End of an era… goodbye to Orelia…

The end of an era as the DSV Orelia is scrapped (above). I would wager she has been one of the most profitable offshore assets in an economic sense over her life. With a build cost much lower in real terms than new build tonnage, and in a market with a much lower number of competitors, this asset would have paid for her keep many times over.

As she goes it is worthwhile considering that the huge margins Orelia generated were a signal for other players to try and replicate this formula and build competitive assets and businesses. Such is the long run nature of the supply curve these new assets continue to arrive long after the margins have vanished, and despite some new-builds costing vastly more in a nominal and real sense, it is not clear, beyond being more fuel efficient, that they are superior economic assets. It is notable that Technip has sold off a large potion of her diving businesses and assets and is only really present in the North Sea now, which is a clear signal how profitable they think the SAT business will be in the coming years. The unwillingness of Technip to commit to specialised replacement tonnage for the North Sea market I also thinks signals their view, and mine, that there has been a structural change in the North Sea SAT diving market and anyone going long on it should have a very robust business case, because without a rebound in construction work, the market looks oversupplied for years. Soon the well Wellservicer will join her and a new generation of assets moves to the fore.

The latest rumour I heard regarding replacement tonnage was that the Vard new build had been sold to Middle Eastern interests (specifically Bahrain) who were going to charter the vessel back to Technip. Given that this is the third version of this story I have heard (although from two sources now) I treat it with a degree of scepticism (linked to JMT!): surely with TechnipFMC’s balance sheet the best option would be just to make Vard a take-it or leave-it cash offer? Vard have always insisted on a clean sale, maybe time and reality have intruded on this wish.

UDS and Tiger Subsea… the mystery continues…

The image above is from the Tiger Subsea Services website. I was trying to find their address, switched on to Google Maps satellite, and helpfully noticed their office address, on which they (or their website designer) located their pin, is in the middle of intersection… Which along with explaining why they have no telephone (the desk being in a rather dangerous position that would conflict with an IMCA standard risk assessment) began to explain a lot of other things…

As a general rule, and please don’t take this as investment advice, chartering two of the world’s most advanced DSVs (with a capital value of c. USD 300m)  to a company whose head office is in the middle of an intersection, and doesn’t even have a telephone, is a bad idea. No good will come from this I predict.

Not only do they not have a telephone number but they also don’t appear to be registered as a business in the state of Louisiana (check for yourself: https://coraweb.sos.la.gov/CommercialSearch/CommercialSearch.aspx). Nor in Delaware which is the most logical place to register a business in the US.

I was driven to this because a friend of mine contacted me today to say that if you send an enquiry form regarding the vessels Shel will email back directly. Strange I thought. Another very UDS like quality also popped up on the TSS LinkedIn page:

ESV 301

This company, with no phone and an office in an intersection are building a self-elevating accommodation lift boat! 97m x 43m with a 250t crane! ESV is the nomenclature Ensco use on their jack-ups but they are not listing this unit and I can find no records of this ship anywhere. If someone can point me on the direction of this vessel, if it exists I would be very keen to hear?

I think we all know what is going on here. The audacity of this is astonishing, and coming from Downunder I appreciate this, like Stephen Horvarth’s car, but when all this ends, and the denouement would appear to be rapidly approaching, someone is going to have to work out what to do with these vessels.

North Sea DSV update… Has the Vard vessel been sold? Will IMR save the world?

We’re eyeball to eyeball, and I think the other fellow just blinked.”

Secretary of State Dean Rusk, during the Cuban Missile Crisis, 1962

It was a little windy (80-100 mph) up the mountain today as you can see from the photo… I thought it was a good metaphor for offshore at the moment anyway…

So in clearing out my emails I have now been told Technip have reached a deal with Vard on the 801. A price of ~$100m, but with no delivery risk and commissioning liability for Vard, has apparently been agreed. Technip is large enough for that to be a sensible risk to take as the Wellservicer needs to be replaced at some point. Unless ordered by SS7 or Technip I think this will be the last North Sea class DSV built without E&P company contract coverage for at least 10 years, maybe ever,  barring some unheard of change in the market. (This isn’t the place to get into why I don’t think any of the UDS vessels will end up North of the Med).

We are watching how an extremely illiquid and asset specific market clears in a huge market downturn. The interesting thing is that Technip and Subsea 7 seem to be making a renewed commitment to IMR having really lost focus during the construction boom, this graphic from Technip makes clear:

Technip Market Growth.png

If you are a smaller IMR contractor expect Technip to come up more often on tenders you are spending money on bidding. A near new DSV fleet fits this theme. It also shows you what sort of percentage/revenue increase on IMR a market leading company thinks it can get and how it is planning on taking market share. Smaller companies should be worried and anyone who publishes documents claiming they can grow organically at 50% in this market just isn’t serious.

I find the pricing of this asset fascinating: to Technip and Subea 7, taking a 25 year asset view it is an asset you could spend some real money on. One needs to replace the Wellservicer and the other the Pelican. But outside of those two companies the asset is almost unsellable at anything like it’s build cost. If you can’t operate that vessel in the North Sea (and it’s not even NORSOK) then it’s just an ROW DSV and you would be lucky to get $50-60m… and only then if you could find a bank to lend against it. So really they are just bidding against each other to take on the asset (not that I think Subsea 7 were)? How long do you make Vard sweat or risk seeing a really good vessel go to a competitor? Other vessels could also have been purchased from distress sellers e.g. How much better is the Vard vessel to the Toisa Pegasus (currently in lay-up)?

