Bibby Offshore restructuring: Latham and Watkins, York Capital, and DeepOcean/Triton…

Latham and Watkins, legal advisers to Bibby Offshore Holdings Limited in their restructuring, recently published a ‘thought leadership’ article on the transaction. It is a short read, and as an exercise in varying perceptions, well worthwhile if you followed the relatively shambolic proceeds that allowed the company to reach it’s current state.

I liked this line:

In early 2017, Bibby Offshore’s directors determined that the company’s capital structure had to be right-sized and that additional liquidity was required to meet the challenging market conditions facing the business.

This is a business that lost £1m a week in 2016 of actual cash. How early in 2017 did the directors determine the need for a change in the capital structure? As I noted in June 2017 paying the interest payment was irresponsible when the business needed new funding within the next few months. The fact is this transaction only started seriously in August, as testified by York claiming £200k per month for their efforts from that point (and public announcements by Bibby at that time), but by which time the business was insolvent in an accounting sense, only a going concern because they were in discussions about a transaction, and the restruucturing plan itself presented when the business was literally days away from administration as they were down to ~£2m cash.

The fact that Moodys downgraded Bibby Offshore Holdings Ltd in Nov 2016 could also have been a hint?

In fact in March 2017 the Chairman of BOHL (who later lost his job in part because of this fiasco) made this statement :

Mike Brown 23 March 2017

I guess it wasn’t that early in 2017 the Directors came to that realisation then? Like, “well positioned” apart from the fact they were running out of money? Or did they just decide to print something blatantly untrue in their statutory accounts?

Maybe this line from the CEO (25 March 2017):

CEO Bibby 25 March

This disclaimer “apart from losing £1m per week at operating cash flow level and we will therefore need to right-size the capital structure” should really have been added to make the Latham and Watkins story credible. Or maybe this one:

Bibby CEO March 2017

In case orders should increase rapidly?!!! Turnover in 2017 dropped 50% over the previous year and they obviously had to drawdown on the revolver! Surely this was obvious by the end of March (which most people calculate as nearly 25% of the way through the year)? The Bibby directors don’t sound like a group of proactively looking at a restructuring “early” in the year here. Reference to the Bibby shareholders putting money in is comedically short given the known financial position of the Group and how far underwater the equity was.

You literally cannot make this up (unless you are a lawyer I guess?).

Look, I get this is essentially a small marketing piece for Latham and Watkins (the vessel on pictured on their website isn’t even an offshore vessel, yet alone a Bibby Offshore one), and they are being diplomatic. But the truth is the Bibby restructuring was a highly uncontrolled event by a management team out of their depth and a shareholder unwilling to accept the reality of his financial situation. All the documents (since taken down) relating to the transaction were clearly drafted late in the process and reflected the power, and weakness, of York at that stage who was committed to a deal. The restructuring agreement contained wide ranging clauses designed in lieu of actual execution documents that would be drafted when more time was available. This is not a criticism of Latham and Watkins, to get a deal over the line at that stage, when it appears that Barclays had refused to extend the revolving credit facility and the much vaunted “supportive shareholder” was unwilling to put anything in, was creating a situation that would have led to an immediate administration, it is therefore a considerable achievement. But it was that close.

The reason I am going on about the past is that it is impossible to understand the dire current position of Bibby Offshore without understanding the context. I guess if you buy companies with zero due diligence you have to expect the occassional dud, and it is clear this is a bomb that has blown up in the investors face.

The crucial point is this say Latham and Watkins:

As echoed by Bloomberg’s comment on the transaction: “(….) this is about as fair of a deal for all creditors as I have seen. Parties may differ on what the future holds, but the terms of the restructuring are clear and equitable. This is a text-book restructuring (…)”.

The reason for this is clear: York and their co-investors dramatically overpaid. The rest of the creditors were happy because they couldn’t believe the terms that someone was putting money in at! The old saying that “if you don’t know who is getting screwed on a deal it’s you” is apt here. The only question now is how much money the Bibby investors lose and how quickly?

