Friday morning cheer for the bulls… and safe thoughts for those in Houston…

“Give me a one-handed Economist. All my economists say ‘on the one hand…’, then ‘but on the other…”

Harry Truman


As I am off on holiday to Spain I thought I would spread some cheer for the weekend…The Bull case for oil was made by the Federal Reserve Bank of San Francisco yesterday looking at oil demand in China and combining it with The Varian Rule (which I hadn’t heard of either):

A simple way to forecast the future is to look at what rich people have today; middle-income people will have something equivalent in 10 years, and poor people will have it in an additional decade.

The economists from the Federal Reserve conclude what every offshore bull hopes for, even if it is in a delightfully non-commital and unspecified in timeframe:

In particular, if both domestic and foreign oil producers are reluctant to invest now in exploration and development, they may be unable to expand quickly to meet a sharp increase in Chinese demand. If global supply cannot expand fast enough, oil prices will have to rise to balance the market, as they did in the early 2000s.

On the other hand DNB came out with this graph this week:

DNB Offshore Spend 2017e

The point about being “unable” to expand is a good one. Even if the price spiked now the supply chain has laid off so many people in the short term all that will happen is there would be an explosion in wage costs not asset utilisation (and therefore day rates) as projects would take time to wind up. For the supply chain there is no easy solution to the current problems apart from slow deleveraging and the occassional exogenous shock maybe?

To all my friends in Houston I hope all is well and you are hunkered down safely. For the record no one obviously wants an increase in demand generated in such a way.

Hornbeck Hurricane map.png

Source: Hornbeck

Fire in the DSV market… literally…

The sea, the great unifier, is man’s only hope. Now, as never before, the old phrase has a literal meaning: we are all in the same boat.

Jacque Cousteau


Ultimately, these strains expose growing problems in the quality of the underlying assets, leading to fire sales of assets which accelerate declines in asset prices, resulting in further balance sheet pressures. Throughout this process, funding liquidity crises can exacerbate solvency concerns. These tensions feed on imbalances in bank funding structures, such as excessive recourse to debt financing that is reflected in historically high degrees of leverage. As the increase in debt often finances expansion into riskier business areas, this spills over into a deterioration of the quality of bank assets. If it goes unchecked, the process may lay the foundation for future financial crises and severe dislocations in bank funding markets.

Bank for International Settlements, 2013 (Financial crises and bank funding: recent experience in the euro area)

That the Nor Da Vinci caught fire on the way mobilise for the BP Trinidad work with Oceaneering seems likely a metaphor for the market as whole. The Da Vinci had sat in Blyth for 18 months without working a day, and then on its mobilisation voyage had a small fire necessitating a mayday call, which does not bode well for a complex worksite and a dive crew that have never worked as a team on the vessel before. I have no idea what Oceaneering and BP have agreed as a scope for getting the vessel on the dive site but one would have thought it would involve trial wet bell runs and other extensive testing, and one would have thought this will be to the owners or charterers account because there is no reason for BP to take this risk on an asset they don’t control in the current market.

The work doesn’t help the Nor owners much as the vessel will undertake a 21-25 day transit for c. 30 days of work, although the asset will be repositioned in a better location than Aberdeen, not that it helped the Bibby Sapphire. But surely the mobilisation and other costs were done on at most a reimbursable basis? But the fact such contracts are being so keenly contested surely shows how unprofitable the whole market is at the moment?

All DSVs are still working at rock bottom rates,  when they can get work, and both Bibby and Nor need further liquidity injections to remain viable in the short-term. Rumour has it that the Sapphire and Atlantis will enter lay-up but they will only join a vast amount of latent capacity in the system that under any rational analysis would point to a profitable market for contractors being a long way off.

But just as some of the fleet will be laid up it would appear the UDS have passed the point of no return where the yard will now deliver the two large construction DSVs. UDS had already struck a deal with the yard to take on the old Mermaid Ausana, the vessel still hasn’t worked and brokers report UDS bidding for anything anywhere with the vessel at rock bottom rates. They can do this because until I see proof to the contrary I do not believe UDS are paying a penny for the vessel and the same can be said for the other two new builds. UDS has in effect created a 3 North Sea class DSV company, the same number of vessels as Bibby who still turned over GBP 120m last year, without paying a cent for vessels. That is not a positive development if people actually want the market to function on some sort of rational basis.

