HugeStadSea and Olympic

Two major pieces of restructuring news today with Solstad merging with Farstad and Deep Sea Supply and Olympic finalising its deal. The interesting thing is the contrast: Solstad goes long on offshore supply while Olympic goes for subsea. I get the Olympic deal but for what its worth I’m not sure about creating a bigger HugeStadSea.

The Solstad/Farstad/Deep Sea is about as complicated as it gets (full details here). However in simple terms Solstad currently has 20 PSVs (32%), 16 AHTS (25%), and 27 CSV/Subsea (43%) as opposed to the new merged fleet of 154 vessels has 66 PSVs (43%), 55 AHTS (36%), and 33 CSV/ subsea (21%). That doesn’t seem like a good deal to me. I get the financial metrics mean Solstad, with a (slightly) better debt profile and fleet profile, is taking a proportionately bigger share. But the economics seem simple to me: Supply and Subsea have similar daily running costs but unless you are a true beliver its hard to see asset price appreciation in supply whereas subsea has the potential for a service element that can add value beyond the steel in addition to the vessels holding their value better. Not many people would trade a fleet with 43% exposure to subsea and trade it for one with 21% in this market.

I don’t see how this business will have enough scale to lower unit costs to make the merger worthwhile? Procurement is still regional in the industry and while it will be a large company with 2100 supply vessels in the industry it won’t be big enough to have any effect on market pricing. Savings of NOK 500m across a fleet of 154 vessels with such high running costs look to have almost no effect. Put me in the sceptical camp. I would have passed on Farstad if I was either Deep Sea or Solstad but I accept different people are more confident in the long-term supply market, but exposing yourself to a similar cost base on commodity vessels when the upturn seems so uncertain is bold to say they least (which could well be one of the many reasons JF is a billionaire and I am not).

Olympic seem to have realised this and effectively cauterised the risk of the supply vessels (by handing them back to the bank and bondholders effectively) and offering upside only on the subsea fleet while providing only for basic running costs for the supply fleet (deal here). Significant new equity is injected (from the main shareholders), along with the ship and crew management companies, and the medium-term liquidity looks confirmed (barring a credit event I guess?). This strikes me as a far more investible proposition whereas the HugeStadSea looks more like assets looking for a transaction to buy them time and hope.

Waiting for Godot: Nor DSVs

In a previous article, I outlined why I believe the market for North Sea class DSVs is as structurally unattractive as could possibly be designed. The investors backing Nor/Harkand are Waiting for Godot. With their own Vladimir and Estragon, parked quayside at Blyth, they don’t know when Godot is coming, and they don’t exactly know what it looks like apart from an unexpected increase DSV days in the North Sea, but at the moment they can’t agree to leave either. This is totally unsustainable given the running costs and there is clearly an oversupply of North Sea class DSVs, a situation that hasn’t existed since 2002. I believe the offshore industry (globally) will only reach back to a new equilibrium when a focus on economics forms the core of decision-making, and at the moment we appear to be some way off that.

One of my real (and clearly biased) issues with offshore has always been the dominance of engineering and operations people who were feted as their skills became so scarce in the boom. Offshore contracting isn’t at a base level a complicated industry, the execution can be, but the economics is relatively simple. Yet for years the “black magic” of operations has been allowed to obfuscate the economic issues, engineering could dominate all other disciplines because there was no cost pressure. First oil mattered to the exclusion of everything else.

But in order for the industry to move ahead, financial investors need to face reality as well. How low could subsea vessel prices go? Look at the rig market: Ocean Rig purchased Cerrado at c. 10% of cost and the Deepwater II cost NOK 7.3bn (USD 870m) and sold for USD 210m.  Subsea 7 sold the ROV vessel Petrel for c. 7, maybe 1/3 of book value. A wave of bankrupt OSVs are coming to market and some sales are close to being announced which may set new benchmarks. OSVs in general are a classic case of asset specificity. But what gives them such high values in a boom market also works in a counter-cyclical way on the way down. That’s a complicated way of saying if you build a ship that’s really good at one thing, and that thing isn’t needed anymore, it’s not worth a lot regardless of how much it cost to build.

Nothing seems more financially irrational than the behaviour of the Nor/Harkand bond-holders. Having taken re-delivery of the vessels from the Harkand administrator in 2016 they then proceeded to move the vessels to Blyth in hope of getting work. The fact that no consultants were engaged to provide some guidance on the regulatory requirements and operational realities of getting work shows how truly out touch these investors and advisers were. Even a basic knowledge of the North Sea DSV market shows that there are only five serious companies and all were too long on tonnage, with massive (non) utilisation issues of their own fleet, and therefore these vessels were simply going to be tied-up quayside. There are enough data providers out there for this not to have been missed.

Apart from Technip, who had used the Da Vinci before, anyone wanting to use these assets would have had to invest in bridging documents from the vessel dive operating system to their company HSE system and then get HSE approval. Its not impossible, ISS did it with the Polaris when they brought it to the North Sea, but its probably 4-5 people taking at least 4-6 weeks. It’s time-consuming, process oriented, work. Then you need to get HSE approval which needs a few weeks best case scenario. And that’s before you tender for work because no one is going to award you work on the off-chance something goes wrong on your approval process. And more importantly, why would you bother? There are five companies in the market with really good assets and track record and they don’t have enough work for their own boats and are bidding at less than OPEX just to get the vessels away from the quay? Economists call this market an oligopoly: a few firms dominate it. In a period of oversupply it leads to an efficient market where there are no economic rents to be made by these firms. In plain English it means they compete on price and there is no economic room for new entrants.

