Pareto Offshoreinvest AS

4th quarter report 2016

Link: http://paretosec.com/pai-reports.php

Executive Summary

Market Development

The OPEC accord has resulted in the oil price stabilizing

at around USD 55/b for Brent crude. This is a level that

allows for increased spending by the oil industry, and

has thus spurred a return of some optimism. Indeed,

global E&P spending plans are now expected to be up

by 7% y-o-y and several oil companies have reported

plans to raise spending by double digits this year. While

this looks first and foremost to benefit North American

land production, but is expected to trickle through to

the offshore markets during the year.

Anecdotal evidence that we are now about to emerge

from the bottom can also be found in solid share price

gains with oil service stocks up by around 33% in the

past three months, higher pricing of oil service bonds,

an increasing sale and purchase activity driven by more

speculative buyers willing to take the risk, a greater

tendency of oil companies wanting to lock in vessel

capacity on term contracts to lock in low prices and a

few positive profit warnings in the seismic industry to

indicate rising exploration spending – a typical leading

indicator. All in all, the tide seems to be turning,

although we are far from out of the woods yet.

Portfolio

The portfolio consist of shares in 8 projects with a total

of 15 vessels. The contract coverage is 100% with a

weighted contract length of 5.2 years. There has been

a charter restructuring for one of the projects, which

will be favourable to the Fund considering the

alternatives.

POI has distributed NOK 70 per share (70% of par) to

its investors since the inception. Further distributions

will depend on running dividends and project

realizations.

NAV as of 31 December 2016 was NOK 22 per share.

Since inception, NAV is down by 8% including

dividends distributed. The Fund will next report NAV as

of 30 June and investors should be wary of further

declines based on the lower vessel valuations we are

currently witnessing, as well as charterer defaults and

debt restructurings. Worst case, the liquidity could

become very tight for the Fund.

The market conditions continue to be very challenging, but we may be close to the bottom now due to

the oil price recovery. That being said, the upturn is likely to be slow in materializing. The Fund is

keeping its powder dry and is preparing for a very difficult 2017, in which investors should not expect

any dividend distributions.

NAV NOK 22/share (as of 31 December 2016)

Portfolio News

Master and Commander IS

An agreement has been completed with CGG whereby

the company has settled all outstanding hire for 2016.

The remaining part of the bareboat contract will be

subject to a reduced day rate, with the reduction being

compensated by an issue of senior unsecured bonds to

M&C. An agreement with the Lenders has also been

secured whereby available funds, plus a call of about

1/3 of the uncalled capital facilitates a major upfront

repayment of debt, in exchange for reduced

amortizations going forward and covenant adjustments.

Going forward, M&C will have sufficient cash flow to

cover all debt obligations, with an additional buffer of

cash holdings and liquid bonds. As a result, one will be

maintaining a solid exposure to any market

improvement in seismic.

3B Offshore IS

Bareboat hire is paid punctually. The vessel valuations

are lower and there continues to be a potential MVC

breach to be handled, while a process to prepare for

the expiry of the BBCP has started. The value of the

vessels are likely so low that the uncalled capital is at

risk. That being said, with some market improvement

possible during the year, the odds may start to

improve.

Azur Offshore IS

The BBCP is in the process of being restructured with a

lower rate payment for the next couple of years, which

is partly compensated for by an extension of the lease

period. In connection with this, some of the uncalled

capital is set to be drawn to prepay debt. The

completion of the restructuring hangs in the balance,

however, as the guarantor is now subject to creditor

demands that may make it difficult to raise the level of

equity required to consummate the restructuring.

Norseman Offshore IS

The main shareholders in the project are taking legal

advice on whether to pursue legal claims against the

bank in the project or the charterer. The call for

uncalled capital is also being disputed. The valuation

reflects full payment of the uncalled capital.

Far East Offshore

The project has reached an in-principle agreement with

its secured Lender regarding a 2-year extension of the

current loan, but has so far failed to reach an

agreement with the charterer regarding an restructured

repayment of the sellers’ credit. In the absence of this

agreement being carried out, the ships are expected to

be sold, but are not expected to fetch proceeds that will

imply any equity recovery. All uncalled is set to be paid

in, and the recovery of such is uncertain.

PSV Invest II IS

One of the Lenders backed out of a restructuring

agreement and negotiations are ongoing to see

whether an acceptable solution can be found. The

alternative is to put the company into liquidation. The

valuation reflects full payment of the uncalled and thus

represents the maximum downside.

