OIL & GAS - Potential for better setting from Brazil FPSO supply side woes

Date: 
2024-02-20
Firm: 
AmInvest
Stock: 
Price Target: 
4.00
Price Call: 
BUY
Last Price: 
2.35
Upside/Downside: 
+1.65 (70.21%)
Firm: 
AmInvest
Stock: 
Price Target: 
7.81
Price Call: 
HOLD
Last Price: 
8.01
Upside/Downside: 
-0.20 (2.50%)

Investment Highlights

  • Another punch to the gut for Petrobras as floater companies continues to shy away. Brazil’s national oil and gas company announced that it has pushed back the submission date by as much as 4 months for proposals of 3 key floating production storage and offloading (FPSO) tenders: SEAP-1 and SEAP-2 for the Sergipe-Alagoas tender as well as the Barracuda-Catinga field. This is the third delay since our report (Tender Submission Delayed for Sergipe-Alagoas Basin Floaters) back in October 2023. The rationale for the delay is to improve bidding rules to enhance the commercial viability of the projects.
  • When push comes to shove. We gather from Upstream that FPSO companies have turned away from these tenders due to high costs associated to acquire very large crude carriers (VLCC) to convert into FPSOs. Most recently, Rystad Energy reported that hull construction costs at Chinese shipyards, the major beneficiary of FPSO conversion and newbuilds in recent years, are expected to increase by 3.2% in 2025 due to surging wages for the labour-intensive process amid an ageing workforce. This is on top of the already high modular construction costs which rose by over 15% during the Covid-19 pandemic period which has yet to subside. Additionally, FPSO companies are reportedly unable to meet the relatively high minimum local content requirement of 30%- 40% to competing prospects globally as Brazilian local contractors are unable to provide topside modules at a competitive rate. The high lending cost has also been a bane as the lending market remains risk averse to sectors with high carbon emission standards, particularly so for Scope 3. For reference, in our recent engagement with a local oil and gas contractor, funding costs are estimated to have risen by more than 300bps in recent years. Similarly, we observe these patterns in pre/post-step-up rates for perpetual bonds held by Yinson.
  • Industry-wide issue, yet addressable, nonetheless. We believe these issues are interrelated and addressable. We understand from industry players that Petrobras is looking towards providing significant upfront payments of up to 50% of contract value to assist FPSO players. We believe the larger portion of equity financing will be able to offset the elevated cost of financing and thus lower the overall cost of capital to finance FPSO conversion works. We expect to see a lower local content requirement, down to a minimum of 25% based on the latest FPSO P-85 bid for the Buzios development. We also believe Petrobras may relax its approach on measuring local content requirements, which may include the use of raw materials sourced from Brazil itself, rather than the construction of modules. As for financing, we gather from FPSO companies that they are looking at alternative lenders such as infrastructure funds willing to provide quasi-equity funding at rates of 8%-9%.
  • Brazil may be back in play if bidding environment improves. Brazil presents the largest area of growth for the FPSO market with 22 upcoming planned FPSO projects. If changes are made to the bidding process and the issues are addressed, we believe Brazil may come back as a potential bid market for Malaysian FPSO players. We believe the prime beneficiary will be Yinson (BUY, FV: RM4.00) as the company has an existing track record with Petrobras with 2 FPSOs to be delivered by 2025. Management has recently indicated to us that they are cognizant of single-country risk exposure to Brazil but are ready to re-enter the bidding market if conditions were to improve with preference for conversion works through a single party negotiation and partial upfront payments.
  • Alternative hull fabrication hubs to benefit from stronger job flows. According to Rystad Energy, owing to its already high-cost basis, hull conversion works in alternative hubs such as Malaysia is expected to rise by 2% and Singapore by 1.3% between 2024 to 2025. For modular construction costs, Malaysia is expected to see an increase of 0.6% and Singapore 1.3%. The relatively modest rise compared to China provides an opportunity for these hubs to capture external job flows. We see Malaysia Marine and Heavy Engineering (Non-Rated) as a potential beneficiary. As the company continues to grapple with legacy contracts, new external job wins with stronger margins which account for the rise in construction costs may help its recovery, providing stronger earnings to its parent company, MISC (HOLD, FV: RM7.81).

Source: AmInvest Research - 20 Feb 2024

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