Offshore & Marine

Kim Eng on 5 Sept 2012

Not the end of rig orders. Sete Brasil has awarded contracts for the package of 21 drilling rigs, in which both Keppel and Sembcorp Marine (SMM) secured their fair share, within consensus expectations. While the Petrobras-related contracts had accounted for a substantial chunk of rig contracts for the duo this year, this does not yet mark the end of the rig-ordering cycle. We believe that rig order flows would remain robust and we continue to favour the rig-building yards (Keppel, SMM, SCI).

Up cycle to last for another at least 2 more years. The latest round of rig-building orders resumed in 4Q10 after a drought of orders following the financial crisis, and has remained unabated for 2 years. Previous newbuilding cycles lasted for at least 4 years and we think that current strong order flows can persist for at least 2 more years. There are signs of tightening in the rig market, with rising utilisation and dayrates, especially in the deepwater segment. Outlook statements by international drillers also suggest the same tightening trend.

Newer and better rigs needed. Areas where offshore activities are prolific include Brazil, West and East Africa, and the Gulf of Mexico. More sophisticated rigs are needed as more oil discoveries are made in deepwater offshore frontiers, where operations are more complex and environmental conditions are harsher. Safety requirements and an aging fleet are also factors which could trigger a rig replacement cycle.

Stay invested in rig-builders. The rigbuilders have secured more than 80% of our full-year contract win assumptions to date. The possibility of meeting our full-year order win forecast is within reach. Stock performances have also outperformed the STI on a YTD basis. We do not expect major reactions to new orders that are within forecasts, but focus should shift towards execution and operating margins.

Start to look at second-liners. Robust activities in rig-building would filter down the value chain. We think that the time is right to start looking at the smaller offshore supporting services companies. Many of these are trading at single-digit PERs. Ezion (Buy) is still a top-pick given an expected EPS CAGR of 36% over the next 3 years. In the offshore construction space, Ezra (Unrated) and Swiber (Unrated) have accumulated strong orderbooks. We also highlight module fabricators like Dyna-Mac (Unrated) and Technics (Unrated), as well as OSV builders and charterers who may be potential beneficiaries.

Petrobras-related orders awarded

Sete Brasil’s 21-rig package fully awarded. Sete Brasil has fully awarded the latest 21-rig package which would be leased to Petrobras for an average of USD530,000/day when completed. According to Upstream, an industry publication, Petrobras would incur about USD76.3b to lease 21 deepwater rigs from Sete Brasil and 5 rigs from Ocean Rig (at USD548,000/day), over a period of 15 years.

More FPSO topside contracts. Shortly after securing the Petrobras-related rig contracts, Keppel and SMM received related orders for FPSO topside modules, worth USD950m and USD674m respectively. Both the contracts include options for similar works. Additionally, both companies are bidding for other Petrobras-related FPSO topside module contracts in which the FPSO conversion jobs are currently being carried out by Odebrecht.

Ex-Petrobras orders. Excluding contracts related to Petrobras, Keppel and SMM respectively secured about SGD8.9b and SGD9.3b of orders YTD. With another 3 months more to go for the year, we expect another SGD2.2b and SGD1.8b in orders for the corresponding yards. This would mean that the duo would end the year with about SGD4.6b and SGD4.2b of orders respectively, excluding those related to Petrobras. We expect SGD5.4-5.6b in yearly orders for the two yards over FY13F-FY14F.

Where would new orders come from?
Recap of factors. We recap the factors that support new rig construction in the current cycle:
• Higher specification rigs needed for operations in deeper water and harsher environmental condition.
• More stringent safety requirements after the Macondo Incident in Gulf of Mexico.
• Tight supply of rigs leading to high utilisation and dayrates which supports the economics for drillers.

More offshore discoveries. Global offshore drilling activities are growing in major regions such as the Gulf of Mexico, West Africa, Brazil and the Asia Pacific. According to IHS, in the last 10 years, more than half of the new global oil and gas reserves were discovered offshore. As onshore oil gets depleted, the move to deeper waters becomes inevitable.

More reasons to trigger rig-replacement cycle. For several years, it has been suggested that a rig-replacement cycle is imminent given the underinvestment over the past two decades. Furthermore, half of the existing fleet is more than 25 years old. Other than being inefficient, many of these rigs do not have the sophisticated technology required for more complicated and deeper water operations. With the additional factors mentioned in the previously, we believe that current conditions are more pronounced to trigger such a replacement cycle.

Up cycle to last for 2 more years at least. Previous rig building boom lasted for at least four years and were supported by periods of sustained high oil prices following the oil shocks in the 1970s. The current rig-ordering cycle started in October 2010 and has been unabated for two years. Barring any major fallout in the global economy, and a similar scenario of sustained high oil prices, we believe that the current cycle is real and could last for another 2 years at least.
• Sustained high oil prices promote continual offshore activities and investments.
• Rig underinvestment in past years, coupled with an aging fleet could trigger a rig-replacement cycle.

Stay invested in rig-builders

We favour staying invested in rig-builders which have outperformed the STI on a YTD basis. Rig builders are within reach of meeting our full-year contract win assumption, given that they have secured more than 80% of our estimates for the full year. The focus would now shift to execution of orders. Our order of preference is for SMM, followed by SCI and Keppel given the relative potential target price upside.

Offshore services players to benefit

Global offshore capex and opex spending to increase. As offshore activities filter down the value chain, we expect players in the offshore services sector to benefit. Global offshore spending is expected to grow considerably over the next few years. Based on IHS Upstream spending report released in April this year, global combined capex and opex is estimated to reach a record of USD1.23t for 2012. Offshore capex is also expected to outpace the growth in onshore capex.

Offshore services players to benefit. We believe that Singapore players in the offshore services segment could benefit from the positive macro developments in the sector. We have seen positive contract win momentum for companies in the offshore construction and subsea services segment. In addition, we think that rise in OSV charter rates would also have positive effects on OSV-builders and charterers.