Pareto Offshoreinvest AS

2nd quarter report 2015 Link: http://paretosec.com/ppim-reports.php

Executive Summary

NAV NOK 77/share

(as of 30 June 2015)

The offshore oil services markets remain very challenging, with lower day rates, lower utilization and reduced asset valuations. We expect a difficult 2015 and 2016, in which investors should not expect meaningful dividend distributions and where it will be hard to make good project realizations. The Fund is set to report its next NAV at 31 December this year.

Market Development The oil price has exhibited significant volatility with a 40% rebound from the winter low, followed by a near 20% decline in the past month. Expectations of a gradual rebalancing of the oil market during H2’15 have been quashed by rising OPEC production and fears of additional export volumes from Iran in the next years. OPEC is definitely not abandoning its strategy of maximizing market share at the expense of price anytime soon. Hence, it appears that the oil price will be capped at the marginal cost of US tight oil producers for the foreseeable future (USD 60-65/b), until global inventories have been worked down to a more normal level. Thus, there is less reason to expect a recovery in global E&P spending next year and the oil service markets are likely to remain depressed. Long term contracts at past rate levels provide some cushion, but many are being terminated by their clients. New contracts are often barely able to cover operating expenses. Asset valuations are continuing to decline, putting financial

covenants at risk and the banks are more restrictive. We expect these conditions to persist through 2015 and 2016, making asset realizations difficult to achieve at sensible prices. Rather, the main task is to preserve underlying values and to position the portfolio for a recovery in the next 3-4 years. Portfolio The portfolio consist of shares in 9 projects with a total of 16 vessels. The contract coverage is 86% with a weighted contract length of 2.8 years. 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. The remaining term of the Fund was extended to July 2017 at the AGM in June. The Fund manager believes further extensions will be necessary if the markets do not improve within the next two years.

Portfolio News Following the sale of Carlisle Subsea in January 2015, POI is invested in 9 offshore projects, which implies a good diversification across different market segments. This section provides an update on the quarter’s most important newsflow related to the underlying investments.

Master and Commander IS Charter hire is paid punctually, while the seismic market is weak. Both counterparts are in reasonably good shape. The vessel valuations have been lowered, which has a negative impact on the residual value expectations.

Asian Offshore IS The average day rate for the four vessels was $ 7,700/d during Q2’15, down 6% on the preceding quarter. While the commercial results are good relative to the market, receivables collection is a main headache and has resulted in liquidity constraints and two capital calls from the investors in the past months. The owners in AO I had to contribute USD 1m in working capital in Q2’15 and is set to contribute another USD 1.5-2m during Q3’15 due to the slow receivables collection. The difficult markets is putting the integration process involving AO III and its pool partners AO I and ACS at risk, despite some progress. Vestland Seismic IS The vessel M/V Vikland is still idle and there have been no material developments regarding a new charter or a sale. All debt has been repaid and the project is 100% equity. The seismic market is very weak and it will take time to secure employment for the vessel. Alternative markets are also being explored. PSV Invest II IS After the initial 3+1+1+ year contract with Apache was cancelled in April, the commercial manager managed to secure an alternative with the same charterer that secures full utilization through September ‘16, with a 3-month window in Q4’15 when the vessel will trade in the sport market. The new contract is at an acceptable rate and will cover opex and full debt service. The value is marked down due to a lower vessel valuation Norseman Offshore IS Dividend distributions from this project is still suspended as the LTV covenant is yet to be satisfied. The charter hire is paid punctually. The project has had

a positive value development as accumulated cash flow has offset the impact on residual value of lower vessel valuations. Far East Offshore The project continues as planned with bareboat hire paid punctually. The bank has not approved any dividend distribution in the project during Q2’15. The vessel values have declined, resulting in a meaningfully lower equity valuation due to the relative short remaining duration of the charter party (Feb ‘17). Azur Offshore IS and 3B Offshore IS These projects are all developing according to schedule with charterers performing (hire paid punctually), debt serviced according to plan and free cash distributed to owners. 3B paid out a dividend in June. Nevertheless, the vessel values have been lowered, resulting in a negative development in equity value. Payments from projects During Q2’15, POI received NOK 1m of distributions from projects. The Fund contributed NOK 0.2m of capital to its portfolio. New investments POI will only make follow-up investments in existing projects, if required.

Portfolio The portfolio continues to be characterised by a high contract coverage (86%), despite the market volatility. As a result of the cancellation of the PSV Invest II contract, the average charter length has dropped to 2.8 years, which is still robust. Barring any unforeseen circumstances, we expect the portfolio to continue to produce a good cash flow for the Fund. Investments and capital POI’s portfolio consists of 9 projects which owns stakes in 16 units. The average contract length is 2.8 years and the contract coverage is 86%.

