The analysis of Solstad continues with the implementation of Porter’s five forces analytical framework. The framework aims to determine the competitive intensity and in consequence the attractiveness of the industry by looking at its underlying drivers. In this context, “attractiveness”
refers to the industry’s ability to produce profits and manage risk. The analysis uncovers possible positive and negative externalities which may help gain a better understanding of market fluctuations, cyclicality, and overall competitiveness. Current market conditions are difficult for OSV-companies; low-utilization rates, bad second-hand market, oversupply of vessels, increased OPEX are some of the factors currently tightening the competitive environment and lowering the attractiveness of the industry.93
4.1 Threat of substitutes
Generally speaking, there are no immediate substituting alternatives within the OSV-segment. The main reason is that every ship type is normally highly customized to serve a specific purpose or a certain customer need. A substitute is also according to Porter (1980) products that are not in direct competition. Furthermore, the technical complexity of the vessels across the three main segments are diverse which implies various – but mostly high - degrees of capital investments for each new build. One example would be for a subsea vessel to be contracted onto a project commonly serviced
92 Fearnley. (April 2016). The Offshore Report.
93 Pareto Securities. (Jan. 2016). Few signs of improvement.
Table 6: North Sea spot rates 2016Q1 change
High and low North Sea spot rates (in £/day excl. fuel costs) Januar – March
Type January 2016 February 2016 March 2016
AHTS 16,500 BHP + 3950 – 70 000 4000 – 100 000 8300 – 50 000 AHTS 10-16,499 BHP 9750 – 20 000 6435 – 47 500 9750 – 50 000 PSV (Deck > 750m) 3500 – 11 000 3000 – 11 000 4150 – 5800 PSV (Deck < 750m) 3250 – 16 000 3250 – 6000 3500 – 4500
Source: Fearnley. (April 2016: 4). The Offshore Report.
50 by a PSV-vessel. Such a substitution of tasks would in most cases be unprofitable as PSVs have significantly lower rates on goods and personnel transportation than a subsea-ship. Moreover, it is impossible for a PSV to service the AHTS segment efficiently as it lacks the technical capabilities of towing an oil rig (A.1).
However, due to an increasingly tighter economic situation shipowners have been encouraged to think more creatively about their vessels capabilities. With the intensification of competitiveness and overall economic tension among industry peers and competitors, companies have been forced to operate different ship types for the same line of work. Instances of vessel substitutions as mentioned above have not been observed on a large scale and will most likely only happen on a case-by-case basis. Thus, the overall assessment of substitutes in the OSV-industry is characterized as low and inconsequential for established industry players.
4.2 Bargaining power - customers
The customers’ bargaining power over the OSV-industry is dependent on the supply-demand conjuncture of the market. Naturally, with easy and quick access to an open market with many available vessels, the E&P companies94 can use their bargaining power to force dayrates down either through tendering or aggressive negotiations with the many OSV-providers servicing the same sector. Overcapacity will – as observed recently – lead to heavily discounted dayrates, lower utilization of vessels and temporary ship layups. In efforts to control costs, profits are secondary to company survival which leads shipowners to prioritize contract coverage and utilization over favorable dayrates. Furthermore, the oil and drilling companies are setting increasingly higher standards of the OSV’s they contract; among these standards are vessel age, durability, capacity and technical complexity. This is closely related to the intensification of the environment in which E&P are being performed, as well as regulations imposed by governments associated with worker safety protocols and environmental intervention. OSV-companies with older vessel fleets are especially exposed to these threats, as their customers are wary to contract potentially inefficient or hazardous ships.
On the other hand, the E&P companies lose bargaining power in times of high demand and the corresponding lack of available supply-vessels. Historically, in periods of surge for demand for available operating OSVs have led to manifold increase in dayrates and profits for shipowners.
