Taking stock of new orders

December 31, 2010

It’s amazing how little it takes for perspective on a business to change more or less overnight and be seen through a completely fresh set of lenses. Andrew McBarnet reviews some surprising developments.

A month or so ago at the annual meeting of the Society of Exploration Geophysicists (SEG) the consensus among the leading lights in the marine seismic contracting world was that the business was entering a period of consolidation.

The manic phase of vessel newbuilding which ignited in 2007 had finally tailed off, it was said.

The impression given was that everyone was done with investing in new capacity - for good reason. Most obviously the market continues to be frustratingly out of sync. Underlying demand for 3D marine seismic surveys has arguably never been stronger. Improved acquisition technology, like towed streamer wide-azimuth which provides higher resolution imaging in complex geological settings such as the subsalt of the Gulf of Mexico and offshore Brazil, has encouraged oil companies to reassess a whole range of prospects. More aggressive international exploration strategies by a number of national oil companies look to be a firm trend giving rise to additional demand.

Meantime it cannot be much longer before the smaller independents will once again be able to access the necessary funding to return to the exploration fray. Finally, in 2011 it is not unreasonable to expect a gradual revival of Gulf of Mexico E&P operations as the Obama administration lifts its foot off the regulatory brake.

All these trends have been observed as encouraging. The discord, voiced in perfect harmony by the entire chorus of contractors, is to be found in the continuing excess in the global marine seismic fleet. No one can make serious or even reasonable money while contractors have to undercut each other to win work for their vessels. At SEG the view was that the issue would not go away overnight, precisely because all the serious players have been upgrading or expanding their fleets and would be in for the long haul. In other words a few minnows may fall by the way side, but we Big Guys will just wait out what may be another challenging year in 2011.

The responsible course, it seemed, was to focus on differentiating acquisition and processing technology to maintain or improve market share. Meantime that elusive market equilibrium would eventually assert itself.

The mechanism by which this might happen, however, has never been very clear.

The best you can get out of contractors is that some form of natural selection will eliminate the weakest players and/ or vessels. It’s never worked in the past, but it sounds good. As you might expect given the parlous vessel supply/demand predictions, no one suggested that building more vessels would be a smart idea. That was then.

Discipline volte face
The British term ‘gobsmacked’ comes to mind on learning that contractors Petroleum Geo-Services and Polarcus have both just announced new vessel building plans which between them could potentially add another six high-end 3D vessels to the global seismic fleet in four or so years time. Both companies are unapologetic about what could be interpreted as a volte face regarding the industry’s professed dedication to maintaining discipline in the market when it comes to vessel numbers. Their justifications are certainly interesting and offer some insight into the way competition could be shaping for the future.

Both companies are looking beyond the prevailing vessel supply/demand conditions but their reasoning for building new vessels is very different, based on their particular circumstances. For PGS this is something of a pre-emptive strike at a time when the company is at least holding its own against the competition. You get the feeling that PGS’ management senses some vulnerability on the part of its rivals. This may partly be based on its recent marine seismic operational results in a challenging market which appear to be more positive than its peers WesternGeco and CGGVeritas. For this it has to thank the introduction of its GeoStreamer acquisition system which, for a while was out on its own as the cost effective new generation towed streamer solution providing improved high resolution 3D imaging, particularly in difficult geological environments. The fact the company is forking up to convert the whole fleet to GeoStreamer is proof, if needed, that it has become an effective selling point for its oil company clients. WesternGeco and CGGVeritas are now marketing their own technology brands in direct response to the claims of GeoStreamer, but for a while PGS had a clear run.

A further indication that PGS currently has momentum is suggested by the support from Norwegian and international investors for the private placement of up to 19,799,998 new shares offered to finance the building of new vessels. The offering is said to have been substantially over-subscribed. We are not in a period of mad money, which Norwegian seismic enterprises have in the past been prone to attract, so we can conclude that PGS has serious investor confidence. For any company this is important. Financial institutions and the like are getting behind a newbuild programme which will inevitably dilute their shareholding and last month was still very sketchy on detail. That is an act of faith in the PGS operation.

The sweetener to the funding proposal is provided by the introduction of a dividend programme from 2011, with a recommendation to the 2012 AGM for the payment of a dividend for the financial year 2011. Further details are scheduled to be presented in conjunction with the company’s Q4 2010 results.

The fresh equity will enable PGS to build two fifth generation Ramform vessels at a cost of some $250 million each, including construction follow-up, commissioning and a comprehensive seismic package. The company is actually talking about the probable spending of more than $1 billion over the next few years on new capacity because it says the newbuild contracts will include the option for the shipyard concerned to build two further identical vessels. PGS is in discussion with several qualified yards and expects to enter into a final contract early 2011. Delivery of the first vessel is expected in Q1 2013 with the second vessel to be delivered one year later.

From a business point of view the equity issue makes a lot of sense. It means that PGS moves forward with virtually no debt. This is a good place to be given the traditional fluctuations in the demand for marine seismic services. In fact the company is in effect trying to buck the feast-or-famine cycles of the seismic market. PGS president and CEO Jon Erik Reinhardsen more or less confirmed this, saying: ‘Our decision to renew and expand our fleet comes at a time when we expect growth in seismic demand. We are electing to raise equity to preserve our financial strength and strategic flexibility. We are dedicated to deliver shareholder value from this investment through increased earnings and introduction of a dividend programme.’

