Offshore and Marine sector: Is the worst over?

THE recent gains in oil prices from the rock-bottom US$20s in February have led to advances in offshore and marine (O&M) stocks as investor interest return to a sector - the offshore drilling and offshore support vessel (OSV) sub-sectors, in particular - that has been badly bruised.

CIMB Securities has proclaimed that "the worst may be over" for the O&M sector, although with Brent oil seen dipping to under US$40 (S$54.30) this week, other brokerages have subsequently begged to differ. But even CIMB's more optimistically headlined research note released prior to the latest oil prices pullback was tempered with caution that the "upcycle (has) not started yet". The March 8 research note also warned investors against trading on "blind faith" fuelled by expectations that oil prices have hit the trough and are set to normalise at US$50.

Seasoned O&M broker Mike Meade of M3 Marine noted that oil prices had recovered to only the November 2015 levels and were still 30 per cent down from March 2015 levels.

More importantly, the fundamentals of the O&M sector remain challenging with supply-demand imbalances expected to persist especially in two sub-sectors - offshore drilling and OSV - which Singapore-listed players are most exposed to. The recent earnings reporting season has shown that listed O&M players here have finally started to take impairment charges to align their asset values with the reality of drastically poorer market conditions.

Investors should therefore guard against the false assumption that the O&M sector will bottom out along with recovering oil prices.

Reality check

Demand does not rebound immediately even if oil prices were to shoot back to US$100 overnight. The industry consensus is that demand for offshore rigs and OSVs will take at least two years to recover and the sector will probably take even longer to rid itself of the supply glut in these two over-invested sub-segments.

"Every operator (or oil company) is expected to cut exploration and production spending by at least 20-25 per cent in 2016 and again in 2017," Pareto Securities' managing director David Palmer said, noting that exploration and production (E&P) spending is officially in the second year of decline after 2015. "Our projections imply about 24 months from the peak in April/May 2014 to trough in April 2016 and 28 months before demand starts rebounding," he added.

The sector has also yet to experience the full impact of a supply overhang, with 115 jack-up rigs still under construction, Ian Craven of Icarus Consultants said. Fifty-one of these jack-up rigs are "speculative" newbuilds or being built without contracts and seven of these are placed with Singapore rig-builders, Mr Craven said.

Even with the opening up of a so-called "new oil market" in Iran, Mr Craven said the Middle Eastern country will not be able to "figure out what they require this year" and the strength of its finances remains questionable.

Pareto Securities estimated about 266 rigs have been stacked - the industry equivalent to being put on standby - and that meant idling of 1,330 OSVs. This will soon be made worse if 374 OSVs on the order books were to be delivered and these do not even include unreported vessels from Chinese yards, Mr Palmer warned.

Against this backdrop, rig operating day rates have declined to just above operating expenditure levels - even in India, where activity has held up better than elsewhere - and OSV day rates too have fallen by up to 60 per cent. More jack-up rigs are coming off charters, Mr Craven said, and this could point towards a further fall to 20 per cent in the global rig utilisation rate by the end of 2016, if there are no new fixtures or charter contract awards.

This raises the question whether rigs and OSVs still on the order books can be eventually delivered. The supply overhang coupled with demand destruction has also forced rig and OSV owner-operators - and to a certain extent, yards - to take impairments.

The stepping up on provisioning for impairment charges by O&M players - yard groups or shipbuilders and vessel or rig owner-operators - in Singapore has been applauded by some equity analysts. But the recent provisions totalling S$2.4 billion across four big-cap yard operators and nine small-cap vessel owner-operators or shipbuilders generally fall under 10 per cent of net book values prior to impairments, according to CIMB's March 8 research note. Mermaid Maritime stood out as the exceptional rig and OSV player to have taken on impairment charges of S$303 million, equivalent to 43 per cent of its net book value, while Sembcorp Marine is the only big-cap player to have accounted for S$609 million provision on its outstanding rig-building equivalent to 16 per cent of its net book value.

These fall far behind the 20-30 per cent asset writeoffs taken on board by key OSV players in Norway and Europe - Farstad and Havila included, Mr Meade noted.

Inadequate

The market may have also welcomed Sembcorp Marine's S$609 million provision towards its outstanding order book. But analyst estimates elsewhere suggested these may be inadequate especially in addressing the risks attached with the seven drillships from Sete Brasil. Although there have been no transactions so far to benchmark against in the resale market, many in the industry have drawn reference to the sale of one of the Odjfell Deepsea Metro drillships in assessing the fallout in rig asset values.

Mr Craven said he shared the sentiments of some analysts that one of the two Deepsea Metro drillships may be sold at only US$200 million, understood to be under half the shipbuilding price paid up by the rig's owner-operator, Odfjell Drilling. Premium jack-up rigs built are not faring much better. One Norwegian bank estimate released at the Marine Money conference held in Singapore in February indicated the bond market there valued a jack-up at US$100 million, at least US$80 million off the contracted newbuild prices to yards in Singapore during the 2010-2014 rig-building wave.

But all is not lost for O&M players. Many in the industry harbour hopes that the protracted downturn could eventually be followed by a sharper rebound. The challenge is in how O&M players can shoulder on against a lack of visibility of a market recovery. Impairment charges aside, industry experts have argued that more scrapping or fleet retirement needs to take place for supply and demand to rebalance. Mr Palmer argued for yards or their shareholders to take equity in both vessels and rigs to deliver their order books. He also said bondholders and banks will have to take over assets, restructure debt and try to move forward.

For those with the spare cash to hold out for a market rebound, O&M counters trading at their depressed prices may appear attractive but, before taking the plunge, it is imperative to take a closer look at fundamentals to evaluate the risks and returns involved.

hweetan@sph.com.sg

This article was first published on March 18, 2016.
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