Bully for Brontosaurus…

“I am truly convinced that both the shipping and the offshore markets will recover.”

Mads Syversen, CEO Arctic Securities (26 Jan 2016)

Arctic and ABG Merger valuation.png

From the Solstad Farstad merger prospectus (9 May 2017) highglighting the extreme optimism of the investment bankers putting the deal together. It should be noted the asset market was under huge stress at the time (the bankers of course were paid in cash on completion).

The Golden Bough

In point of fact magicians appear to have often developed into chiefs and kings.

 James George Frazer, “The Golden Bough” (1890)

The Emporer

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

 Ryszard Kapuscinski, “The Emperor” (1978)

Mons Aase, DOF Subsea CEO, said: “The appointment of Mr. Riise is an important step towards realizing our vision of being a world-class integrated offshore company, delivering marine services and subsea solutions responsibly, balancing risk and opportunity in a sustainable way, together, every day. I look forward to working closely with our new CCO and I welcome Steinar to DOF Subsea.” (15 October, 2018)

“Our business will probably die over the next 10 yrs because the demand for oil probably will start peaking – we think in 2028-2029.”

Ian Taylor, Vittol Chairman, June 8, 2019

“If you get lucky for a long period of time, you think the rules don’t apply to you… These guys thought they could walk on water. They weren’t smart, they were lucky”.

Maarten Van Eden, Anglo Irish Bank CFO, in Anglo Republic: The Bank that Broke Ireland

(Anglo Irish bank initially assessed its downside losses in the credit crunch at less than €2bn. Over €45bn later they had nearly bankrupted the Irish state by lending on illiquid property assets reliant on a booming Irish economy and a global credit boom).

 

Have a look at the graph in the header, particularly 2016/17, and then the Solstad liabilities for 2016/17, just as they were “buying” Farstad and DeepSea Supply:

Solstad liabilities 2016_17.png

(I saying “buying” because it was then second major rescue attempt after Aker made a spectacular error in timing with REM. It was a deal pushed by the bankers who didn’t want to deal with consequences of Farstad and Deepsea Supply).

That would be just the time the rig count in the Permain was to explode:

BH rig count June 2019.jpg

And here are the latest Solstad Q1 2019 liability figues:

Solstad Q1 2019 Liabilities.png

Roughly NOK 2bn higher! The assets are older, the market isn’t much better, and they owe NOK 2bn more! (Don’t get me started on look at the assets side of the balance sheet: it was well known the Farstad/DESS were worth significantly less than book value).

If you believed Solstad had a future in anything like its current form you would be asked to believe the impossible: that despite the most extraordinary structural shift the oil and gas industry, despite owning depreciating assets barely covering actual running costs, despite no indication of oversupply ending (and in fact every indication that funding a mutually assured destructive battle will continue with NAO planning to raise money), you would be asked to believe Solstad could actually pay that money back… And of course they can’t: the numbers on paper, the amounts the banks and creditors claim they are due, are indeed a fantasy. A wish, with no basis in economic substance despite their accounting clarity.

Solstad made an operating profit of NOK 162 918 000 in Q1 2019 on NOK 33bn of balance sheet and asset risk. If someone had lost the petty cash tin they would have been in a loss. It’s totally unsustainable.

It may have been reasonable to believe that NOK 30bn of debt could be supported by offshore demand when the US graph was at 2014 levels but it is no longer credible now. Too much of the investment and maintenance expenditure flowing through the global energy industry is just going to other places. This is a structural shift in the industry not a temporary drop in demand like 2009.

I am not picking on Solstad here, they are just the most obvious example as their resolution seems (reasonably) imminent. Without exception all these crazy asset play deals that relied on the market coming back will fail.

When I was at university I first read the palaeontologist Stephen J Gould who introduced me to the difference between Lamarckian and Darwinian evolution (Bully for Brontasaurus). If you can’t bothered clicking through to the links the easiest way to think about this (in a purely demonstrative example) is that Lamarckian evolution argues that giraffes evolved by gradually growing longer necks and reaching for higher leaves on trees that others couldn’t reach – which is wrong. One of the many brilliant things about Darwin was that he realised that it was the randomness in evolution that caused the process – giraffes that just happened to have the long neck gene prospered and had more baby giraffes and passed the gene on. The race of giraffes that prospered was the result of random selection that ended up adapting best to their environment. They got lucky not smart.

