing efficiency and unit cost reductions in shale production. To avoid shale, to take your firm off the technological trajectory, would so limit the future  options of a large E&P company that it would not be a wise strategic decision. More marginal capital will be deployed not less. has It is far less risky to invest in a lower margin product like shale, with a shorter payback period, than those custom designed deepwater fields with economic lives vastly in excess of price forecast accuracy.

Worringly for people in offshore is this paper: “Depression babies” by Ulrike Malmendier and Stefan Nagel. If you want to understand how formative experiences can be in lifelong economic actions then this paper demonstrates that investors whose careers were built in recessions invest in fewer equities (i.e. risk capital) even in positive economic times. My rough analogy, which I have no intent to take further, is that E&P execs who lived the 2014 downturn are in no hurry to turn on the CapEx spigot to satisfy all those who tell the world is running out of energy (and as 3 above shows are consistently wrong). And they will be like this forever. Just as those in offshore sit around waiting for the next boom E&P company execs sit around trying to avoid the next investment driven crash.

I have said before loss-aversion theory greatly explains the behaviour of the banks who are crucial to the clean-up of the industry (particularly in Europe and Asia as American losses have been equitized). Every time they have delayed the losses pretending the comeback will happen. And offshore supply in particular was dominated by European and Asian banks. Sooner or later, when the cash flows from the offshore supply and rig asset base cannot make even token payments, and the banks loan books are revealed to be more like Italian regional banks, the real contraction will begin. John Law intimately understood the link between a banks assets and liabilities in a way that would do a modern risk officer proud.

I also mentioned the DSV market last year. I am not mentioning names but building a $150m DSV and selling the vessel for 100k per day for 150 days (at best per annum) is a fools errand in economic terms regardless of the outstanding organisational skills required to deliver it in physical terms. It is simply not possible in a market as competitive as as the Asian DSV market for one firm to outperform others over the long run.

The sale of the Toisa DSVs for between $20-34m shows the economic clearing price of such assets. Such a large gap between actual economic values of operational assets and the historical build costs of new assets can be met by the Chinese taxpayer forever, but eventually the unsustainable nature of this will catch-up with itself. I shall say no more. But Uber can lose money on running taxis for longer than I thought… eventually I will be right here too. Delivering cold Starbucks at $5 won’t keep Uber at a $60bn valuation and IRM work in Malaysia cannot pay for $150m DSVs.

Offshore will continue to be an important part of the energy mix. But the supply chain supporting it to be like that has a great deal of shrinkage to be an economic part of this mix.

Solstad has a solvency problem not (just) a liquidity problem…

The motions of Grace, the hardness of the heart; external circumstances.

Pascal, Pensee 507

“Lend without limit, to solvent firms, against good collateral, at ‘high rates’.”


I disagree with Solstad on this:

It has therefore been decided to commence negotiations with lenders and other stakeholders to improve the overall liquidity situation and to create a robust long-term platform for the Company.

Solstad doesn’t just have a liquidity problem it has a solvency problem. They may have enough broker valuation certificates to keep the auditors happy that the assets add up to the liabilities in a balance sheet sense, but in reality does anyone really believe that the fleet can service ~NOK 30bn in debt? Solstad fails a balance sheet test under a realistic set of assumptions. The fact is if the banks really thought they could sell the vessels for the outstanding debt and be made whole they would have done so long ago. This situation has been allowed to continue, despite clear evidence to the public protestations of its success, because the creditors have no good options. A liquidity problem can be solved with more short-term measures but a solvency problem is endemic and structural and requires a fundamental adjustment. Bagehot’s dictum of lending freely when in crisis relied on the collateral being of high quality and the crisis being temporary in nature, a situation that clearly does not apply here where there has been a structural industry shift.

