Updated: Apr 16
With the COVID19 pandemic hopefully behind us soon enough, the shipping markets have shown signs of strength both internationally and domestically. From the mega containerships to the lowly inland barges, as demand came back, so did utilization rates, freight rates, and, yes, asset prices. There is overall, a sigh of relief that a repeat of the 2008 calamity seems to have been avoided.
However, not all shipping sectors have bounced back equally vividly, and some markets seem lingering stubbornly close to a distressed state; clearly, we are talking about the offshore drilling market in the US Gulf (USG) and the Gulf of Mexico (GOM). For anyone who has driven about in south Louisiana recently, offshore assets seem to be docked up and down the coastal line and the bayous by the dozen, smaller and larger vessels, some vintage but quite a few rather modern, sophisticated and expensive. Despite some signs of life, the market overall—highly correlated to the fortunes of oil—stays depressed to the dismay of many owners, operators, investors and bankers.
Besides the strategic question of a market recovery, the most pressing question for now in this area is what is the value of these offshore assets? How much cash on the barrel are worth now? How much one should be paying to buy them in this market? And, even more interestingly, what a seller should be accepting in order to part with them? These are not just curiosity questions or philosophical questions: huge amounts of money are at stake given how much money these offshore assets had cost originally in the not-too-far past. From an accounting and appraisal point of view, huge numbers are at stake as well—potentially to be written off—that will affect lending and investment portfolios of lessors and banks alike.
For vessels whereby an active market exists, when sale and purchase transactions take place regularly and the assets can find employment in the charter market, the so-called Market Valuation Method can establish an asset’s value, the Fair Market Value (FMV) to be specific: check what other comparable assets have transacted at, adjust for features like age and incremental specification, and the market value can be found. However, for quite a few of these offshore assets in the USG / GOM, there has not been a bona fide sale for several months now (even for more than a year), or any of the recorded sales were effectively at fire sale levels just to get rid of the asset, setting an abysmally—and artificially— low benchmark for all similar type of assets in the market.
Given that the charter / employment market for offshore vessels has been so sporadic, no estimate of cash flows for the foreseeable future can be prepared and any buyers have to depend on speculating about market prospects and thus they were mostly opportunistic (“vulture”) buyers at prices that could not be wrong. Under such market conditions, the Income Valuation Method, the second valuation method valuing assets on reasonable assumptions of the earnings, has been of little utility—good luck trying to estimate the value of a DP1 platform supply vessel when they are laid-up by the dozen and stacked on top of each other in the bayou, when there are few short month charter prospects here and there for one of these vessels, and at a rate that barely cover operating expenses.
Both the Market Valuation Method (sometimes called Market Comparable Valuation Method) and the Income Method require a certain commercial understanding of the markets and access to commercial information and data—which are not always easy to come by, even when the market is more active than today’s lethargic state. For marine asset appraisers who also act as shipbrokers, regular access to commercial market info by talking to buyers, sellers and charterers, by getting, accepting and rejecting offers on marine assets and thus having a deeper market insight to prepare more accurate appraisal reports, as compared to reports prepared by appraisers—whether physical appraisers or the ever more popular algorithmic valuation models—depending on historic data and commercial market reports that can be stale by the time they get published.
Given the state of the market, as outlined above, and having excluded the Market Valuation and the Income Valuation Methods, one is left with the third method of valuation, the Replacement Cost Method. And, here is when life is getting interesting! Some of these Jones Act, high-spec offshore vessels cost an arm-and-a-leg to build a decade ago or even today; one trying to appraise them based on their original / replacement cost—especially when that original cost was high to begin with— any present values derived on such calculations tend to be unrealistically high; the expression that “book value is not market value” was meant for this occasion. “Book value” has certain utility and from a lender’s or a lessor’s point of view, book value is almost everything: the fulcrum upon which they book profits (or losses), getting to approve a quick sale (or not), getting to renew a lease (or not). It’s about money they have put into an investment and need to recoup if they were to stay in business. From an investor’s point of view, however, the book value is only relevant to the extent they can make the lessor or bank they will sign off on a transaction; in their view, book value is irrelevant in any other respect.
Again, to remind the reader, we are still in a weak market in this sector when employment of offshore vessels is very uncertain, dozen of competing vessels sit idling and often competing brutally for any tender that happen to hit the market. One cannot blame the investors and fresh buyers of assets for not jumping the gun and pay up somewhere close to the book value. There are no solid prospects for employing the vessel, definitely there will be some downtime upon the acquisition before any future employment, not to mention storage costs that will keep adding. Thus, the book value is not current market value.
And, to make it even more interesting, at an age of so many technological developments and change in social attitudes—that can affect energy sources—for every day passing whereby high spec offshore assets are idling, the risk of technological obsolesce and functional obsolescence is increasing. There may be new technological developments in the field that can make these assets in the near future either outright obsolete, or by the time the market comes back, they will be so out-of-condition that they only function at a percentage of their original design.
Going back to our original question, what is the value of an offshore vessel in a distressed market, the problem by now has been compounded not only by the lack of an active (market approach) or a reasonably functioning market (income approach) but also by the concerns of the owner of the asset based on their historic cost, and more critically, by the question of whether the vessel will have much value at all in the future if technologies evolve. Not easy questions to quantify when preparing a marine appraisal in the sector, for sure, and, when the appraiser happens to be wearing a shipbroker’s hat too (for other assets in the market not the same asset to raise conflict issues) such appraisal and market concerns are much more pronounced.
One can say that the definition of Fair Market Value (FMV) presumes a reasonable amount of time to market an asset for sale, and potentially choose the time the sale—even within a market trough—to avoid circumstances that would be “distress”; after all, there is the Orderly Liquidation Value (OLV) definition that defines that the sale has to take place in a predetermined window of time, thus giving up certain marketing and timing options. And, for some of the sales in the sector that appeared to have set a very low benchmark, they mostly conform with the Forced Liquidation Value (FLV) definition, when a sale has to take place in short order and any hard cash offer effectively will be considered fair game.
We have been involved with the shipbrokerage and appraisals of several offshore assets in the last few years. Needless to say, the numbers have been “all over the place”, and certain owners and appraisal methods—and yes, appraisers—have been bending for numbers at one end of the spectrum while legitimate market discussions for the commercial aspect of the asset tend to give a different assessment. We have seen actual offers for the very same asset at the very same time on the very same terms that had a variance by a factor of four! That’s a very divergent range of opinion of value,, which again, it’s a characteristic of a market in distressed. As far as appraisals are concerned, however, values provided should adhere to strict definitions of value and explanation of the valuation approach.
Karatzas Marine Advisors & Co has extensive experience with marine asset appraisals under normal and distressed conditions for inland, coastal and international shipping, based on both the commercial and shipbrokerage practice of the firm and also the academic and professional credentials of its principals as (Accredited Senior Appraisers (ASA), Certified Marine Surveyors (CMS-NAMS), Accredited in Business Valuation (ABV-AICPA), Fellow of the Institute of Chartered Shipbrokers in the UK of its principals.