Offshore is full of companies that may have been lucky on the way up but are totally inappropriate financial and operational structures to survive in the modern energy era. Evolution is a brutal, mechanical, and forward acting process. It is irreversible and path dependent. In economics the randomness of the evolutionary process is well understood with most research showing industry effects are stronger than firm effects. By dint of randomness the genes of many of the asset heavy offshore companies companies, but especially those with debt held constant at 2015/16 levels, are fundamentally unsuited to their new environment.

In case you are wondering where I am going with this (and want to stop reading now) I have two points:

  • A lot of the offshore supply chain confused managerial brilliance on the ride up to 2014 with good luck, a high oil price, and a credit bubble. Seemingly being lucky enough to have been running small fishing vessels when North Sea oil was found was rarely posited as an explanation for the growth of many West Coast Norwegian offshore firms, but it is in reality true. A random act of economic circumstance that threw them into a rising commodity and credit bubble. A newer, far less wealthy, future beckons for many of the small coastal towns that supported this boom.
  • The randomness of US geology colliding with the most efficient capital markets in the world, the largest energy consuming nation, and technological circumstance has caused a complete change in the structure in the underlying oil market. The profound implication for North Sea producers, and the supply chain underpinning them, is a transition to be an ever more marginal part of the global supply chain. That will mean less dollars in flow to them and that however long companies try to fight this will be in vain because we are dealing with a profound structural change not a temporary reduction in demand.

What the offshore industry is faced with now is a fundamental regime change – in its broadest sense both statistically (which I have argued before) and sociologically. The economic models of debt fuelled boats and rigs with smaller contractors are over in principal. It’s just the messy and awkward stage of getting to the other side that beckons now.

For pure SURF contracting and drilling consolidation is the answer and will occur. Financial markets will squeeze all but the largest companies from taking asset risk. DOF Subsea’s business model of buying ships Technip wasn’t sure about long-term will look like the short term aberration to economic rationality it was. For offshore supply the industry will be structurally less profitable forever. Asia shows the future of offshore is a vast array of smaller contractors, operating on minimal margin and taking vast risks, and yet the E&P companies are happy with this outcome because they get competitive prices. There is no reason to believe this model will not work in Europe as well. Where procurement is regional there are no advantages to being a global operator as the unit onshore costs are such a small proportion of the offshore/asset costs.

Although it feels unique to many in offshore it isn’t. If you only read one book about a collapse of ancien regime make sure it is Ryszard Kapuscinski’s “The Emperor” (1978)  on the collapsing Ethiopian empire. By interviewing a large number of the courtiers Kapuscinski gets you into the collective mind of an institution unable to face the reality of circumstance. The inability of Haile Selassie to realise that his random luck was totally unsuited to adaptation in the modern world is deeply reminiscent of the management in offshore, and to a certain extent the banks behind it (I’ll write more on the Stiglitz- Grossman paradox which answers why this may occur later).

Slowly the power and the capital of marginal oil production is being shifted to the Lower 48. Make no mistake the replacement of low capital cost Super Majors for high cost of capital (often PE backed) E&P companies in the North Sea marks the slow withdrawal of capital long-term from the area. Note not removal: just slower investment, higher cost hurdles, more pressure on cost etc. That will require a structurally smaller supply chain.

Old capital structures, and especially debt obligations, written in the good times will be completely re-written. Over the next couple of years the Nordic banks are going to write off billions dollars (that isn’t a misprint) as the hope thesis of recovery loses credibility. They will shut down credit to all but the most worth borrowers and sellable assets (if you think that is happening now you aren’t watching the crazy deals going on in the rig market). Equity across the industry will rise and leverage will substantially decline.  Smaller operators will vanish driven the same process reducing biodiversity on earth now: a less munificent environment. I believe when these banks have to start really taking write-offs, and Solstad and DOF are important here because they are close in time and significant in value, bank loan books will in effect close for all but the largest companies. In the rig market where are few companies have been responsible for nearly all the deals and private bubble has built up in the assets this will be contrasted with a nuclear winter of credit. And if banks aren’t lending then asset values fall dramatically.