Both sides blinked at 100m if you ask me. More compromise than Mexican standoff.

The Seven Kestrel is arguably the best DSV in the world and as soon as construction work starts to pick-up SS7 will just ask the Koreans to build a replica (for less) if the need to relace the Pelican. And at that point that will be the last North Sea class DSV built for a very long time.

Both Technip and SS7 have some pretty new DSVs and both have an old (fully depreciated) one that operates when the market peaks… But as I wrote earlier the only realistic scenario for 2018 is for North Sea day rates to stay low for DSV work, and in this market making a trade off against a low capital cost to lose money on OpEx for a bargain purchase is getting ever harder to make? The lower than expected contract size for the Snorre Extension for Subsea 7 shows how low margins are for awarded work at the moment and how long it may take for day rates to recover. And if, as looks likely,  Boskalis and Bibby start a brutal price war to gain or keep market share, then dropping $100m on a vessel to go out at $100k a day (a cash loss amount in the North Sea) doesn’t seem that clever at the moment. Go back $10m a year for a few years on a DSV, easily possible in this market, and savings in CapEx were illusory.

Optimists point to graphs like this:

North SEa SAt MArket.png

But this ignored Boskalis taking the Nor vessels and Vard vessel replacing the Rockwater 1. [As a methodological point it is also worth noting that each movement on the vertical axis represents 3 DSV vessel years! showing you how easily the forecast could be out here]. It is also worth noting that if those Decom figures are wrong, and they look agressive, the market imbalance is illusory. No one in this market is going to force E&P companies to pay divers to remove mattresses etc off the seabed.. its just not going to happen. Just as importantly, a modest increase in day rates, which would see the DSV fleet operating at below economic cost, could curtail IRM or EPIC project demand as this graph seems to assume constant demand. There is a large amount of latent supply in the market that will come into the market as rates increase (which happened in 2014)… economic change happens at the margin… which is not reflected in a static graph like this.

Ultimately running vessels, even for companies the size of Subsea 7 and Technip, is a utilisation game as the fixed costs are so high that a small drop in utilisation and day rates /project margins can lead to a massive drop in profitability and cash losses. Shareholders would not welcome a cash call if it means they have overpaid for vessels and ultimately been diluted in a down market, and a North Sea class DSV is a very expensive vessel to have underutilised. I am always reminded mentally that Technip looked seriously at acquiring CGG not that long ago… in which case this would be a great bargain…

Let’s wait and see…I still have my doubts… but if the Vard 801 rocks up to the North Sea in April/May under Technip control for the North Sea summer my photo above will be a good reflection of economic conditions for North Sea DSV owners in 2018…

DSV age and new build demand… To Fathom the future…

In an insightful LinkedIn post Gareth Kerr, MD and owner of Fathom Systems (who make components for DSVs) raised a couple of important issues. Gareth noted:

As I recall, about 30% of the worldwide fleet is older than 30 years so when these vessels are scrapped (which will be soon) there will certainly be space at the table for a new generation of green, efficient and sensibly priced assets.

There is a lot going on in that sentence so let’s deconstruct it a little bit. Firstly, I agree with the fact that ~30% of the worldwide fleet is older than 30 years. The problem at the moment of course is that the global DSV fleet is nowhere near utilised at an economic level, so the safest assumption is that DSV owners will scrap tonnage when it cannot cover its economic cost of capital (eventually), and are unlikely to replace this tonnage until demand picks up signficantly and for a long period of time (and in reality there is a significant change in the financing market). The mistake Gareth has made here is only looking at the supply side of the market and not integrating it with the demand side.

Discussing the DSV fleet as a global market also makes no sense as it is in reality 3 regional markets with no inter-regional procurement. This lack of economies of scale in diving has confounded many people, most recently Harkand, who tried to claim they were building a global IRM business despite it being obvious that if people didn’t run procurement like that so there was no demand for such a business.

The three distinct markets are: 1) Norway, 2) North Sea other, and , 3) Rest of the World. I don’t intend to discuss Norway much as the total number of DSV days has fluctuated from about 480-620 for the past 10 years. It is a 2 vessel DSV market and will be forever, and I doubt anyone will ever build a new NORSOK class DSV without a firm commitment from an operator to cover the financing costs of the vessel (i.e. a 200-250 day charter for 10 years), but the reality is one won’t be needed. However, when it is very quiet in Norway these vessels trade down to the UKCS/North Sea sector.

Then North Sea other, a market that includes the UKCS, Canada, Denmark, Netherlands etc. Vessels can trade down from this market but ROW tonnage cannot trade up. It is therefore a supply constrained market in boom times and releases tonnage as the market contracts as the higher spec vessels seek to trade down and take work from other lesser spec boats.