One of the great mysteries of this deal is why York, charging £200k per month for their competence and skill, allowed the business not to go through an administration process (which they would have controlled as the largest creditor), and emerge via a pre-pack debt free. The business had virtually no backlog, and as has happened in the Norwegian restructurings, trade creditors can be protected. By not doing this the business has been saddled with many of the historic obligations that now call into question the viability of the business. In particular the office space in Aberdeen and the US (both entered into at the peak of the market), residual liabilities to Olympic (the Ares redelivery costs are owing and the Olympic Bibby charter), and ROV leases and hangers, redundancy costs, Trinidad tax etc, all these costs must be paid for from current market revenues and rates which are significantly below levels when the contracts were entered into, by a business that is dramatically smaller in scale.

A quick look at the uses of the £50m rights issue shows Bibby Offshore to have solved its immediate financial problems but it has not solved the issues with its economic model. Without a substantial change in market conditions the business will require a further capital injection, potentially as early as later this year. This is a rough guide to how much cash Bibby Offshore currently has available:

Bibby 50m.png

I have made aload of assumptions here, I have, for example, no idea what the Latham and Watkins fee or EY fee is, but have made an esitmation based on London Big 4 rates. If anything I could have underplayed these, but the overall number will be correct within a few million, especially as trading losses are likely to have been higher. I haven’t included rebranding costs as York are hoping to flip this prior to dropping a 6 figure number on these. The point is this though: it is not exactly an impregnable balance sheet and unless market rates for DSVs rise substantially, and there is no indication they are doing so, it will not be enough to get to this time next year as a credible going concern. Bibby/ York realistically require victory in the (highly speculative) EMAS case for the business to have a viable financing strategy that can absorb trading losses for longer than the ~£20m they realistically have available.

I believe York confused a liquidity crisis for a solvency crisis and therefore acted as if all the business needed was a short-term cash facility. York appear desperate now to offload the business quickly to Triton/ DeepOcean. There are few other logical buyers and yet there are huge challenges if Triton/DeepOcean take on this risk. DeepOcean appear to be keeping the diving personnel on to give them some options in this area.

One challenge is contractual risk: Bibby Offshore recently won a large decomissioning job for Fairfield. I haven’t seen the exact specs, but it is probably ~30 days DSV work and ~120 days ROV work. Which is good… but … to win they have taken all weather risk, which is just gambling. They may have needed to in order to win the work, but that is taking an active decision to take risk that you cannot mitigate. It may all work out well and they could make a profit, but a bad summer and the boats will be bobbing around unpaid while they finish the work, and all to Bibby’s account. For a small loss-making, undercapitalised, contractor that is a disaster scenario. Anyone buying the company would be mad to take on this, literally, incalculable risk. Why not just wait and see what happens?

The problem for the seller is the longer the cash burn continues the weaker their position becomes and the harder raising, or justifying raising, capital will be. Bibby’s competitive position is significantly weaker than a year ago with Boskalis buying the Nor vessels. Bibby faces three very well capitalised companies who are clearly committed to the market. Any further fundraising for the company would recognise this, and the fact is that the Bibby fleet is older than comparative fleets.

There are very few investors who will continually inject new money into a micro-scale, loss making, niche business, competing against three global players with strong balance sheets, in an industry that requires vast quantities of CapEx , has over capacity issues on the supply side, with weak demand growth forecast, and a realistic chance of dropping from the #3 player to number #4. And that is exactly the scenario facing Triton/DeepOcean as well (they can capture some cost savings but how much do you pay for those when the order book is less than a year and your newest competitor has €1bn cash?).

The whole economic and market environment has changed. DSV rates look to be settling at £100-130k for the Boskalis/Bibby fleets (slightly higher for the Technip/SS7 new builds) and at that level I don’t think the business model, especially with historic obligations, works. Is there really room for four DSV companies in the North Sea market? in 2014 the Harkand boats worked in Africa to get utilisation. If not, do Bibby, currently operating at a trading loss, have a real plan to battle it out against 3 publicly listed giants, with no other plan than a market turnaround in day rates? Without CapEx work picking up the IRM space will be competitive for years.