Operationally PGS was in any case facing the need to review its core fleet. Some of the highly productive Ramform design vessels with which the company earned its spurs in the 1990s will soon be 20 years old, while the non-Ramform Atlantic Explorer and Pacific Explorer are also reaching their ‘sell by’ date. The design for the new proposed vessels is said to based on the strengths of the current Ramform fleet, while improving capabilities along a number of key parameters. A significantly upgraded GeoStreamer based seismic package will be part of that equation as the company intends to increase its share of the growing high density segment of the market in locations such as Brazil, West Africa and the Gulf of Mexico. PGS believes that large spreads, long streamers and towing efficiency are the key to success. It also sees an opening up of opportunities in mature basins, such as the North Sea, where the higher fidelity data promised by GeoStreamer can reveal new geological plays.

The timing of the newbuilds is also propitious. After the glut of the last few years, shipbuilders specializing in seismic vessels are hungry for work, there are helpful government subsidies floating around in Norway, and even the price of steel is favourable. In a year or two these conditions may not so readily apply.

Overall PGS can make a credible case for ordering vessels now as part of a strategic fleet renewal programme that can flatten out some of the market craziness all too characteristic of marine seismic investors. The question is whether the same can be said of Polarcus, the emerging marine seismic contractor based in Dubai but to all intents and purposes a Norwegian company listed on the junior Oslo stock market.

Polarcus has already set out its stall by launching a series of new vessels built in Dubai to an innovative design from an Ulstein company. This was always a bold enterprise with considerable risks, particularly as the contract market took a turn for the worse just as the company’s vessels were being built and rolled out. In the circumstances the company has done well to more or less stick to its original programme of bringing in six modern 3D vessels, although technically one is owned by a principal shareholder. With three vessels operational, company results are showing a very modest operating margin. This masks some serious debt from construction costs, but nonetheless points to a company making the best of difficult times.

Polarcus has now apparently raised sufficient money through a private placement to be confident about ordering two more high-end 3D seismic vessels for delivery in March and June 2012 respectively. Construction this time will be at the Norwegian yard of Ulstein Verft. The high capacity vessels, capable of towing 14 streamers, will be built to the innovative Ulstein SX134 design already adopted by Polarcus, but with a higher ice class, increased propulsion and other efficiency enhancing features.

Capital cost per vessel including seismic equipment is put at $168 million, which given the Polarcus balance sheet earns points for bravado if nothing else. However, one decision which makes total sense was to opt for Ulstein rather than continuing its newbuild programme with Dubai Drydocks World, a significant company shareholder. By building in Norway the company can qualify for long term financing from the government/ bank agency Eksportfinans, in this case up to 80% of the total project capital expenditure at a fixed interest rate of 2.85% plus some other benefits.

This does not answer the question of how a company essentially running a touch-and-go operation can justify expansion.

The rather humdrum answer is that Polarcus does not really have any other option if it is to thrive in the marine seismic business. Rolf Ronningen, CEO of Polarcus, spoke of the new orders in terms of underscoring the company’s commitment to be the new seismic major. But the more mundane reality is that a core fleet of six vessels will always struggle to be competitive in a market as global as marine seismic, so Polarcus has to go bigger. Transport and mobilization costs weigh too heavily if vessels have to be moved constantly over long distances to meet the next contract. Larger fleets and their crews can be more strategically located and economical to manage. As a result they can consistently operate at a lower cost which shows up when it comes to tendering for contracts.

Gaining critical mass
It’s all about criticial mass. When the additions are in service, Polarcus will have seven vessels. This will give it a projected increase in market share to approximately 13%, according to the company. It will most probably have preferred access to one more vessel, the Selma, which is under construction and was part of the original plan. A fleet of eight makes more economic sense and must be assumed to give the company a better chance of paying its way and gradually reducing its start-up costs.

So far there has been little public reaction from the other major marine seismic contractors to what could be construed as a breaking of the ranks on the vessel expansion front by PGS and Polarcus. It seems unlikely that a further wave of new orders is in prospect. You can almost tell by the tone set in fiscal reporting. PGS has been much more upbeat of late than either WesternGeco or CGGVeritas about their marine seismic operations.

In practice WesternGeco has been bedding down the vessels it acquired through its purchase of Eastern Echo, the Dubai-based predecessor of Polarcus, as well as other newbuilds and conversions, and has shown no appetite for more capacity to complement what is a pretty modern fleet.

Jean-Georges Malcor, newly installed CEO of CGGVeritas, in the last published quarter acknowledged the challenging conditions facing its marine seismic operations. The quarterly statement referred to the oversupplied marine environment to which the company is responding by accelerating vessel upgrades and planned repairs. It is believed that some of the vessels acquired from Wavefield-Inseis, which were conversions not custom-built for seismic, are included in this programme. Cost savings rather than fleet expansion would appear to be the company’s current priority, although it has in the past talked about a phased programme of fleet renewal.

The other significant worldwide player is Fugro. A long time ago it made clear that a fleet of eight modern vessels was its target, and following a programme of newbuilds that is exactly what it is going to end up with. There has been no hint that it has any grander ideas.

But given the surprise announcements of last month, there is no real telling what any of the marine seismic contractors are holding up their sleeves. OE

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