From a demand perspective the outlook the North Sea region is grim: until shallow water construction returns to the region DSV rates will remain low. Construction work uses vastly more DSV days than IRM work and what made the market tight was the multi month construction work the North Sea fleet used to undertake. Now the same assets, that covered the 2014 boom year, are doing a reduced amount of IRM work. This isn’t going to change anytime soon as this data from Oil and Gas UK shows:

UKOG Capital Investment 2017

You get a sense of the drop from over £14bn in 2014 to c. £8bn in 2016 to a likely drop to under £8bn in 2017. It is not surprise that in 2014 IRM DSVs were going out at £180-200k per day (+ mob fees) and now the vessels are going out at £90-130k per day. Until that Capex number picks up the DSV fleet will not be fully utilised and an increase in IRM work. In 2014 Bibby had four North Sea class DSVs but the Harkand/ Nor vessels still had to go to Africa for work. The supply side was already peaking in the best year of demand.

It is no coincidence that the highest operating costs came in the regions with the highest DSV requirements that were pulled off maintenance work and into marginal construction projects:

UK Operatng costs.png

The E&P company plans are to drive these costs down and the increasing supply of DSVs, relative to their demand, makes this easy. In an environment with this sort of cost pressure and volatility in demand the investment risk for new assets, that operate in the spot market, is insurmountable. The pressure on operations departments will be to reduce DSV costs for years not to get to first oil and that creates a completely different contracting environment.

Unit operating costs

Ultimately DSVs are an expensive plumber connecting the wellhead to other infrastructure so a good leading sign of future construction is drilling that could lead to further subsea projects. Again its all grim for the North Sea:

Exploration wells spudded.png


Appraisal and Development wells.png


The industry is just not building enough well “stock” that will lead to subsea development projects. And the projects that will be brought forward for development are just not the small, shallow-water, step-outs/ tie-ins that keep the DSVs busy. Oil and Gas UK notes the most promising areas for investment:

the potential of the UK remains exciting, with opportunities such as the fractured basement plays west of Shetland; ultra-high-pressure high-temperature prospects in the central North Sea; and the carboniferous resources in the Southern Gas Basin.

These are not projects that will require much DSV time (but Subsea 7’s new pipelay vessel will be useful). Clair Ridge, Mariner, Bressay, all these high flow/high Capex projects need next to no DSV time and they are driving the construction stats in volume terms.

Now let’s look at the supply side of the fleet. I put the core North Sea fleet at this:

North Sea DSV Fleet.png

That doesn’t include the Vard 801 (2017 build) that at some point will enter the market. I have been generous to DOF putting the Achiever in, I have left off a Subsea 7 vessel that is in lay-up and can be reactivated, and I have left out the Boskalis Constructor/ EDT Protea and others that are mainly Southern North Sea/ Dutch sector. There are also assets that could return to the market (the Mermaid Endurer and Bibby Sapphire were all working in the region in 2014). Toisa also have some vessels (Pegasus/Paladin) that could, for a fraction of the new build cost return to the region.

But it is obvious to even the casual observer that there has been a massive capital investment in the fleet and that this is a relatively new fleet for assets that can work for at least 20-25 years in the region before seeking more benign conditions. Since this fleet upgrade started day rates have dropped from c. 180k per day to c.90-120k (a 30% reduction) yet the cost of the vessels has increased from ~$100m for the Topaz in 2007 to ~$160m for the Vard 801 (a 60% increase). In that time the two independent operators and new builders of North Sea class DSVs have had their equity wiped out (Harkand and Bibby) and the assets trade at substantially below depreciated book value and has ensured debt providers have also taken a hit. This is not a market where it will be easy to order or finance new assets.

So you can hold all the positive meetings you want in Bergen and discuss cool diving technology, but the economics of this are pretty obvious: neither the demand side or the supply side will push for any new build North Sea class DSVs for at least the next 5-7 years. I don’t see any new buildings in this market commissioned without some sort of contract underwriting the financing cost, and even then it could well be a decade or more before someone (other than Helix) commissions one.

The one thing I can guarantee is that there is almost no chance of any of the sepculative builds in Asia entering the North Sea market. If Technip and Subsea 7 ever want a new DSV (as opposed to a project one) they will get a contract with a yard that has export financing and they will see the pickup in construction activity early enough to order it early enough such that it arrives in time for another boom and not too early. At this stage it is more rational to wait to order a DSV and lose some market share in IRM if they need to and bag the construction work at a higher margin, than to order or commit to a $150m vessel that only trades in the spot market. The high fixed costs and barriers to entry virtually ensure no new market entrants will follow Boskalis into the market, and the vastly reduced industry spend makes it questionable whether there is even room for more than three substantial SAT dive contractors.

The ROW market is almost irrelevant in supply terms. There is sufficient new tonnage for years and as the market booms there sre substitute products in the form of modular diving systems that will reduce the pressure on day rates. As I have said before there is a very obvious reason why no one has been building North Sea spec vessels for Asia: No one will pay for them. There are more than sufficient high-end DSVs to cover for demand and there are no signs that the market is coming close to absobing the new tonnage coming. Yard Inc. is rapidly becoming the biggest owner/financier of new tonnage in Asia with the Southern Star, all the UDS vessels, the Keppel new build, and others all being owned by the yard effectively.

Old DSVs will work out in Asia because the marginal cost of operating them i.e. the cost of one extra diving day, is substantially below the cost of building a new one and comparable in productivity terms to a modular system with a PSV. Day rates are substantially below the North Sea and vessels like the Mermaid Endurer simply don’t command a sufficient price premium to regional tonnage (although they have utilisation advantages). It is a cheap market for cheap ships and until customers pay more then it will remain so.