For this reason there has never really been a spot market for DSV charters in the North Sea, it’s actually the opposite, you need to control an asset before being seriously considered for work. So in reality there was never any chance of the Nor/Harkand assets getting any work at all in 2016 as any independent party could have pointed out (saving millions in transit and operational costs).

But what the Nor/Harkand investors lack in humility and foresight they make up for in intractability. These vessels, having sat around for the better part of 9 months without any work, raised USD 15m in November last year giving them more time to pursue exactly the same strategy for longer. Like Haig at the Somme, no amount of money is too great to commit to proving their point, against the face of all evidence to the contrary, that the North Sea market is going to bounce back. The Nor/Harkand vessels, like Vladimir and Estragon, wait in Blyth to take advantage of a break-out of demand so extreme all the current dive contractors are going to suddenly go-long on two more vessels and allow the whole crazy cycle to start again. [And it’s actually more than that because with the Vard new-build and a couple of other you could add 20% capacity to the market almost instantly.]

To be fair I met one of the distressed investors who said to me “if they were going to win work with this strategy they would have done it last year, hopefully we’ll have to so another cash call and I can buy some more when people realise how bad it is”. I get that….It’s not quite as irrational as trying to put the Cal Dive band back together, but its not that far off either.

The Atlantis and Davinci are totally unsuited now to the North Sea market (where demand meets supply as opposed to strictly environmental factors). As DSVs go they clearly have the technical capability to operate in the region but the real question is who would need them and for what? One of problems with DSV is that because you cannot put a diver down more than 300m, the same technological boundary of 30 years ago, newer vessels offer few advantages over old ones, and certainly nothing price cannot fix.

E&P companies buy DSV time on 5 criteria : 1) the operator, 2) the SAT system, 3) the crane, and 4) deck space 5) schedule. A DSV is a compromised vessel on everything compared to a general purpose OSV unless it’s working as dive vessel. If you are not working as a dive vessel what are you?

Obviously as an operator the Nor/Harkand proposition doesn’t make sense. There is no infrastructure, management team, capital or long-term plan that would make someone buy a complex project off them. Using a bunch of subcontractors to replicate a solution that other integrated SAT dive companies could provides a solution for Nor but not for the customers. Nor seemed to have recognised this and have stated explicitly they are not seeking dive work… but then what are they seeking?

As ROV vessels the Atlantic and Davinci don’t work: they are over specified and too heavy on fuel. M2 have ROVs on board, but they have also struck a deal on the Go Electra, and need to build their first year campaign around this vessel (which is a great ROV vessel and full credit to the guys here). Who would cover tendering costs, bid bonds, warranty issues etc? I will write on ROVs soon, but they are shaping up to be an extremely competitive area with everyone from start-ups to established companies having access to a huge variety of custom ROV tonnage these assets simply aren’t needed in the market,

As a heavy-lift vessel they don’t work. The cranes are rated at 140t but that is double fall. More importantly, these vessels have not worked doing lift operations in a long time. Anyone looking to do a decent lift isn’t going to save a few dollars to have a temp crane driver do the lift offshore on an asset that hasn’t worked in a year with an offshore team that has never worked together.

In the current market where every asset type is oversupplied these assets simply have no logical market space. Simply being cheap doesn’t help because everyone is cheap. The Nor bondholders are soon likely to find that their USD 15m bazooka is actually a pea-shooter and simply will not convince potential customers or buyers they are here for a long time. Long-term DSV charters are extremely rare, and at the moment some of the most contested contracts around. Everyone is competing on price so Nor offer nothing. And there are NONE in the North Sea where their vessels are.

Nor have a basic commercial problem: no one wants to buy what they have to sell. Nor need a massive change in strategic direction. However, Maritime Finance Corp, the largest shareholder, appear committed to following this strategy to its logical conclusion (another fundraising round after months of no work) as to pull out now would mean owning up the residual value of the assets being significantly lower than they would like. MFC purchased about 37% of the bonds on issue meaning they put in c. USD 81.4m in 2014. In the current market you would be lucky to get that for both vessels implying that MFC would have to write off c.50m (i.e. 37% of USD 80m is USD 30.1m).

Moving the vessels out of the region means owning up to the fact that they aren’t worth all the extra money above an Asian or US flagged DSV. Keeping the vessels in the North Sea requires an act of faith, a contrarian view, that diving in the UKCS will bounce back. Sooner-or-later this strategy must fail. The core point is this (thanks to DNB):

The UKCS and NCS saw a boom in oil and gas investments post the financial crisis in 2009, particularly the former, where development capex increased by ~125% from 2010 to 2013. The rebound in the oil price made several smaller projects economically attractive, and a sizeable majority of these were developed as subsea tie-backs. In addition, ageing infrastructure needed significant upgrades to accommodate a much longer lifetime than originally envisaged, and new production from smaller fields…

The outlook on the UKCS does not look as strong, however, and we highlight that only ~GBP0.5bn of new investments was sanctioned in 2016, versus an average of ~GBP8bn in 2010–2015. In other words, we believe the recovery in activity in 2017– 2019 is likely to be limited to the NCS, which is a major difference from the 2010–2013 recovery in this region.

CAPEX is at 1/16 of previous levels. The CAPEX vessels are trading in the OPEX market and will do for a significant period of time given lead times. A small CAPEX project could easily take 180-270 DSV days, that work simply doesn’t exist now, and Technip and Subsea 7 have moved their corporate resources back to IRM. A strategy to add capacity, without infrastructure, in a brutally declining market, against better-capitalised and more committed competitors, is economic madness.