How much is the Skandi Nitteroi really worth? There is no spot market for PLSVs, Petrobras have no tenders for flexlay? No one else capable using it needs one and Seadras are getting theirs redelivered? Banks are going to take the hit here and then the industry will really feel it.

I am reading Anglo Republic, a book about the collapse of Anglo Irish Bank, at the moment. Again the inability of management (and Treasury, and the goverment) to see the scale of the losses has a strong parallel with offshore. And like offshore initially everyone believed the Irish propery market would come back, that liquidity not solvency was the problem, that this was temporary blip. The crisis was a slow burner for this reason. But when it really came, just like all asset heavy industries, it starts with the refusal of credit institutions to renew liquidity lines because they know it’s a solvency problem. And that is why Solstad and and DOF are significant. They are the BNP Paribas of the next phase. But you know what… my next book is this, and it will have the same story of excessive optimism, leverage, an event (literally a revolution in this case), and default. If there are only really seven major plots in literature there is surely smaller set in economic history? So we know what is coming here.

This needs to happen in an economic sense. The cost to produce offshore will have to rise to reflect the enormous risk the supply chain take in supplying these hugely unique assets on a contract basis. But for this to happen there needs to be a major reduction in supply and it needs to happen while competing against shale for E&P production share. And it cannot happen while the industry continues to attract liquidity from those who buy assets solely on the basis of their perceived discount to 2016 asset values in the hope of a ‘recovery’ to previous profitability levels.

Which brings us on to what will happen to Solstad? It is in the interests of both the major equity investors (Aker/ Fredrikson) and the banks to play for time here. I fully expect a postponement of the 20 June deadline. Next summer, the bankers will tell themselves, the rates will be high and we will be fine (just like the Irish bankers and countless others before). But some of the smaller syndicate banks clearly get the picture here, the business is effectively trading while insolvent, regulators will also eventually lose patience, and the passage of time will not be kind. The solution everyone wants: to put no more money in and get all their money back isn’t going to happen.

Normally in situations like this, where the duration of the assets is long and illiquid, like a failed bank, a ‘bad bank’ and a ‘good bank’ are created. One runs down (as DVB Bank is doing with offshore) and the good one trades and is sold (as DVB Bank have done with aircraft finance). That would see the Solstad of old split off into a CSV fleet maybe or a Solstad North Sea while the old Asian/Brazil DESS was liquidated and the Farstad AHTS business also liquidated. But that will require the banks writing off c. NOK 20bn (maybe more) and I don’t think they are there yet.

After Solstad comes DOF. And in all likelihood following them will be some smaller tier 2 contractors, and certainly some rig companies, who realize that in an economic sense this just cannot continue. No matter how hard they keep reaching for the greener leaves higher up.

Unconventional verus offshore demand at the margin…

Economic growth occurs whenever people take resources and rearrange them in ways that are more valuable. A useful metaphor for production in an economy comes from the kitchen. To create valuable final products, we mix inexpensive ingredients together according to a recipe. The cooking one can do is limited by the supply of ingredients, and most cooking in the economy produces undesirable side effects. If economic growth could be achieved only by doing more and more of the same kind of cooking, we would eventually run out of raw materials and suffer from unacceptable levels of pollution and nuisance. Human history teaches us, however, that economic growth springs from better recipes, not just from more cooking. New recipes generally produce fewer unpleasant side effects and generate more economic value per unit of raw material…

Every generation has perceived the limits to growth that finite resources and undesirable side effects would pose if no new recipes or ideas were discovered. And every generation has underestimated the potential for finding new recipes and ideas. We consistently fail to grasp how many ideas remain to be discovered. The difficulty is the same one we have with compounding. Possibilities do not add up. They multiply.