I’m struggling to see why you would create Solstad today in its current form and my base view is if you can’t answer that question then you don’t have a viable business model in the current market. The scale of the credit write-downs that need to occur here to keep the business alive are just so large it is hard to know if Solstad are just good at PR or good at avoiding reality. I don’t know what the number is but the debt must need to be reduced somewhere in the range of NOK 15-20bn to make Solstad a viable business? The rump of Deep Sea Supply will never be a viable business. And then it needs equity…

The only way to get equity is to find an investor who is going to potentially get such a big return on their investment that the creditors get nearly nothing. There is probably someone willing to make that trade but it is a small pool and it offers the creditors nothing. Market sentiment, as opposed to the actual market, has worsened substantially since MMA pulled of the most successful OSV equity based solution. There is no guarantee that Solstad will survive this encounter with creditors intact and almost a certainty a very different beast will emerge. I am not even sure now splitting the subsea fleet from the supply tonnage will make much difference? The subsea fleet has a large number of marginal vessels that still need scale to survive and given many are being hawked out on windfarm work there is no guarantee their value will “recover” in percentage terms more than a supply vessel. And when some of them come of contract the day rates will also be dramatically reduced.

Systemically it will be interesting to see what happens here. The banks will be desperate not to be handed the keys to Solstad, but as Pacific Radiance in Singapore has shown getting someone to come in behind the banks in the capital structure is tough (with exceptionally good reason). The size of the write-offs the banks would have to take to induce this will make for some uncomfortable meetings in the coming days. Surely soon auditors will force companies to use market transactions (like the recent SDSD FS Arundel for $2.8m!) as the actual realistic value not this “willing buyer/willing seller” ruse?

Not everyone can survive a downturn on the scale we have seen. If the banks somehow, and it will be hard, find a way of keeping the money flowing then all it guarantees is that another company will go. And it will have to be another large “unthinkable” one at that, because there is simply not enough work, and unlikely to be for the next couple of years, for all the supply companies to survive.

The other missing piece of this puzzle is the changing financial structure of the industry and the huge amounts of equity that need to be raised to keep it viable. All the banks behind Solstad have no intention of lending to similar companies for the forseeable future, and every bank is the same, this is a systemic issue directly related to depressed vessel values. But as the contract coverage has shortened so the economic rationale for leverage has also disappeared: lending against a PSV on a 5 x 365 contract is very different to one on a 270 day contract. That sort of spot market risk is essentially equity risk and the average day rate needed to make this economically viable is significantly above current levels. An industry which needs to cover 365 costs on a 270 day utilisation year is again a very different economic model from the past for offshore supply and it only reinforces the size of the adjustment the industry still requires. This is an industry that will significantly delverage going forward and that will mean far more (expensive) equity levels and lower asset values.

An interesting conundrum is whether Standard Drilling and Solstad can really co-exist? I mean either you can buy vessels for a few million and bring them to the most sophisticated market in the world and make money against historic tonnage, or you can’t? At the moment both companies are a financial disaster but surely a recovery story really only works for one company as a logical proposition? There is no indication that the Solstad vessels are trading at a premium in the PSV market to the Standard Drilling/ Fletcher vessels which gives you an idea of what the Solstad fleet would be worth in an open market sale. The same is true for the high-end AHTS fleet where rates remain locked at marginal costs (or below on a 365/economic basis) and competition shows no sign of abating.

Solstad has also provided a natural experiment into the limits of synergy realisation versus the depth of this industry depression: quite simply consolidation alone will not be sufficient. All year Solstdad has highlighted the cost synergies it has achieved by combining with DeepSea Supply (in default before the first quarterly results) and Farstad (in default before the second quarterly results). But these are insignificant in relation to overall running costs and the level of day rate reductions E&P companies have extracted from OSV (and rig) operators. Pretending that consolidation alone is an answer now lacks credibility. New business models need to emerge and a fundamental factor of these will be collectively less supply and capacity.

The Solstad announcement presages a horror season of Q3 reporting coming up across the OSV sector. As I said some time back the summer simply hasn’t come in terms of the volume or value of work for either the supply firms or the subsea contractors. The cash crunch is coming. New money will be come on extortionate terms and prices to reflect the risks involved and not everyone will get it. Rebalancing is beginning to start in earnest and the fact is this market is the “recovery”: a slightly busier summer to build up a cash reserve to cover the costs of an expensive an under-utilised winter. The new normal – lower for longer is the reality of offshore supply and subsea.

The slow fade to obscurity and Gell-Mann amnesia…

Dum loquimur, fugerit invida ætas: carpe diem, quam minimum credula postero.

(While we speak, envious time will have fled; seize today, trust as little as possible in tomorrow.)


For this will to deceive that is in things luminous may manifest itself likewise in retrospect and so by sleight of some fixed part of a journey already accomplished may also post men to fraudulent destinies.