Back to the future… It’s Cal Dive apparently! Putting the band back together…

Like most people in offshore I reacted with a degree of amazement when I read this week that the old Cal Dive fleet had been sold to an AIM listed E&P company with onshore acreage in Columbia. The industry is going through a total reset at the moment, a sign perhaps we are nearing the bottom, but I still feel when financial investors, with no operational knowledge at all step in, one has to question the industrial strategy. As an investor I was exposed to Red7, a company that made a specialty of going long on old tonnage, and it was a disastrous failure. Maintenance bills cripple older tonnage where drydock expenses can exceed the capital value of the assets. Companies operating older tonnage are forced to compete at the very bottom of the market and therefore often do not charge enough to cover for anything other than daily OPEX. One big maintenance bill or drydock and it’s all over.

On a strategic level does anyone mourn Cal Dive? The Horizon acquisition finished them as they overpaid for a company that specialised in laying shallow water pipe in the US Gulf of Mexico, a market that died a natural death as shale became big. Diving in the US Gulf is about as price competitive as anywhere in the world and the safety standards among the lowest. Currently a mass of four-point mooring vessels sit idle and there is a dearth of work. From an economic point-of-view it’s structurally one of the most unattractive markets you could design.

It’s so incongruous, therefore, in this market, to go long on old Cal Dive assets and try and put the band back together so to speak. To be clear of the 11 vessels six are classed as in lay-up! One was built in 1967!!! The barge, built in 1995, is also in lay-up. But Global Energy Developments, a company with no offshore operational experience ever, went long on the oldest, most downmarket, un-operational vessels you could possibly scour the globe for. I was looking for a Nigerian email address for the company to send their account details to but this wasn’t outlined in the documents. Others in the market clearly felt the same way as the shares dropped c. 15% on the news.

You can get a large amount of the background from the regulatory filings here. The crucial one dealing with the transaction is this. I could be cynical but I got the feeling it was largely designed to be impenetrable.

This investment story begins in July 2014 when DeepCore Marine Inc. (a company 76.5% owned by Alan Quasha) purchased the Cal Dive surface dive fleet for USD 18.9m and giving the seller (Cal Dive) 19.9% of the company. Financing for this deal was provided by McClarty  and potentially Caleura (although it appears they joined later). In July 2015 Everest Hill Energy Group Ltd (a company 100% owned by interests associated with Mr Quasha) acquired 5 vessels from the Cal Dive administrator, including Pacific, Cal Diver I, Rider, Midnight Star and Mystic Viking, as well as related equipment. The total consideration for all five and the equipment was USD 10m.

Global Energy Development Plc (“GED”) is a company c.62% owned by HKN and effectively Alan Quasha. The Executive Chairman of GED is effectively one of the beneficial owners of HKN. Having sold its profitable assets in 2014 it was flush with USD 21m cash. Coincidentally in September 2015 HKN and GDE issued loan notes to Everest of USD 10m. Later GED would buy its shareholder, HKN, out of its share of the loan note (at par), add USD 2m to it, and change the repayment terms to a position less favourable to itself.  It seems safe to assume this was used for consideration of the vessels.

ged-ln-s

Now GED is entering into two transactions to purchase the vessels that essentially puts the Cal Dive fleet back together. In one of the great ironies of this a core company that owns DSVs as a financial investor is called Maritime Finance Corp (“MFC”). In this case MFC is an SPV designed to do nothing other than make the acquisition clean, in the Nor Offshore DSVs, at the other end of the spectrum, is MFC Bermuda, a par bondholder from the inception of their original deal to back the high-spec North Sea DSVs. What appears to link these companies in more than a name is a firm desire to hark back to the past that doesn’t exist at either end of the DSV quality spectrum and design an industrial strategy for a time unlikely to return.

ged-a-b-s

In Transaction A GED gets three vessels, ranging from the Cal Diver 1, a vessel so ancient and decrepit rumour has it dinosaurs refused to cross the GoM in it because of rust damage (built 1974), the Midnight Star, built 1975, and the Mystic Viking built 1983. All classed in lay-up. For the privilege, GED will write off USD 8m of the loan note! Bear in mind Everest settled 5 vessels for USD 10 and some ancillary equipment, and that these vessels have just been floating around since then.   In addition (seriously) they are paying the less of USD 5m or 75% of EBITDA of the vessels for 18 months. That will be 0. Seriously 0.

Let me assure you, as I am sure most people who read this blog will realise, it will cost millions to get those vessels classed and in shape to pass a US Coast Guard inspection.

cal_diver_i

The Cal Diver 1. The future apparently!

Transaction B is even better. These are the old DeepCore Marine Inc. (“DCM”) vessels that were purchased from Cal Dive. In this transaction the sellers of the vessels agree to purchase a USD 10m loan note from GED and in return hand over 5 x 4 point mooring DSV vessels, built in 1967, 1969, 1983, 1977, and 2000 and 3 out of service vessels. In addition the 1995 built Rider Barge, classed in lay-up, will also be delivered. But in return they also get USD 21.6m in loan notes from the company as consideration bearing the attractive interest rate of 6% and these do not expire until 2029 and 2032.

Everest is a 76.5% holder of equity in DCM. DCM borrowed money off McClarty Capital (a local PE House) and Caleura (which appears to be Luxembourg company registered in September 2015) to buy the assets off Cal Dive. Interest has accrued and not been paid. These assets have been capitalised in a new company which is being handed over as part of the deal (Maritime Finance Corporation). Everest appears to do particularly well in the deal because having brought the Rider Barge as part of the transaction A assets originally (for USD 10m in total) it is selling the barge back to the company for USD 6.1m in loan notes (USD 5.5m clean) having already made USD 8 on the three vessels in lay-up that constitute transaction A. The extra carry in the loan notes on the barge would appear to cover any losses incurred on the loan note covered in transaction A.