Paul Romer (Nobel Prize winner in Economics 2018)

Good article in the $FT today on Shell’s attitude to US shale production:

Growing oil and gas production from shale fields will act as a “balance” for deepwater projects, the new head of Royal Dutch Shell’s US business said, as the energy major strives for flexibility in the transition to cleaner fuels. Gretchen Watkins said drilling far beneath oceans in the US Gulf of Mexico, Brazil and Nigeria secured revenues for the longer-term, but tapping shale reserves in the US, Canada and Argentina enabled nimble decision-making.

“The role that [the shale business] plays in Shell’s portfolio is one of being a good balance for deepwater,” Ms Watkins said in her first interview since she joined the Anglo-Dutch major in May…

Shell is allocating between $2bn and $3bn every year to the shale business, which is about 10 per cent of the company’s annual capital expenditure until 2020 and half of its expected spending on deepwater projects. [Emphasis added].

Notice the importance of investing in the energy transition as well. For oil companies this is important and not merely rhetoric. Recycling cash generated from higher margin oil into products that will ensure the survival of the firm longer term even if at a lower return level is currently in vogue for large E&P companies. 5 years ago a large proportion of that shale budget would have gone to offshore, and 100% of the energy transition budget would have gone to upstream.

The graph at the top from Wood MacKenzie is an illustration of this and the corollary to the declining offshore rig numbers I mentioned here. Offshore is an industry in the middle of a period of huge structural change as it’s core users open up a vast new production frontier unimaginable only a short period before. The only certainty associated with this is lower structural profits for the industry than existed ex ante.

Note also the split that the – are making between high CapEx deepwater projects and shale. Shell’s deal yesterday with Noreco was a classic case of getting out of a sizable business squarely in the middle of these: capital-intensive and not scalable (but still a great business). PE style companies will run these assets for cash and seem less concerned about the decom liabilities.

You can also see this play out in terms of generating future supply and the importance of unconventional in this waterfall:

Shale production growth

As you can see from the graph above even under best case assumptions shale is set to take around 45% of new production growth. When the majority of the offshore fleet was being built if you had drawn a graph like this people would have thought you were mad – and you would have been – it just highlights the enormous increase in productivity in shale. All this adds up to a lack of demand momentum for more marginal offshore projects. The E&P companies that are investing, like Noreco, have less scale and resources and a higher cost of capital which will flow through the supply chain in terms of higher margin requirements to get investment approval. This means a smaller quantity of approved projects as higher return requirements means a smaller number of possible projects.

Don’t believe the scare stories about reserves! The market has a way of adjusting (although I am not arguing it is a perfect mechanism!):

Running Out of Oil.png

Capital reallocation and oil prices…

The above graph comes from Ocean Rig in their latest results where despite coming in with numbers well below expectations they are doing a lot of tendering. At the same time ICIS published this chart…

IMG_0770

It is my (strongly held) view that these two data points are in fact correlated.

I saw an offshore company this week post a link to the oil price as if this was proof they had a viable business model. Despite the rise in the oil price in the last year there has been only a marginal improvement in conditions for most companies with offshore asset exposure.  There is sufficient evidence around now that the shape and level of the demand curve for offshore services, particularly at the margin, is in fact determined by the marginal rate of substitution of shale for offshore by E&P companies. That is a very different demand curve to one that moved almost in perfect correlation to the oil price in past periods.

IMG_0778.JPG

Source: BH Rig Count, IEA Oil Price, TT

This week two large transactions took place in the pipeline space. The commonality in both is new money comping into pipeline assets that E&P companies own. Over time the E&P companies hope they make more money producing oil than transporting it. But they have found some investors who for a lower rate of return are happy just carrying the stuff. More capital is raised and the cycle continues. On Friday as well Exxon Mobil was confirmed as the anchor customer for a new $2bn Permian Highway pipe. These are serious amounts of capital with the Apache and Oxy deals alone valued combined at over $6bn and shale producers confirming they are raising Capex.

