Extracts with courtesy of Straits Times 30April 2013
KepCorp and Sembcorp Marine are the behemoths that build around 70 per cent of the world's oil drilling jack-up rigs. Both which employed approximately 75,000 people and contributed 1.6 per cent to economic output in 2011 per estimate figures.
However they are now facing challenges from several competitions. These include the Chinese players and structural changes to the industry. In what could be a replay of the earlier challenges the two companies faced in the 1990s, the key question is whether Keppel and SembMarine can yet again pull a rabbit out of the hat. Their stories are held up as examples of Singapore's success in ship building industry. In the 1960s shipbuilding and shiprepair were identified as key economic sectors as they could quickly create jobs for many workers. The Government took up stakes in shipyards, including two that were renamed Keppel Shipyard and Sembawang Shipyard.
After decades of growth, consolidation and expansion into the rig construction business, these two are today known as Keppel and SembMarine. However, their main activities are no longer in shipbuilding. Both now build rigs used by energy companies to drill for oil at sea. These include jack-up rigs ( for shallow water depth of 400feet ) - which cost around US$200 million (S$247 million) each - as well as the more expensive semi-submersible rigs that operate in deeper waters ( around upto 10,000 feet ). They can be priced at US$400 million to US$500 million each, with high-specification builds costing more than US$800 million. Those that are working for the north seas cost much more due to the harsher environment and many features that required additional cost to cater for.
Leadership challenged :
The lucrative rigmaking industry has increasingly seen competition from both Chinese and South Korean shipmakers in recent years. Like Keppel and SembMarine, Chinese shipmakers have been shifting from building ships to rigs, as the shipping industry continues to slump amid a massive oversupply of vessels.
With cheaper prices and more favourable financing conditions, these Chinese yards have been snapping up contracts from firms looking for lower-specification, lower-cost builds.
To add to the problem, more and more high-value contracts, like ultra-deepwater "semi-submersible" rigs, have also recently been going to Chinese yards, like Cosco and Raffles CIMC.
For instance, drilling rig services provider Frigstad Offshore early this year ordered two US$650 million untra-deepwater rigs from China's CIMC Raffles. Such orders are right up the alley of Singapore's rigmakers. They're one of the newest most advanced designs, meant to work in harsh deep water environments.
CIMC can build these two rigs for Frigstad is the day that CIMC is on a par with Singapore yards. They won't just be taking low-value rig work from Singapore. It is estimated that as of April 22, Chinese yards this year have won US$2.95 billion in jack-up rig contracts. This means they overtook Keppel and SembMarine, which won only US$2.12 billion.
At the same time, South Korean companies such Hyundai Heavy Industries, Samsung Heavy Industries and Daewoo Shipbuilding & Marine Engineering are also muscling in. They specialise in ship-shaped vessels such as drillships.
Keppel and SembMarine have been investing hundreds of millions of dollars in Brazil, especially after the 2007 discovery of likely rich oil reserves in the deep waters off the country's coast. The aim was to win lucrative rigbuilding deals from Brazil's state oil company Petrobras and its unit Sete Brasil.
Brazil has strict "local content" requirements which state that most of the components for oil platforms sold to these firms need to be produced in the country.
Keppel was an early mover, having been in Brazil since 2000. It bought a yard in the country in 2010 in order to focus on offshore support vessels which are used alongside oil rigs. This added to its existing yard which builds rigs.
And SembMarine is building a Brazil yard and has already secured contracts in the country.
All well and good, except that their biggest client in Brazil, Petrobras, has run into financial difficulties. These include spending and investments that have ballooned far more than initially planned, and government caps on how much it can charge domestic customers for oil. As a result, Petrobras shares have plummeted, losing half their value since 2010. Petrobras has also been squeezing the margins of its suppliers.
Also, Brazil is facing high inflation which could put upward pressure on labour costs.
Adapting to challenges:
TO THE credit of Keppel and SembMarine, they have already identified these issues and taken steps to ensure their businesses remain profitable. Mexico is one frontier. It is growing in importance after state oil firm Pemex made a big crude oil discovery in the deep waters of the Gulf of Mexico last August. Both Keppel and SembMarine have won deals from Mexican customers since then, leading market players to cheer their effort to seek out business opportunities in other high-growth markets.
The two companies are also focusing more on some of their specialities outside rigbuilding.
Keppel is co-designing an Arctic jack-up rig to tap the demand for platforms that can withstand the tough conditions there. The company has also signed a deal with Norway's Golar LNG to convert liquefied natural gas (LNG) vessels into Floating LNG vessels. This will give the firm more exposure to the fast-growing LNG market.
Both shipyards should continue to differentiate themselves, and spend more on research and development, say analysts.
"The key thing for Singapore yards is to find new products that are not in direct competition with these guys," said Mr Saw, referring to its overseas competitors.
Competition also works both ways. Even as Chinese companies eye the customers of Singapore firms, Keppel recently bagged an order from Falcon Energy Group, a company which previously ordered two jack-up rigs from China.
Back in the 1980s and 1990s the environment for the shipyard business was bad after the global recession of the mid-1980s, with cost pressures and external competition. The two companies were told at that time that they were in a sunset industry.
According to CIMB, Korean yards beat Singapore yards hands-down in terms of yard size. Each Korean yard is almost as big as the combined size of KEP’s and SMM’s yards in Singapore, explaining their competitive advantage in the market for large-scale offshore structures (newbuild FPSOs, FLNGs, TLPs) and drillships (hulls as big as 13,000 TEU container ships).