The big surprise is how slow the inevitable restructuring has been. The US and Norwegian offices were closed within weeks (despite L&W claiming ” that it has a strong consolidated position from which to expand in the markets in which it operates”) but there are well over 200 people in Aberdeen! 3 vessels working have to cover not only the crew onboard but nearly 70 people onshore per vessel as well (and some very expensive consultants to boot at the moment). That is totally unsustainable and it is causing the company to burn through its much vaunted cash pile. The DOF Subsea ratio is 1 boat to 42 people.

Scale and legacy cost issues pervade the business: the Bibby office in Aberdeen, for example, must be at least £3.5m per annum, that means even with three vessels working 270 days each one needs earn £4.4k per day just to pay for a proportionate share of it. And these three vessels still have to pay for the US office until they can get out of the ten year lease. The same for the ROV hanger. The same for the upcoming restructuring and redundancy costs. There are simply too few boats working to cover proportionately the expenses being incurred.

In addition Bibby Offshore has the least competitive asset base of any North Sea DSV contractor. The Bibby Polaris needs a fourth special survey next year. At 20 years old she is two generations behind the newer vessels (the Bibby ST and Tecnhip/SS7 newbuilds), the forward bell arrangement is awkward, and the carousel is not efficient. So even if someone paid the equivalent of £20m for the vessel, and assuming you got ten years of life out of it that means c.£7500 per day in depreciation if the vessel works 270 days a year, over and above running and financing cash costs. If the drydocks come in over budget you would be lucky to achieve even cash breakeven at current market rates. PE investors, like York, mainly talk cash, which is fine until you run into an asset with a finite life. Sell the vessel out of the North Sea and you would be lucky to get £10m, and it would cost you six months running costs to get that.

The Bibby Sapphire looks to have temporarily avoided the fate of layup and is currently at anchor in Aberdeen. Sapphire will dive some days this summer, but having an asset that is needed only 90-100 days a year, at £100-120k per day (less 50k for project crew), is not economic at more than a de minimus price when the full 365 costs are taken into account and dry-docks/surveys are needed. Yes, she can work as an ROV vessel as well, but in-case no one noticed the reason that companies like Reach, M2, and ROVOP are making money at the moment is that they get the boat for free (in an economic sense).

I get how the spreadsheet added up to £115m Bibby valuation that York led the investment at… it’s just the assumptions required to get there that I think are erroneous.

York don’t have a good track record in offshore. Cecon, which York gained control of via distressed bonds, was a disaster, and for many of the same reasons the Bibby Offshore: a fundamental misunderstanding of the asset base and business model of the acquisition. The rump of Cecon is Rever Offshore, which mainly consists of a rusting hulk in Romania (ironically named the Cecon Excellence originally), rapidly going nowhere. York may have made some money off the one  Cecon vessel sold to Fortress at the peak of the market… But transactions such as this saw York Capital Management lose a significant portion of assets under management in 2017:

…funds to see withdrawals included York Capital Management, which lost $6.10 billion [from $22.3bn to 16.2bn]. The fund posted negative 2015 performance of 14% and was flat in 2016, a year in which The Wall Street Journalreported fund CEO Jamie Dinan said he experienced “his most intense client interactions in years.” That can happen when dramatically underperforming benchmarks.

York must be hoping there is a hoping there is another financial buyer who knows even less about subsea than they do.  Triton/DeepOcean want to make sure that York’s one good investment in offshore, their minority position in DeepOcean, doesn’t go the way of their other investments in the sector by trying to take advantage of York’s … er … skills…

New ship Saturday…

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

UDS Lay vessel.png

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

Seven Borealis

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

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

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


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

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

Petrofac JSD 6000.jpg

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

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

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

Ocean Explorer.jpg

Ocean Explorer Lego.jpg

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

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

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

The age of abundance… Schlumberger exits seismic…

“Geophysical measurement, survey design and seismic operations have been an essential part of Schlumberger and our R&E [research and engineering] efforts for more than 30 years,” Kibsgaard said, pointing out the company’s unique position in terms of intellectual property and its engineering and manufacturing capabilities. But as the downturn enters a sixth year for the seismic data acquisition business, “the present outlook provides no line of sight for the market recovery.”