When I people talk of an offshore “recovery” as a certainty I often wonder what they mean and what they think will happen to shale in the US? There strike me as only three outcomes:

  1. At some point everyone realises that shale technology doesn’t work in an economic sense and that this investment boom has all been a tremendous waste of money. Everyone stops investing in shale and goes back to using offshore projects as the new source of supply. I regard this as unlikely in the extreme.
  2. Technology in shale extraction reaches a peak and unit costs struggle to drop below current levels. In particular sand and water as inputs (which are not subject to dramatic productivity improvements but are a major cost) rise in cost terms and lower overall profitability at marginal levels of production. This would lead to a gradual reduction in investment as a proportion of total E&P CapEx and a rebalancing to offshore. Possible.
  3. Capital deepening and investment combined with technology improvements cause a virtuous cycle in which per unit costs are reduced consistently over many years. Such a scenario, and one I think is by far the most likely, would place consistent deflationary pressure on the production price of oil and would lead to shale expanding market share and taking a larger absolute share of E&P CapEx budgets on a global basis. This process has been the hallmark of the US mass production economy and has been repliacted in many industries from automobiles to semiconductors. Offshore would still be competitive but would be under constant deflationary pressure and given the long life of the assets and the supply demand balance would gradually converge at a “normal” profit level where the cost of capital was covered by profits.

I don’t know what the upper limit of shale expansion in terms of production capacity. I guess we are there or near-abouts there at the moment, but I also don’t really see what will make it stop apart from the limits or organizational ability and manpower?

It is worth noting that a lot of shale has been sold for significantly less than the highly visible WTI price (delivery Midland  not Cushing):

IMG_0765.JPG

And Bakken production is at a record:

IMG_0764.JPG

Each area creates its own little ecosystem which deepens the capital base and either lowers the unit costs or takes in used marginal capital (i.e. depreciated rigs) and works them to death. The infrastructure created by the temporary move away from the Permian may just create other marginal areas of production.

I think “the recovery”, defined here as offshore taking production and CapEx share off shale, looks something like this model from HSBC:

IMG_0783.JPG

I suspect it’s about 2021 under this scenario that the price signal starts kicking in to E&P companies that at the margin there are more attractive investment opportunities to hit the green light on. That’s a long way off and is completely dependent on some stability in the market until then, but under a fixed set of assumptions seems reasonable. Note however the continued growth of shale which must take potential volume from offshore at the margin.

The offshore industry needs to get to grips with the challenges this presents (I have some more posts on this on the Shale tag). Mass production is deflationary, indeed that is it’s purpose. Shale is deflationary in the sense of adding supply to the world market but also deflationary in terms of consistently lowering unit costs via improving the efficiency of the extraction process and the technology. Offshore was competitive because it opened up a vast new source of supply, but it has not been deflationary on a cost basis (until the crash caused its assets to be offered at below their economic cost).

I’ve used this graph before (it comes from this great article) it highlights that the 1980s and 1990s had generally deflationary oil prices based on tight-monetary policy and weaker economic growth expectations. Ex-Asia the second part of that equation is a given today and US$ strength means oils isn’t cheap in developing countries. As the last couple of weeks have reminded us there is no natural law that requires the oil price to be in a constant upward trajectory.

Inflation adjusted WTI price.png

 

My holiday reading…

I’m off to Spain for some reading and beach time on Wednesday… Strangely prescient reading awaits …

If anyone wants a book recommendations one of favourite economic history books is The Wages of Destruction (but The Deluge is up there as well) and The Museum of Innocence is one of my favourite novels. I went to Turkey for the first time in 2001 and then everyone wanted dollars, then I went back four years later and everyone wanted €. The script looks written for a currency crisis here when the President asks the population to change $ into Lira as an act of patriotism, and so when I next go back to Turkey they may well be looking for Yuan if David Goldman is right.

The graph above just shows that Turkey isn’t going to stop buying Iranian oil. They will just barter for it and actually end up paying less in $ terms. Russia and China are getting a back door channel to the whole region the longer this keeps up.

Shale and offshore… the competition for marginal investment dollars…

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

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

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

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

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

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

Ocean Rig Recovery.png

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

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

Long term offshore.png

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

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

What will a deepwater recovery look like for contractors?

