Offshore supply vessel companies struggling with weak demand

The shipping industry has faced considerable turbulence in recent years, as trade volumes plummeted while major investments came online. Many in the industry are facing unsustainable levels of demand and debt, especially smaller players with older, more costly fleets.

The cost of strategic errors in any business can be high, while the negative impact of speculative investment can result in a range of unwanted side effects. The shipping industry has for some time been taking on water, figuratively, with huge investments into ever larger ships having routinely failed to meet with expected demand. As a result, the industry faces a perilous period in which various large shipping players are heavily leveraged, with more debt than equity and at risk of going under.

While container shipping continues to contend with uncertain conditions, the offshore supply vessel (OSV) industry has also faced challenges arising from excessive supply in capacity – partially thanks to low cost credit and speculative investment by Chinese shipbuilders. In a new report, titled ‘Too many ships, too few rigs’, AlixPartners has explored the current risks and future change in the industries.

According to the study, the oil industry has seen significant reductions in demand for high-cost oil recovery operations, particularly from oil rigs and shale oil. At the same time, lower oil prices have seen demand for on-shore oil rocket. The number of active rigs has fallen to 474 from 738 in 2013. Meanwhile, the number of vessels in the OSV fleet has increased from 3,200 to almost 3,600, which has seen the OSV/rigs ratio increase sharply to 7.6 in the latest survey, from 4.3 in 2013. The fleet is expected to see further growth to December this year, with the addition of a further around 40 ships.

This continuing expansion carries with it the risk of continued investment when demand may rapidly fall away, however. Even with a slight recovery of oil prices in the near-term, the long-term picture is not positive for high-cost, and high-risk, oil production. With peak oil on the horizon, as energy efficiency technologies and the use of renewables increasingly supplement the power demands of the world, a shift away from oil is projected, with a plateau in various models predicted as early as the 2020s.

The change in market dynamics, at around the same period in which shale oil will become harder to source in the US, means that the firm projects a maximum of around 550 working rigs in the near term. If such predictions come to pass, they will result in an OSV oversupply of more then 1,154, or around a third of the current total fleet. The effect of the imbalance between OVS and rigs will have a number of negative impacts on the OVS industry.

Navigating change

AlixPartners’ study has determined that one way forward for companies is to retire over 15 years, which tend to also be less efficient than newer vessels. Older ships also increase the negative impact of OVS operators on the environment, something which is likely to impact the industry in coming years, as debates on a blanket carbon tax on global shipping increase in volume. However, the industry is notoriously slow to change course, and moves to shift direction are often impeded internally, which may well see the industry itself hit hard, as well as the environment.

One of the major issues for reducing the impact of older fleets on the wider supply chain of the industry is that the majority of the fleet, around 2,500 ships, are in the hands of small-time operators, many of whom own only 4-6 ships. For these operators it is rational to continue to rely on older ships – even if some have mothballed stock waiting for improved margins – given the capital costs of new ships and their already precarious position in a time of low or even negative yields. Scrapping ships is not particularly economical, given the relative cost of scrapping a small number of ships.

The result is considerable overhang, and an effectively irrational market place, which is reluctant to take what it perceives as a risk on changing its mode of operation – even in spite of visibly stormy seas ahead. To this end, researchers AlixPartners noted that restructuring will eventually be required by many firms just to keep the lights on, with an unlikely reprieve in terms of higher oil prices. Latin America, Africa and Asia are the markets with the highest level of supply overhang – with likely negative impacts on operators that are unable to adapt to the changing landscape.

Commenting on the likely outcome for many in the sector, should they fail to change their ways, the firm said, “OSV operators wanting to stay in the game must get cost-competitive and restructure their balance sheets. Lenders to the sector may find a better outcome if they offer flexibility on the restructuring solution and facilitate consolidations as and when they make good financial sense.”