Spencer Dale and Bassam Fattouh published an excellent article at Oxford Economics on Peak Oil Demand and Long-Term prices this week (where the headline graph comes from and is a summary of various forecasters). The core of the article is that we have entered an ‘age of abundance’ in oil and it discusses some of the consequences of this:

the real significance of peak oil demand is that it signals a shift in paradigm from an age of (perceived) scarcity to an age of abundance. The conventional wisdom that dominated oil market behaviour over the past few decades, based around the notion of peak oil ‘supply’ and the belief that oil would become increasingly scarce and valuable over time, has been debunked.

Over the past 35 years or so, for every barrel of oil consumed, two have been added to estimates of Proved Oil Reserves.  In its recent Outlook, BP estimated that based on known oil resources and using only today’s technology, enough oil could be produced to meet the world’s entire demand for oil out to 2050, more than twice over! And future oil discoveries and improvements in technology are likely to only increase that abundance. The world isn’t going to run out of oil. Rather, it seems increasingly likely that significant amounts of recoverable oil will never be extracted.

Co-incidentally, or perhaps thinking abstractly causatively, Schlumberger also announced this week that it was divesting it’s interests in seismic.

Historically one of the key drivers of offshore (and onshore) demand at the front-end has been the need to keep reserve replacement ratio (“RRR”) above 100% for supermajors. If you want an idea of how key this is read the first few chapters of Steve Coll’s outstanding book ‘Private Empire: ExxonMobil and American Power‘ (and while you’re at it do yourself a favour and grab a copy of ‘Ghost Wars’). In an age of scarcity knowing that you had a stock of a scarce resource was an important differentiating factor and gave shareholders comfort that they were paying for a company with a future.

Now the RRR of the E&P majors is declining:

Reserve Replacement Ratio Majors Since 2014

Eventually it will tautologically lead to increased exploration activity in the future. For offshore a key question is how much and in what time scale? Clearly Schlumberger think it is someway off happening. In an age of abundance reserves assume considerably less importance.

And indeed investors don’t seem to value it as much either:

Rohan Murphy, energy analyst at Allianz Global Investors, which holds shares in Shell, BP, Total and Statoil, sees a reserve life of eight to 10 years as “quite a healthy level”.

“I don’t think these companies should have a reserve life much above eight to 10 years, especially when we are trying to get to grips with what oil demand will be in 10 years from now.”

From an E&P company these reserves will not be worth as much in the future, and potentially with technology changes will be cheaper in real terms to extract. So what investors are saying (already) is don’t pull forward this expenditure now, wait… And that is a completely different dynamic to the one prior to 2014 where first oil drove all decisions.

Not only are reserves going nowhere but neither is demand as Dale and Fattouh point out. The demand side of the market is likely to be relatively stable for decades, it’s on the supply side where the action is occurring. But it is hard to overplay the significance of this, an 8 year RRR would be a ~30% drop from historical levels and see a massive reduction in rig work and associated activity. Schlumerger is changing its business model accordingly. Slowly working through these reserves down to an 8 year period would fundamentally change models used to forecast rig demand used in exploratory wells for example.

This is playing out exactly as Spencer Dale predicted in 2015 where shale can act as a “kink” in the supply curve. Marginal production gives E&P companies more flexibility and lowers CapEx and offshore commitment. It makes uncomfortable reading for offshore as the logical assumption, from a senior figure who obviously has a large influence in how an E&P major acts, is that short-term price movements will be met with an increase in investment in tight oil. It might not be as profitable per barrel, but it can adjust quickly to short term movements, and isn’t as risky given the cycle times and upfront commitment offshore requires.

The call on offshore requires a vast number of assumptions in models, which as the graph at the top of this post shows can lead to a multiplicity of reasonabe assumed outcomes contains vast room for deviation. A few percentage points in extending current fields, a few percentage points increase in productivity from existing wells, and a small drop in forecast demand (either from efficiency, substitution, or a global recession) and the amount required from offshore drops signficantly. E&P companies are underpinning a huge amount of base demand on offshore but those few percentage points in each assumption that could change they appear to be backing themselves to supply with tight oil. The future for offshore will not be a mirror of the past.

