Everyone knows China’s got an issue with the amount of capital the shipyards tied up during the jackup newbuilding boom that started over eight years ago. Speculators, ready to make millions off asset flipping (and a few established drilling contractors like Seadrill), signed construction contracts with Chinese shipyards left and right – some of which required astonishingly low amounts of equity.
Now, Chinese yards are left trying to navigate in the wake that the jackup ordering frenzy created for them. They’ve still got over 50 of them sitting around at China Merchants, SWS, DSIC, CIMC, COSCO, and other yards throughout the country.
Over the past year, the only solutions Chinese yards have found have been to a) offload a few to China’s COSL who’s managing and putting them to work in the state-run system and b) bareboat two out for low-margin ADNOC contracts in the UAE.
So the question remains: what the hell are they going to do with all those rigs?
More newbuild rig acquisitions were expected to have happened by now
The optimistic side of the market (which hasn’t had the best time recently) says this is the time to buy newbuild rigs as old rigs leave the fleet and demand for newer jackups increases.
If there are enough people out there who believe that the market needs newbuild jackups, you’d think some of them would actually start buying those assets – especially if you can buy them for significantly less than they cost to build.
Well, it’s not that easy.
Market forces have created an illiquid market
For a while, the bid/ask spread seemed to be narrowing due to buyers’ outlook on the market and, to a lesser degree, Chinese yards’ willingness to reduce their prices. But things have gone downhill again: the oil price has dropped by 30% and implied offshore rig values have fallen in step with rig contractor share prices.
Borr Drilling hasn’t helped things either. They timed the equity markets right and went all in. Now the share price has dropped below its October 2017 IPO pricing level – all while having burned through millions in cash. This has created uncertainty.
So, perhaps barring a unrealistic change in Chinese jackup pricing, stock exchange-listed companies with cash won’t buy rigs at non-accretive prices (their share prices will drop). And companies without cash can’t raise money for rigs because nobody wants to invest.
Today, companies need strong contract coverage to be able to commit to taking delivery of, buying, or bareboating (leasing) newbuild rigs. Noble proved this in their acquisition of the CJ-46 at PaxOcean in September.
But things can change, and there’s a lot in China’s favor
After Borr’s Singaporean buying spree, China virtually controls the supply of stranded jackups. If somebody wants a newbuild jackup, they’ll have to go to China.
China also has a powerful financing system that allows yards to sell rigs at reasonable levels with better-than-market financing. This makes the real cost to the buyer lower while still maintaining a better sale price for the shipyard.
Chinese yards, if still a little stubborn on pricing, seem to be becoming more commercial and willing to look for creative solutions.
On the buy-side, and ignoring some of the negative sentiment in the market, several large-scale jackup tenders for long-term requirements are nearing completion – especially QatarGas and Saudi Aramco which could add nearly 50 years of backlog. Companies are bidding newbuild rigs for these jobs, and if any of them are awarded contracts, they’ll be enabled to buy or bareboat these rigs.
While it’s less likely that Chinese rigs will be purchased on speculation, the likelihood of well-funded owners finding contract opportunities creates an opportunity for Chinese shipyards which hasn’t been very present since 2014.
In effect, the market seems to be more dependent on buyers’ abilities, risk tolerance, and sentiment than sellers’ flexibility. That’s changed compared to one year ago.
What’s the market-clearing price?
Bassoe Analytics sets values for 2018-delivered, ready-to-drill, premium jackups in the $145–160 million range. Assuming the rig needs around $15 million for equipment, spares, and reactivation, sales prices should land somewhere in the $130–145 million range. We’ve kept charter-free jackup values based on a willing seller, willing buyer transaction relatively stable over the past few months, but market-clearing values could start moving down again if utilization and backlog don’t show stronger signs of an upward trend soon.
Basically, the only thing holding values up is the Chinese yards’ unwillingness to completely capitulate and dump these rigs on the market. They’re maintaining values by holding onto their end of the spread – which they’ve already lowered over the last few months. But values are still hanging in a fragile balance.
And as most of the jackups in China are quasi-distressed assets, we could perhaps see even lower levels depending on the rig design, money already paid to the yard by the original owner, rig specification, and financing terms.
Deals should start happening at some point
With a more flexible commercial attitude and owners’ ability to get contracts for newbuild jackups, we expect deals to be done soon.
Some of the deals we might see could be leasing or bareboat agreements which, as mentioned above, can present less transparent (or subjective) pricing.
We don’t expect all Chinese rigs to be sold quickly though. The transaction rate will likely be sporadic until market conditions reset themselves.
There will still be rigs which are likely to remain stranded indefinitely (those of non-standard design or at lower-quality yards), but China should see a gradual decrease in the supply of newbuilds on their books during 2019.
How many sales we see is anyone’s guess. The Chinese want to make deals, but it all depends on oil price, tendering activity, and dayrates which drive buyers’ sentiment and their ability to perform.
Data: Bassoe Analytics; Image attribution: main image is author's own.