Interview: Higher oil prices alone can’t save debt-laden OSV players

There is a long ride ahead for the offshore support vessel owners, and some of them might not make it to the finish line. Namely, a recent study by AlixPartners has shown that a number of OSV players are looking at a potential bankruptcy.

By Bartolomej Tomić

A recent study by AlixPartners confirmed that what most of the people in the industry have come to know so far: there’s a significant supply/demand imbalance in the market – too few offshore rigs and too many offshore vessels, leading the owners to become price takers, with rates at or below operational costs.

This was of course caused by OSV companies’ overly optimistic ordering spree during the heyday, without forecasting one of the worst downturns in the history of the oil industry. The wakeup call came in mid-2014 when oil price started its free fall from over a $100 a barrel to, at one point in 2016, below $30.

The oil price has since then recovered, going over $86 a barrel for Brent blend in October 2018, only to nosedive to around $50 late in December 2018. It is now trading around $62 a barrel. The point is, oil price will be volatile, and while oilfield services sector will pray for it to be higher, higher oil price alone can’t save the OSV players.

AlixPartners’ recent report on OSV’s has shown that there are a couple of dozen OSV companies looking at a potential bankruptcy unless something drastic happens to change their fortune.

Offshore Energy Today interviewed Jeff Drake, AlixPartners’ London managing director, asking him first what the reason was behind the extensive OSV study.

He said: “We were sitting here at one point, hearing that oil price had come up, “everything’s good, everything is going to pick up,” there was a lot of positive sentiment.”

“Of course, people are now questioning this because of the recent decline. I think the point is you can’t react to the volatility of the oil price. You have to take a longer-term view. Who knows what the oil price is going to be, but it is going to be volatile, so they can’t pin everything on oil price recovery.”

OSV fleet overcapacity

So, Drake and his team decided to take a deeper look, looking at players, what they’re trading at, what would need to happen for the sector to become healthy.

“And then we started looking at the analysis. We kept going deeper. A couple of things really struck us. One is just the absolute overhang and overcapacity,“ Drake says.

Drake also cites radical and structural changes that have deepened the OSV players problems.

He said: “Oil companies have taken a lot of cost out of their base. You’ve seen oil companies say:’ Now we’re leaner, our contracting costs are much lower.’

The trouble is that a good part of oil and gas companies’ margins have been squeezed out from offshore vessel owners.

“While some of the big oil majors have taken thirty to forty percent out of their production costs, it’s been out of the skin of the operators and the service providers. And it’s almost a false economy a little bit,” Drake says.

What has changed?

Talking further about the change of the operating environment for the OSV players, Drake recalls “the good times” when the drillers would go out and hire more OSVs than they would actually need, trying to minimize downtime.

U.S. onshore shale boom and the oil oversupply led to a decline in offshore drilling, meaning offshore belts needed to be tightened.

“(OSV players’ clients) are much more careful now. If you look at the number of OSVs to drilling rigs, it’s actually continuing to come down,” Drake says.

Offshore rig count rising but not enough.

“Going from 700 rigs back in 2015 down to 450-500. That’s the big challenge and it’s not going to come back. So OSV players are getting hit from both ends. New capacity coming in, but also less demand.”

“If you look what most analysts are saying when the market recovers there’s going to be  approximately 550 working rigs.”

There are about 4.5 offshore support vessels per rig, Drake says, and if the ratio stays the same, and if the 550 working rigs in 2020 prediction becomes a reality, this will mean there’s going to be a need for about 2500 vessels.

“Currently, the OSV fleet is estimated to be around 3600, by the end of 2020…that means there’s an excess of about 1100 to 1200 vessels. Pretty simple math, but that’s pretty consistent with what people are saying.”

Theoretically, 30 players could go bust

Alixpartners analyzed 38 publicly listed companies for which data is available and found that 34 out of 38 OSV players had Altman-Z score of less than 1.8 in the trailing 12 months ended March 31, 2018.”

This indicates a high likelihood of bankruptcy for these companies within the next 12 months unless they take substantial steps to remedy their financial situation, the report says.

Talking about the Altman score Drake stresses there is no certainty that the 1.8 score will lead to bankruptcy.

He says: “It’s just an indicator. It was invented by Professor Altman of the New York University. It was developed back in ‘68 so it’s really old, it’s almost as old as me, I’m a couple of years older but not much (laughs).

The fragmentation of the sector, as well as a relatively low steel content in the vessels, are some of the factors preventing a massive scraping of long-stacked offshore vessels, that would somewhat alleviate the oversupply problem.

“It’s quite a detailed calculation to indicate what’s the probability of a potential bankruptcy based on these different factors. It does not guarantee it (that the company will go bust), but certain elements in terms of debt and earnings over a period of time, will give you That Altman score, and if that score is below 1.8, it gives you a higher propensity for a potential bankruptcy.

For this indicator to be valid, it assumes that creditors demand continued payment of debt and interest. The reason why OSV players are not going bankrupt is that their creditors give them principle and/or interest “holidays” allowing them to continue to survive.

Again, Drake says, it’s an indicator; it doesn’t say it’s going to absolutely happen, because there are more factors in that, so that’s more of a propensity.

Drake also stressed that this only includes publicly traded companies with available data, adding there are loads of OSV operators, which don’t provide public info.

Too many vessels. Too many operators, too.

As said before, there are simply too many vessels out there, and scrapping would be a logical option to bring the supply down and utilization numbers up.

However, what Drake has said about many OSV operators is backed up in the AlixPartners OSV report.