It is just not credible to suggest that in a market like Asia, where there is substantial overcapacity, rates at Opex breakeven on a full year basis, and massive utilisation risk for owners/charters/operators, that age alone will provide the route to new build demand. These assets have to be paid for and the assets in Asia are not generating an economic return and until they do they cannot be financed. The future could well be India where old assets eke out a living more or less indefinitely.

All the indications from brokers in Asia is that UDS is as desperate as anyone else to get work. They cannot achieve a price premium for these assets and the assets operate at substantially below economic return levels. A wave of new buildings will only occur if Chinese yards decide they want to build DSVs that they then operate at below economic levels more or less indefinitely. I just don’t see that going on for more than the ordered vessels at the moment.

Gareth also asks the question:

We have all seen the industry restructure over the past 3 years where companies were losing money at >$100 oil but are now making profits at $60 oil.  Why should the DSV market be any different?

I think I can answer that question. The major reason is that at $60 oil companies sell 100% of their output above the cost of production, overhead, and finaning and at a rate that allows them to meet dividend commitments. At $60 oil, and with an increasing amount being produced via US tight oil, there is not enough DSV demand to cover the cost of operating the vessels and associated overhead, yet alone making an economic return. Gareth has again made the mistake of looking at only the supply side of the market.

So let’s leave the ‘black magic’ diving stuff to the people who know best (clearly not me). But let’s also let discussions on likely future demand for extremely expensive capital investment decisions be guided by economics and data rather than meaningless prayers of hope for the future. The fact is the DSV industry needs less capital not more in order to help the market to equilibrium.

Business Sense versus Economic Sense… UDS and Say’s law …

A product is no sooner created, than it, from that instant, affords a market for other products to the full extent of its own value. When the producer has put the finishing hand to his product, he is most anxious to sell it immediately, lest the value should vanish in his hands. Nor is he less anxious to dispose of the money he may get for it; for the value of money is also perishable. But the only way of getting rid of money is the purchase of some product or other. Thus, the mere circumstance of the creation of one product immediately opens a vent for other products.

Jean-Baptiste Say, Traité d’économie politique, (1802)

[Say’s law: Supply creates its own demand as Keynes described it. ]


Men err in their productions, there is no deficiency of demand.

David Ricardo in a letter to Thomas Malthus commenting on Say’s law (c. 1820).


More than one press appearence lately of the UDS Lichtenstein (ex Marmaid Ausana) in transit to the Middle East for Sat diving work in Iran apparently. I am a huge supporter of any new business, and taking over assets that others can’t work is a time tested model in cyclical industries. The question is: who is the winner here and who is going to make money? As anyone who has run a dive vessel in Iran, or tendered for work there, can explain the rates make India look attractive. A plethora of choice from around the region and customers who only care about price, and perhaps the size of the backhander, mean that even a 30 year old PSV with a portable Sat system can struggle to make money… Thus a newbuild 130m+ DSV is not a natural candidate for the region.

But there can be a real difference between business sense and economic sense: if you can convince a Chinese yard to build you a ship without having to pay for it I think it is a great business model, and UDS are well connected in certain regions to get DSVs working, I am just not sure of the longevity. I haven’t seen the deal UDS have agreed but if it is similar to others floating around then UDS will only be paying for the vessel when it is actually working, and even then a proportion of profit the job generates not a fixed fee. In Iran that is likely to be the square root of a very small number, and if it’s linked to actual payment then even that is a long way off.

UDS therefore is likely to be making money. How much it is impossible to say with certainty but it is possible to have a good guess…The beauty of this business model is its splits the oversupplied capital element away from the necessary cost of operating the service. It’s like a good bank/bad bank with Chinese yards operating as central bank. Cash costs are covered by the profitable service companies while asset owners hope The Money Illusion and the miracle of demand saves them. The Money Illusion is just that and this demand chart shows why demand is unlikely to help DSV owners:

Global E&P Capex

Near stagnant shallow water Capex for years meaning an oversupplied maintenance market.

One of the reasons new DSVs struggle to trade at a premium to old DSVs is the lack of functional benefits from a new vessel for the customer. 30 years ago people were diving at 300m below sea level and we still are now (in fact I have been told Tehcnip and Subsea 7 now call all dives over 200m “special” and need higher approval). Sure the newer vessels may use a bit less fuel on DP, carry a few more people, have a better gym etc, but for the customer, especially in a place like Iran, no one actually cares. The fact is an old banger can do pretty much what a new build Chinese all-singing all dancing DSV can do.

In brutal terms going long on a $150m doesn’t command any pricing premium, or only marginally so, it may just help you secure the work. When people are operating at cash breakeven only that may be a blessing for the company who operates the vessel but that extra capacity is curse for the industry.

Not only are customers cheap in every region outside the North Sea, they can afford to be! Environmental conditions are far more benign which means for a lot of jobs you can use a PSV with a modular system or one of the many $50m build cost Asian focused DSVs… they might not be quite as “productive” or “efficient” as a North Sea class but the owner just reduces the day-rate to the customer to reflect this.