Charterparty Distribution based on NAV

Bareboat 72%

The gross nominal value of the contract backlog is roughly NOK 71m. The backlog is evenly distributed among solid counterparts. POI had a cash holding of NOK 8.1m as of 30 June 2015. Capital calls for projects should not be ruled out, but it is not expected to be material for the Fund. Until the situation is more clarified, the Fund plans to retain its cash position. The life cycle of POI has been extended to 30 June 2017. 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 not be ruled out.

Timecharter 9%

Spot/Asset Play 14%

High yield bond 5%

Segment Distribution based on NAV

Seismic 29%

PSV/AHTS (Europe) 42%

Semi Submersible Rig 5%

PSV/AHTS (Asia) 24%

Charter hire backlog by counterpart

Bourbon 26% CGG 36%

Apache 2% Viking Supply Ships AS 7%

Ezra Holdings 29%

Net Asset Value Development Net asset value was down 4% during H1’15. A stronger USD vs the NOK has cushioned the decline and measured in USD NAV dropped by 8% during H1’15. Overall, the portfolio’s high contract coverage is providing a buffer against the developments in the oil services markets, but one cannot escape the effect that lower vessel values have on the residual value estimates. NAV development

Direct yield

NAV as of 30 June’15 was NOK 77 per share, down 4% from the previous NAV as of 31 December ’14, but up 9% in the past twelve months, both adjusted for distributions to shareholders. POI makes semi-annual NAV calculations. Accordingly, the next NAV will be published as of 31 December’15 and will be reported to investors in the report for the fourth quarter of 2015.

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. Thus, the entire return has been returned to shareholders, as well as excess capital.

NAV is up 47% since inception in 2009 (adjusted for repayments of capital). This is a solid return considering the fact that the first investment was made as late as Q2’10 due to a lack of deal flow during the financial crisis.

Future distributions is mainly expected to follow realisations of projects, which could take some more time considering the current detrimental market outlook.

The Fund’s reliance on long term bareboat contracts with solid underlying dividend yields has shows its benefit during the past two years, when the overall oil service markets have weakened substantially. Moreover, the fund has made some very strong realizations during this period, which has added further to the performance.

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

-4.1%

9.0%

24.0%

47.0 %

47.0 %

Oslo Stock Exchange

9.2%

1.8%

34.2%

171.0%

72.6%

Offshore Index*

-4.0%

-45.4%

-40.1%

46.5%

-22.3%

* Based on OSLO Energy Equipment & Service

160

POI - NAV development

140

120 100 80 60 NAV per share

40 NAV per share (dividend adjusted)

20 0

Portfolio Project / company

Segment

3B Offshore IS PSV/AHTS (Europe) Master and Commander IS Seismic Azur Offshore IS PSV/AHTS (Asia) PSV Invest II IS PSV/AHTS (Europe) Vestland Seismic IS Seismic Asian Offshore IS PSV/AHTS (Asia) Songa Offshore SE 2011/2016 FRN Semi Submersible Rig Far East Offshore IS PSV/AHTS (Asia) Norseman Offshore IS PSV/AHTS (Europe) PSV Invest II IS shareholder loan PSV/AHTS (Europe)

Charterparty Distribution based on NAV

Contract Charterparty

Charterer

Nov-17 Aug-18 Jun-23 Sep-16

Bourbon Maritime CGG/Fairfield Nodal Ezra Holdings Apache UK Albatross Shipping

May-18 Feb-17 Dec-20 Sep-16

Bareboat Bareboat Bareboat Timecharter Spot/Asset play Spot/Asset play High yield bond Bareboat Bareboat Timecharter

Songa Offshore SE Sanko Steamship Ltd Viking Supply Ships AS Apache UK

Semi Submersible Rig 5%

PSV/AHTS (Asia) 24%

High yield bond 5%

% % % % % % % % % %

Seismic 29%

PSV/AHTS (Europe) 42%

Spot/Asset Play 14%

26.0 21.8 10.1 5.6 7.3 7.1 4.7 6.5 7.2 3.5

Segment Distribution based on NAV

Bareboat 72%

Timecharter 9%

Proportion of NAV

Second Hand Market and Liquidity As of 30 June 2015 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 45 per share, which implies a 42% discount to NAV (of NOK 77 per share). Investors who wish to buy or sell shares should contact their advisors or alternatively PSec directly.

