Deflation, Shell, and Bourbon…

Shell gave a strategy update this week (the graphic above is from the presentation). More of the same really if you read this blog: more investment in shale and targeted and steady investment in offshore:

Shell 2025 outlook.png

And you can see the effect that over time Deep Water will be an increasingly smaller (but still important) part of production at Shell:

Shell 2025 Investment Tilt.png

But there is a clear tilt to shale and power. Yes they are spending more but the supply chain aren’t getting it:

Shell cost reduction to 2025.png

Shell Vendor Spend.png

For the offshore supply chain this is a very different world because a large number of the assets were acquired when that 2015 number was sloshing around the industry along with all the other money. Boats and rigs were ordered with 2015 dollars in mind and those days are long gone.

This is an age of deflation. Oil companies can, and have, sustainably changed the cost of production and met long-term demand expectations. The last offshore asset price bubble required both a demand boom and a credit boom. The demand boom has clearly gone and instead of the credit boom were are starting to see a credit contraction in a meaningful sense.

Slowly banks are realising that when the industry declines this much they don’t own and asset (loan), all they really own is a claim to the economic value an asset can produce. For all offshore assets that is much lower now than it was in 2015, and therefore those assets are not going to pay back anything like all the money they owe in an accounting sense. Slowly some banks stop rolling over credit, as has happened with DOF and Solstad among other firms, and the liquidity really starts to dry up.

The smaller banks are trying to force the larger banks to buy them out of these positions. This is clearly what is happening at DOF and Solstad. The larger banks in these deals will have to double down or accept large write-offs. In addition the number of hedge funds and other who have lost money on asset recovery plays is now so large that selling these deals is all but impossible (see Seadrill). Easy to get into but very hard to get out.

Bourbon creditors appear to have realised this.  A restructuring proposal has been sent to the Board for consideration. In reality the default is so large the creditors own the company. The creditors will write down billions of debt, Bourbon will reappear as a new financial entity, looking operationally a lot like the old, but like everyone else in the market believing their assets must be worth at least what they restructured them at. Capacity will be kept high and competition will ensure rates continue at below economic levels. It is a parable of the whole industry at the moment which shows no sign of abatement. Watching with interest DOF and Solstad because the larger Nordic banks stand to lose some real money here and yet the investment required to go on pretending would seem untouchable to any serious investor without write-offs in the billions of NOK from the banks. As offshore supply leads so will the rig companies as the head for their second round of restructurings (who inexplicably still seem to have access to bank financing).

But this is crazy world we live in. Much like the dotcom boom people are going to ask one day how they ever put money into a shipping company that excluded the cost of running a ship from it’s reported numbers:

  1. Positive EBITDA (adj.) of USD 617 thousands, excluding start-up cost, dry dock, special survey and maintenance (Q1 18 USD 400 thousands) from chartering out the 5 large –sized PSV’s. Including the ownership in Northern Supply AS (25.53%) the group netted a positive EBITDA (adj.) excluding start-up cost, dry dock, special survey and maintenance of USD 518 thousands (Q1 18 USD 200 thousands).

This isn’t going to happen quickly. Credit effects take significantly longer to work through than demand side effects. Once these banks have written off loans in a meaningful sense getting them to lend against these assets again will be nearly impossible.

And yet the cost pressure will continue:

Shell Cost pressure.png

If only it wasn’t a ship…

For those who want a little clarity re: my comments on Standard Drilling yesterday it really comes down to this paragraph in their most recent financial results:

Looking at the performance of the vessels there is a positive EBITDA (adj.) excluding start-up cost, dry dock, special survey and maintenance in Q2 18 of USD 0,4 million (Q2 1.7 negative USD 1,1 million) from chartering out the 5 large –sized PSV’s. Including the ownership in PSV Opportunity AS (25.53%) and in Northern PSV AS (25.53%) the group netted a positive EBITDA (adj.) excluding start-up cost, dry dock, special survey and maintenance of USD 0,2 million (Q2 17 negative USD 1,5 million).

To put this in laymans terms: the company has calculated an adjusted cash flow and said “hey, if the costs of dry docks, survey, and maintenance were excluded from the running of these assets we would have made 0.x million”…Excluding maintenance????!…But then it wouldn’t be a ship would it?  It would be like a property which you purchased in a property crash and then held onto paying only land tax until the value recovered? But the whole point of why buying a ship in a downturn is really risky is because it has running costs so excluding those is just an offence to common sense. EBITDA is a flawed metric at the best of times, adjusted EBITDA is close to meaningless.

Also, as can be seen from PSV Opportunity I, the start-up, dry dock, survey costs etc are material so excluding them is also deliberate obsfucation:

PSV OP I Structure.png

Source: PSV Opportunity I Information Memorandum

If only they hadn’t purchased ships … but they did…

Rigs and vessels… traders become operators…

Yet again another great commentary from Bassoe on the Borr acquisition of Paragon. I like this bit:

In the beginning, some may have considered Borr to be an asset play with no intention of becoming a long-term, established contractor.  The company could stack its rigs efficiently, wait for a rise in rig values, and sell everything for a profit.  In and out.

As time went on, Borr continued adding assets.   And although jackup values rose (primarily as a result of Borr’s transactions), the prospect of Borr selling off rigs at higher prices faded as they eventually became too big for any of the established drilling contractors to acquire them.

Whether this was the plan the from the beginning or something that just happened over time, the quick sale and profit option became less tenable.   So what could have started as a pure asset-flipping maneuver turned into a deliberate quest to become a fully-fledged drilling contractor. [Emphasis added.]

That has happened to a lot of people in the industry. Standard Drilling now aim for medium term capital appreciation, which is a significant change in their original position. The Nor bondholders had to sell out to an operational company in less than a year after their 2016 capital raise. York can’t really believe the Bibby DSVs or their Rever Offshore assets will ever appreciate? Will the Boa Deep C and Sub C ever return to active service? What on earth will someone pay for the Lewek Constellation? etc…

Without some fundamental change in the demand side of the market the asset recovery story should really be dead-and-buried now under a welter of evidence and transactions. You need to be long delivery capability and short assets to profit from “The New Offshore”. Backlog, liquidity, and capability. Everything else is noise.