What makes this important is this: for as long as UDS can convince (yard) shipowners that they are the best people to manage unpaid for DSVs, or their own, then they should make money. For the yards and DSV industry it’s a difference story…

In normal times people like to make a return on their capital. The reason you invest is obviously because you want to be paid back. Economists have a really easy way to calculate this: economic profit (which is completely different to accounting profit) and is derived by simply allowing for the cost of the capital in the investment. In crude terms SS7’s cost of capital today is ~12%. Assume a new DSV, with no backlog, all equity financed (a realistic assumption as what bank would lend on this (ignore fleet loans)?). So the “market capital cost” per annum of a new DSV for a recognised industrial player is c. $18m per annum ($150m * 12%); at 270 days utilisation the vessel needs to make $67k per working day just to pay the capital provider. No Opex, no divers, no maintenance, just finance. No one in Iran gets more than $85-90 in total, and it may well be substantially less.

Now UDS don’t need to pay that because the yard unfortunately had a customer credit event and got left with a vessel. Mermaid wrote of over $20m so the yard is probably exposed for $130m, and it maybe more because rumours abound of a fisaco with the dive system which will have been expensive to fix. But there is no doubt UDS have added great value to the yard by providing them with the technical expertise to finish this vessel. UDS just needs to cover their costs and the yard can get something which they probably feel is better than nothing, but it doesn’t mean this work is “economic”. The subsidy here is being paid for by the yard’s equity holders, effectively the Chinese taxpayer, who are involved in an extremely expensive job creation scheme… but times were different… who am I to criticise anyone for going long on OSVs in 2013?

The UDS new-builds are a somewhat different story. If a private equity firm were financing a new build DSV their cost of capital would be ~30% (in this environment probably a lot higher); so at 270 days utilisation that would be c. $167k per working day as a cost of capital. That is after paying for divers, maintenance, and OpEx, a market level of return commensurate to the level of risk of starting a new build DSV company would require that just for the vessels, ignore the working capital of the company. Each new build DSV needs to generate $167k per working day to make an economic profit for the investors. Rates have never been that high in the region, which maybe why economics is a “dismal science“, but it also explains why no one has built $100m+ DSVs for Asia: no one will pay for it!

Rates have been higher in the North Sea but never anything like that consistently and cannot realistically be expected to grow to even half that economic level.  There is also simply no realistic chance of any of the UDS vessels being a core part of the North Sea fleet where rates could traditionally support a capital cost appropriate to the investment in such a specialised asset. SS7 and Technip simply do not procure 25 year assets by chartering off companies like UDS, and frankly they could get a better or cheaper product in Korea or the Netherlands if they built now.  And even if the Chinese built the most amazing DSVs ever (a big if) no one in the North Sea would believe it and pay for it. Given the high profile problems of chartering North Sea DSVs it simply isn’t credible to have any scenario where any of these DSVs come North of the Mediterranean.

I haven’t even dealt with the most important problem: There isn’t enough work in the North Sea. People relax constraints in the region when they need to but at the moment they don’t. The UDS vessels when completed will not be North Sea tonnage… and the only market I think it’s harder to sell a DSV into than Iran is China…

The UDS startegy seems pretty clear at this point: to try and flag the vessels locally and take advantage of local cabotage regulations (like OSS did in Indonesia with the Crest Odyssey) to ensure some local regulatory support for utilisation. The problem with this strategy seems to be it doesn’t have a meaningful impact on day rates. Asian markets with strong flag state rules have never paid top dollar before and it is hard to see these vessels changing the situation. On a boring technical note it is normally impossible to get a mortgage over the vessel as arresting it can be difficult. It’s probably worth a punt for utilisation but it isn’t going to change the profitability of this and makes the capital commitment enduring for anything other than a token price.

I think UDS has great business sense don’t get me wrong. Owe the bank $1m and you are in trouble… owe the bank $100m and they are in trouble. UDS looks set to owe yard c. $450-600m, depending on how many vessels they take delivery of. UDS has great business sense because the yards have a problem way bigger than any of the shareholders in UDS and in an economic sense the yards are never going to make money from this.

All of which brings me to Jean-Baptiste Say, who in 1802 ennuciated a theory that dominated economics for over 120 years. Say’s law was actually the macroeconomy but that wasn’t invented until Keynes. Say looked at the incredible industrial development of the early 19th century cotton industy and thought the economy as a whole must work like that. Without people building something there would be nothing to sell, and therefore there could be no recessions. To anyone working in oil services Say’s further writings looks close prophetic:

Sales cannot be said to be dull because money is scarce, but because other products are so. … To use a more hackneyed phrase, people have bought less, because they have made less profit.

But this was a world away from when Keynes wrote The General Theory at the start of The Great Depression. Until this time Say’s law was the dominant theory of what Keynes later termed “aggregate demand”. We now know that at a macroeconomic level there can be a chronic demand problem, it took WWII for the world economy to recover from The Great Depression, and it is impossible to overstate the importance of the new view in 1936 when Keynes published The General Theory which intellectually overturned Say’s law. Say had confused what happens with companies for what happens to the economy as a whole.

I am reminded of UDS when I think of Say’s law: they might make money out of this, but whether this is economically rational for the whole economy is another story.  Say was wrong in micro and macroeconomics: supply doesn’t create demand.