Cormac McCarthy, Blood Meridian 

Amid the seeming confusion of our mysterious world, individuals are so nicely adjusted to a system, and systems to one another, and to a whole, that by stepping aside for a moment man exposes himself to a fearful risk of losing his place forever.

Nathaniel Hawthorne

Media carries with it a credibility that is totally undeserved. You have all experienced this, in what I call the Murray Gell-Mann Amnesia effect. (I call it by this name because I once discussed it with Murray Gell-Mann, and by dropping a famous name I imply greater importance to myself, and to the effect, than it would otherwise have.)

Briefly stated, the Gell-Mann Amnesia effect works as follows. You open the newspaper to an article on some subject you know well. In Murray’s case, physics. In mine, show business. You read the article and see the journalist has absolutely no understanding of either the facts or the issues. Often, the article is so wrong it actually presents the story backward-reversing cause and effect. I call these the “wet streets cause rain” stories. Paper’s full of them.

In any case, you read with exasperation or amusement the multiple errors in a story-and then turn the page to national or international affairs, and read with renewed interest as if the rest of the newspaper was somehow more accurate about far-off Palestine than it was about the story you just read. You turn the page, and forget what you know.

That is the Gell-Mann Amnesia effect. I’d point out it does not operate in other arenas of life. In ordinary life, if somebody consistently exaggerates or lies to you, you soon discount everything they say. In court, there is the legal doctrine of falsus in uno, falsus in omnibus, which means untruthful in one part, untruthful in all.

But when it comes to the media, we believe against evidence that it is probably worth our time to read other parts of the paper. When, in fact, it almost certainly isn’t. The only possible explanation for our behavior is amnesia.

Michael Crichton

Fearnley Securities resumes OSV coverage as slow pickup starts to take shape…Analyst Gustaf Amle places buy ratings on Tidewater and Standard Drilling at a time market is experiencing a slow recovery…


Energy companies and investors are focused on profits and reluctant to boost spending even after crude prices surged to four-year highs, a senior Goldman Sachs banker said on Thursday…

But this time round, the barriers for investments are high, with investors seeking returns of as much as 15 to 20 percent from multi-billion dollar oil and gas projects, Fry said.

“In the near term the focus is on returns as opposed to growth for the sake of growth,”

Big Oil still reluctant to open spending taps: Goldman

I haven’t written much lately a) because I have been busy with an LNG project I am working on, and b) because it’s a bit like Groundhog Day at the moment: a bunch of offshore companies come out with bad results and tell you it’s grim out there and then a bunch of Norwegian investment banks and consultants write reports about what a good time it is to invest. In the same way the relentless expansion of shale continues apace so to does the inevitable decline in value of the offshore fleet and the capital intensity required to maintain it.

Offshore supply is so grim, with such vast oversupply, it is not even worth the effort to rebut some of the more outlandish claims being made. But if you buy Standard Drilling shares expecting the World Wide Supply Vessels to reocver anything like 60% of their historical value I wish you luck, the money would probably be better spent on lottery tickets, but good luck. If you have relied on one of these above-mentioned reports it is likely you are suffering from Gell-Mann amnesia, forgetting the false positives these self-same analysts saw before (this time it’s different…)

On the contracting/subsea side in the North Sea a denouement slowly approaches regarding capacity and the number of firms. I am interested in the North Sea not only because I worked in that market but also as a quite specialised market, with a small number of players and potential assets, it is as close to a natural experiment in economics as you are likely to get. So when you see a load of small firms losing cash, charging rates below what it would cost them to replace capital equipment, and competing against diversified and well capitalised multi-national corporations, the most likely scenario is that sooner or later their private equity owners decide they are not worth putting money into and they are shut down.

It isn’t the only scenario: the investment industry is awash with liquidity, every PE house wants to be the hero that called the bottom of the market right before it boomed. This idea found its ultimate expression in Borr Drilling, but York Capital buying Bibby Offshore was based on a similar sentiment. The problem is that the price of oil has doubled and the amount of offshore work has remained relatively fixed. Next year (apparently?) the oasis in the desert will appear…

Despite the music journalist from Aberdeen claiming that the management reshuffle at Ocean Installer a few months back was just a small thing and all about focus, this week the ex-CEO left to join DOF Subsea. No one would have had more share options in OI than Steinar, and I bet DOF Subsea wasn’t buying any out: when insiders know the shares are worthless you can bet they are. Even a PE house as big as Hitec Vision has to admit sometimes they cannot keeping pumping money into such a marginal venture as OI with such clearly limited upside for an exit? McDermott and OI couldn’t agree on price and unless another bidder can be conjured up to pay more for a business than you could build it from scratch then it’s days are surely numbered?