In the five years since the 1996 bill became law, telecommunications companies poured more than $500 billion into laying fiber optic cable, adding new switches, and building wireless networks. So much long-distance capacity was added in North America, for example, that no more than two percent is currently being used. With the fixed costs of these new networks so high and the marginal costs of sending signals over them so low, it is not a surprise that competition has forced prices down to the point where many firms have lost the ability to service their debts. No wonder we have seen so many bankruptcies and layoffs.

Brookings Institute, 2002

McKinsey Energy Inisghts has a good article on how a recovery in the offshore energy might play out. The article makes the point I have made here that large deepwater projects, especially in Brazil and the Gulf of Mexico, are likely to economically attractive going forward but smaller, and shallower projects are in trouble.

First let’s appreciate the scale of the downturn the offshore contracting and supply industry is dealing with:

Global upstream investment has suffered dramatic cuts in the recent low oil price environment. Upstream oil and gas capex was halved from ~$800 billion in 2014 to ~$400 billion in 2016, and global exploration and appraisal spending fell by 40% to $11.2 billion during the same period…

Spending cuts are expected to cause a 50-60% decrease in oil volumes coming online from new projects in the next three to five years, compared to the 2010-14 average. As with brownfield projects, the greenfield pipeline for the next few years has been significantly reduced due to the lack of investment since 2014, especially for shallow water developments. [Emphasis added].

So if you own a shallow water asset, like a DSV for example, this massive drop in demand is proportionately harder. Mckinsey say $654bn will need to be invested in currently unsanctioned projects by 2030, but that doesn’t come close to replacing the level of spending cut. Obviously a greater volume of work is being delivered for a greatly reduced price, which is one of their key points. Having predicted a supply gap in the oil market I also thought this prediction was interesting:

Projects that reached FID before 2014 – including mega-projects such as Lula and Golden Eagle – will cover 60% of the anticipated supply gap in 2020-21…

This is an industry with a long run supply curve. Talk of “inflection points” from some contractors just don’t seem to be backed by data.

Read the whole thing. I have a broader point than simply doing a cut and paste from McKinsey but it is based on this:

As a result of cost compression, deepwater breakeven levels are likely to continue being 20-25% lower than 2014, despite a situation where oil prices increase to $70/bbl in our base case. The wider margin created by lower costs should place deepwater investments firmly at the left side of the global oil cost curve, making these projects viable to close the supply gap.

McKinsey see the cost reductions in the offshore supply chain as permanent and structural. Not all relate to oversupply, but they are all based on spending less time offshore.

Although not as widely reported a bigger investment boom than the Dot Com investment bubble was the telecoms investment bubble that occurred at roughly the same time. The global, but particularly US, industry was overcapitalised as companies laid the “dark fibre” of the future internet. A vast number of firms went bankrupt and were subject to fraud (remember Bernie Ebbers and Worldcom?) before they even “lit” the fibre. It was a speculative mania in an industry that like offshore had very high fixed-costs and very low marginal-costs. But the thing is the telecoms companies made nothing from the boom, shareholders and bondholders were largely wiped out, the same thing happened in the English railway mania of the 1840s, and an earlier canal boom in the 1790s which ended in 1793 (and here). The winners from the telecoms investment boom have been companies like Netflix, Google, and Facebook which have used the networks paid for earlier at well below their true economic cost (and without the coordination issues of splitting the installation costs between themselves), similar arguments can be made for railways and canals. The net private losses were potentially an overall social gain.

So the question really is has the offshore industry just supplied a huge amount of latent capacity that will allow E&P companies to close the supply gap cost effectively while wiping out the equity of those who built the infratsructure behind it? I hope pre-2016 Seadrill shareholders (amongst others) enjoy their quality viewing, direct from the internet, and appreciate the irony.

The French Revolution and Venezuela…

As a follow on from my post on Venezuela a really interesting, and short, article at FT Alphaville (free) comparing Venezuela’s proposed “Petro” and the Assignats of the French Revolution. Maduro is well on his way to becoming a modern Robispierre, with exile or a similar fate awaiting him. Tony Yates highlights that nothing in Venezuela, not the revolutionary tendencies, or the economic solutions of the revolution’s leaders, have changed over time much over time as real options dry-up.

A more in-depth paper here for anyone really interested.