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BERENBERG EQUITY RESEARCH

Oil Field Services

Bottom-up analysis points to earnings growth

Part I: sector overview

Asad Farid, CFA

Analyst

+44 20 3207 7932

[email protected]

Jaideep Pandya

Analyst

+44 20 3207 7890

[email protected]

10 July 2013

Oil & Gas

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For our disclosures in respect of section 34b of the German Securities Trading Act (Wertpapierhandelsgesetz – WpHG) and our disclaimer please see the end of this document. Please note that the use of this research report is subject to the conditions and restrictions set forth in the disclosures and the disclaimer at the end of this document.

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Table of contents

Bottom-up analysis points to earnings growth 4

Executive summary 5

Sector performance – oil beta has lowered 13

E&P capex decouples from oil price at above USD100/bbl 15

Demand – offshore capital spending to remain strong 19

Profitability and growth: a sector headed towards earnings recovery 26

The supply side responds 31

The value chain 40

Technology matters 45

Preference and selection framework 49

Valuation and performance 56

Risks to thesis 60

Contacts: Investment Banking 61

Disclosures in respect of section 34b of the German Securities Trading Act (Wertpapierhandelsgesetz – WpHG) 62

Oil Field Services Oil & Gas

4

Bottom-up analysis points to earnings growth

In the last 10 years, the European oil services sector has outperformed the European integrated sector and the wider market by more than 3x following a 3.7x increase in the price of oil. More recent performance has been lacklustre, with the sector index declining by 19% ytd on the back of negative earnings momentum due to one-off contract losses.

In a separate note also published today, we initiate coverage on Aker Solutions, Subsea 7 and Technip (all Buys) and on Saipem and Petrofac (both Holds). We are positive on the sector for three reasons.

o Demand outlook is robust: Consultant Infield projects subsea capex to grow at a CAGR of 15% over 2012-17.

o Oil beta has lowered: E&P capex decouples from the oil price when the latter surpasses USD100/bbl. Over 2008-12, E&P capex and the Brent oil price grew at CAGRs of 11%/3% respectively, while in 1998-2008 respective growth was 20%/23%. This is because even the most difficult projects (ie in the Arctic or in ultra-deepwater) are feasible above this price level.

o Consolidated market: The deepwater subsea installation and hardware markets are highly consolidated with strong entry barriers. If E&P demand grows, pricing/margins will expand.

Our sector approach: The conventional sector view is based on a top-down approach driven by oil price projections and associated global E&P capex. This macro level approach makes earnings momentum difficult to forecast. Our methodology is based on a bottom-up modelling of:

o revenues and the profitability of companies’ individual contracts;

o global E&P capex following analysis of the multi-year capex programmes and production targets of 13 large NOCs and IOCs.

Based on this analysis, we expect a margins recovery, which should help the sector re-rate back to levels in 2012 on 12-month forward P/E for the following reasons.

o Improved pricing on new contracts: The number of large contract awards (more than USD0.5bn) has risen since 2009. Market consolidation and strong demand has resulted in tight installation and hardware markets.

o Project phasing: Better quality contracts won since 2011 will be in their late execution phase from 2014 onwards. This will provide a positive skew to margins – profit recognition is highest at the late execution phase.

o Phasing out of bad contracts: Low-margin contracts won in 2009/10 are now at a late execution phase. From 2014, their share of the backlog should fall sharply and hence lift overall margins.

We prefer stocks with exposure to 1) the hardware and subsea installation sectors, 2) Brazil and West Africa, and 3) national oil companies (NOCs) and integrated oil companies (IOCs) such as Petrobras, Statoil and Total over smaller independents.

Stock preferences

o Aker Solutions (Buy): Strong exposure to hardware.

o Subsea 7 (Buy): Recovery in earnings momentum due to phasing out of low-margin contracts and opportunities to grow.

o Technip (Buy): Strength in subsea and diversified services.

o Saipem (Hold): Exposure to commoditising downstream and shallow water E&C projects plus legacy issues.

o Petrofac (Hold): Risky capex heavy growth strategy to enter subsea installation segment where it lacks competitive advantage.