Vestland Seismic IS

The vessel is still idle. The project is 100% equity

financed and the cash burn is insignificant.

Asian Offshore IS

The Sea8 pool’s average day rate was USD 3,900

during Q4’16 adjusted for utilization, up 9% q-o-q. The

cash flow situation is reasonable at the moment with

distributions from the pool covering operating

expenses. There is no development regarding a

restructuring agreement with the Lender, apart from an

understanding that AO I is not paying interest or

amortization. If the need for additional working capital

re-emerges, the board may have to consider placing AO

I into liquidation. Vessel values are clearly well below

the outstanding level of debt.

Payments from projects

No payments were received during the quarter, and no

payments were made.

New investments

POI will only make follow-up investments in existing

projects, if required.

POI is invested in 8 offshore projects, which implies a diversification across different offshore oil service

segments. This section provides an update on the quarter’s most important newsflow related to the

underlying investments.

Spot/Asset Play

9%

Timecharter

4%

Bareboat

87%

Charterparty Distribution based on NAV

PSV/AHTS (Asia)

45%

PSV/AHTS

(Europe)

13%

Seismic

42%

Segment Distribution based on NAV

Ezra Holdings

64%

CGG

8%Bourbon

18%

Fairfield Nodal

10%

Charter hire backlog by counterpart

Project / company Segment Contract Charterparty Charterer Proportion

of NAV

Master and Commander IS Seismic Dec-18 Bareboat CGG/Fairfield Nodal 66.2 %

Azur Offshore IS PSV/AHTS (Asia) Jun-23 Bareboat Ezra Holdings 63.1 %

Vestland Seismic IS Seismic Spot/Asset play Albatross Shipping 13.8 %

3B Offshore IS PSV/AHTS (Europe) Nov-17 Bareboat Bourbon Maritime 0.6 %

Far East Offshore IS PSV/AHTS (Asia) Feb-17 Bareboat Sanko Steamship Ltd 0.0 %

PSV Invest II IS PSV/AHTS (Europe) Timecharter Team Marine 0.0 %

Asian Offshore IS PSV/AHTS (Asia) Spot/Asset play 0.0 %

Asian Offshore I IS shareholder loan Spot/Asset play 0.0 %

Norseman Offshore IS PSV/AHTS (Europe) Other Viking Supply Ships AS -14.0 %

PSV Invest II IS shareholder loan PSV/AHTS (Europe) Timecharter Team Marine -29.8 %

Portfolio

Investments and capital

POI’s portfolio consists of 8 projects which owns stakes

in 15 units. The average contract length is 5.2 years

and the contract coverage is 100%.

The gross nominal value of the contract backlog is

roughly NOK 40m. The backlog is now weighted

towards Ezra, which is in danger of not being able to

perform its obligations, according to the restructuring

in Azur Offshore.

POI had a cash holding of NOK 10m as of 31

December. The Fund is preserving its cash holding in

the expectation of further capital calls in the portfolio.

Worst case, liquidity may become an issue.

The life cycle of POI has been extended to 30 June

2018. It goes without saying that it will be difficult to

make project realizations at good prices with the

current market conditions. Hence, if the markets do

not improve within such a time frame, further

extensions should be expected.

The portfolio continues to be characterised by a high contract coverage (100%), despite the market

volatility. The average charter length is 5.2 years, which is robust. We expect the portfolio to continue

to produce a decent cash flow for the Fund, but the situation continues to be that cash is trapped in the

projects for debt repayments, rather then becoming available to the Fund.

0

20

40

60

80

100

120

140

160 POI - NAV development

NAV per share NAV per share (dividend adjusted)

Net Asset Value Development

NAV development

NAV as of 31 December 2016 was NOK 22 per share,

down 48% from the previous NAV as of 30 June and

down 63% for the past year. POI makes semi-annual

NAV calculations. Accordingly, the next NAV will be

published as of 30 June ‘17 and will be reported to

investors in the report for the second quarter of 2017.

NAV is down 8% since inception in 2009 (adjusted for

repayments of capital). This is an acceptable return

when compared to how other investments within oil

service investments have fared in the same period.

The Fund’s reliance on long term bareboat contracts

has benefited the performance and enabled substantial

dividend pay-outs. Nevertheless, liquidity is tight in

view of the wide range of capital calls the Fund is

becoming subject to and may, worst case, force

through asset disposals or additional capital having to

be raised in order to preserve the portfolio’s exposure

to a potential market recovery.