Schlumberger exiting seismic is a small example of how the offshore industry will delverage from a position of being overcapitalised as an industry relative to the amount of work, and it is a clear industrial sign that “the age of abundance” isn’t some ethereal academic concept. Schlumberger also took a huge writedown on the asset value associated with its seismic business which again places a numerical value on an economic theory. If you go long on seismic companies at this point you might want to ask yourself what you know that Schlumberger management, actively reweighting their corporate investment profile to tight oil, know that you don’t?

The scrapping of older tonnage, which has begun in earnest in the rig industry, has been delayed for longer in the offshore industry as banks resist the economic reality of depreciating tonnage by delaying principal payments. Such a situation cannot continue forever. The Seacor/COSCO deal this week, which sees vessels taking delayed delivery in the future is a sign of industry weakness not recovery. Declining values highlight that these assets no longer offer access to a scarce resource but something now viewed as an abundant commodity.

I’d have to say the more I look at presentations where the core of the logic is a return to 2013/14, after a suitable gap for the market to return to “normality”, the less convinced I am.


The drawdown on offshore… My views on shale and offshore…

A friend asked me this week what my view on the graph above was (courtesy of Sparebank1  Markets) given my views on shale? I have been pretty consistent here that shale isn’t going to displace offshore, but it doesn’t need to in order to have a major impact on the economics offshore: It just has to take demand at the margin.

There are many graphs floating around like the one above. The Seadrill restructuring presentation contains this:

Seadrill offshore gap.png

Oceaneering had this graph recently:

Oceaneering Deepwater Demand.png

Ocean Rig has this one (while I agree with the headline the logic and data supporting this don’t make sense to me as the sanctioning replacement ratio has been historically over 100% for meaningful periods so a drawdown as firms pay down debt in a low price environment is logical):

Ocean Rig Industry Demand.png

You get the idea.

Schlumberger recently put the scale of shale production into perspective:

2017 Oil Supply

So to be clear: all tight oil had to do was add ~5% to the global supply and it has turned the entire offshore industry into a financial mess. Now it isn’t a strict causation, offshore has suffered a severe financial bubble based on oversupply as well as a demand crisis driven by the speed of change in the shale industry, but still it shows how finely balanced things were.

And indeed if you look at all the stories of hope and recovery that aim to recreate the world cast in a 2013 shadow they all profess unrealistically high utilisation and day rates at their core. The reason is obvious: the industry from 2007 was built on very high day rate levels and utilisation figues and any small change in those realities, given the very high fixed cost base, causes financial chaos.

A few percentage points in utilisation and day rates is all it takes to massively swing profitability in such a high fixed cost industry. Economic change happens at the margins.

Look at this chart from HugeStadSea which sums up the dominant thinking in the market (Q2 2017):

HSS Market Assumptions

Back to a cheeky 90% utilisation from 60%. Nice… what could go wrong?

Seadrill has the same:

Seadrill RP day rates

Everyone has the same story. But the problem is unless everyone is at very high utiilisation then day rates won’t pick up as the economic incentive for anyone with idle tonnage is to bid it cheap. Rowan in their latest results stated that they believed the market had to hit 85% utilisation before day rates improved.

So shale has an importance on the economics of offshore far beyond it’s output in the physical market displacing offshore oil as a source of supply. Shale only needs to reduce the utilisation of the offshore fleet by a few percentage points and that fundamentally changes the economics of rig and vessel companies. Seadrill, Solstad, Bibby, Technip DOF, in fact EVERYONE in the industry, is a completely different financial proposition at 51% utilisation compared to 91% with concomittant increases (or decreases) in day rates.