Like the Keppel new build it will be interesting to see if there is a good second-hand market for the UDS vessels should the yards decide to stop financing them. Flashtekk is one of the major component suppliers and is controlled by parties related to UDS and not a known supplier of high quality systems (or rather I shoould say systems at all having never delivered a complete DSV on anything like this scale). One of the intriguing questions of this money go round is whether the yard is paying Flashtekk and then receving the funds back as progress payments? And frankly how big are the progress payments?

The backer of UDS is a wealthy individual but not wealthy enough to start buying multiple DSVs at USD 150-200m. There have been no announcements of any financings or associated fundraisings with the new builds and no indications that any banks, even Chinese, are behind the yard in this and it would appear that Chinese yards are in effect financing at least four very expensive new DSVs now if you include the Fugro chartered DSV in Asia. In the North Sea Vard still have the Haldane sitting as latent capacity and no realistic hope of moving the vessel to a North Sea contractor, and thus realise close to its build cost, for the foreseeable future.

All these assets are effectively financed by debt. Paper obligations with almost no equity or real cash backing them. It is well known what happens in markets where a small group of companies, holding highly illiquid assets with little tangible equity, when they drop: asset prices plummet and and cause major instablity in both solvency and liquidity terms for those involved. There is now no difference between banks and DSV owners in terms of their interactions between asset values and financing as they are both equity light/asset heavy companies and hence my quote above (albeit DSVs have no central bank to backstop asset prices.. well maybe in Singapore). Someone can no more give you the accurate “value” of a North Sea class DSV at the moment any more than they could a complex CDO in 2008, all you can get is a price and that makes raising any finance to back these assets very hard because the prices are fire sales only.

You can read all the optimistic pronouncements you want about the market getting better but until someone shows me the money and the numbers I won’t believe it. It is also worth stressing again with additions like the Kruez new Vard vessel  to Brunei, the NPCC purchase of the Swiber Atlantis, and other additions the time charter market is even more competitive than ever as these vessels are replacing jobs that were chartered every year.

But the UDS story is the biggest mystery of all. In order to justify the price of these new-builds they would have to work in the North Sea, and as Harkand and Bibby have shown that isn’t profitable, but current Asian DSV rates are not even reaching USD 100k with divers.  So either UDS have got some sort of Chinese government/oil company linkup or the yard/ an associated bank will finance those vessels forever, and if that happens the market will be in disarray for years because a substantial part of the the high-end DSV fleet will be effectively getting the boats for free in a time of over capacity. It is a recipe for endless sub-acceptable economic returns.

Bourbon results offer no comfort or light

Bourbon released numbers this week that were bad, this isn’t an equity research site so I don’t intend to drill through them. Bourbon is a well-managed company and there is little it can do given the oversupply. But I can’t look at these stats without feeling like the HugeStadSea merger was too early. And quite how NAO, with 10 PSVs, raised money at USD 15m per vessel when the industry is at this level also looks like a triumph of hope over data. Subsea looks just as bad.

First, I think the graph below (from the Bourbon presentation) is telling and worrying for offshore. One of my constant themes is productivity. Shale is generating increasing productivity (i.e. constantly reducing unit costs) from all this investment, offshore fundamentally isn’t. The cost reductions from offshore are the result of financial losses, not more outputs from unit inputs.

Capital Investment Forecast: Shale versus Offshore

Capital Outlook

Clearly, the capital increase is good for vessel owners, but as this graph shows, the fleet was built for much better times.

Global E&P Spending

Global E&P Spending

And as the Bourbon numbers show, demand isn’t going to save offshore because the supply side of the market is too overbuilt.

Stacked vessels

The subsea fleet globally looks just as bad. Rates are only just above OPEX if you are lucky and nowhere near enough to cover financing or drydocking costs. The hard five-year dry-dock is the real killer from a cash flow perspective.

In order for this market to normalise not only vessels, but also capital, needs to leave the industry. I was, therefore, surprised that NAO raised USD 47m to keep going. NAO have 10 vessels, and are clearly subscale by any relevant industry size measure, are operating well below cash breakeven including financing costs (USD 11 500 per day), and still, they plow on. I understand it’s rational if you think the market is coming back (and the family/management put real money into this capital raise), but if everyone thinks like this then the market will never normalise. And when Fletcher/Standard Drilling can keep bringing PSVs back into the market at USD 8-10m, that do pretty much the same thing as your 2016 build, and 1/3 of the fleet can be recommissioned, the scale of a spending increase needed to credibly restore financial health to operators looks a long way off. Someone is going to have to start accepting capital losses or the industry as a whole will keep burning through new infusions of cash on OPEX. ( I know PSV rates, in particular, have increased this week but this looks like a short-run demand as summer comes and vessels come out of lay-up than a recovery.)

