with Jon H. Wilmann, CFO, Sevan Drilling ASA
The financial difficulty of the Sevan Group was a big story last year. This year the group was extricating itself from these problems and Sevan Drilling was extricating itself from its parent. Would you take us through how the story developed and where we are today?
Sevan is a fairly young company, having been founded in 2001 by three Norwegian entrepreneurs. Their concept was to build, own and operate cylindrical FPSOs. The business model was built around two main competitive advantages. Firstly, these units are cheaper to build than a conventional ship-shaped FPSO because you do not require a turret and you therefore require less steel. Secondly, their operational performance is also be better than the ship-shaped design, with reduced pitch, roll and heave.
The owners took this innovative model to a very conservative industry – oil and gas – and were able to conclude a frame agreement with Petrobras in 2004. They listed the company in 2005 and they secured the first contract for the Ipanema. They raised a lot of equity and considerable amounts of debt to finance the Ipanema and further projects. On the back of the Ipanema contract Sevan also received a North Sea contract for the Hummingbird unit. Unfortunately, the first two units encountered heavy cost overruns and delays which hit the company hard financially and was the root cause for the financial difficulty in which the company found itself.
Before this happened, Petrobras had taken the initiative to develop the Sevan design for drilling units and awarded a drilling contract for the first unit, the Sevan Driller, in 2006 for the Gulf of Mexico. Petrobras then awarded a second contract in 2008 for the Sevan Brazil. Sevan therefore entered contracts with Cosco in China to build two drilling units. When I entered the company in 2010, my first step was to finance both the Sevan Driller and the Sevan Brazil. We put bank financing in place for these two units. Looking at the balance sheet today, we have healthy equity and bank financing in place.
The financial situation of Sevan Drilling was and continues to be different to that of Sevan Marine. The drilling business was assisted by two factors: drilling contracts are longer than those of production contracts and our drilling contracts were signed at the full market rate, whereas the first FPSO units were done at discounted, penetrating rates.
Why do you think you were able to get market rates on the drilling vessels?
It is an interesting question. It should have been possible for Petrobras to propose discounted rates for these drilling units because there was no buyer competition for this untested concept. At the same time, in order to attract financing, Sevan needed a certain rate to get the project up and running. I therefore think that the agreement was reached in order to prioritize the development of this concept, rather than cost savings for Petrobras. Then the second drilling unit was awarded in a tender in 2008.
What was the danger of going the same way as the FPSOs and getting into cost overruns and financial difficulty?
The first unit was the victim of cost and time overruns. The Sevan Driller was delivered, having been heavily delayed from China. However, this was more a case of unrealistic expectations than true delays. Sevan asked for the drilling rig to be completed in 18 months, when 30 months is the average time that the giant Korean yards take to build their semi-submersibles and drillships. The Sevan Driller ended up taking 30 months. There was simply no reason why it should have taken less time to build the Sevan Driller; Sevan’s expectations were simply too high.
Unfortunately, in terms of perception, there was a one year delay on the construction of the vessel. The budget was also completely unrealistic at USD 450 million when the final cost was USD 700 million. To put it in perspective, the average drillship constructed by Samsung and Daewoo is more expensive than the final cost of the Sevan Driller. Yet again from a market perspective there was a significant cost overrun. However for the second drilling rig the Sevan Brazil, with more realistic expectations, everything was delivered on time and on budget.
Sevan Drilling has placed its faith in the Cosco yards, which are the best in China. The Sevan Driller was the first drilling rig they had ever built and they did a very good job on this unit. Cosco then delivered the same quality in a shorter time for the Sevan Brazil. We have a very good relationship with them and now have a turnkey contract for number three and four drilling rigs which are underway. Number three will be delivered in October 2013 and number four will appear in March/April 2014. As turnkey contracts, Cosco is responsible for any future cost overruns.
How much supervision of the supply chain is needed in the construction of these vessels?
It is important to have a presence but the newbuilds require less of a presence than when we were building the Sevan Driller. Korea has built more than 30 drillships over the last 30 years and I feel that China too is heading towards serial production. It is clearly important to be present and we have a project management team in China to handle this. At the moment there are 15 people in this team but as we head towards the end of construction, this will move up to around 30.
What was the rationale in the first place behind separating the drilling business from the FPSO business of Sevan Marine with the IPO?
The drilling business is quite different to floating production, even though both are offshore oil and gas platforms, they represent different segments, attracting different investors. Increasingly investors are looking to invest in one business or the other. There were also no economies of scale between the two businesses, except in accounting. In terms of HR they represented very different recruitment businesses.
At the end of 2010 the investor community was ready to invest in the oil and gas business again, following the global financial crisis. This led to a series of divestments by Aker Drilling, Ocean Rig, Pacific drilling and many others. Ours was a part of this divestment story.
How challenging was it to build interest in this IPO, given Sevan’s financial challenges?