Direct yield

POI has an ambition to make annual payments to its

shareholders. Such payments are made within the

relevant laws, and may come in the form of ordinary

dividends, as well as repayment of capital.

POI has distributed NOK 70 per share to is investors,

which is 70% of par value.

Future distributions are mainly expected to follow

realisations of projects, which could take more time

considering the current weak markets.

Net asset value was down 48% during H2’16 and is now down 8% since inception, adjusting for

dividends. The reason is a continued decline in asset values, which is resulting in capital calls to reduce

debt, and in some instances a forced sale of assets below debt levels. Charter parties are also being

renegotiated, leading to lower future cash flows and in turn lower project valuations. The risk continues

to be high, particularly when it comes to liquidity.

Last 6 mths Last 12 mths Last 24 mths Since inception Since first investment

POI -48,1% -63,4% -77,5% -8,4 % -8,4 %

Oslo Stock Exchange 13,4% 12,1% 18,2% 187,3% 75,8%

Offshore Index* 31,3% 22,8% -5,6% 76,9% -5,4%

* Based on OSLO Energy Equipment & Service

Second Hand Market and Liquidity

As of 31 December 2016, POI had 851,877 shares outstanding. Pareto Securities AS (”PSec”) aims to

facilitate an active second hand market for shares. The last trading price was NOK 30 per share in

March 2016, which implies a 36% premium Q4’16 NAV (of NOK 22 per share). Investors who wish to

buy or sell shares should contact their advisors or alternatively PSec directly. Given the challenging

market and situation of POI, shareholders and potential investors should exercise caution when trading

in the shares.

Date Share price No. of shares Volume (NOK)

06/08/14 82 4,129 338,578

25/08/14 65 1,000 65,000

23/01/15 35 5,000 175,000

27/04/15 45 2,000 90,000

04/03/16 30 2,065 61,950

Number of trades since establishment 43

Volume traded since establishment (NOK) 8,173,723

Average volume per trade (NOK) 190,087

Last 5 trades in second hand market

The oil market

Inventory correction seen to continue

The OPEC production cut-back agreed in November

2016 is targeting a reduction of OPEC crude production

by 1.5 mb/d. This has spurred an oil price increase of

about USD 5/b and restored a bullish sentiment in the

oil market.

As can be seen in the chart to the left, it will

essentially now be OPEC’s turn to shoulder the burden,

after 2016 was characterized by large production

declines in US tight oil. Nevertheless, the inventory

draw downs look to accelerate, which is positive.

On the other hand, OECD inventory levels are still very

high and it will take a major reduction to really push

oil prices back to previous levels. The key danger here

is the recovery of US tight oil production. Oil prices are

now at levels that make many wells profitable again

and the US horizontal land rig count has started to

increase steadily. The higher the oil price goes, the

more will come back on line and it will only be a

matter of time before there is a meaningful response

in actual production.

In the next 12-18 months, we therefore expect rising

US tight oil production to put a damper on the oil price

recovery. We may see USD 60/b in the not too distant

future, but we have a hard time seeing material upside

from that level until we see the impact on global

production from conventional reserves of the past

three years’ underspend on reserve replenishment.

That effect is bound to emerge at some point and will

have a profound impact on prices. However, we

believe this is likely to happen in 2018-19 rather than

this year.

Consensus forecasts on the rise

The average 2016 price for Brent Crude was USD

44.8b and has averaged USD 54.4 YTD. The consensus

forecasts for 2017 are USD 55/b, which we think may

be on the conservative side. For 2018 and 2019

consensus is flat at USD 62/b. As explained above, we

think there might be meaningful upside to the 2019

forecasts.

The OPEC decision in November to cut production by 1.5 mb/d will strengthen and continue the

inventory correction cycle. As a result, consensus oil price forecasts have increased, although

moderately so. Most are wary of a rapid come-back of US tight oil production. We believe this will put a

damper on the price acceleration and that a more profound oil price increase will be delayed until we

see the actual impact of the past three years’ lack of spending on reserve replenishment globally.

Source: Pareto Securities, IEA, Opec

Source: EIA, Nordea Markets

The oil services market

E&P spending seen to rebound in 2017

Global E&P spending was down 22% in 2016, less than

expected. The leading E&P spending survey from

Barclays Capital was updated in January 2017 -

predicting a 7% increase for 2017. Observations of

updated spending plans from oil companies seem to

confirm this with several companies now expecting to

grow their investments by 20%-30% this year.

Looking at the graph to the left, this should be no

surprise, as oil price gains historically have always

coincided with rising E&P spending.

