DnB Nor Downgrades Credit Ratings of Offshore Support Vessels

DnB Nor Markets recently has issued a credit analysis and rating on 7 offshore support vessels companies. In a very detailed analysis, DnB Nor credit analysts produced a report that focuses on the offshore support vessel market. “The demand for offshore support vessels is in the medium/long-term highly correlated with the oil price, and together with increased supply, we expect a challenging period ahead. This implies lower day-rates, lower utilization, lower market values for the units and potentially liquidity problems for some companies,” the report says. DnB Nor continues, “Although we expect lower day-rates across the vessel types, we do recognize that the direct driver for demand for PSVs and AHTS’, floating production units and drilling rigs, will show an increase in 2009-2011 when most of the drilling and FPS new-builds are delivered. For construction vessels in general, we find supply to outstrip demand, although the construction vessel market is highly segmented, and we might see niches where the market is more in balance. The jackup well intervention market is negatively affected due to lower cost for alternative units capable of doing a similar job.”

Can you Say: “Høyrenteobligasjoner”: Analyzing the Norwegian Junk Bond Market

With average yields reaching above 30%, there Norwegian bond market is crystallizing those fundamental human emotions that drive Wall Streets everywhere – Fear and Gear.

The question for investors, both current and prospective, is which of these companies will live and which will not. By way of review, the Norwegian bond market played a very large role in supplying the capex required to build drill rigs and a sprawling armada of vessels to service the burgeoning oil exploration and production industry. Since then, oil prices have collapsed from $150 into the $30s and many project once thought to be sure things with a $65 marginal cost are suddenly in question and rates on all sorts of equipment are coming down.

Norwegian Bond Market – At a Glance
For those who aren’t very familiar with the universe of Norwegian bonds, here are some key statistics:

Total Market Capitalization: $13 billion
Number of Bond Issues: 150
Average Size: $86 million
Currency: About 50% USD / 50% NOK
Interest Rates: 55% floating/ 50% fixed rate
Tenors: 1-6 Years
Issuer Industries: 80% oil and offshore / 30% Offshore drilling
Security: Majority have 1st or 2nd lien
Investor Base: 70% International (mainly US and UK)

Contango Storage Arbitrage

One of the real bright spots in the shipping markets in recent weeks has been the so-called “Contango Storage Arbitrage Trade”. For those unfamiliar with the parlance, the term Contango refers to the condition in the futures market when a commodity has a higher value at a future date than it does presently. Backwardation is the opposite market condition. In an environment of Contango, if the difference between the current price and the future price is greater than the cost of storing and delivering the commodity, then there is the potential for arbitrage.

In the recent weeks, such an arbitrage opportunity has been available and savvy traders from Koch to Phibro to Morgan Stanley have taken advantage of the opportunity by loading 30-35 VLCCs and 10 Suezmax tanker full of crude oil and having them sit idle until its time to lighter the cargo.

Because the precise figures are constantly changing, and the opportunities to make money by putting on a Contango Storage Arbitrage trade open and close, we thought it might be useful to walk through the exercise to show how it works.
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Does the Time Charter Market Need Credit Analysis?

“Hold on, let me get this straight,” a wide-eyed investor said to us the other day as we were explaining the current conditions in the dry cargo markets. “You’re telling me that some companies are renegotiating charter rates downward without actually going bankrupt?” he asked in disbelief.

“Correct.”
“And that other companies are canceling contracts to buy ships without the equity of those companies feeling the pain first?” he queried quizzically.
“Sort of,” we said.
“Then may I ask I rather obvious question?”
“Shoot.”
“Does anyone in your industry do any credit analysis before entering into a multi million dollar contract with a counterparty?”
“In a rising market, there is no need for credit analysis,” we said sarcastically.
“But how do you price the credit risk, and default risk of a counterparty. I mean does an investment grade charterer pay less for their ship than a mom and pop operation with no assets.
“Nope. The big companies pretty much try to renegotiate charters too.”
“Right. So then what you are saying is that the time charter business model is just one giant sub-prime ponzi scheme whereby there is an incalculable amount of leverage afforded to people that cannot afford to pay it back in the absence of a rising market. And for the company that finances a ship on the basis of such a charter, its just leverage on top of leverage.”
“Well-“
“Seems to me young man, that your industry has some painful de-leveraging of its own to suffer through.”