In an extremely complicated completion mechanism the sellers of this tonnage get issued with USD 21.6m in loan notes.  But do you get what happened here? They hand over USD 10.5m (and get 8% per annum back), to a company with USD 21m cash in hand, and no other apparent transactions planned, a company controlled by the sellers and with no other creditors, and in return for the vessels took loan notes of USD 21.6 m (with a 6% yield) and have USD 8m written off. You need to put money in here because otherwise the enitre equity value has been wiped out by the issuance of the loan notes. I’d go long on this trade every day of the week with unlimited money… only if I was the seller mind…

I am not suggesting anything improper. Norton Rose are the GED lawyers, and “[t]he Independent Directors, having consulted with finnCap (the company financial adviser)… [believe]… that the terms… are fair and reasonable”. Kennedy Marr blessed Transaction A with a Fair Value USD 8m brokerage report apparently (although scant details are provided). But what is clear is that these assets were purchased from the administrator of Cal Dive in a quick process, have been laid up for two years, during that time the market has significantly worsened, and yet the investors via this transaction are made whole temporarily via a company they control 62% of.

Its just extraordinary on a number of levels. All of us, with even a modicum of vessel knowledge, consider these assets to be some of the most compromised and poor quality in the market. I don’t believe you could get USD 8m for the vessels in Transaction A in an open market deal under any circumstances. They are just such bad ships the sooner they become Matchbox cars, or whatever else you do with recycled steel, the better. Prediction is hard, especially about the future, as Nils Bohr said, but the scenarios under which there was any economic value in those assets must be on a statistical basis with a large meteorite strike.

The old DCM  assets are actually so bad I can’t be bothered expending mental energy on insulting them. They are still being advertised on the DCM website and the only real route to market is through them. A company owned 76.5 by the seller, and no apparent sale-and-leaseback arrangements, as would often be the case here. DCM have had extremely poor utilisation with these vessels post-acquisition from Cal Dive.

I rang a contact in the US today to make sure I wasn’t going mad and he actually couldn’t stop laughing when I talked him through this. Unlike the North Sea, the Gulf has a lower level that is really low, and some really unsafe and unsound tonnage can find work. But a Plc cannot compete in this space, and its real “Mom and Pop’ stuff, and it is absolutely not the future.  I accept Cal Dive’s issues were largely related to the Horizon acquisition, but their issues were also to do with the quality of tonnage used. The Rider Barge is emblematic of that: shallow water pipelay stopped on the US GoM shelf around 2005, that’s why Horizon was such a bad acquisition for Cal Dive. It drove them bankrupt. There is simply no market for shelf pipelay, and unlikely to be ever.

The charitable explanation here is that this transaction helps the company access the tax credits on USD 26m of earnings. I can’t help feeling more would have been made of this if really the case. But it would take a lunatic to believe these assets, in the most price competitive market in the world, or actually any market in the world, actually represent a serious industrial strategy.

 

The North Sea DSV Market: no deus ex-machina forecast…

I have been asked by request for my opinion on the North Sea DSV market (that’s you Mr Cappalletti). At the moment I appear to be nothing but a catastrophist on here,  but I have only one word for my prediction: Grim. The following is from a presentation I have given to a small number of people in the market.

A near 40% reduction in the UKCS DSV fleet in 2016 still saw poor utilisation and very low day rates.

ukcs-dsv

(Source: Stamford Maritime)

New vessels are arriving in 2017 for Subsea 7 and Technip. I predict low profitability as a result of excess supply and weak demand.Why such a grim forecast? There are basically two reasons for this that point to a structural decline in the market and it is not easy to see what will make it reverse:

  1. CAPEX work at shallow water depths has all but disappeared. This was major driver of DSV utilisation taking Technip and Subsea 7 out of the Inspection, Repair, and Maintenance (IRM) market and leaving it for Bibby and Harkand (to a lesser extent who still traded their DSVs a lot in Africa).
  2. The decrease in OPEX/IRM has been far more dramatic than many people, including myself, ever thought possible. But the facts are clear.

UKCS DATA.png

The CAPEX cut back is most serious for Bibby Offshore. Despite having made major strides in becoming a construction contractor, like Icarus, they flew too close to the sun; prior even to the bond issue Bibby committed to the Olympic vessels, ultimately moving from specialist vessels to commodity vessels at the top of the market. I understand this move, in the subsea Dark Ages (c. 2012), vessels with large back decks and 250t cranes were unavailable unless lengthy charter commitments were taken. Not only did Technip and Subsea 7 have access to the pipelay assets but for much of the year they had others locked out of the heavier tonnage required for complex ROV-based interventions. Accessing this work, inevitable once the commitment to ROVs had been made, the fateful journey began. Bibby dialled up the risk without increasing the equity to anything like the extent of the financial commitments made.

Then they doubled-down! A GBP 175m bond for a dividend re-cap, a general purpose bond, that essentially withdrew equity from the business. While the operational effect of the moves was different the net balance sheet result was the same: a highly leveraged bet on the North Sea oil price and a management team executing flawlessly in an international expansion strategy. No one is criticising the management here, most of whom I have a great deal of time for, but the balance sheet made this impossible. The time-honoured, and well-tested instrument for pure risk, which is what this was, is equity. That beautiful part of there balance sheet that can expand and contract as cyclical markets move without shattering the other constituent parts. And the Bibby balance is as bereft of this as I was of girls as a teenager.

There is no doubt Bibby, aware of their predicament, must already talking to the largest bond investors about the situation they are in (the only logical strategy to try and preserve some value for Group). Difficulties abound and there is no certainty of success. I don’t think Group will make a significant contribution (as a minimum I would be demanding the 20m taken out this time a year ago but that maybe unrealistic now), and it certainly won’t be at current equity levels, because that equity is worthless. The bondholders face the terrible prospect of getting redelivered two North Sea class DSVs, some of the most specific and costly shipping assets in the world to maintain, or making a complete shambles of it as the Harkand bondholders did as financial investors. Clearly neither is an appealing option and the Bibby bondholders will have to choose between kissing their sister or the dog.

