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Offshore Support Journal

Offshore Support Journal

Operators must act on oversupply

Thu 04 Oct 2018 by Jeff Drake, managing director, AlixPartners

Operators must act on oversupply

Oversupply means operators cannot just sit back and wait for recovery but must take steps to address the problem with creditors, says AlixPartners managing director Jeff Drake

The offshore support sector remains in trouble despite the rising oil price. A rising tide does not necessarily lift all boats and if operators want to survive they cannot just passively wait for better times but must instead take proactive steps to safeguard themselves.

The title of our recent report on the sector, Too many ships, too few rigs, succinctly outlines the problem operators face. The number of active rigs stood at 404 in July this year, a 33% drop on 2014ís count of 706. Meanwhile, the OSV fleet has climbed to 3,583 vessels from 3,389 over the same period. This gives an OSV-to-rig ratio of 7.6x, up from 2014ís ratio of 4.8x.

Structural shifts in the oil industry, namely the rise of hydraulic fracturing as a feasible extraction method, have dramatically altered the cost basis of the industry. The impact of this in the near-term and the longer-term issue of the energy transitionís impact on oil demand will act as constraints on the drilling of any substantial number of offshore wells. Market consensus for future offshore rig levels currently runs at about 550. With an assumed OSV-to-rig ratio of 4.5x, this still leaves an implied overcapacity of 1,150 vessels.

Operators have historically tended toward stacking as a low-cost means of handling oversupply and keeping the option open for a market recovery. However, even with a potential recovery in offshore drilling activities, as highlighted above, significant oversupply will likely continue to plague the sector.

While many operators discount these inactive, stacked vessels as unlikely to come back into service, the potential still exists that they could be brought back. The impact of potential reactivation should not be discounted. While these actions may improve OSV spot rates, it does not fundamentally alter depressed term charter rates, as the assets could potentially re-enter service resulting in a prolonged perception of oversupply.

Something else is required. Banks remain reluctant to write off an asset that could still have potential future value. However, given the forecasts for future oversupply and the real possibility of some vessels not being brought back into service due to factors such as age, class status and regulatory noncompliance, operators and creditors may have to work together to acknowledge that these vessels no longer have value and take action to clean up balance sheets. It may not be pleasant, but a clinical approach is required in assessing an assetís useful life and deciding to take these difficult decisions sooner rather than later.

Consolidation could help, but the fragmented nature of the industry means this will be limited. Outside of the top 10 owners, the remaining 71% of the supply is in the hands of approximately 400 operators, with an average of 6.3 vessels each. There is a risk of a two-tier market developing regarding profitability, whereby operators who cannot clean up their balance sheets will be unable to compete with those who can.

A big percentage of every dollar operators with high debt levels bring in goes toward paying debt, rather than covering operating costs. As more companies address their balance sheets, those with less debt will be able to price more aggressively, and those who retain debt will risk being driven out of business.

My advice to operators is: continue to re-evaluate the overall business/asset strategy to determine what parts of the business/fleets have the potential to recover. With this clear picture in mind, operators need to proactively engage with their creditors to deal with any issues now, as opposed to ďkicking the canĒ down the road and hoping for the market to drive a recovery.

The banks donít want to be asset owners, they want businesses to succeed. The companies that are realistic and transparent now will have a better chance of succeeding by getting something mutually beneficial in place. The challenge for all players in the OSV sector is not the market. Rather, itís the structural problem of oversupply that needs to be solved.

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