You also get an idea how large the investment in shale has been (Source: Schlumberger) since 2008:

Shale CapEx.png

25% investment since 2008 has gone into tight oil and it has seen productivity improvements like this (although the presentation highlights these rates are slowing):

Shale productivity.png

So I repeat again that that shale will not displace offshore as a source of supply. But it doesn’t need to in order to completely upset the economic structure of the offshore industry by lowering the amount of marginal demand generated where offshore service companies made profits above their fixed costs. By that I mean if your rig/vessel covered its costs and overheads on 85% utilisation and profits came after that (i.e. at 86% utilisation and above you started to be profitable), and the impact of tight oil is such that you only ever get to 85% for ever, then shale will have managed to removed excess profitability from the industry by ensuring a drop in demand at the margin. All shale needs to do is meaningfully alter the global fleet utilisation, and win a significant amount of E&P CapEx share, both goals shale has achieved, to have a massive impact on the offshore industry.

In economic terms this is what looks likely to happen:


The Demand (for offshore services) = the extra unit of revenue firms get for selling (Marginal Revenue) which matches the point where the extra costs of supply (Marginal Cost + Average Total Costs) balance. So yes, there will be more work, and assets may well be busier than they are now, but it could be just enough to keep everyone in the industry cash flow positive but making zero economic profit. I am not saying there won’t be accounting profits, that all firms will all be loss making, and all shares will go to zero, but I am saying firms will find it very hard to earn returns above their cost of capital.

The one prediction I will make is that any business model in this industry that just relies on an increase in day rates and utilisation is doomed unless it has a massive cash pile (because getting there is going to take a very long time) or you are buying assets at distress prices. But most of the distress investors have moved far too early and there is so much money floating around from these funds I think the distress funds are killing the price discovery mechanism in this market.

It is clear that the quantative deployment of capital in large E&P companies will have a significant portion focued on tight oil as well as offshore. A few percentage points, that could go either way in many companies, collectively have a huge impact on the global offshore fleet utilisation (and therefore dayrates) and that is the core impact shale has.

What will recovery looks like?

I came across the chart above the other day while starting to think how to write a post the other day about how 2018 will look (I have been really busy on an FLNG project so have not had much time lately), the reason I like it is I think it sums the two eras we are dealing with: Before Crash (2014 and earlier) and the After Drop. The chart is for Ocean Rig Q3 2017 and is just a very simple illustration of the scale of the drop in day rates the entire industry is facing.

Quite simply ORIG was banging out rigs at $500-600k per day and now they are going out at ~$150-170k, when they can get work. I am no rig expert (I think the best commentary is at Bassoe for rigs) but it’s no different in the vessel market where discounts of a similar percentage (~70%) have been common since 2014. Not only that but whereas before the utilisation was near 100% now it is patchy at best.

It’s all well and good talking about a recovery, and clearly as the oil price increases work for offshore will come back, but the scale of a comeback here needs to be kept in context, and the best way to do that is to look at historic utilisation and day rates. It is also well worthwhile remembering the subsea value chain and being honest that if the rig market is struggling with such onerous day rate decreases to make projects “economic” for the E&P companies then even these projects are a long way off hitting those with vessel exposure, and will they even be economic for offshore contractors?

The definition of economic on this blog is economic profit not simply surviving. That means consistently earning returns the actual cost of capital. I think the industry will be better from a demand perspective in 2018 the question is really at what price point the surplus capacity soaks up demand? Unfortunately I can’t see anyway that a marginal increase in work doesn’t simply encourages some companies to stay in the market and keep profits weak for everyone else. Individually economically rational, but collectively destructive. Nothing will make the E&P companies happier than to watch the contracting industry burn through their equity while projects are de-risked for them with the resulting cost reductions.

The North Sea PSV market is a classic case where as soon as day rates pick up someone buys another distress sale PSV for around what it costs to operate at cash breakeven and lures investors with the unrealistic proposition that if asset values recover to previous levels they will make supernormal profits. If anyone other than the project promoters and the operating company make money then I will be very surprised and the situation is being replicated across a range of asset classes. The Seadrill restructuring plan for example requires a heroic belief in day rate increases and utilisation:

Seadrill RP day rates.png

It is a very rare market where both the quantity and price of work increases at the same time so aggressively when there is so much excess capacity. You can argue that the industry is at an unaturally low levels but I struggle to see the commissioning of rigs and projects on a scale to make these numbers realistic.

