Subsea construction/engineering firms:
Who will benefit from drilling in the Santos basin offshore of Brazil?

By Gillian Livingston
Globeinvestor Magazine Online, July 21, 2008

Brazil’s potentially massive Santos oil field discoveries in the deep waters off the South American country’s coast could be a multibillion-dollar bonanza for the world’s subsea companies who have the expertise to get at vast reserves of hidden oil under the ocean.

There’s only a handful of companies in the world with the know-how to build the wells and platforms needed to extract oil from below the sea floor. A few key names in the subsea installation sector include Subsea 7 Inc. (SUB-Oslo), based in the Cayman Islands; France’s Technip SA (TEC-Paris); London-based Acergy SA (ACY-Oslo); and Saipem SpA (SPM-Milan) from Milan. A recent report by UBS tags these four names as the subsea installation firms to watch as Brazil digs under the ocean floor for oil. UBS suggests subsea installation firms could see revenue of $180-billion (U.S.) or more from work in the Santos basin.

Reserves in the basin could reach 50 billion barrels of oil equivalent, UBS says in its report. Developing these fields over the next decade and beyond will have a significant impact on oil services companies, particularly the subsea installation sector.

To these companies, Brazil represents one-third of their business, said London-based UBS analyst Alex Brooks, one of the writers of the report. “And that will grow substantially,” as the fields offshore Brazil are developed by Petrobras, the country’s state-owned oil producer, formally known as Petroleo Brasileiro SA.

Exactly how much these and other companies might reap from the ongoing development in the Atlantic Ocean shores off Brazil is hard to pinpoint, he said, due to the early stage of development.

However, the scope of the work will be huge, Mr. Brooks added. If development occurred in just the Tupi field, estimated to have five to eight billion barrels of oil, “that alone would provide enough work for the entire industry for a couple of years,” he said. “Whatever happens, it will have a very material effect on these companies.”

Thomas Dietz, head of the European small companies team with ABN Amro, recently taken over by the Royal Bank of Scotland, says because of the magnitude of the work that will be doled out in coming years, almost all subsea companies in the world will benefit in some way from Brazil’s offshore development. For example, in June, Petrobras said it would lease 57 drilling rigs between 2009 and 2017 to develop the oil-rich basin. So far, about half of the rigs needed are contracted but another 28 must still be leased – and they must be built in Brazil, Petrobras said.

Firms are already working to beef up their manufacturing operations in Brazil, or build new factories to handle the demand, Mr. Dietz said, since Petrobras is insistent that most of the work relating to the offshore development happens within its borders. That means that companies that already have facilities in Brazil are a step ahead of others.

“You could say nearly every oil services company is going to benefit from any kind of development in Brazil because it’s such a vast market and Petrobras – oil price being what it is – is very keen to develop its resources as soon as possible,” Mr. Dietz said. In addition, Petrobras has the resources to finance these massive projects.

Of the four big firms named by UBS, Subsea 7 stands to benefit the most, the analysts said in their report, mainly because it has the highest exposure to Brazil of the European services sector with 36 per cent of its backlog in Brazil. But Mr. Brooks couches that statement: “Frankly, the differences are marginal.”

UBS likes Subsea 7 in particular because of the investments the company has made in recent years. “The strength of Subsea 7 is that it has a younger fleet than the others by about five years,” he said. Its average fleet age is about 7 years, while the others are at about 12 years.

Acergy and Technip have “significantly” larger engineering businesses than Subsea 7, which gives them the ability to take on more unusual work where they have to design or adapt rigs or other equipment.

Technip, the world’s largest flexible pipe manufacturer, will see more work because Petrobras already employs that technology, Mr. Dietz said. “Technip has a very good position and history as well with Petrobras,” he added.

Acergy and Subsea 7 are also strong. Subsea already has vessels under contract to Petrobras “so they have recurring work there,” Mr. Dietz said.

There’s a few other names in the business that Mr. Dietz expects will get a fair chunk of business from Petrobras. Floating platform builder and operator Sevan Marine ASA (SEVAN-Oslo) in June won an offshore drilling contract with Petrobras. The company will now have two drilling rigs contracted out to the Brazilian energy giant. Bermuda-based Seadrill (SDRL-Oslo), an offshore drilling contractor, won three significant contracts from Petrobras in April totalling $4.1-billion (U.S.).

Although Canada has several big firms who own offshore oil fields and an array of smaller firms that work in the subsea sector, they weren’t pinpointed in the report by the UBS analysts to be heavily involved in the Santos Basin at this point. However, Canada does have firms involved in offshore developments with Petro-Canada, a part owner in Hibernia; EnCana Corp. with its Deep Panuke natural gas operation, and Talisman Energy Inc. and Nexen Inc. with their operations in the North Sea.

Investors looking to dive in, make a quick buck and jump out won’t be interested in the subsea business, Mr. Brooks said. “Frankly, it’s a very, very long-term story.” These companies won’t likely see any “significant” orders from the Santos basin until 2011, he said. And from the awarding of a contract to its completion can be upwards of two and a half years, he added.

But as long as oil prices stay above $85 (U.S.) these discoveries will be worth developing. “Every single project out there makes money at $85,” Mr. Brooks said.

Though the work will be done over the next 20 years, “there is a phenomenal amount of activity going on currently,” Mr. Dietz said. “So all those companies are generating a lot of revenues already.”

Currently, the Santos basin and offshore Brazil is expected to see development from now until about 2025 – and further if new discoveries are made, Mr. Dietz added.

Offshore Brazil is not the only area of the globe where companies are drilling into the seabed for oil. There’s work in West Africa, the North Sea, and the Gulf of Mexico. There’s also lots of activity around the world in East Africa, India, Australia, Southeast Asia, Malaysia and Vietnam.

For investors, they should watch the trend of which companies are getting the best contracts. Investors also have to realize that it’s a bit of a feast-or-famine industry. “This is a lump sum business,” Mr. Brooks said, and right now, and over the next number of years, it’s expected to be a busy time.