Rising cash margin for the oil industry

The integrated oil companies are estimated to have a

cash break even price of USD 51/b to cover production

costs, debt service and dividends. Hence, any oil price

above this level will allow for increased spending, the

opposite of what has been the case for the past three

years. The average oil price assumption that lies

behind the 7% projected E&P spending increase for

2017 is USD 52/b, so the current price level leaves to

margin for further expansion. Indeed, the oil industry

has historically raised spending above budgets if actual

prices have outperformed budget prices. Moving into

2018, this margin looks set to increase further,

although any price increases for services and

equipment will mitigate some of this effect.

US onshore to benefit first, then spread offshore

The Barclays E&P survey predicts North American

spending to increase by 27%, in line with the

expectation that tight oil production can (and will) be

ramped up quickly along with the rising oil prices.

International spending is only forecast to rise by 2%

and offshore, which is typically capex heavy and

driven by major field development decisions, is not

expected to start improving until late this year. This

sentiment was echoed by Schlumberger in its recent

Q4’16 report. For our portfolio, it appears to be no

longer a question of if, but when a recovery will

happen. However, patience is needed.

Anecdotal evidence of a recovery

The financial markets have become more optimistic

with US and Norwegian oil service stocks up by 19% in

the past three months. Drilling stocks, a typical

leading indicator, have fared even better. There have

been a selection of positive profit warnings from

seismic companies for Q4’16, owing to better-than-

expected multi-client sales. This hints at recovering

exploration spending, a typical leading indicator. We

are also seeing a rising wave of term fixtures in the

OSV space, as it appears that the oil industry is

sensing that we are at the bottom and is eager to lock

in capacity at low rates for the coming years. We are

also starting to see contract extensions within the

offshore rig industry, instead of contracts just being

allowed to lapse upon expiry. Finally, we have seen a

few speculative buyers of assets start to bite, both in

the rig industry and the OSV space. At least some

pieces in the recovery puzzle are there…

Source: Barclays Capital, , EIA,Pareto Securities

Source: Barclays, Nordea Markets

Source: Nordea Markets, Barclays Capital, EIA

Source: Bloomberg, Oslo Stock Exchange

Fund Management Team Richard Jansen Head of Maritime Investments Phone: + 47 22 01 58 96 E-email: richard.jansen@pareto.no Dronning Mauds Gate 3, P.O. Box 1396 Vika, NO-0114 Oslo, Norway, Tlf: 22 87 87 00, www.paretosec.com/pai.php

Patrick Kartevoll Fund Manager Phone: + 47 22 01 58 79 E-mail: patrick.kartevoll@pareto.no

Disclaimer

This Quarterly Report has been prepared in order to

provide information about Pareto Offshoreinvest AS

(“POI” or the “Company”) and must not be considered

an offer to trade in the shares of the Company.

Information contained in this Quarterly Report is

obtained by Pareto Alternative Investments AS (“Pareto

Alternative Investments”, “Pareto”, or “PAI”).

Information is presented to the best of our efforts and

knowledge, but Pareto cannot guarantee that the

information is correct or all inclusive. Pareto takes no

responsibility for any loss caused by information given

being misleading, wrongful or incomplete nor for any

other loss suffered as a consequence of investments

made in the Company.

This Quarterly Report includes and is based on, among

other things, forward-looking information and

statements. Such forward-looking information and

statements are based on the current expectations,

estimates and projection of the company or

assumptions based on information available to the

company and Pareto. Such forward-looking information

and statements reflect current views with respect to

future events and are subject to risks, uncertainties

and assumptions that may cause actual events to differ

materially from any anticipated development. All

investors must verify these assumptions themselves.

The company cannot give any assurance as to the

correctness of such information and statements.

Historic returns and return forecasts do not constitute

any guarantee for future returns. Returns may vary as

a consequence of fluctuations in currency exchange

rates. Investors should be aware that there is

significant uncertainty related to valuations in the

current volatile market. The valuation process is

described in Pareto Securities’ market report as per

November 2016. Risks and costs are further described

in the prospectus (information memorandum) produced

in relation to share issues in the Company.

The contents of this presentation are not to be

construed as legal, business, investment or tax advice.

Each recipient should consult with its legal-, business-,

investment-, and tax advisors as to legal, business,

investment and tax advice. Specifically, Pareto has

been engaged as the company’s financial advisor and

does not render – and shall not be deemed to render –

any advice or recommendations as to a transaction.