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Doing The Right Thing

Having spent time in the container leasing business, we like to keep our fingers on the pulse of that industry both in terms of personal interest as well as our belief that in some respects it may have some importance as an indicator.

We chatted with some of our old informants and learned that not surprisingly the lines have been re-delivering their run of fleet (short-term lease) containers. The reasons are quite simple. These are the most expensive containers in the fleet, as they offer the most flexibility, and they can in fact be re-delivered. With the slowdown, the lines have sufficient capacity in their owned fleet. To minimize off-hire or, at least, be the last guy out, the leasing companies have opted to offer savings now for long-term future value.

On a positive note, supply is constrained. Container manufacturing is dominated by China and within China two manufacturers, CIMC and Singmas, have an 80% market share. The Chinese have learned from past experience. Manufacturing facilities were effectively closed in December due to declining demand. They will likely remain closed through the Chinese New Year if not longer. Units will not be built speculatively to keep the factories open. In fact, the manufacturers understand that by keeping supply in line with demand, they can maintain their pricing at the $2,000 for a 20’ container, which is the right price to cover steel costs. The times of the $1,400 20’ container are gone.

Survival requires a focus on cash and debt. More of the former and less of the latter are preferred. We were also reminded of a risk forgotten in this low interest rate environment. Although rates are currently at an historic low, when the market turns they could rocket upwards. Beware!

How to Win Through Renegotiation

Following on the heels of Eagle’s successful renegotiation, Excel Maritime Carriers also restructured its future obligations. Having taken delivery of a newbuilding Capesize, with employment, in December, the company sought to cancel its obligation to purchase a 2002 built Supramax it had agreed to purchase for $72.5 million as part of the Oceanaut transaction. Excel had agreed to purchase this vessel in the event that Oceanaut could not lift the subjects by October 31st. As a consequence of the credit crisis, Oceanaut was unable to lift the subjects and Excel assumed the obligation to purchase the vessel.
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The World Turns

It was just a short time ago when Wall Street extolled the benefits of being a public company. For example, once public a company had access to the equity markets and would be able to use its paper as currency for purposes of acquisitions. The world has changed and so has the vision.

Now it appears that some want to go back to the dark side and return to private ownership. The key benefit is of course the ability to control your destiny without the interference of minority shareholders as well as access to the company’s entire cash flow. Both are extremely important if one has to re-structure.
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What Were They Thinking?

As a result of the credit crisis and the ensuing economic crisis, no one has been spared blame for creating this debacle. Fingers were pointed at the investment bankers who created the insidious financial products as well as the accountants who exacerbated the problem with their mark to market rules. Initially, we were sympathetic to the accounting profession as the effects of their ruling were unintentional and unforeseen. Moreover, we believed that they had learned their lesson from Enron and had strict guidelines in place from Sarbanes-Oxley.  From that perspective, we can report both good news and bad news. The following quote discussing “own credit” is extracted from Barclays PLC’s Interim Management Statement dated October 31, 2008:
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All Quiet on the Financing Front

Given the collapse of the shipping and financial markets in the second half of 2008, it is no surprise that we returned to the sounds of silence after an enjoyable holiday season. It was a pleasant respite after months of nothing but bad news on the economic front capped off by the disclosure of $50 billion Ponzi scheme. The good news is that we can begin afresh and we think our good friends at the Connecticut Maritime Association got it right when they chose “back to basics” as this year’s theme for their conference. Its general relevance for the upcoming year is a certainty.
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New Commodore

The Connecticut Maritime Association (“CMA”) went out of the box with this year’s pick for the 2009 Commodore. Captain Wei Jiafu, the President and CEO of China Ocean Shipping (Group) Company has been named the CMA Commodore for 2009 and will receive the award at the gala dinner which concludes the CMA Conference in March.

It is hard to argue with the choice given China’s preeminent role in world trade and the important role that COSCO plays in ensuring the inflow of raw materials and the outflow of finished goods for what has become the world’s industrial manufacturing center. By honoring what is probably the world’s largest shipping company, the CMA has met its diversity goals by including for the first time in its shipping pantheon a liner company.

Congratulations Captain Wei. The lines of people anxious to meet you are already forming.