If you think Bourbon Offshores, Tidewater Marines, Gulfmarks, Topazes, Hornbecks, Edison Chouests, Solstads of the world own most of the world’s OSV fleet, think again… Ten OSV majors own only about 30 percent of the overall OSV fleet.

The report shows that more than 70 percent, some 2,500, of OSVs are owned by some 400 other operators who own, on average, 6.3 vessels.

This fragmentation of the sector, as well as a relatively low steel content in the vessels, are some of the factors preventing a massive scraping of long-stacked offshore vessels, that would somewhat alleviate the oversupply problem.

Drake says the problem is that the players keep will go for the stacking option as it appears to be a cheap option.

“If it’s not scrapped it can always come back. Unless they’re physically gone there’s the possibility that they come back, and that’s why when you do see a little bit of recovery you see spot rates will surge up and do pretty well and then they’ll come down,” Drake says.

Another thing is that they may not be able to scrap a vessel even if they wanted to, as due to their bank covenants, they’re not allowed to.

“It’s a really difficult situation. I think the big thing is going to be clear, at some point in time, that some of these vessels will never come back.

“OSV operators and the banks should be more clinical about it and say: “OK, if this is a fairly new asset, maybe it’s been hit a little bit, but it’s a good asset, it’s likely to go back to work.”.

“OSV operators and the banks should be more clinical about it and say: “OK, if this is a fairly new asset, maybe it’s been hit a little bit, but it’s a good asset, it’s likely to go back to work.”

But if this is an old asset that’s 15-20 years old, Drake says, why would I want to keep it, when I’m much better of just scrapping it because the probability of it ever working again if it hasn’t worked for a couple of years, is pretty close to zero.

While many vessels probably won’t come back from the cold-stacked mode, AlixPartners feels there’s also a sort of a psychological barrier, that’s preventing the dayrates to go up as long as the stacked vessels physically exist.

“The longer-term contract rates remain depressed because it’s the possibility or the threat of that capacity coming back. Unless you address that it’s going to be really, really tough for any type of meaningful recovery,” Drake says.

“A lot of people say that you know, the OSV fleet, you can’t count all of them, because they’re not higher spec with the latest technology, but the problem is they’re still there.

“And the threat of them is still there, so you won’t get a recovery until that number is really squeezed down a little bit.”

While the Altman score scenario was what spurred OET into wanting to interview Mr. Drake, he says there’s even something worse than having the 1.8 Altman Z score – EBITDA margins.

The report shows the perfect storm of oversupply and low-demand caused by several factors continued strength of shale, underinvestment in offshore drilling, and euphoric over-ordering).

“The financial consequences for operators have been devastating, with EBITDA margins shrinking and leverage ratios soaring to unsustainable levels” the AlixPartners study shows.

Drake says that there’s always a debate on where the debt to EBITDA ratio should be: “So what that means is, if you have EBITDA of 1 dollar, how much debt would you have to generate that EBITDA of one dollar,” he says.

“Historically debt to EBITDA ratio was in the five to seven times, which is high anyway. Most industries want to be in the 3-4x ratio, right?

“If you look at the performance for 2017, for those players that publically report their financial performance, these are 24x (for OSV players). That’s just massive.”

“Two things have happened. One is debt’s gone up, because people have during the boom times gone and said: “wow, I can make a lot of money, I’m going to build some OSVs.”

“So you have the confluence of that and new capacity coming in and, on the other side time you have a depression of the earning power of these, so it’s gotten hit from both sides.

“You’ve had more capacity, more debt, and then you have these horrible ratios. That’s really bad, 23X!!!”

No one-size-fits-all solution

“It’s not surprising that Altman Z score is so bad. What is required though, is if the banks or bondholders give you an interest-free period, or you don’t have to pay principal or anything like that, it’ll keep these companies from going into bankruptcy.”

We asked Drake what he’d do if he were a bank or a creditor invested in such an OSV company. Enforce your rights? Give them more breathing space?

“There’s no right or wrong answer in this. What I would do is a couple of things. There’s going to be winners and losers in this.  I think, if I’m the bank, I can’t treat all the customers the same. So I have to see if the assets of the OSV company, if it does certain things, or if the market recovers a little bit, if they’re going to be worth more in the future that they’re now.

Drake feels there’s no blanket solution, and it is on a case by case basis.

“It’s a really tough thing but what I would do, I wouldn’t treat everybody the same, I’d differentiate between customers and give different level of support.

I wouldn’t want to be an owner. I’d try to keep the assets with the particular owner operator…as enforcing and taking away the assets is not a great alternative.”

“If it’s an older vessel that hasn’t worked in the last year or two and is unlikely to get work, I would very much try to take the pain now and write down my loan, but the challenge is that it depends how exposed I am to the sector an what I can push out.”

Long road to recovery?

While overall, looked globally, there’s an excess of over a 1000 OSVs, there bad and worse situation when broken down by regions. We asked Drake to break this down for us.

“So the ones that have been really worst hit have been North America, Asia Pac, and West Africa.

“Those have been the most heavily hit, and you can see it in that chart.

While you can move assets around, there’s no question about that, you don’t do that on a regular basis.”

The AlixPartners’ director feels we’re far from a full recovery in the OSV sector, but it is recovering.

“We’re a good way away from seeing a recovery in this, but some players depending on where they are and assets they have are gonna do better than others. But there has to be some churn.

“I think the sector is recovering, the question how far of a trip it is. It’s a long trip. Make sure you get extra bottles of water, it’s gonna be a while.”

Read AlixPartners’ full report titled “Too many ships, too few rigs: why recovery is still a distant dream for the OSV sector” (PDF)