Because, if everyone is honest, Bibby isn’t going to be a major construction contractor with activity at these levels. The majority of the construction work that is being done in the North Sea is deep-water and requires rigid pipelay, or floating bundles, for flowlines that Bibby do not have the asset base for, and these projects use very little DSV days (if any being significantly deeper than 300m but maybe some riser hook-up). Technip and Subsea 7 have this to themselves, but to add insult to injury, as they are so quiet they have now moved in to significantly take market share off Bibby in the IRM market. In the old days (c. 2013) smaller E&P companies with a USD40-50m construction project would be lucky to get a call-back from Technip or Subsea 7. Now they are all over these companies for even 10 days diving, and like the ugly duckling at the school ball who suddenly finds the cool guys chasing her, the nice guy isn’t getting a look in.

This highlights the other problem the Bibby bondholders have: if you were recreating Bibby tomorrow it wouldn’t be with the Polaris and Sapphire yet these are the vessels they have a mortgage over. Polaris at 25 years is operationally capable, but in reality probably unsellable, which locks the investors into an irrational course for a long-term business decision. A better bet would be to buy a pre-pack of the management system and IP and merge it with the Topaz and the Vard new-build. If I was Vard I would trade a sale now for an equity stake in a service business, but there are clearly a vast number of complications and agendas to be overcome before a transaction like that could be done.

The news get worse because as many people have noted the UKCS is not going to rebound like Norway. As DNB noted (in a pessimistic market report) this morning:

The outlook on the UKCS does not look as strong, however, and we highlight that only ~GBP0.5bn of new investments was sanctioned in 2016, versus an average of ~GBP8bn in 2010–2015. In other words, we believe the recovery in activity in 2017– 2019 is likely to be limited to the NCS, which is a major difference from the 2010–2013 recovery in this region.

Technip, Subsea 7,DOF Subsea, and Ocean Installer are going to cross subsidise their UK operations with the Norwegian market where Bibby has minute market share and no NORSOK operational DSVs. The cancellation of another Brazilian PLSV for Subsea 7 will only strengthen their determination to get what work they can on the UKCS, and if that vessel isn’t stacked is likely to head North anyway.

Until the construction market returns there will be no sufficient market for an independent IRM focused dive contractors until their asset-base is revalued and expected equity returns and loan profiles subsequently adjusted.

Which leads us nicely to the IRM market:

SSDT.png

The fact of the mater is we were all wrong. No one more than me. E&P companies could, and did, cut back IRM spend more than we thought. There is no reason to believe this isn’t structural as there are currently a large number of wells “shut-in” as operators simply refuse to spend on maintenance and defer production.  If you believe the optimists and think the E&P companies have been storing IRM up you need to explain why the DSV schedules for the major contractors is empty? Economic logic would suggest book work now when DSV contractors will give the vessel for OPEX only? Speak to people in Aberdeen and they will tell you the schedules of all five serious DSV companies are wide open next year. S&P commented on the lack of backlog at Bibby in their recent downgrade.

My views on the Harkand/Nor vessels are well known: sooner or later the grown-ups will take charge and at least one of these assets will leave the North Sea. They don’t have the crane size to compete as heavy-lift vessels, Nor has nowhere near enough capital and infrastructure to compete as a dive contractor, and they will be completely dependent in M2, a start-up, on winning work for them. Unless Technip runs short on vessel days, which would seem unlikely at this stage, I don’t see them working in the North Sea much at all.

Helix will continue to cover their OPEX with well intervention and continue to keep pressure on rates by virtue of having excess capacity and a well regarded delivery capability.

DOF I believe are the real wild card as I have said. DOF Subsea are a serious company with a far stronger balance sheet than Bibby and an ability to cross-subsidise across the fleet.  The Skandi Achiever may only be single-bell but she has worked for Technip and already done some decommissioning work.

The supply side remains of real concern for overall profitability. The Vard new-build has to be delivered and find work. DOF again would make a good home but don’t need the OPEX. Bibby must either strike a deal with the Volstad Topaz bondholders or redeliver the asset which would return to the market. Bibby would have to spend millions removing the dive system something I don’t believe they will do. As an aside, I believe Bibby did the diving for EMAS Chiyoda on Angostura… I hope they got paid because otherwise I think they will take a serious credit impairment there.

I don’t see the UDS vessels making it at all the North Sea: they simply aren’t needed. Norway appears to have about 600 addressable dive days per annum and 2 x NORSOK DSVs already.

These are genuinely epochal times for contractors in the North Sea. The market will adjust to a more normal level, probably higher than now. But there won’t be a deus ex-machina event here that will keep everyone whole.

I hope I haven’t lost you in my verboseness Sergio!

 

Ezra and Bagehot… the denouement is nigh.

News that Ezra had delayed its annual meeting didn’t come as a huge surprise to me. I think, and I have no special insight or contacts here, that Ezra has a solvency problem, not a liquidity problem. By that I mean I believe the value of its assets do not secure, or can in anyway pay, for the liabilities incurred in building up the business. I think the reason the AGM has been delayed is because Ezra management and Directors are struggling to get the auditors to sign the statement of going concern. I don’t see how it can be done without the banks agreeing to roll over their loans from short-term to long-term, and as this would jeopardise their security interests,  I don’t think they will. There are cross default clauses in loan and charter agreements etc, its not as easy as calling people up and demanding a rate cut here.