OI is a subscale business with a few chartered vessels and is exposed to their charter rates rising if the market booms. The downside is limited to zero for equity and but the upside effectively capped. It is no one’s fault it is just a subscale firm in a remarkably unattractive industry from a structural perspective. Eventually, just as with M2, the grown-ups take charge and face reality. As my shore-based offshore engineering guru reminded me: only a well-timed exit from the Normand Vision kept the business open as long as it has been in all likelihood.

But in the long-run OI has no competitive advantage and will be lucky to earn a cost of capital beyond Reach or other such comparable firms, certainly not one to move the needle on a PE portfolio for Hitec. Is there a market in Norway big enough to keep OI as a Reach competitor? I doubt that despite it being a favoured Equinor outcome.

DOF Subsea revealed in it’s most recent numbers that it only makes a ~9% EBITDA margin on projects (excluding the long-term pre-crash Brazil boats).

DOF pre-post.png

That one graphic shows you the scale of the change in the industry: contracts signed pre-2014: profitable, business post that? Uneconomic. No firm in the market will be making much more than DOF Subsea in IMR  and that is loss making in an economic sense: a signal to the market that there is severe excess capacity in contracting.

The Chief Strategy Officer of Maersk Supply recently went public and admitted even an oil boom won’t save them (a relatively frank admission for a company seeking a buyer whose only interest must be seeing MSS as a leveraged play on an oil boom!). For Maersk Supply the future is charity projects (waste collection), decom (E&P forced waste collection), deepsea mining, and a crane so clever it will make windfarms more than a zero sum game for the vessel provider. The chances of that being as profitable as helping an oil company get to “first oil” are zero. But still with a big corporate parent Maersk remain there supplying capacity at below economic cost and ensuring “the great recovery” remains an elusive Loch Ness styled creature.

A slow descent into obscurity would seem the best case scenario for OI while the worst case is clearly a suddent stop in funding when the investors realise 2019 will just be another drain on cash. Something the ex CEO and CFO have acknowledged in their career choices…

I fear the same thing for Bibby. Clearly York are delaying spending on the re-branding (required by their acquisition) because they were hoping to sell the business before the year was out. The financial results released make it clear how hard that will be. Not only did they overpay to get into the business they then, despite Bibby having spent £6m on advisers, had to pump in £15m more in working capital. When you have to put 30% more investment into working capital don’t believe the line about customers paying slowly: it was a simple, yet dramatic, complete misundertsanding about how much cash the business could generate and would therefore need. If you really believed Polaris, Sapphire, and the ROV fleet were worth 80m you would take the money and run…

Like OI the most likely, but not the only scenario, is that Bibby is simply ground down by Technip, Subsea 7, and Boskalis. At the moment North Sea DSV day rates are such that they do not come close to covering the funded purchase of a new DSV (likely to be USD 170m), and yet Bibby have a relatively old fleet. The 1999 built Polaris for example only has 10 years life left in her: on a DCF valuation model that means she has a finite life and not a capitalised value. In all probability Polaris simply cannot earn enough money in the next ten years to pay for the deposit on a new-build to replace herself (particularly given the dearth of bank financing). When I talk of capital leaving the industry this is a classic case of how this will happen. Boats can be chartered now but then the value accrues to the owner, a situation Volstad are only too aware of and will take advantage of when the Topaz charter comes up for renewal.

A quiet winter and a couple of dry-docks later in June 2019 and it is going to be hard to convince an investor to put another £15m because the customers just keep paying slowly (sic). A bidding competition to renew the Topaz charter would in effect render the business worthless.