All the UDS vessels will do is create extra capacity from sellers who are forced to accept lower than opex from anyone with an external financing constraint. The UDS vessels, and the Magic Orient, and the Keppel Everest, and the Vard 801, and the Toisa new build etc will simply wipe out the equity slowly of all those who stay at the table playing poker.

Sooner or later the funders of this enormous gamble will come out. Unwittingly China Yard Inc. is clearly going to be a dominant equity holder, they might think they have a fixed obligation at this point, but just as Keppel and others are finding out: at this level of leverage debt quickly becomes equity. For existing DSV operators in markets where these vessels turn up they are nothing short of an economic disaster. 2018 is going to be another poor year to be long DSV capacity.

Just what the world needs…. another dive support vessel…

Time is not a thing, thus nothing which is, and yet it remains constant in its passing away without being something temporal like the beings in time.

Heidegger -who revived the concept of Aletheia in philosophy

Congratulations to CCC (Underwater Engineering) UAE for delivering the DSV Said Aletheia. It’s a fine looking vessel, a single bell 12 man system that is perfect for the Middle East and built in China for probably a very attractive price.

Unfortunately for the owners it is arriving at a terrible time in the market and I use it to highlight one of the big problems for a market recovery that the subsea/offshore industry faces with it’s over capacity: the over segmentation that has resulted in the build programme.

This table from Kennedy Marr makes clear how large the fleet expansion has been:

KM DP Fleet Aug 17.png

In the old days (pre-2010) all vessels were multi-purpose to a certain extent. They might not operate optimally all the time but some work where they were over specified balanced out higher days rates for more specialised work. As the number of vessels grew so did the number of more specialised vessels.

In Asia and the Middle East this has seen a number of purpose built dive support vessels delivered for contracts that used to be important charters for contracting companies to win. The best example of this, if delivery occurs, is the Vard new-build for Kruez, that will go long-term to Shell Brunei. This vessel will displace older tonnage in the market and at the lower end modular systems but in such price sensitive markets the productivity benefits this vessel offers are unlikely to command a price premium. In other words it is going to keep prices low.

Here is the big problem for DSV owners (in all markets):

Global E&P Capex

Shallow water Capex is forecast to remain near stagnant for years at levels significantly below the period preceeding 2014. Shallow water fields are smaller, and often more marginal fields and they require vast amounts of DSV days to support pipelay and general construction. As the graph makes clear there has been a structural change in the market and even if the oil price recovers it will not flow into shallow water construction and ergo a portion of the market that existed prior to 2014 has gone.

There is no magic cure here and no deus ex machina that is simply going to allow the “maintenance fairy” to make all the problems go away. A DSV in field construction mode uses far more days than one involved in IRM work. Now all the DSVs are trading down from construction work into IRM and that isn’t going to change either. Logically asset values in the DSV sector have dropped significantly because there is no plausible story for how a DSV could deliver the cash flows you used to be able to believe it could. Markets are mean reverting eventually but the process is going to continue being extremely painful financially for a while yet.

Aletheia apparently means “the state of not being hidden; the state of being evident… it also means factuality or reality”. I find that highly apt for a new DSV delivering into the current market.

DSV valuations in an uncertain world: Love isn’t all you need… Credible commitment is more important…

“Residual valuation in shipping and offshore scares the shit out of me”

Investment Banker in a recent conversation


“Alice laughed: “There’s no use trying,” she said; “one can’t believe impossible things.” “I daresay you haven’t had much practice,” said the Queen. “When I was younger, I always did it for half an hour a day. Why, sometimes I’ve believed as many as six impossible things before breakfast.”


The FT recently published this Short View about how the bottom may have been reached for rig companies and that there may be upside from here. The first thing I noted was how high rig utilisation was, the OSV fleet would kill for that level, and yet still the fleet is struggling to maintain profitability (graph not in the electronic edition but currently about 65%). The degree of operational leverage is a sign of how broken the risk model is for the offshore sector as a whole. A correction will be needed going forward for new investment in kit going forward and the obvious point to meet is in contract length. Banks simply are not going to lend $500m on a rig that will be going on a three year contract. Multi- operator, longer-term, contracts will be the norm to get to 7G rigs I suspect (no one needs to make a 6G rig ever again I suspect). The article states:

No wonder. Daily rental rates for even the most sophisticated deepwater rigs have tumbled 70 per cent, back to prices not seen since 2004. Miserly capital spending by the major oil companies, down more than half to $40bn in the two years to 2016, has not helped. Adding to this lack of investment from its customers is a bubble of new builds, which is only slowly deflating.

Understandably, the market is showing little faith in the underlying value of these rig operators. US and Norwegian operators trade at just 20 per cent of their stated book values. The market value of US-listed Atwood Oceanics suggests its rigs are worth no more than its constituent steel, according to Fearnley Securities.

What the article doesn’t make clear, but every OSV investor understands, is that in order to access more than the value of the steel rigs and OSVs have very high running costs. The market is making a logical discount because if you cannot fund the OpEx until operating it above cash break even or a sale then steel is all you will get: it’s the liquidity discount to a solvency problem. That tension between future realisable value and the option value/cost of getting there is at the core of current valuation problems.

