The downturn in the offshore markets has clearly been deeper and longer lasting than had originally been expected following the collapse of oil prices in 2014. This article takes a brief look at the current situation and some of the contracting solutions in these markets.
Despite it being almost six years since the 2014 oil price crash, there would appear to be still only limited appetite for new investments in the offshore space, with many offshore investors and other stakeholders appearing to be keeping their powder dry until more obvious signs of an upturn are visible on the horizon.
For offshore shipyards, this means that many completed or nearly completed units (most of which were contracted for in the heady days of 2012 to 2014) are still lying idle in their yards, with the underlying construction contracts having been either amended to permit postponed delivery pending a market upturn or long since terminated for default.
In retrospect, it is now clear that the current situation was brought about primarily by a prolonged spell of high oil prices which prompted many owners (both existing players and new entrants to the market) to place speculative orders, often without employment contracts having been secured for the units at delivery. Adding fuel to the flames was the fact that, in such a competitive contracting environment, many offshore shipyards were willing to offer extremely favourable payment terms in order to secure new construction projects for their yards. Indeed, at the height of the construction boom in 2012 and 2013, 10:90 payment terms almost seemed to have become industry standard in the offshore markets and even terms of 1:99 were seen in a small number of projects.
Unfortunately for shipyards, many such construction contracts were entered into by single purpose company buyers with no balance sheet of substance and no real parent company guarantee covering their payment obligations under the contract. From an owner's point of view, given the comparatively small pre-delivery payment profile, they were almost able to look at these pre-delivery payments as mere options to buy. Consequently, since the 2014 oil price crash, it has often been less onerous for special purpose vehicle buyers to forfeit their pre-delivery instalments and avoid delivery (thus triggering termination of the underlying contract) than to try to source (expensive) funding and take delivery of an asset that they would likely struggle to employ but that would require significant ongoing operational expenditure. However, with no recourse against parent guarantors, the only remedy of shipyards has been to accept postponed delivery or terminate the relevant construction contract and try to recoup their build costs by realising the value of the asset. That said, in a market where offshore units are typically worth significantly less than when the original construction contracts were placed, realising any value in these units has proved to be a tall order.
While the immediate aftermath of the downturn saw shipyards (particularly the larger state-owned Chinese shipyards) almost paralysed with indecision about how best to recover their losses, both private and state-owned shipyards have been increasingly realistic over the past 12 to 24 months, figuring that the only way to get these units out of their yards is to consider new and alternative contracting structures and to potentially take a haircut on the original build price.
By way of example, transaction structures in recent years have ranged from:
- so-called 'sleeping beauty' arrangements where delivery is postponed pending the purchaser being able to source employment and financing for the unit;
- seller's credit arrangements (up to the 100% of the purchase price), whereby title in the unit is transferred to the buyer and the seller's credit amortised over a number of years post-delivery with the underlying debt secured by the usual range of security (eg, mortgages and assignments of earnings);
- bareboat chartering arrangements whereby title in the unit is retained by the shipyard and the unit bareboat chartered to the prospective purchaser with the contract price amortised over the charter period with a balloon payable by way of a purchase option or obligation;
- the shipyard transferring title in the unit to the prospective purchaser in return for an equity investment in the purchaser group in lieu of the contract price; or
- the shipyard simply selling the units off at a heavy discount to the original contract price.
With the exception of a straight sale and purchase transaction, the above contracting structures are typically bespoke arrangements (and heavily negotiated). However, one issue that arises in most of the above scenarios is the condition of the unit at delivery.
While much depends on the respective bargaining power of the contracting parties, in each of the above arrangements the shipyards will typically require that any purchaser (or bareboat charterer) accepts the unit's 'as is, where is' condition at the time the agreement is made, with the owners or bareboat charterers having to pay up front for any work as may be necessary to reactivate the unit.
Tied to the condition of the units are shipyard warranties from the shipyard, which are also subject to negotiation. While a purchaser might reasonably expect to receive a full 12-month warranty for defects in design, engineering and skill under a normal construction contract, in a distressed scenario, shipyards will typically resist giving any form of warranty (unless paid handsomely for the privilege), not least because the units are no longer 'new' given that many have been lying idle (and deteriorating) since their original delivery dates, but also because their subcontractor warranties will have long since expired. Giving any form of warranty is therefore high risk for any shipyard.
While offshore shipyards are increasingly willing to look at alternative contracting structures to get units out of their yards (and ideally off their balance sheet), it will no doubt take some considerable time before the last of their distressed assets has left the yard. However, there are still opportunities to be found for investors and purchasers.
This article was first published by the International Law Office, a premium online legal update service for major companies and law firms worldwide. Register for a free subscription.