The language from Ezra/ EMAS Chiyoda is all about temporary suspension of payment. They are implying they have a liquidity crisis, and despite people arguing to the contrary, its a crisis when you are a public company and you come out and ask for a respite from creditors and then can’t produce your accounts.

In the 19th century Britain had a series of credit crunches and banking crises that led to panics and investor (depositor) losses, and each seemingly became worse than the last. Walter Bagehot, wrote a book Lombard Street: A Description of the Money Market, and famously enunciated the idea that if a bank had good quality collateral, but a problem with accessing it, the central bank should lend against this. The distinction between illiquid and insolvent was born and central banking was changed forever; as Bagehot wrote:

If it is known that the Bank of England is freely advancing on what in ordinary times is reckoned a good security—on what is then commonly pledged and easily convertible—the alarm of the solvent merchants and bankers will be stayed…

The point about the value of the collateral in ordinary times is as crucial as the insolvency versus illiquidity. In 1907, prior to the US having a Federal Reserve, a banking panic broke out in New York; a private sector solution was found when J.P. Morgan called the large banks into his office and locked them in until they found an answer (issuing clearing certificates) because all realised the problem was one of liquidity. In 1931 Hoover tried to get Thomas Lamont (the senior J.P.Morgan partner) to organise a private rescue of the Chicago banks, it failed because the banks knew the asset base of the other banks did not match their commitments: it was a solvency problem.

Ezra needs funds, it is only the type of securities and the amount that are in question.  EMAS Chiyoda  has insufficient project work to cover its charter obligations to Ezra and therefore compromises the ability of Ezra to pay its creditors. A private sector solution could be found here, the Singaporean government could call up Temasek and Clifford Capital ask them, on an arms length basis, what the cost of a term sheet would be for a start-up  deep water offshore contractor, with limited backlog and some very expensive ships. Investment analysts love comparable company analysis, the government caller could point out the last company that went long on deep water pipelay without infrastructure, CEONA… “…Hello, is anyone there?…. Where are you? Strange the line has gone dead….”

I can’t speak for the Japanese but I would be having a sense of humour failure about this. They thought they were buying a controlling stake in a smaller Saipem or Technip, whereas Ezra appear to have thought they were selling a working capital facility. The investment bankers did a cracking job here. The due diligence report must have been a novel of intense fiction…

One of the first lessons in investment theory is sunk cost: don’t invest/speculate on prior investments: judge each new capital outlay on its merits. And on this basis I just have to have some semblance of belief that a group of rational financial investors will put no more money in based on the current capital structure. The investment proposition, stripped to its basics is this: new money will go in to fund a deep water pipelay contractor, in one of the worst markets ever, to take market share off Technip, Heerema, McDermott and Subsea 7? Really? This would be a multiyear investment in the hundreds of millions (given the vessel OPEX) to have any chance of success. And for what payoff? Stranger things have happened… but not many…

Ezra and EMAS Chiyoda don’t need another loan here they need plain vanilla equity. Pure risk capital, that realises and prices the size of the task management would have to rebuild the company in a down market, and compete against some of the most skilled offshore engineering houses in the world, and do this on an asset base acquired at the top of the market when everyone else did theirs more slowly (i.e.lower average cost) over years. I suspect the price of that is too high given the possible upside without a huge reduction in liabilities.

And the asset side is a problem. Regardless of the fact that Norwegians just like building ships (and they are very good at it), the economic logic for owning ships as a contracting company is the risk reduction from controlling the asset where the majority of the execution risk takes place. DSVs and pipelay vessels are the perfect example of Coase theorem, of internalising costs to insure against externalities (risks) you can’t control. The problem here is many  Ezra vessels are just commodities that can be acquired for less than half what they are paying and the company has burned through its equity, and the market hasn’t turned, and they cannot be chartered to anyone else.

The fact of the matter, following the Bagehot dictum, is the collateral will not be good in normal times. The Lewek Constellation, a beautiful ship, is unsellable at anything like an “economic/book” price because anyone who needs one has one. The asset illiquidity is too high and banks did not demand enough equity in the vessel to reflect the volatility in price. The same is true for the Lewek Centurion. ABB have built a competitor to the Lewek Connector … I could go on. This isn’t short term illiquidity these are assets that will never recover close to book value.

And right now all Ezra/EMAS Chiyoda suppliers will start demanding payment upfront so working capital will go through the roof, companies will be reluctant to make upfront payments as they will become unsecured creditors, bankers will be reluctant to make payments because they will lose more…It is very hard for a company to recover from this, as Bagehot realised the only real solution here is a flood of liquidity, but there is nothing here that would warrant it from a private or public sector investor.

As I have said before any Board that sanctions a major field development with a company in this financial position could well be accused of negligence, but without these contracts the company has no future. I am not ruling out some Lazarus like resurrection from the dead here because I don’t think the Singaporean government and DBS want to admit the scale of the mess yet. But loans won’t solve this. If Ezra is to emerge as anything like a credible company there needs to be a major change in the capital structure, a massive debt for equity swap, and a decent amount of plain vanilla equity. Anything less will not save this.

I could be wrong, but we are going to find out very soon; because either a decent amount of cash will go in and suppliers, banks, and charters will start getting paid or its terminal. I’d like not be right here as this will affect a lot of people, so I’ll happily be wrong. We will all know really soon.

Actually, it’s the Swordfish… Nor bondholders have a problem…

dsv-swordfish

Okay I was wrong…. it happens once in a while… McDermott it seems are going to go for the old Harkand Swordfish, since redelivered back to Veolia, and not one of the Nor Vessels to trade in the Middle East Africa. From an operational perspective it’s probably a better bet with the twin crane layout at the back to being a true multipurpose vessel, well suited to the regions. And the seller/ charterer was also realistic, or desperate (depending on how you look at it), cutting an unbelievable financial deal.

