The steep decline in oil prices is having an adverse impact on the oil service industry. Oil majors are continuing to reduce their investment budgets and projects are being postponed or cancelled. Charterers under offshore
contracts are looking for opportunities to suspend performance or to re-negotiate terms and reduce day rates. “Cashed in” options for contract extensions are not being exercised and tenders for new contracts are few and
far between. For many offshore vessel and rig owners, the contract backlog is shrinking and cash flow evaporating, leaving few places for a highly leveraged oil service company to hide.
DEFAULT ON THE HORIZON?
Offshore vessels and rigs are CAPEX-intensive investments and most owners will have external take-out financing in order to bring their unit to the market, either through debt or bond financing or a combination. The financial covenants imposed by lenders are likely to be strict and, where project finance is in place, the security package will be all-encompassing. For oil service companies, the time to re-visit the financial model and to start scrutinising loan terms may be fast approaching. If the outcome of that analysis is a possible default lurking on the horizon, this should be the time to start preparing a strategy to steer the company through a challenging market.
A golden rule in these situations is that there is always a better chance of succeeding in negotiations with creditors before a default has occurred, when there are viable options for resolving the funding crisis. Generally, private negotiations and commercial solutions are much easier to deal with than trying to rescue something from a formal administration process.
PREPARATION IS KEY
From the company’s perspective the preparations for such negotiations are key. The following are some of the main elements that must be carefully considered and analysed:
(i) what type of default (including cross-defaults) may occur in the short-term, and will the company be capable of remedying any such default;
(ii) who are the different stakeholders (shareholders, financiers, clients, suppliers) and what is their exposure and likely agenda;
(iii) if a default occurs, are the financiers likely to choose to enforce their security (including the mortgage) or will this in reality be deemed (a) too cumbersome, time-consuming and costly (depending on the country of operation) and/or (b) too inefficient, where the expected sales price will not provide for an acceptable level of recovery; and
(iv) depending on jurisdiction, is any formal administration rehabilitation scheme or even filing for bankruptcy a possibility or will it be deemed as a threat to stakeholders?
The company need to be able to convince perhaps less experienced lenders that the current market conditions are part of a recognised cycle in offshore activity and that the underlying long-term fundamentals remain strong. In particular the lenders will need to be satisfied that the offshore vessel or rig, and the company’s management, has proven operational capabilities, and that it is expected to be competitive and attractive as soon as the market returns to an upward cycle.
RESTRUCTURING PLANS
Once the homework has been done, the management team, together with its financial and legal advisers, will need to put together a restructuring plan involving all stakeholders. The best prospect of success occurs when the plan adopts a rule-of-thumb approach that spreads contributions evenly, creates a shared future upside, is open and transparent and allows creditors to be involved on the management side if required as a condition for continued support. It is essential to create trust between all the participants involved, based on a good and open dialogue and allowing sufficient time for everyone to do their due diligence and properly assess the options presented.
COMMENT
There is no guaranteed recipe for ensuring a successful restructuring, but it is important to remember that shipping and offshore cycles are well-known and the need to restructure or make adjustments to offshore projects in distress is not something new to the industry. Most experienced players understand the need to
maintain investments through market cycles. If a company is aware that a breach of one of its material contracts is likely, then preparing for re-negotiation and trying to achieve a solution that allows the company to continue as a going concern has a very limited downside. In most jurisdictions the directors of a company will also have a statutory duty to try to improve the company’s financial conditions.