However, the process of adjusting investments in E&P is less complicated and faster than in the OSV-industry. This is explained by the long-term investments shipowners have to commit to construction and deliveries of vessels some 18-24 months ahead of expected returns. Oil and
94 “E&P-companies” does in this case refer to the oil – and gas companies that is most known for operations related to exploration, drilling and refining of oil and gas; such as Statoil ASA and Petrobras
51 drilling-related activities can be halted essentially instantaneously if needed to cut production costs.
The most recent occurrence that illustrated such a scenario was the 2014 oil crash. A case that has been highlighted throughout the thesis – and made a significant impact - on the overall analysis of Solstad. As a response to the declining oil price we have observed significant cuts in the OSV-customers’ budgets. The Norwegian OSV-companies have been mostly affected by heavy cost-cutting initiated by Statoil and Petrobras who are the primary costumers of high-end OSV’s in the sector. It is apparent that in the light of the described scenario, the oil-companies (e.g. the customers) have modest to strong bargaining power over its suppliers which in turn is dependent on socio-economic developments.
4.3 Bargaining power – suppliers
Shipyards are considered the most influential supplier in the OSV-sector. They construct newbuilds to the industry and companies that want additions to their existing fleet. The shipyards have a significant impact on their customers’ bottom line by deciding prices and quality of the newbuilds.
The competence of each supplier decides what type and how fast products can be delivered to the customers, which is crucial for the OSV-companies. An example would be the faster, cheaper, but less technically advanced vessels (notably PSVs) coming out of Asian shipyards compared to European shipyards renowned for their technical know-how and quality of its vessels – albeit with longer lead times and higher costs. Thus, due to the pressures imposed by Asian shipyards, European shipbuilders have lost much of their bargaining power in the OSV-sector. A wave of vessels accessible on the second-hand market, as well as the ability to cancel contracts of new ships have contributed to the difficulties of running a profitable shipbuilding business in Europe, and especially Norway in 2016. However, delivery delays of ships normally have a strong negative impact on the profitability of an OSV-provider, which tightens the competition between shipyards to ensure high levels of reliability and trustworthiness. Thus, it may therefore turn out that choosing a European shipyard in certain situations is less costly than its Asian counterpart.
The price of vessels follows the business cycle of the OSV-sector. When the market demands more ships to support increased E&P-spending, the OSV-companies naturally want to get their hands on more vessels. The bargaining power of the shipyards increases as an effect of the favoring market conditions, while the situation may be somewhat reversed when the market experiences a downturn and shipowners are struggling to fully utilize their fleet.
Crew expenses is another important element that in many cases retain some bargaining power in the sector. In Solstad’s case, crew expenses accounted for 54% of the company’s total expenses in
52 2015 making it the most important cost driver.95 Solstad has invested a significant portion of its operations in Brazil, which in more recent years has seen an increase in OPEX. The main reason is because the country requires personnel onboard the vessels to be of local origin, thus forcing OSV-companies to invest in costly training programs of new crew on location.
4.4 Threat of new entrants
A threat of potential new competitors entering the industry is dependent on the barriers to entry. In the OSV-sector, the difficulty of entrance is affected by a number of factors such as; yard capacity, construction time of newbuilds, ability to attract capital investments, operational complexity, economies of scale, and legislative environment. Although the industry may appear accessible when considering the number of competing firms, the fact is that the OSV-sector is highly segmented and specialized which increases the requirement of competence for every project. The PSV-segment in considered the most exposed to new competition in the industry. This is mainly caused by the relatively low technical and capital investment requirements compared to that of the CSV and AHTS-segments, as well as their considerably shorter construction time between 12 and 18 months from order to delivery. Exploiting economies of scale is considerably more likely in the PSV-segment, while diversification of vessels intensifies in the Subsea-segment. Due to PSVs relative vessel simplicity most shipyards across the world having OSV-construction capabilities are able to deliver these to the market.
On the other hand, the AHTS-segment can be distinguished between high-end and low-end when discussing possibilities for new entrants. High-end AHTS’ are much more cost – and time sensitive compared their low-end counterparts. Low-end AHTS’ are less dependent on technical expertise which makes them easier and faster to construct. Asian shipyards therefore capitalize on their cheap labor and short construction times to supply the established companies– and in extension new entrants. OSV-companies that have geared their operations towards the Asian market or the low-end AHTS’/PSV-segment are therefore more exposed to the threat of potential new entrants.