There are other scenarios for these firms. I sometimes think optimism is a mineral in Lofoten. A veritable army of Norwegian investment bankers are no doubt trudging around with pitchbooks and research reports showing that if you just pay them a transaction fee in cash these contracting companies will bring you untold wealth (next year). But the most likely scenario is that a dramatic reduction in demand is followed by a large reduction in supply and at the moment only the first of these outcomes has occured as the previous cyclical nature of the industry has encouraged hope for a demand led revival. “It’s not the despair, Laura. I can take the despair. It’s the hope I can’t stand” as John Cleese famously remarked.

But it is starting to feel like the end of the road… Solstad has become a national embarrasment, OI a vanity project, and Bibby simply a mistake (to name just three examples). Eventually, when all the other possibilities have been exhausted mean reversion and cash needs will begin dictate economic reality.

One of the most bullish offshore data firms recently published this forecast:


Just remember as a general rule: the larger the orange bar at the bottom (particularly in a relative sense) the less your offshore asset is worth.

[Graph in the header from this Seadrill presentation. Not a graph I suspect that will appear in one from Borr Drilling soon].

Offshore takeovers and the psychology of preferences…

Haile selassie.jpg

Courtier T.L. — Amid all the people starving, missionaries and nurses clamoring, students rioting, and police cracking heads, His Serene Majesty went to Eritrea, where he was received by his grandson, Fleet Commander Eskinder Desta, with whom he intended to make an official cruise on the flagship Ethiopia. They could only manage to start one engine, however, and the cruise had to be called off. His Highness then moved to the French ship Protet, where he was received on board by Hiele, the well-known admiral from Marseille. The next day, in the port of Massawa, His Most Ineffable Highness raised himself for the occasion to the rank of Grand Admiral of the Imperial Fleet, and made seven cadets officers, thereby increasing our naval power. Also he summoned the wretched notables from the north who had been accused by the missionaries and nurses of speculation and stealing from the starving, and he conferred high distinctions on them to prove that they were innocent and to curb the foreign gossip and slander.

Ryszard Kapuscinski, “The Emperor” (1978)

“It was surreal. When someone asked why he was doing the deal, here–now, he actually said, basically, ‘Because Americans are the dumbest investors around, and there’s lots of liquidity in this market.’”

From Kathryn Welling


An industry in decline has much in common with the decline of an Empire and the ancien regime. The changing of the guard, the Schumpterian competition that upsets the stability of the known order, is a constant in the evolution of social systems. Kapuscinski’s account of the fall of Haile Selassie’s empire is a classic account of a system unable to intepret information in the light of new objective realities with direct relevance to businesses facing structural changes. 

I think one needs to look at recent takeovers in offshore with a degree of cynicism that moves beyond the stated narrative of ‘confidence in the future’ based on rising oil prices, but also reflects the unwillingness of the participants to objectively view the risks being taken as the ancien regime of offshore faces a more competitive environment. One of the best comments I have read on the Tranocean/Ocean Rig deal is from Bassoe Offshore ‘Transocean Saves Ocean Rig from slow-moving train wreck‘. But the article only highlights the huge utilisation risks this deal (like so many others) creates: if the work doesn’t come at forecast levels Transocean will have gifted value to Ocean Rig who had few other options. A collection of rigs in cold-stack is not worth billions.

I would also add that I think the Transocean/Ocean Rig and Tidewater/Gulfmark takeovers bear striking similarities beyond the superficial of underutilised asset companies proffering a Common Knowledge of future confidence in future demand. The core similarity is that the shareholders of the selling entities were largely restructured debt holders and distressed debt investors seeking an exit from their investments. Behind the scenes these investors appear to have looked at the lack of forward demand, the high cash burn rate, and the willingness and ability of their competitors to burn cash with an identical strategy and asset base, and instructed an investment bank to get them out of their position. A peculiarity of the ORIG deal is the ability of the colourful Mr Economou to extract $130m over and above his proportionate economic interest in the company (the MSA break fee in the presentation), a situation that I imagine only encouraged the other shareholders to want to relinquish control (FT Alphaville has some interesting background on the him and here).

