Oil prices up, but O&M players are not rolling out the barrel

Ian Craven of Icarus Consulting argues that SembMarine deserves credit for offloading its undelivered rigs.

SINGAPORE (THE BUSINESS TIMES) - The road to recovery for Singapore's embattled offshore and marine (O&M) sector will be a bumpy one - with consolidation looming on the horizon for large-cap yard operators and small- to mid-cap offshore support vessel players, analysts said.

So is Keppel Corporation and Sembcorp Marine's recent surge past the psychological S$8 and S$2 price points premature?

The driving force behind the share recovery could lie in recent advances in oil prices and talk of a potential merger or privatisation.

Speculation over the privatisation or divestment of SembMarine by Sembcorp Industries is not new. As far back as last May, DBS Vickers painted this and a merger between Keppel O&M (KOM) and SembMarine as options on the table for Sembcorp Industries. More recently, some analysts see KOM's announced US$422 million fines for corrupt payments in Brazil as a possible catalyst for the merger between the two yard groups.

Credit Suisse equity researchers suggested last Friday that the fines may lead to Keppel Corp potentially taking further provisions. They considered a "kitchen sinking" on impairments, particularly for the completed jack-up rigs and the Can-do drillship - described by Keppel as a state-of-the-art vessel - as paving the way for the sale of undelivered rigs on KOM's order book. n the corporate world, "kitchen sinking" is the practice of announcing all the bad news at once so any subsequent upturn would be more impressive.

Credit Suisse's comments came after news broke on ongoing talks between KOM and Borr Drilling of the potential sale and resale of up to six yet-to-be-delivered jack-ups at the yard group's premises in Singapore.

As for SembMarine, the market is still awaiting clarity on its role in the Brazil corruption probe that has also implicated Sete Brasil, which is behind over US$5 billion of drillships placed with the yard group.

But on the overhang from the rig-building order books, Ian Craven of Icarus Consulting argues that SembMarine deserves credit for offloading its undelivered rigs.

It has divested nine jack-up rigs and one semi-submersible drilling unit in two deals valued at a combined US$1.8 billion with Borr Drilling and a second undisclosed party.

That leaves the yard group with just one outstanding jack-up that will soon be accepted by BOT Lease, and the drillships contracted by Transocean and Sete Brasil, according to Mr Craven.

In contrast, he estimated that KOM still has about a dozen jack-ups sitting at its Keppel Fels yard in Singapore. He noted that market talk has it that unlike SembMarine, KOM did not wish to offer discounts in favour of divesting jack-ups to Borr Drilling during previous negotiations.

What this also implies is that SembMarine now stands to take far less new provisions than KOM for the rigs on order from non-Sete Brasil clients.

SembMarine has also made significant progress in diversifying its exposure to the exploration and production (E&P) value chain. It has won large turnkey contracts for offshore production facilities and stands to gain from a further expansion of its net order book, which last stood at S$4.85 billion as at the end of the third quarter.

SembMarine's order book expansion is fed by the sanctioning of deferred upstream oil and gas projects, made possible by oil prices stabilising at above US$50. E&P companies surveyed by Pareto Securities have also raised the planning oil price for their 2018 budget to US$52, up from US$49 for 2017, implying they are inclined to fund more upstream projects.

Yet, going by their share recovery trajectory, investors seem to favour Keppel Corp more than its rival. The market may have bought into the proposition that Keppel can count on revenue streams from its multi-business model to counter its exposure to the O&M downcycle.

Now that KOM has reached a plea bargain with the authorities in Brazil, the US and Singapore pertaining to the corruption probe, the group is also perceived as one step ahead of SembMarine in dealing with the overhang on its contracts won in the Latin American country.

Share price recovery aside, analysts warn that the fundamentals remain weak for the O&M sector.

Margin erosions will continue to squeeze yard operators and two other sub-sectors that are also laden with overcapacity. Competition for turnkey contracts linked to production facilities has been cut-throat. For instance, in the tender for the Johan Castberg contract with Statoil, trade media reported that SembMarine out-bid its closest rival by US$70 million with a US$490 million offer.

IHS Markit's APAC lead for fabrication and yards Ang Dingli said the price difference was one "determining factor" backing Statoil's award to SembMarine, a yard group with no track record in delivering a newbuild FPSO (floating production, storage and offloading vessel) hull. The pressure is now on SembMarine to deliver the project on time and within budget, so as to ensure a healthy margin.

Fuelling this cut-throat competition among yard groups is the slow recovery in upstream projects, said Mr Ang, with contract awards not expected to return to pre-2014 levels even by 2020.

In addition, Wood Mackenzie, an energy and commodities consultancy, pointed out that E&P companies as top feeders of the O&M value chain are most keen to "lock in rock-bottom costs for their upstream projects".

Mr Ang warned that charter rates for rigs and vessels - two sub-sectors dragged down by big supply gluts - could further decline in 2018. This is consistent with a general industry consensus that low day rates for offshore support vessels (OSV) may be here for two to three more years.

Against this backdrop, heavily leveraged OSV players will have to press on with restructuring of vessel loans, which will involve haircuts for creditors, in order to stay afloat.

UOB Kay Hian's Foo Zhiwei believes most OSV players here would face an existential threat if banks withdrew support. "Consolidation is likely to remain a central theme this year," he said.

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