The investments needed in the sector is high, but not the highest compared to many other capital intensive industries, which makes it attractive for banks and investors – given the right incentives – to help possible new entrants secure contracts that cover the entire lifetime of a vessel. Naturally, during economic expansion and growth, willingness to invest and take risks increases. Thus, favorable market conditions not only positively affect the bottom line of established companies in the industry, but enable potential new entrants to exploit banks’ and other institutions’ outlook on
95 Solstad Offshore ASA, “Annual Report”, 2015
53 the market. In conclusion the threat of entries is relatively high (to the other segments) for the PSV-segment, and medium-low for the AHTS and Subsea-segments.
4.5 Industry rivalry
Large, cyclical conjunctures in the OSV-industry affect the competitive landscape and the rivalry amongst Solstad’s peers. Furthermore, the rivalry intensity in an industry is the result of interactions between six factors: diversity of competitors, product differentiation, exit barriers, concentration, and cost conditions.96 However, in the OSV-sector, rivalry is most importantly affected by the balance between supply and demand of OSV-vessels. Competition to win the RFTs (Request for tenders) issued by the oil and gas companies are fierce, and the winner has traditionally been the ship owner that offers the best financial terms. However, in more recent time, as touched upon earlier, clients now have begun to focus more on health, environment and safety regulations on board their suppliers’ vessels. As competition amongst OSVs react correspondingly to market cyclicality, the rivalry is strongest when the market is struggling and oppositely weak when market demand is high because the industry as a whole may actually struggle to cover the flood of demand.
In low-conjuncture periods vessel utilization is favored over profits as contract coverage and maintaining client relationships are more important for long-term sustainability. Financial stability ensures a more reliable source of services which makes for a more attractive supplier of OSVs to the E&Ps throughout the business cycle.
On the other hand, an upwards trend in the OSV business cycle changes the competitive OSV environment completely; the shipowners tend to hold on committing to long-term contracts due to expectations that dayrates will continue to rise. During this period a rapid increase of vessels entering the spot market is seen, and the shipowners have stronger bargaining power over its customers. The share of vessels on long-term contracts opposed to vessels operating on spot rates affect rivalry which in turn shows on the companies’ bottom line. In periods of high E&P-spending coupled with a rising oil price, the demand for OSVs naturally respond in tandem. As a result, rivalry is slightly reduced but competition on offering the best terms and rates are always to a certain degree present.
4.6 Porter’s five forces and the OSV-sector
Figure 25 visualizes the degrees of impact the five different forces have on the OSV-industry. They rank from 1 to 10, where 10 is the strongest and 1 the weakest. From the graph, we can conclude that industry rivalry is by far the strongest influence on market dynamics, whereas bargaining power of costumers and new entrants lie somewhere in the middle on the scale between high and
96 Wilkinson, J. (2013). Porter's Intensity of Rivalry Definition.
54 level threats. This is mainly due to the possibilities and differences in types of entrants; e.g.
PSV/low-end AHTS’ vs. high end-AHTS’. Bargaining power of suppliers are naturally low because of their position in the market to their customers and dependability on factors such as oil price, production and investor optimism.
In doing predictions of future cash flows and profitability of Solstad it is important to not only consider the overall attractiveness of the industry, but also look how these forces shape the organizational structure of the companies operating in the OSV-sector. Each of Porter’s forces play a part in how Solstad address market changes, opportunities and downturns, and their organizational structure reflect their ability to adapt to these. However, looking at the current state of the industry, there may be reason to assume that some or all of these forces have the possibility to change their influence dramatically in the foreseeable future. Our assumption relies on the fact that the market may experience large structural changes, several consolidations, and refinancing. Whether these changes are significant enough to shift the paradigm of the aforementioned forces or not is currently impossible to predict, but they should be considered in the context of future assumptions of industry profitability and economic sustainability.