It is worth taking a recap on what the Common Knowledge was until quite recently (see here and here ) regarding the offshore industry (pushed by the Missionaries at the investment banks and other promoters). In 2017 and at the start of 2018 a credible story, as can be seen from the Seadrill restructuring presentation below, was for a sharp rebound in day rates and utilisation. The Seadrill restructuring was so complex and long that by late 2017 when it was actually due for completion, an update had to be issued and lo-and-behold the recovery was further off than first anticipated (if at all)…

Seadrill VA Dec 17.png

This presentation was by no means unique. Credible people will tell you that not only will day-rates double in three years (or less), but also that this will happen in addition to utilisation hitting 2014 levels. And this will all happen apparently in an environment where E&P companies are deliberately using shale as a competing investment to lower offshore costs…

It may happen, I don’t know the future, there is Knightian uncertainty, but on a probability weighted basis I would argue these sorts of outcomes are low probability events. The offshore industry will over time reach a new equilibrium in terms of demand and supply, in almost all other industries where there has been severe overcapacity issues before normalisation, it has led to lower structural profits on an ongoing basis.

Financial markets work on narratives and Common Knowledge as much fundamental valuation models rooted in the Efficient Market Hypothesis. Indeed these are the core of a financial bubble: a mis-alignment of current prices with long-term risk-weighted returns. What offshore industry particpants wanted to believe in 2017, against the face of significant evidence to the contrary, was that there would be a quick rebound in the demand for offshore drilling and subsea services. Despite the public pronouncements of the major E&P companies that CapEx was fixed and excess cash would be used to pay shareholders or reduce debt, despite the clear investment boom forming in shale, and despite stubbornly low day rates from their own contracting operations. People wanted to believe.

And so the investors rushed in. For Seadrill, for Borr Drilling, for Standard Drilling, for Solstad Farstad, and a myriad of others. While other investors through restructurings became reluctantly (pre-crash security holders) and willingly (post-crash distress debt investors) owners of these companies. Now, having realised that they own asset heavy companies, losing vast amounts of cash, with no possibility of bank lending to support asset values, and a slow growing market, they want out.

The meme for these deals is meant to be one of success… but really it isn’t. And just as the hard cash flow constraint is binding on the individual companies involved many of the hedge fund investors who get involved in these deals are required to produce quarterly performance reports. Charging 2/20 for an oil derived asset declining in the face of rising oil prices can cause questions, or even worse, redemptions.

So having rapidly opened the ‘black box’ of the companies they own the shareholders in both Gulfmark and ORIG realised that they were the proud owners of companies with no immediate respite from the market. The the most logical way to get out was to get shares in an even bigger entity where the shares are significantly more liquid and tradeable. That management of the acquired entities managed to get an acquisition premium is testament to the skills of the bankers involved no doubt, but also down to the fact that the acquiring companies wanted to be bigger, not because they really believe in a market recovery and pricing power (although the pricing power is valid), but because if or when they next raise capital it is better to be bigger in absolute value terms. Show me the incentive and I’ll show you the outcome…

In behavioural finance it is well known that humans overweight the possibility effect of unlikely high risk outcomes and underweight more likely certainty effects (the canonical reference is here):

POP 2018

What does this mean for offshore in general and Transocean/ORIG in particular? It means that the managers backing this deal are overweighting the possibility of a sudden and unexpected rise in offshore demand versus the more statistically likely chance of a gradual return to equilibrium of the market. It is exactly the same miscalculation that the management and shareholders of Borr Drilling appear to have made. The decline in share values recently indicates some shareholders in all these companies get the deal here. The risk of a slow recovery, and a vast increase in the stacking costs of the ORIG rigs is borne more significantly by Transocean shareholders who have borrowed ~$900m to fund the deal, while the upside is shared on a proportionate economic interest basis.

I have confidence in offshore as a production technique for the long-term. It will be a significant part of the energy mix for the foreseeable future. But a 2008 style recovery, given the importance of shale as a marginal producer and the increased offshore fleet size, looks to be an unlikely outcome that is still being heavily being bet on.


Dead man walking…

Hilton Barber: [at Matthew Poncelet’s appeals hearing] The death penalty. It’s nothin’ new; it’s been with us for centuries. We’ve buried people alive; lopped off their heads with an axe; burned them alive at a public square… gruesome spectacles. In this century, we kept searchin’ for more and more *humane* ways… of killin’ people that we didn’t like. We’ve shot ’em with firing squads; suffocated ’em, in the gas chamber. But now… Now we have developed a device that is the most humane of all. Lethal injection. We strap the guy up. We anesthetize him with shot number one; then we give him shot number two, and that implodes his lungs, and shot number three stops… his heart. We put ’em to death just like an old horse. His face just, goes to sleep, while, inside, his organs are going through armageddon. The muscles of his face would twist, and contort, and pull, but you see, shot number one relaxes all those muscles so we don’t have to see any horror show… We don’t have to taste the blood of revenge on our lips, while this, human being’s organs writhe, and twist, and contort… We just sit there, quietly. Nod our heads, and say: ‘Justice has been done.’