The OSV fleet is struggling with utilisation levels that are well under 50% for most asset classes and even some relatively new vessels (Seven Navica) are so unsellable (to E&P customers I don’t think Subsea 7 is a seller of the asset) they have been laid-up.  From a valuation perspective nothing intrigues me more than the North Sea DSV fleet: The global fleet is limited to between 18-24 vessels, depending on how your criteria, and with a limited number companies who can utilise the vessels, they provide a near perfect natural experiment for asset prices in an illiquid market.

North Sea class DSVs need to be valued from an Asset Specific perspective: in economic terms this means the value of the asset declines significantly when the DSV leaves the North Sea region. Economists define this risk as “Hold Up” risk. In both the BOHL and Harkand/Nor case this risk was passed to bondholders, owners of fixed debt obligations with no managerial involvement in the business and few contractual obligations as to how the business was run.

The question, as both companies face fundraising challenges, is what are the DSVs worth? Is there an “price” for the asset unique from the structure that allows it to operate?

In the last BOHL accounts (30 June 2017) the value of the Polaris and Sapphire is £74m. I am sure there is a reputable broker who has given them this number, on a willing buyer/ willing seller basis. The problem of course is that in a distress situation, and when you are going through cash at c.£1m per week and you have less than £7m left it is a distress capital raise, what is a willing seller? No one I know in the shipbroking community really believes they could get £74m for those vessels and indeed if they could they bondholders should jump at the chance of a near 40% recovery of par. A fire-sale would bring a figure a quantum below this.

Sapphire is the harder of the two assets to value: the vessel is in lay-up, has worked less than 20 days this year, and despite being the best DSV in the Gulf of Mexico hasn’t allowed BOHL to develop meaningful market share (which is why the Nor Da Vinci going to Trinidad needs to be kept in context). Let’s assume that 1/3 of the £74m is the Sapphire… How do you justify £24m for a vessel that cannot even earn its OpEx and indeed has so little work the best option is warm-stack? The running costs on these sort of vessels is close to £10k per day normally, over 10% of the capital value of the asset not including a dry dock allowance etc? Moving the vessel back to the North Sea would cost $500k including fuel.  The only answer is potential future residual value. If BOHL really believed the asset was worth £24m they should have approached the bondholders and agreed a proportionate writedown and sold the asset… but I think everyone knows that the asset is essentially unsellable in the current market, and certainly for nowhere near the number book value implies. Vard, Keppel, and China Merchants certainly do… The only recent DSV sale was the Swiber Atlantis that had a broker valuation of USD 40-44m in 2014 and went for c. USD 10m to NPCC and that was not an anomaly on recent transaction multiples. If the Sapphire isn’t purchased as part of a broader asset purchase she may not return to the North Sea and her value is extremely uncertain – see how little work the Swordfish has had.

Polaris has a different, but related, valuation problem. In order to access the North Sea day rate that would make the vessel worth say a £50m valuation you need a certain amount of infrastructure and that costs at c.£5-8m per annum (c.£14k -22k per day), and that is way above the margin one of two DSVs is making yet you are exposed to the running costs of £10k per day. Utilisation for the BOHL fleet has been between 29%-46% this year and the market is primarily spot with little forward commitment from the customer base. So an investor is being asked to go long on a £50m asset, with high OpEx and infrastructure requirements, and no backlog and a market upturn needed as well? In order to invest in a proposition like that you normally need increasing returns to scale not decreasing returns that a depreciable asset offers you.

This link between the asset specificity of DSV and the complementary nature of the infrastructure required to support it is the core valuation of these assets. Ignoring the costs of the support infrastructure from the ability of the asset to generate the work is like doing a DCF valuation of a company and then forgetting to subtract the debt obligation from the implied equity value: without the ability to trade in the North Sea the asset must compete in the rest-of-the-world market, and apart from a bigger crane and deck-space the vessels have no advantage.

It is this inability to see this, and refusal to accept that because of this there is no spot market for North Sea class DSVs, that has led to the Nor position in my humble opinion. The shareholders of the vessels are caught in the irreconcilable position of wanting the vessels to be valued at a “North Sea Price”, but unable or unwilling to commit to the expenditure to make this credible. It would of course be economic madness to do so, but it’s just as mad to pretend that without doing so the values might revert to the historically implied levels of depreciated book value.

The Nor owners issued a prospectus as part of the capital raising in Nov 2016 and made clear the running costs of the vessels were c. USD 370k per month per vessel for crewing and c. USD 90k per month for SAT system maintenance. In their last accounts they claimed the vessels value at c. USD 60m each. Given Nor raised USD 15m in Nov last year, and expected to have one vessel on a 365 contract ay US 15k per day by March, they are so far behind this they cannot catch-up at current market rates.

Again, these vessels, even at the book values registered, require more than 10% of their capital value annually just to keep the option alive of capturing that value. That is a very expensive option when the payoff is so uncertain. If you are out on your assumption of the final sale value by 10% then you have wasted an entire year’s option premium and on a discounted basis hugely diluted your potential returns (i.e. this is very risky). Supposedly 25 year assets you spend more than 2.5x their asset values to keep the residual value option alive.

