01.11.13 Established Growth And Emerging Opportunities

David Phillips, managing director, HSBC Global Equity Research, Oil & Gas and Oilfield, spoke to S2S about the challenges and opportunities for subsea services.

We see the subsea services sector as vitally important to investors who are tracking the performance of the global oil and gas services industry. In Europe, offshore oil and gas have been the most important drivers in the oilfield services sector, with about three-quarters of oil and gas company earnings coming from the offshore arena. Subsea services are clearly a crucial part of the picture in Europe and in many other parts of the world, particularly where huge oil and gas reserves are being tapped by new deepwater developments.

Subsea services is an established growth area within the oil and gas industry, and has had sustained growth for the past 10–15 years. Since its foundation in 2004, we have seen Acteon being an exemplar of this trend. By acquiring companies that offer complementary services in the subsea services arena, it has extended its technical capabilities, product lines and global geographic reach.

Following the brief pause that resulted from the global downturn, the subsea services sector is moving forward once more; we have witnessed growth of about 10–15% per year over the past few years. We believe that this is very encouraging for subsea services companies. It shows that there is a continuing global appetite for investment in subsea infrastructure and suggests there are opportunities for further growth in the marketplace.

Responding to market conditions
As equity analysts, the main challenge that we see for subsea services companies today is achieving and maintaining a good rate of growth. Sustained growth will depend on the decisions that companies make in relation to where and how they choose to operate. The key requirements are to be participating in the most profitable regions, to have the right technology and to be patient. Patience is essential in parts of the world where substantial upfront investment is required or where the payment systems operated by customers hinder cash flow.

In many industrial sectors, companies see the potential threat of increased competition as a serious issue. In subsea equipment and services, the emergence of new competitors is likely to be limited because there are significant entry barriers to the subsea arena, so it seems likely that the established names in the sector will continue to dominate. However, as the business cycle improves, other companies are likely to try to make their presence felt, particularly in vessel-based subsea services such as maintenance and inspection, and construction. Any new entrants will make demands on resources such as skilled employees, for example, engineers, and this could stretch already limited resources.

When they operate internationally, subsea services companies must also have an awareness of and sensitivity to issues of local content. Most companies will need to hire a high proportion of local staff and, when operations start, they may have to deal with companies in the local supply chain that they have never heard of. For example, it is vital to have access to the right number of Portuguese speakers in Brazil. Companies like Acteon will maintain or expand their market position by being based in the best locations, finding appropriate local partners and ensuring that the services they offer meet or exceed customer requirements.

Regulation and risk
Another factor that plays an important part in setting the business agenda is regulation and perception of risk. Post-Macondo, many oil and gas companies have become even more cautious about who they choose to use as subcontractors, particularly for the supply of critical equipment. Consequently, the barriers to new suppliers and new systems entering the subsea services market are high. Renewed emphasis on safety and strict adherence to new regulatory frameworks have required additional scrutiny for offshore projects. However, the industry is becoming more familiar with the interpretation and implementation of these post-Macondo changes, so they are gradually becoming less of a barrier to project initiation, although project design and product qualification is often still an onerous process.

Leading subsea services companies like Acteon can point to their track record of delivering high-quality projects, long-standing business relationships and ability to influence the market. These characteristics will help them to forge closer customer links and to find new business opportunities with oil and gas companies that want to work with wellestablished service partners.

Politics and taxation have always been important issues for the oil and gas industry: both have a direct influence on the commercial attractiveness of subsea developments. Recent events mean that we are living in a world that is politically less certain than it was just 18 months ago, so international oil and gas companies will weigh investment decisions against potential political or fiscal changes in emerging markets. For example, in Mozambique, there is huge potential for gas development and a highly profitable liquefied natural gas scheme. However, the possibility of changes in the local tax regime or in the profit/production sharing agreements that the government imposes could have a profound effect on the attractiveness and potential profitability of a development project.

Despite these issues, we expect offshore developments, particularly in deepwater settings, to be a major source of hydrocarbon production and revenue over the coming decades and that oil and gas companies will continue to find attractive investment opportunities offshore.

Looking to the future
Over the next few years, we expect to see the offshore rig count increase by some 30%. The number of rigs available for operations, particularly in demanding environments or deep water, has been a bottleneck in the past. The leading players in the market are increasingly keen to make use of new rigs rather than older ones, but greater rig availability means more operations and rig costs may fall slightly as new assets enter the market.

Growth will continue, though it may be affected by oil price volatility. Continuing unrest in areas such as the Middle East and North Africa could lead to an upswing in the oil price, but the oil and gas companies will not see this as a green light to do more work. Oil companies will continue to be cautious over the coming years; many of the projects now being pursued were held over from the last cycle.

We anticipate that rates of growth in the subsea services sector will vary from place to place around the world. Africa offers higher potential growth for the subsea sector than any other region, but this is tempered in some countries in the region by a higher perceived risk for the oil and gas companies that may wish to operate there.

In South America, Brazil will continue to lead the way in terms of overall activity, although there is a need for improved infrastructure and better equipment to meet the operational demands that the country’s offshore industry faces. Other regions with good growth prospects include Mexico, which is moving towards the long awaited opening up of its energy industry to international companies.

Growth in Asia will be dynamic but from a relatively low base. We think the need here is for more technical experience and better vessels to achieve the necessary developments. In Australia, the focus will be on the emergence of liquefied natural gas projects.

In the more mature subsea markets of Europe and North America, the picture is one of stable-to-growing development using established techniques and technologies. We anticipate that growth in the North Sea will be steady rather than spectacular with a mix of brown- and greenfield work and that in the Gulf of Mexico growth is likely to be faster, especially in deep water.

In order to respond to and maximise the value from these opportunities, international subsea services companies will have to balance their levels of commitment and exposure in the various markets around the world and to seek the appropriate commercial balance between longterm stability and rapid growth opportunities.

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