In 2017 the problem for the offshore industry was over confidence in demand. Move too early and you lost money, and because there is so much distress money looking at the sector, people feel they have to do something or lose out regardless of how unrealistic the plan (i.e. the Nor liquidity issue). But the market dropped lower than people thought, maintenance demand was more elastic than presumed, and new Capex virtually dried up. The problem in 2018 is going to that same level of supply for only marginal increases in work. Good for workers as job losses abate but offering no respite in profit terms and asset valuations.

New FID’s will take years to flow through to offshore execution. Literally two seasons for most of them under a best case scenario by the time the engineering and financing has been arranged. So you need to last until 2020 under best case scenarios. Also not every asset class will benefit from a straight increase in the oil price as E&P companies are being far more selective about the types of fields they develop. All the data I have seen point to large scale, high flow, developments being the focus for development: that will favour large contractors with bigger balance sheet and a more complex asset base.

Vendor financing is becoming a big issue. For example Premier and Rockhopper are trying to finance the Sealion development with nearly 100% vendor financing – paid on installments following first oil. In earlier years these companies would have gone to the capital markets for financing and paid cash. It is another sign of the broken financing market that this vendor financing is being considered large scale: contracting companies have limited ability to assess downhole risk, and if these deals ever go really wrong then this will be very messy as the creditors fight it out. There is also a limit to the number of deals contracting companies can absorb like this.

A common thread in this (that I will talk more about later) is that in addition to the price of oil needing to be high financial markets need to recover as well to help companies take advantage of the opportunities, and we appear to be a long way off that happening. E&P companies are concentrating on paying down debt and prioritising dividends, and when you can sell 100% of your output, and your shareholders have been scared by the volatility in your price level, then you have less incentive to spend to keep market share that other types of companies (i.e. supermarkets) might worry about. The longer E&P companies want to be cash rich, or distribute it, then the harder it will be for offshore.

Smaller E&P companies that focus on offshore need to be able to raise debt and equity for the industry to improve – these were called marginal producers for a reason and they created marginal demand for the offshore contractors. Until some degree of access comes back for these companies then the global fleet is simply too big as the supermajors refocus on shale.

Don’t get me wrong offshore isn’t going away, and for the vessels not in lay-up 2018 is likely to be busier than 2017. But I think it will be utilisation, not day rates, where the majority of the pick-up will be felt, and a vessel doesn’t pay for itself with 4-5 months work (unless you buy it super cheap), a fact that won’t help financial markets open up for offshore as the same banks are behind the pull-back in the vessel and offshore market as were often behind the offshore E&P companies.

Not every business model is going to work here and not every asset will have value as the market recovers. I think we will only see the bottom when the banks start accepting the scale of the losses they will have to take, there some indications of this: DZ Bank has appointed Goldman to sell DVB, DNB looks to be setting up a “bad bank” etc. But there are a host of deals across the sector: Seadrill, Mermaid (Australia), SolstadFarstad, Eidesvik ad infinitum where the banks are just delaying repayment and hoping for a miracle. Much like the Euro crisis this will just create zombie companies and banks from which the industry will struggle break free of.

A well intervention/lay-vessel or a DSV?

I’ve missed something with this… is it a Dive Support Vessel or a lay-vessel? News that UDS is building a new vessel left me confused:

The Salt 310 design vessel will be capable of well intervention, flex lay and rigid pipe lay operations in 3,000 m of water.

The vessel will be fitted with first-of-its-kind ‘3 in 1’ tower designed by Huisman in the Netherlands. It will also be fitted with a Huisman 600-1,000 tonne crane which can work in depths of up to 3,000 m and a 650 m hydrogen saturation diving system along with two integrated hydrogen refineries.

Either it’s the worlds most advanced DSV, capable of diving at an incredible 650m (no info on the Hs at that depth), and therefore it will need to travel and be a global asset as those jobs are so rare, or it’s a deepwater well intervention and lay vessel? In either mode of operation it will be overcapitalised, with one part of its functionality redundant? But it would still require dive techs etc even in pipelay mode and vice versa? I am perplexed… Questions abound… A 1000t crane is a monster… Who does 1000t lifts? How often? How much does this crane cost? How many days does it have to work to pay for itself? How much strengthening of the deck was required for the payload? This vessel will clearly be an astonishing technical achievement.