Three factors are crucial for the valuation of these assets:

  • The gap between the present earning potential and the possible future value is speculation. You can craft an extremely complicated investment thesis but it’s just a hypothesis. The “sellers” of these assets, unsurprisingly, believe they hold something of great future value the market simply doesn’t recognise at the moment. Sometimes this goes right, as it did for John Paulson in the subprime mortgage market (in this case a short position obviously) and other times it didn’t as owners of Mississippi Company shares found to their discomfort. We are back to the “Greater Fool Theory” of DSV valuation.One share.png
  • Debt: In the good old days you could finance these assets with debt so the equity check, certainly relative to the risk was small. In reality now, for all but the most blue-chip borrowers, bank loan books are closed for such specialist assets. And the problem is the blue-chip borrowers have (more than) enough DSVs. The Bibby and Nor DSVs are becoming old vessels: Polaris (1999) will never get a loan against it again I would venture and the Sapphire (2005) has the same problem. The Nor vessels are 2011 builds and are very close to the 8 year threshold of most shipping banks. As a general rule, like a house, if you can’t get a mortgage the vessel is worth less, substantially so in these cases because all diving companies are making less money so their ability to find equity for vessels is reduced. Banks and other lenders have worked out that the price volatility on these assets is huge and the only thing more unsellable that a new DSV is an old DSV. It will take a generation for internal risk models to reset.
  • You need a large amount of liquidity to signal that you have the commitment to see this through. At the moment neither Bibby or Nor have this. From easily obtainable public information any potential counterparty can see a far more rational strategy is to wait, the choice of substitutes is large and the problems of the seller greater than your potential upside.

Of course, the answer to liquidity concerns, as any central banker since Bagehot has realised, is to flood the market with liquidity. Bibby Line Group for example could remove their restrictions on the RCF and simply say they have approved it (quite why Barclays will agree to this arrangement is beyond me: the reputational risk for them foreclosing is huge). As the shareholder Bibby Line Group could tell the market what they are doing, in Mario Monti’s words, “whatever it takes”. Of course, Mario Monti can print “high powered money” which is not something Bibby Line Group can, and that credibility deficit is well understood by the market. A central bank cannot go bankrupt (and here) whereas a commitment from BLG to underwrite BOHL to the tune of £62m per annum would threaten the financial position of the parent.

I have a theory, untestable in a statistically significant sense but seemingly observable (e.g. Standard Drilling, the rig market in general), that excessive liquidity, especially among alternative asset managers and special situation funds, is destroying the price discovery mechanism in oil and gas (and probably other markets as well).  I accept that this maybe because I am excessively pessimistic, but when your entire gamble is on residual value in an oversupplied market, how can you not be? In offshore this is plain to see as the Nor buyers again work out how to value the assets for their second “super senior” or is that “super super senior” tranche, or however they plan to fund their ongoing operations. The Bibby question will have to be resolved imminently.

At some point potential investors will have the revolutionary notion that the assets should be valued under reasonable cash flow assumptions that reflect the huge increase in supply of the competitive asset base and lower demand volumes. Such a price is substantially lower than build cost, and therein lies the correction mechanism because new assets will not be built, in the North Sea DSV case for a considerable period of time. Both the Bibby and the Nor bondholders, possessors of theoretically fixed payment obligations secured on illiquid and specialised assets will be key to the market correction. Yes this value is likely to be substantially below implied book/depreciated value… but that is the price signal not to build any more! Economics is a brutal discipline as well as a dismal one (and clearly not one Chinese yards have encountered much).

How these existing assets are financed will provide an insight into the current market “price discovery” mechanism. For Nor the percentage of the asset effectively that the new cash demands, and the fixed rate of return for further liquidity, will highlight a degree of market pessimism or optimism over the future residual value. If you have to supply another USD 15m to keep the two vessels in the spot charter market for another 12 or 15 months how much asset exposure do you need to make it work? Will the Nor vessels really be worth $60m in a few years if you have to spend USD 7.5 per annum to realize that? What IRR do you require on the $7.5m to take that risk? Somewhere between the pessimism of poor historic utilisation and declining structural conditions and the inherent liquidity and optimism of the distressed debt investors lies a deal.

The Bibby valuation is more binary: either the company raises capital that sees the assets tied to the frameworks of their infrastructure, and implicit cross-subsidisation of both, or the assets are exposed to the pure vessel sale and purchase market. The latter scenario will see a brutal price discovery mechanism as industrial buyers alone will be the bidders I suspect.

Shipbroker valuations work well for liquid markets. The brokers have a very good knowledge of what buyers and sellers are willing to pay and I believe they are accurate. I have severe doubts for illiquid markets, particularly those erring down, that brokers, like rating agencies, have the right economic incentives to provide a broad enough range of the possibilities.

Although the question regarding the North Sea DSVs wasn’t rhetorical it is clear what I think: unless you are prepared to commit to the North Sea in a credible manner a North Sea DSV is worth only what it can earn in the rest-of-the-world with maybe a small option premium in case the market booms and the very long run nature of the supply curve. The longer this doesn’t happen the less that option is valued at and the more expensive it is to keep.


[P.S. Around Bishopsgate there is a theory circulating that Blogs can have a disproportionate impact on DSV values a theory only the most paranoid and delusional could subscribe to. I have therefore chosen to ignore this at the present time. The substance of the message is more important than the form or location of its delivery.]