Last 5 trades in second hand market

Date

Share price

No. of shares

Volume (NOK)

06/08/14

82

5,000

410,000

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

Number of trades since establishment

42

Volume traded since establishment (NOK)

8,111,773

Average volume per trade (NOK)

Pareto Offshoreinvest AS - Second Hand Trades Volume (Thousand NOK)

150

NAV per share NAV per share (dividend adjusted) Second hand price per share

125

2,000 1,800 1,600 1,400 1,200

Price per share

100 1,000

75

50

800 600

400 25

0

200 0

Volume (Thousand NOK)

175

193,137

The offshore oil services market The oil price has exhibited significant volatility from the bottom in February this year. The sharp decline in US onshore drilling activity and rising demand drove the prices upwards. Rising OPEC production, the imminent introduction of potentially large Iranian export volumes and worries about Chinese demand have re-introduced a bearish sentiment. Until global inventories have been meaningfully reduced, the marginal cost of US tight oil production (USD 60-65/b) may represent a cap on the oil price. The US re-balancing act The sharp drop in the oil price has driven through an unprecedented decline in US onshore drilling activity and it seems to continue at a level roughly half of the levels seen prior to the oil price collapse. We have finally starting to see US onshore production starting to fall, with decline rates slowly increasing.

Source: Pareto Securities

At the same time, US oil demand is booming in response to the lower prices. The latest reports from the IEA indicating that US oil demand is up by 0.60.7mb/d from a year ago. This means that the US markets are heading into an inventory correction phase that will continue to strengthen and provide a positive driver for oil prices. The bearish news are found outside of the US OPEC production has increased by nearly 1.0mb/d in the past 18 months, due to higher Iraqi volumes and maximum output from Saudi Arabia. It seems the Saudis continue to be focused on market share instead of higher prices, as indicated by the significant ramp up in production during Q2’15. As a result, it now seems that we will not see any meaningful global inventory correction until the turn of the year.

Source: EIA, Pareto Securities Source: EIA, Pareto Securities

Source: IEA, Bloomberg, Pareto Securities

The prospects for a nuclear deal with Iran has hit the optimism that existed for 2016 oil prices. If the deal is approved by the US congress, the sanctions on Iranian exports are to be lifted. This may add significant crude export volumes to the global markets. Estimates vary from 0.5-1.0 mb/d of increased supply during the next 12-24 months, on top of what is already added by Saudi/Iraq/Libya. Hence, what a few months ago looked like a 2016 with marginal production growth, significant demand growth and a sharp downward inventory correction, now looks more like a slow and gradual inventory correction cycle. All in all, this bodes for a more gradual recovery in prices with the marginal cost of the US tight oil producers (USD 60-65/b) probably representing a cap until global inventories have come down significantly. The longer term outlook for prices in the range of USD 75-90/b is the same, but looks certain to be pushed out. This, plus the significant volatility, is obvously not good news for oil services.

Source: EIA, Pareto Securities, Nordea Markets

Oil services, continued E&P spending 1991-16e

The investment parameters are being reset Global E&P spending is expected to be down around 25% this year, the biggest decline in three decades. This masks some important regional differences, namely that with North American spending expected down 40-45%, it means that the RoW spending is down around 18%. Still a big number, but not quite as dramatic as the headline numbers would indicate.

Source: Barclays Capital. Pareto Securities, EIA

An interesting exercise is to look at how low activity levels have actually dropped. One may get the impression that with a 25% decline in E&P spending, the oil industry’s demand for assets and services are dropping by the same magnitude. That is not the case, most of the decline is driven by decline in pricing. As shown in the chart to the left, the day rates for various types of offshore oil service assets is down an average of around 30% from the start of 2014. In comparison, the decline in demand (i.e. activity levels) is only down roughly 5% during the period. This means that the oil industry is actually maintaining their business levels at quite healthy levels.

Source: PPIM, Pareto Securities, Clarksons Platou

Development costs USDm, Maria field - Norway

Lower pricing means lower costs for the oil industry. In an offshore development, the cost of seismic, drilling, support and construction units make up about half of the totalcost. While somewhat more sticky, the rest of the cost base will also shrink in a low oil price environment. All this implies that more projects will gradually meet the economic hurdles even with a low oil price. As a result, activity levels will slowly start to ramp up again. The graphs on the left illustrate a few concrete examples of this. Of course, the reduced costs are not solely due to pricing, but also through optimizing the development solutions. Nevertheless, a roughly 35% decline in costs means a lot to the profitability of a project with an oil price in the 50s to 60s.

Development costs USDm, Kaombo field - Angola All in all, we expect a re-setting of the oil industry’s cost base, coupled with a gradually increasing oil price to start turning the markets around in the next 1-2 years. The process will be slow, but there will definitely be light at the end of the tunell.

Source: Pareto Securities

Fund Management Team Richard Jansen Head of Maritime Investments Phone: + 47 22 01 58 96 E-email: [email protected]

Patrick Kartevoll Fund Manager Phone: + 47 22 01 58 79 E-mail: [email protected]

Dronning Mauds Gate 3, P.O. Box 1396 Vika, NO-0114 Oslo, Norway, Tlf: 22 87 87 00, www.paretosec.com/ppim.php

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 Project Investment Management AS (“Pareto Project Investment Management”, “Pareto”, or “PPIM”). 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 May 2015. 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.