It was challenging for a number of reasons. Firstly, Sevan at that point was not a strong name among investors because of the lack of delivery and overpromising. Sevan Marine’s share price had dropped from 90 Norwegian Krone from the peak in 2007 down to below 6 and even 1.5 at one point during the IPO. As a result, there was a lot of fatigue in the investor market related to the name. In hindsight, the price we asked was too high, because it was a new design and a discount was needed. Another factor was that Pacific Drilling launched their IPO 2 weeks before us and the share price shot down 10 percent immediately. However in spite of these major challenges, we managed to raise USD 360 million which was an achievement.
How was your relationship with Petrobras throughout these challenges?
Petrobras has been extremely supportive of both Sevan Marine and Sevan Drilling. Without this company it is clear that neither company would be in the market today. Petrobras took a bet on this company, awarding contracts without any track record which is pretty bold and they have been extremely important in developing this company. That said, they do not operate as a charity and are a very professional counterparty. We have had to vindicate their trust in us.
The Sevan design has some innate competitive advantages, which Petrobras appears to like. The motion characteristics are better than, those of semi-subs or drillships. This better sea performance equates to longer uptime for the operator. From an environmental perspective, the second factor is that our design has a moon pool, which a semi-sub does not. The riser and the drill string are protected in this moon pool, whereas in a semi it is just open sea. Our units are also cheaper to build, so we do not need the peak rates to generate returns, so from a pricing perspective we are competitive to semisubmersibles and drillships.
If you compare the Sevan concept to a drillship, then the deck capacity, which is important in deepwater drilling is basically the same as on a drillship and three times higher than on a semi-sub. This is why you see very few semi-subs in deepwater drilling. Regarding storage capacity, the Sevan concept has slightly larger storage capacity compared to drillships and it is much larger than on semi-subs. Semi-subs have better motion characteristics than drillships and that is why you see many semi-subs used in harsh environments – due to their stability. The Sevan motion characteristics are equivalent to semi-subs. We therefore combine the best features of semi-subs with the best features of drillships.
What then are the limitations of this cheaper solution?
Our heave is larger than on semi-subs, but we are working to reduce this. For the moment we are therefore less competitive than semi-subs in harsh environments. Also, when it comes to transit speeds, drillships have a major advantage in moving at a transit speed of 30 knotts. If a contract demands that you move from one location to another you need to have this type of transit speed. If you have a contract demanding one well in Brazil, one in West Africa and one in the Gulf of Mexico then drillships are much faster at carrying out this work. However, most contracts are within one geographical area so we are not excluded from too many contracts. So the main weak points would be harsh environments and transit speeds but in all other areas, the Sevan concept has competitive advantages.
Nonetheless, pushing this concept forward is challenging because this is a very conservative industry and drilling is the most expensive component of this industry. Predictability of delivery is important for oil companies and proving a new concept is therefore extremely difficult. As time goes on the market, including conservative players like Chevron, Shell and ExxonMobil, will start to recognize the advantages of the Sevan concept and our organization.
Some of the people who have worked on our rigs have been in the business for decades. However we are a new company, with a new design and building in China, so time is needed to calm the scepticism of the majors. We believe national oil companies like Pemex, Petrobras, ONGC, and Petronas and Pertamina are companies which could move towards this design as well as the independents like Anadarko, Repsol and BG Group.
Looking at your international development, do you plan to focus on building up in Brazil, or are you looking to expand into other regions?
In terms of building up our global position, the most effective method is simply to deliver these units on time and make sure that we do a good job for our clients. It is important to attract new clients and in doing so you build up the possibility of working in new areas. Petrobras currently handles 80 percent of the contracts awarded in Brazil, but it is important to diversify the client base and the risk. By expanding our client base we will gain further acknowledgement of the concept. We will try to move these units into other geographic areas, these are mainly West Africa and Gulf of Mexico which are areas where we have a competitive advantage.
China is also an interesting market but so far there is no deepwater drilling. The day they start contracting for exploration or development drilling, Sevan Drilling would like to be involved. The fact that we are building in China should be a competitive advantage. When you are building in China you really feel that you are dealing with China Incorporated. We are not just working with Cosco but attracting financing through Cosco from companies like CNOOC. Indonesia would also be an interesting geographic area for us to work, given the balance in E&P between NOCs and IOCs.
How do you see the pace of development of Sevan Drilling over the coming 5 years?
Sevan Drilling has not been in the same distressed situation as Sevan Marine; it has been a stable company since the IPO. In addition, since November 2011, Seadrill acquired Sevan Marine’s stake in Sevan Drilling. Seadrill is the world’s most successful operator – they are a strong owner.
There is however a high financial risk associated with Sevan Drilling coming from the fact that we have high leverage. The most important step going forward is to deleverage the company. We are aggressively amortizing the debt that we have today. In addition, rigs three and four have much lower capex than the previous two and they are exposed to a market with much higher day rates than the first two. Assuming market rates for those two units, this will generate deleveraging for the company and will give us better financial flexibility.
If you measure risk by operational leverage: debt to EBITDA, we are aiming to move from a net ratio of more than 8 down to 3 in 2015 when all four rigs are on contract, assuming that all rigs are at market rates. The key will be to get contracts for rigs 3 and 4. We then have options for a further two rigs from Cosco