The Nor bondholders have a real problem now: they have two North Sea class DSVs in port at Blyth and no operational infrastructure at all. I have been told by two independent people over the last week that the new commercial managers are desperately trying to buy the Harkand management system off the receiver but don’t have a clue how to value it.

On November 7 2016 the bondholders did a liquidity issue where they raised USD 15m to fund the ongoing expenditure on the vessels. That money may have taken them through 2017, if they got one of the vessels away on a long-term charter, but if anyone wants a reminder of how expensive it is to own a DSV the bond documents showed they are spending USD 350k per month on OPEX per vessel. So the investors are c.10% through their liquidity in 8 weeks with no work on the horizon at all. Platitudes about not being forced sellers won’t mean much come June if a significant dent has been made in that cash pile through a lack of utilisation. Even worse in trying to secure potential charters the bondholders are now an extremely disparate group, ranging from the original investors (who in effect lent money to world’s greatest distressed debt house Oaktree Capital Management) to the distressed debt investors who have brought in. A second capital raising may not be so easy, something any potential charterer will have to consider as Nor’s cash buffer diminishes.

Quite why the vessels were brought to the North Sea in the first place remains one of the great mysteries… one of the most heavily regulated markets in the world, and only Technip  having the correct bridging documentation to use the Da Vinci as a DSV, with no guarantee the HSE regulator would accept the old Harkand system with new owners? Or even checking with the market if they wanted it? One would have thought the bondholders or their representative would have checked this most basic of points. I have been told the real reason was that the largest bondholder believed that the Port of Blyth was large enough to land a time machine which would take them back to 2013 and sky high day rates. The lack of appearance of the time machines not deterring the owners from continuing with this strategy.

In reality, the bondholders have a very difficult problem. They own something no one wants to buy that they desparately want to sell at a 2013 price. Just because something cost a lot to build doesn’t make it valuable. Markets are made where demand and supply meet not simply where supply provides. To use a hotel analogy the Nor bondholders have turned up in Aberdeen, which in the current downturn has lots of spare capacity in all the good hotels, with a half furnished hotel, no staff, no booking system, and no kitchen, and seem confused why no one wants to stay there when the Malmaison has loads of great rooms for £120 a night.

In the current downturn I see no market for these vessels in Aberdeen, and because I might be biased I have had a ring around some people I trust, and they confirm that this is their view as well (one of whom was rung by a shipbroker and asked how you valued a management system!). The problem at its root lies I believe in Knightian Uncertainty: a risk impossible to calculate. A kind of Rumsfeldian Unknown Unknown. This as opposed to risk which could be quantified by attaching probabilities and therefore measured and valued.

At the moment there are too many DSVs in the North Sea and given the safety focus why would any buyer, frankly at almost any price, take the risk of a new team, new contractor etc when they don’t need to? This has been acknowledged by Nor while saying they don’t intend to start dive operations. But there is no other credible dive contractor at the moment who is short of tonnage? Diving has relatively high entry costs for the North Sea, with a fair degree of asset-specific investment as a sunk cost, in a down market, there is no rational reason for anyone to make this investment. Particularly when a recovery looks like 2018 and an anemic one at that.

So the Nor investors are left with two ROV vessels with a medium crane and some deck space (with high fuel consumption);  who doesn’t even have basic ISO accreditation and a management system. There are a lot of competitive vessels (like the Grand Canyon and the Olympic Bibby) that are frankly better equipped and have more coherent teams. Why for the sake of a few thousand dollars would you charter a ship that has sat around for 7 months doing nothing and just have an agency crane driver? Crane maintenance history? When was the last time the wire was re-spooled etc.  Will the bondholders agree to see trials and crane trials before commencing operations? All this will eat further into their cash pile if they do but they cannot get work without doing so.

In the current market these, and an innumerable number more, are just incalculable risks that people just don’t need to take. For the same money they can get something better and safer. A decent risk assessment, the basis for any North Sea operator to take a new vessel, is going to have the auditors coming back with more a host more questions than answers, not just about the vessel but corporate structure and commitment as well.

M2 have some ROVs on board but it is very hard to see them committing that much to the vessels as they know the risks involved with such a dysfunctional ownership structure and the ultimate desire of the investors to bail out as soon as the market turns. Private equity companies traditionally don’t do favours for distressed investors and the logical reading here is M2 will just want to focus on getting their ROVs wet, they will want vessels they can build a business out of rather than just annoy Bibby with. I like the guys behind M2, and wish them every success, but they are a start-up. The Nor investors haven’t just taken market risk at the moment they have in effect taken equity risk (without any upside or financial gain) in M2 if they plan on them driving utilisation?

Can a DSV fit in the Tardis I hear you asking?…

Nor don’t have an operational problem they have a strategic problem: what are they and what are they going to do? Until they can answer those basic questions I would argue they are going nowhere.

Solstad today showed that the market for high-end CSVs is still hard and took a long term windfarm walk-to-work contract. When  WTW is strategically important for a vessel of that quality you know how tough the market is. The TSG connection may open up similar opportunities for Nor; but rates on those contracts have been as low as €14k per day, so a contribution to dry-docks etc is out of the questions. However, if you really believe the capital value will come back with high POB they would be praying for something like that to cut OPEX.

While the ownership units the Nor bondholders have are called “recovery bonds” they are in effect equity. The Nor owners are trying to start a shipping company without really being one and doing it on the cheap. It didn’t work for them last year and there is no real reason to believe it will this year with demand looking even worse.

