Rig-building backlogs come under the spotlight

The health of the rig-building order books of Singapore's shipyard groups - Keppel Offshore & Marine and Sembcorp Marine - is once again under scrutiny following another announced deferral of the delivery of five jack-up rigs that Transocean placed with Keppel FELS.

The market has been left wondering - under limited disclosures - whether the two yard groups have been covered adequately against deferments and cancellations that have proliferated across all rig-building projects, including those from Transocean and industry stalwarts like Ensco.

With rig utilisation having plummeted along with a drastic decline in contracting activity from deep and shallow-water markets, Transocean and Ensco had struggled to secure drilling charters even with their stellar track records, for the uncontracted newbuild rigs they have under construction.

Against this backdrop, Transocean has once again deferred the delivery of the five KFELS Big Foot design jack-ups - now due in stages from early 2020. These rigs, ordered under a contract pegged at US$1.1 billion, were originally scheduled for staggered delivery from the first quarter of 2016.

Keppel Corp subsequently told The Business Times that its rig-building arm would be compensated by Transocean for the agreed deferment of the five jack-up rigs.

But what has not been addressed in Transocean's disclosure or Keppel Corp's statement is the extent of compensation going towards the deferment.

Ian Craven of Icarus Consultants noted, however, that some inference may be drawn from Ensco's announced deferment of the harsh-environment Ensco 123 jack-up originally contracted for delivery from Keppel FELS in the second quarter of 2016. Ensco is paying an extra US$15 million for postponing the Ensco 123 delivery to the first quarter of 2018, according to Mr Craven. Additionally, the rig owner-operator indicated in a February investor presentation, it expects the deferred delivery to delay capital expenditure of about US$200 million.

Maybank Kim Eng said Ensco 123 was contracted to Keppel Fels at US$265 million. This suggests Ensco may have paid up about US$65 million to Keppel Fels towards the jack-up construction that is believed to have reached an advanced stage, based on the outstanding capex of US$200 million outlined by the rig owner-operator.

How much Keppel FELS has received in compensation from Transocean for the five Big Foot units cannot be ascertained, but the saving grace (noted Maybank Kim Eng) could be that "not much work has (likely) started on the rigs", meaning "no significant working capital" has also been committed by Keppel FELS.

One cost element that yards would seek compensation for is the capitalised interest cost from any contract deferral or cancellation. These are now likely inflated along with heavier tail-end payment terms tied to the rig-building projects (including Ensco 123) signed from 2010-2014.

Transocean reportedly also signed on SembMarine's Tanjong Kling, then Jurong Shipyard, for the construction of two drillships during the 2010-2014 rig-building wave under a 5 per cent down, 95 per cent on delivery basis.

Transocean did not comment on the delivery of these drillships from Sembcorp Marine when approached by BT, but a Clarkson Platou report last October indicated that delivery had been deferred to Q2 2019 and Q1 2020, from the contracted dates in Q2 2017 and Q1 2018.

RHB Bank analyst Lee Yue Jer views deferrals as a lesser evil than cancellations, and the additional compensation Keppel FELS has received for most (if not all) deferral requests from its clients as a relative positive. However, going by Keppel Corp's share price dip on Tuesday, clearly not all investors share Mr Lee's opinion. The market is no less split on the outlook for the offshore drilling sub-sector following Transocean and Ensco's announced deferrals.

Not too long ago, the commitment of Transocean, Ensco and other bona fide offshore drillers towards the sub-sector was cited as assurance of the sanctity of rig-building contracts secured by Singapore's yard groups. But Moody's downgrading earlier this week of the pair's credit ratings - Transocean by three notches from Ba2 to B2, and Ensco by five from Baa2 to B1 - may be a sign that the financial market is still jittery about a sub-sector besieged by significantly reduced demand, heightened bad debt concerns with respect to the creditworthiness of their end-clients, and a growing supply glut.

Nonetheless, Mr Lee sees deferrals - along with the rebound in oil prices - as positively pointing towards reducing "incoming supply" that will bring the rig market "back to balance" more quickly.

Maybank Kim Eng, however, has taken the opposite view, arguing that "the magnitude of the recent oil bounce is insufficient to alter the fundamental weakness (from) fragile drilling demand in an oversupplied rig market".

"Unless oil price can rally rapidly (past) the US$60 level on a sustained basis, the rig market will have to grapple with an oversupplied situation over the next two years," Maybank Kim Eng said.

"Without a return in new orders, rig-builders are unlikely to deliver meaningful EPS (earnings per share) growth, but would instead face downwards pressure from more deferments or even cancellations," it added.

The rig-building order books of Keppel Corp and Sembcorp Marine also remain exposed to default risks from a proposed bankruptcy filing by distressed Sete Brasil, which has commissioned the two yard groups to build billions of dollars of drillships and semi-submersible rigs.

Keppel Corporation and Sembcorp Marine shares closed at S$6 and S$1.745 respectively on Wednesday, up 23 cents and 6.5 cents.

This article was first published on March 10, 2016.
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