Dead Man Walking

Let’s just be clear: there is no chance of Viking Supply suriving as an economic entity. The question is around the method of demise not the ultimate question of it. For those aware of my history with the Odin Viking there are no surprises, and the irony of it’s association with “war, death divination, and magic” is not lost on me.

GOL Offshore was also put into liquidation last week. Again a subscale operator with no discernable point of difference from all the other assets and service providers out there.

This is how the industry in the supply side will rebalance. Small operators with commodity ships, no competitive advantage, and simply not enough asset value or liquidity to survive. But there are a lot more to come.  These size of these companies are small enough for the banks to write-off and are simply not worth saving. When the asset sales are done Viking Supply will effectively be in wind-down mode, the result of structural forces more than any other reason, but a necessary step to economic rationality. I don’t know what the minimum efficient scale is for a supply company but it’s a lot more than 15 vessels.

The largest companies in the supply industry have either large parent companies (Maersk, Swire, etc) or so much asset value post-restrcturing there will always be some logic to put money into to see the next year (Tidewater). For those without a cheap local cost base and contacts or without the advanatges of financial scale a grim existence beckons.

The real question is do the Viking Supply results presage the Q2 results for other operators or have they lost significant market share in the AHTS space? I think you can take it as a given that this comment reflects the general industry conditions:

The offshore supply market was very disappointing throughout the first half year, and the very weak market has caused both fixture rates and utilization to remain on unsatisfactory levels.

The real question isn’t who is selling the shares of companies like Viking, Solstad, and Standard Drilling but who on earth is buying them? The banks were desperate for Viking to survive but even they have abandoned hope now. Expect more banks and investors to do the same in offshore supply.

Buying time for a managed exit from Deep Sea Supply….

The solution to a debt crisis is rarely more debt and a complete avoidance of the issue. From Solstad:

The Financial Restructuring includes a deferral of scheduled instalments, interests and bareboat payments until December 31st, 2019 in a total amount of approximately USD 48 mill. The Financial Restructuring also entails suspension of the majority of financial covenants in the same period.

As part of the Financial Restructuring, SI-3 will be provided a loan from Sterna Finance Ltd. in the amount of USD 27 million, which shall be applied for general corporate purposes in SI-3.

So the banks stop time and Fredriksen (Sterna Financial) lends the company $27m to get them through the next 18 months? And then what? Day rates rise and solve everything? Where that loan sits in the capital structure will be interesting…

Ships depreciate. That means they are worth less next year than this year ceteris paribus, and therefore their earning power is reduced. This plan is predicated on the fact that this is the bottom of the market and the vessels must work next year. Good luck with that. For the old Deep Sea Supply vessels this is your competition.  Yet in 18 months time they have to earn, after OpEx, $48m just to keep the creditors at bay? It’s just not serious. All the more so because the vessels have an Asian focus and there is widespread agreement that that is the most price-competitive oversupplied region in the world.

All this deal does is keep potential credible supply in the market. The problem for any industry rebalancing is the perceived capital value is so high compared to the actual layup or running costs, and that is an industry wide problem. Pacific Radiance, EMAS, Solship, etc., they can’t all survive at current demand levels, but while they try it is mutually assured destruction.

#lastrollofthedice surely?

Which leads me to believe that all involved know this. Have a look at the bulk of these assets and their status:


No lenders really believe they are getting paid all they are owed here surely? My guess is that the JF money has been provided on some sort of “super senior” basis, which gets paid out before the banks, and provides working capital while the next 18 months is spent trying to unwind the Solstad exposure to the DESS fleet. The banks don’t write off anything because it protects their legal position to the claim and preserves the illusion of commitment (and allows the loss to be booked later). A managed wind-down of a clearly not viable business that avoids an immediate firesale would seem the most likely scenario here. A bottle of champagne awaits the first person to send me the IM 🙂