Having had a rant I should note that the core point of Knight’s writing was that this uncertainty, as opposed to risks that could be insured, created the opportunity for profit and therefore the entrepreneurial enterprise or venture. Ultimately someone will make money off these vessels, I just doubt it’s the investors that lent money to Oaktree and frankly I doubt it will be in the North Sea. However, I also note with a degree of humility at the start of this post that I can be wrong… read into that what you will.

 

2017… watch financial markets not just the oil price.

bloomberg-oil-4-jan-2017A wise New Zealand philosopher once said “the future looks a lot like the past… only different”;  which pretty much sums up my thoughts for 2017 regarding Offshore and SURF. I accept sentiment in the market is increasingly positive but without wishing to sound permanently negative here are some of the issues I see coming up this year.

On the plus side… Offshore and SURF in particular enter 2017 in a far more positive note than 2016 with the price of oil having stabilised after doubling from its lows. The psychological impact on the industry has been hugely positive. Staff leaving are now actually replaced, and in many instances, the general feeling is that we are on the path to some sort of recovery. Tendering activity looks like it is increasing but rates are still at rock bottom levels.

But for the offshore /SURF industry while 2017 may mark the start of the recovery of the demand side of the industry the supply side still has some significant adjustments to make and therefore it is not just the price of oil that is important it is also the profitability of the contractors and the state of the financial markets that underpin the assets and infrastructure.

Offshore is an asset-intensive business and therefore a business dependent on credit in the modern economy. The offshore/SURF industry went into the downturn after a massive increase in capital allocation to the sector that led to an enormous new building programme, and much of the capital was in the form of debt. Previous downturns in the oil price have not coincided with such a large proportionate increase in tonnage. The industry remains over-capitalised and overbuilt and this adjustment period is likely to prove extremely painful with debt corrections being far more painful than equity corrections (compare the minimal fallout from the dotcom bubble with the US housing crisis). There are too many owners and investors who have not accepted the economic reality of what this means for asset prices with high operational costs.

Even ignoring the AHTS/PSV fleets the subsea side of the OSV fleet looks well overbuilt. There has not been such a glut of North Sea class DSVs since 1999. If the Ultradeep and Vard vessels deliver with the build quality as high as the spec then all of sudden the Bibby and Nor fleets start to look like second rate tonnage. The Bibby Polaris was built in 1999 and is still a very capable ship but I can confidently say it will never find a bank to provide a mortgage style facility against such an old specialist vessel again. Similarly pipelay, as recently as 2008 the North Sea rigid reeled market was effectively a duopoly, now there are at least four credible systems and a couple on the margin. Large OCVs? 250t crane? Coming out of the 2007/08 downturn you couldn’t magic one up. Now the Boa Deep C and Sub C look headed for lay-up and certainly don’t look that special with plenty of vessels of that spec being offered for nearly OPEX only on a day rate. Flex-lay system in Asia? Take your pick and have a free portable SAT system to go with it… Ex-Brazil tonnage… I could go on…

The other big change I see slowly percolating down into the industry psyche this year will be the realisation that there has been a structural change in the financial markets that underpin the industry. It’s not just the Norwegian high-yield market that has disappeared but bank lending to asset-backed transactions will be fundamentally different as well going forward, and just as when banks go on strike in the mortgage market and house prices drop, the inevitable is going to happen to vessel and asset prices in the offshore industry. Hopefully, it leads to more scrapping at the older end of the age profile which will help restore balance.

Banks, in particular, will be slow to return to the party I feel. The severity of the downturn in asset prices has blown out their Value-At-Risk (“VAR”) models so beloved of financial regulators and internal risk managers. The new standard deviation parameters are likely to materially increase the pricing offered to new transactions which will again lower the price of these assets and force sellers to recognise equity losses (either on paper or psychologically the effect is the same).

This change will favour larger players with bigger balance sheets as a recovery takes place as they will be able to put in place fleet loan facilities and cash flow facilities that will not be available to smaller companies and raise equity in public markets. It is inevitable that the recovery becomes dominated by larger and better-capitalised companies. The industry as a whole will require more equity to grow, and more I suspect will come from retained earnings, which will limit capacity increases in any sustained upturn. After a long period of low volatility returns equity investors will re-price seeking higher rewards for the obvious (and now historically documented) risks. I fear smaller vessel operators who put 10 (at the peak) -25% down on a vessel and financed the rest of a $100m vessel on the back of a 5 year charter, or used the project finance market and took the margin, are consigned now to the archives. These markets will return but the risk profile will more closely align to the economic life of the asset than we have previously seen. I haven’t done the calculations but if you estimated that all spot market vessels would need 60% equity going forward, on a 20% reduction in their book value, on tighter LTVs, and all vessels over 15 years would need to be fully equity financed, then the amount of extra capital required by the industry is in the billions and the effect on the vessel S&P market would be profound and chilling. Profit has a habit of erasing bad memories, but financial institutions and investors are famous for never making the same mistake twice, and any thawing out of the banking side will take an extended period of time. Bank Directors will view offshore as just another cyclical shipping business and allocate capital accordingly.

But this still feels some way off that with distressed investors working on individual asset deals rather than anything with an industrial strategy angle, beyond the Aker/Solstad deal in subsea, and some of the moves Seacor has been making in supply. Whereas the recently closed PSV III deal (purchase price for 2 x UT 755 at 11.7m) shows that distress asset prices are still well below what owners in layup situations hope to achieve but more in line with a risk reward profile that equity investors may need going forward. Nor bonds trading in the 30’s only reinforce this picture.

So 2017 is looking better than 2016 without a doubt but we are not looking at a 2008 quick recovery here. Asset prices are going to be weak for a prolonged period. 2017 marks the start of the deep structural changes in the supply side which will define the new industry structure going forward.