It also noted that very little apprehension was expressed over Singapore yards’ intention to break into the drillship segment as the Koreans’ market share appears to be protected by more advanced technologies and shorter construction time (of 12-15 months vs. >24 months for Singapore yards.
The Koreans were generally curious about Singapore’s capabilities in conversion and the outlook for jack-up rigs – in the event they decide to venture down the value chain. Though we were awed by the Koreans’ yard space, we believe Singapore still has the upper hand incosts, margins, business flexibility and global yard presence.
Firstly, a reliance on cheaper foreign labour is almost non-existent in Korea. The Koreans’ average low-end pay is US$40,000 p.a., triple that of Singapore.
Secondly, profitability remains the top priority of Singapore yards, with operating margins of 12% vs. the Koreans’ 8%. Thirdly, Singapore yards are able to diversify to from rig-building to building semi-sub accommodation and FPSO conversion while the Koreans remain fixated on high-steel content structures (newbuild FPSOs), ship-shape vessels (drillships, LNG carriers) and mass-produced containers in bulk orders.
Finally, Singapore builders leverage their global yard presence, including Brazil, to beef up their capacity.
Although Chinese rig builders have recently made some breakthroughs in rig building, they still are no threat to Singapore yards, CIMB said in a recent report about the offshore sector.
CIMB points out the rigs which are ordered at Chinese yards including Waigaoqiao and Rongsheng are "either heavily financed or have lower specifications" and heavy financing by Chinese yards is the main attraction for companies to build rigs in China.
"We are not overly concerned by the competition posed by the Chinese for Singapore yards. Traditional drillers with stronger cash flows should still find comfort in Singapore and Korean yards, unwilling to take on risks in quality and delivery," CIMB said.
The aged global rig fleet is in need of replacement as consumption for energy increases in emerging economies. Of the world's 500 jack-up rigs, about 300 are over 30 years old.
A new jack-up rig could set back a drilling operator or national oil company by about US$200 million at current prices. And now, their choices are not confined to the top five yards in Singapore or Korea any longer: China yards like Cosco, CIMC Raffles, and Dalian Shipbuilding have entered the picture. Barclays estimates that, Chinese yards have grown their market share of rigs from 5 per cent to about 30 per cent currently.
And it could increase further. Religare Capital surmised that Chinese yards will be capable of rivalling Singapore yards in terms of rig production capacity by 2015. The Barclays projections corroborate that: China yards may capture 10 percentage points more of market share in the next two years. While the perception is that Chinese yards stick to less complex and commoditised jack-up rigs, and are not competing head-on with the likes of Keppel and Sembmarine, that has proven to be increasingly untrue.
State backing has meant Chinese yards often offer discounts between 10-20 per cent off contract prices and extremely attractive payment terms of a one cent downpayment upfront and 99 per cent of the contract value upon delivery.
In contrast, Singapore yards have a milestone payment system or a 20 per cent-80 per cent payment structure.
But CIMB stands by their belief that the Chinese financier-builder model will not deprive Singapore yards of their fair share of order wins. Traditional drillers with stronger cash flows should still find comfort in Singapore and Korean yards, unwilling to take on risks in quality and delivery.
Yet, the aggression shown by Chinese yards has led to a drop-off in operating margins of rig projects, reported Keppel Corp and Sembmarine recently.
Gone were the boom eras of margins that could go as high as 20 per cent. Instead, going forward, management for both companies are keeping to more modest ranges of between 10 and 13 per cent.
For yards in general - whether in Singapore or China - they will see a weakening in pricing power because they're competing against each other for business.
Singapore yards have articulated clearly that their competitiveness hinges on a mixture of productivity gains and innovation.
"We recognise that there is increased competition in the rigbuilding sphere but we are
confident that Keppel Offshore & Marine is able to distance itself through innovation, technology and experience," COO of Keppel Offshore and Marine, Chow Yew Yuen told BT. Keppel has pursued a strategy of "Near Market, Near Customer", setting up overseas yards in markets like the US, Brazil and China to tap on interest from oil and gas regions around the world and to meet local content demands, said Mr Chow.
And Sembmarine will be shifting from its Jurong premises to a new Tuas Integrated Yard end of 2013. The new space is configured to minimise the movement of manpower and materials.
This year, Yangzijiang chairman Ren Yuanlin told BT that one way for Singapore yards to keep their edge over Chinese yards is to partner with them. Know-how is Singapore's strong suit while China has labour, a resource Singapore has sore demand for.
Yangzijiang itself pursued this strategy in 2010 when it bought over Baker Technology's 15 per cent stake in Sembmarine rigbuilding subsidiary PPL Shipyard, sharing board seats with Sembmarine.
Competition has emerged for the two Singapore companies with news that Daewoo Shipbuilding and Marine Engineering, part of South Korea’s Daewoo conglomerate, plans to re-enter the jack-up rig-building market since its last produced them in 1983.
Earlier this month two Chinese shipyards, Shanghai Waigaoqiao and China Rongsheng Heavy Industries, secured orders for three jack-up rigs, two of them for a Luxembourg-based company called Prospector Offshore.
Analysts say that while the emergence of rivals poses a long-term threat, it will take time for Korean shipyards to catch up as they are not yet configured to build jack-ups. DBS Vickers Securities adds: “However, the potential increase in competition from Korea may limit Singapore yards’ ability to raise prices”.
Potential customers for Chinese yards may be attracted by the financing packages they offer, but would have to overcome concerns over lower specifications and patchy delivery records at such yards, some market watchers said.
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