Specialty tonnage, such as DSVs, are in a worse position because as Nor/Harkand are showing people are reluctant to cold-stack due to the uncertainty of re-commissioning costs. Project work simply isn’t returning to at anything like the levels needed to get vessels and engineers working. Subsea construction work significantly lacks rig work, and companies are delaying maintenance longer than people ever thought possible.

Rig Demand

I think restructuring, consolidation, and capital raising are clearly the answer don’t get me wrong. I just think some falling knives have been caught recently (the Nor/Harkand bondholders being the best example) and the industry seems reluctant to admit the scale of the upcoming challenge. And again I am perplexed why the Solstad shareholders allowed themselves to dilute their OSV fleet with greater exposure to supply, when the dynamics are clearly so bad? The subsea and offshore industries appear to be facing structurally lower profits for a long time, and more restructurings, or a second round for some, seem far more likely than an uptick this year and next.


I’m a believer… just in something different…

A good FT article here about how oil and gas discoveries have recently fallen to their lowest levels ever. I’m with Spencer Dale and the shale crowd… it’s the marginal production expansion reserve of choice… but I’m also with offshore… I just think the next boom will be somewhat different and probably less of a boom.

However I also think the focus on Reserve Replacement Ratio (RRR) will also diminish somewhat and E&P companies will be more focused on other issues beyond discovery levels. RRR is a good concept when you are reaching the frontier of oil production, and certainly no one cared about it more than Exxon Mobil, but its a measure of interest really only when the entry and CAPEX costs of increased production are so high. Its not even a measure of exploration efficiency because companies that cut back offshore CAPEX clearly are not seeking to replace reserves 100%. RRR is a relic of bygone era when  you couldn’t drop a few billion and buy some decent shale acreage or a small Swedish start-up didn’t strike it big in the Barents.

Large E&P companies have shown in the downturn that they are committed to constant dividend payments, regardless of underlying cash flow generation where possible, and I think it likely reserves will go the same way: some years there will be a bumper increase and other years a decrease, the trend and stability more than the absolute limit will become important.

I mention this in the context of offshore because not only has shale changed the production economics (as I have discussed before) but also because it is likely to make a recovery from this offshore exploration trough slower than people would like. I do believe in offshore long-term… just the new offshore economics not the old.

Where has the market gone?

The chart above is from the Olympic restructuring presentation given to the market this week. Of all the data points I have seen recently this one summed up the current market to me more than anything. Olympic are a great operator, with great assets and backup infrastructure, and even then the cupboard is bare. There is nothing more to say really. Recovery looks a long way off and the optimists who talk of a boom in IRM projects this year look deluded.

Have a look at the fleet quality underpinning this lack of work:


HugeStadSea… and the loser is Farstad on the day but maybe Solstad overall.

And the market says Farstad you’re down by a 1/3, Deep Sea by a mere 7% and Solstad up 1.5% today (for comparative purposes Hornbeck was down 2.2% and Subsea 7 down 1.3%). Farstad was always going to have to do a debt for equity swap and given the share issue mechanics this appears now to have essentially wiped them out, a market cap of NOK 86m when you have debts of NOK 1.2bn always meant the shares were an option on the unlikely or absurd . Clearly the Solstad investors are buying a scale story and the dilution margins for the other investors that put Solstad firmly in the driving seat. Personally I would have paid Deep Sea and Farstad to take my supply vessels if I was Solstad and Aker, the  NOK 600m at the top end of the synergy savings, would seem cheap insurance if the shareholders could offload their PSV and AHTS exposure. The most recent Solstad financials show that its 43% fleet mix of subsea vessels in 2016 generated 78% YTD revenue and 96% YTD EBITDA.

Into this they have now merged a large PSV fleet, with limited contract coverage, and a large AHTS and PSV fleet, with limited contract coverage. Banks have effectively reduced the asset value exposure somewhat and there is precious liquidity and working capital facilities. But this is a market where Standard Drilling is buying PSVs at .10-.30 of implied depreciated value and these transaction multiples are nothing like this. I get why the banks like this deal I just don’t get the shareholders support here.

And the deal just doesn’t seem to provide sufficient scale to generate pricing power with more vessels in lay-up in the North Sea than the combined fleet. If you had the time or the energy to run an HHI model I am sure the number for HugeStadSea would come in at close to zero as the merged company will have 111 supply vessels out of a total fleet of 2100. Also JF is really selling Deep Sea to Solstad here, and as a general investment rule that you can’t argue with quantitatively, you are better off financially buying with JF than buying off him.