The economics on the other hand look more challenging: If you made the assumption that the dive system was worth $100m, not unreasonable comparing a CSV to a DSV price, then the dive system is depreciating at 11k per day (365 over 25 years), regardless of whether it is being used, and excluding OpEx (about 15% of a working DSV day rate in Asia). The lay system/well intervention system, at say $150m, would be depreciating at $17k per day (365 over 25 years), again excluding running costs. And I have a feeling this j-lay/ flexlay system is closer to $200m, with the tower giving you the well intervention capability for free (with another expensive Lego set).  This effectively adds that to the cost of diving or lay each day depending on what you aren’t doing? And that is without OpEx? I am struggling to see how that is economically efficient.  An economic value calculation would substantially increase those numbers. On a more realistic assumption of 270 days utilisation, given schedule gaps and transit, those numbers rise by a quarter.

Are UDS planning on being a EPCI contractor for rigid lay? There is no spot market for rigid lay vessels? Or do they have a charter for this vessel? Surely for a core delivery asset, such as this, a charterer would be intimately involved?

I could be wrong but this reminds me of the CSS Derwent. It could do almost everything possible (in the right region and water depth), and nothing economically efficiently. At a cost of USD 110m it ended up in Angola once Hallin folded, where I doubt the collective value of offshore shipping assets is USD 110m, and certainly caused a massive loss for the yard (STX).

CSS-Hallin Derwent

In an industry which requires standardisation and cost reduction I struggle to see this as the future. I have voiced concerns before about the willingness of the offshore industry to do something because it can, not because it is economically viable, hidden in a boom market it is a real issue now. But the great thing about capitalism is it’s not my money, and I don’t know everything.

Don’t get me wrong, I have huge admiration for UDS. They are delivering and ordering, by an order of magnitude, a DSV fleet bigger than Subsea 7, a company with a market cap of USD 4.8bn! It is an astonishing organisational and financing achievement, and when  the history of this period is written this will be one of the more interesting stories. By any rough calculation UDS must have ordered, and/or taken delivery, of ~$1bn in vessels.

This is all happening at a time when very good DSVs are underutilised or going into lay-up (Toisa Pegasus) and there is massive over capacity in the lay fleet. If I owned a DSV I’d be dreading seeing UDS pop-up in my LinkedIn feed, as they start delivering these vessels it will almost be call for an asset impairment review everytime. This is turning into a countercylical bet so large it will deserve a place in financial history whichever way it goes.


Rystad on the future of offshore NW Europe…

Really good article and graph from Rystad Energy on the future of NW Europe and the size of reserves and output of the region but highlighting the challenges to production through a lack of exploration activity. It is very hard to disagree with this conclusion:

Northwest Europe, as one of the leading offshore regions globally and with OECD exposure, should therefore expect to see continued capital and resource allocation as along as the projects are competitive. Given the wide array of commercially very robust projects in the region, the expectations are towards a new development boom. However, poor exploration results over the last four years have not filled the project portfolio, potentially creating declining activity past 2020. [Emphasis added].

Rystad make a good point about resource availability and is something I have mentioned here under the #shalenarrative. E&P companies don’t always make capital allocation decisions on a strictly rational basis. The one area I think Rystad could help clarify (given their database) it looks intuitively to me like the bigger E&P companies are divesting smaller offshore areas in favour of larger projects. Statoil announced an increased stake in Roncador (Brazil) today and all the West of Shetland work is harsh environment/ high capex/high flow rate investments.

As an example Subsea 7/ Aker Solutions have won the Skogul tie-back to North Alvheim. These are large contracts, technically complex (pipe-in-pipe) with umbilicals, risers etc. Again it highlights to me that the project work that is going ahead favours larger contractors. In this case case the Aker BP/Aker solutions link was vital: but that is the point that all are large companies and Aker has been actively continuing exploratory and production drilling. It is the smaller E&P companies who have pulled this work back disproportionately.  Those who think there will be a linear increase in offshore work with a rise in the oil price I fear will be disappointed.