Aker Solutions

Buy (initiation) Current price

NOK82.00 Price target

NOK115.00 9/07/2013 Oslo Close

Subsea 7


NOK107.50 Price target

NOK146.00 9/07/2013 Oslo Close

Technip


EUR80.90 Price target

EUR106.00 9/07/2013 Paris Close

Petrofac

Hold (initiation) Current price

GBP12.50 Price target

GBP13.70 9/07/2013 Oslo Close

Saipem

Hold (initiation) Current price

EUR14.30 Price target

EUR14.20 9/07/2013 Milan Close

Rating system: Absolute

10 July 2013

Asad Farid, CFA Analyst +44 20 3207 7932 [email protected]

Jaideep Pandya Analyst +44 20 3207 7890 [email protected]


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Executive summary

Over the last decade, the European oil services sector has outperformed the European integrated oil majors and the market on the back of a 3.7x increase in the price of oil from 2003 levels. However, over the last two years, its performance has been far less impressive, mainly due to flagging earnings momentum (the result of various execution challenges) as well as the effects of project phasing (where low-margin contracts won in the tough operating environment of 2009-10 have entered the late execution phase). The price of oil during this period has traded sideways, while E&P capex growth has been strong at +20% pa.

We expect an earnings recovery from 2014 onwards due to the phasing out of low-margin contracts and the improving quality of the sector’s order book for. Pricing, we think, is improving for subsea installation and hardware on the back of strong growth in global E&P capex and due to the highly consolidated nature of the sector. We expect that E&P spend will remain strong over the next five years, driven by investment in deepwater and ultra-deepwater offshore fields.

We think that subsectors and associated services with high technological content will tend to outperform. We prefer the offshore exploration and construction (E&C) and hardware subsectors over the downstream E&C subsectors.

Today, we initiate coverage on five companies in the oil field services (OFS) sector: Aker Solutions (Aker), Subsea 7, Technip, Petrofac and Saipem (please see separate initiations note entitled Bottom-up analysis points to earnings growth – Part II: company initiations, also published today).

Within this coverage universe, we have Buy ratings on Aker, Subsea 7 and Technip.

Aker is a leading supplier of high-end subsea field equipment and drilling systems for deepwater rigs and a market leader (with a 40% market share) in after-life services, especially in the Norwegian Continental Shelf (NCS) area. The key reasons for our Buy rating on Aker are as follows.

• Aker has strong positioning in the value chain, where it has exposure to both subsea hardware capex and after-life opex. The hardware market is tight and prices are trending upwards (pricing for Christmas trees, for example, is up by 14% for 2010-2012). There is rising demand for deepwater equipment (Christmas tree demand growth: a CAGR of 12% between 2013 and 2016) and drilling packages, which are both product areas in which Aker specialises, and should support earnings momentum in the future.

• The structure of the hardware market is conducive to incumbents in that technological barriers to entry are high and the market is already highly consolidated, with the top five players controlling more than 80% of the market. This should help incumbents such as Aker maintain high margins.

• We forecast that Aker’s sales and EBITDA will grow at a three-year CAGR of 12.9% and 14.7% respectively over 2012-15. This should be supported by improvements in project execution and a reduction in quality costs (which are costs associated with poor project execution) as well as by an aggressive capex plan to boost manufacturing capacity.

• Valuation is undemanding; the stock is trading at a 12-month forward P/E of 7.3x, well below the average of ~12x over the last three years. Our DCF-based target P/E ratio is 10.3x based on 2014 EPS estimates.


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Subsea 7 is a global leader in subsea field development with a particular expertise in the subsea, umbilicals, risers and flowlines (SURF) sector. The company is a pure installer with associated rigid pipe manufacturing and spooling facilities. Our Buy recommendation is based on the following.

The company is gathering upward earnings momentum, due to the phasing out of loss-making and low-margin Brazilian contracts. The intrinsic margins on revenue streams generated by the current order book are set to rise from 2014 onwards.

Subsea 7 has a sector-leading asset base, including 40 deepwater and ultra-deepwater vessels, along with a strong position in the high-margin West Africa area. We believe that its strong asset base, established track record and geographical reach will help the company leverage on the strong anticipated growth in the subsea installation segment, which is expected to grow at a 15.4% CAGR over 2012-17. Market consolidation should also help limit any downward pressure on pricing, in our view.

The stock has de-rated and is down 19% ytd due primarily to one-off loss provisions on a single bad contract. It is trading at a 12-month forward P/E of 8.3x (based on Berenberg’s 2014 EPS estimates) as compared to the five-year historical average of 14.5x. Similarly, its discount to its closest peer Technip has grown to 11% versus a five-year average premium of 2%. The DCF-based price target of NOK146 assumes a terminal growth rate of 1% and a WACC of 9.8%.

Technip is a leading global oil services contractor with a dominant position in subsea installation and field hardware (flexible pipes and umbilicals), and with engineering expertise in high-end onshore LNG, gas to liquid (GTL) and petrochemicals projects. The key reasons for our Buy rating on Technip are as follows.

• Technip has a diversified product portfolio including hardware (flexible pipes), installation (34 vessels) and front-end engineering (via subsidiaries Genesis and Stone & Webster) and a balanced order book (46% in the high-growth subsea division and 54% in the onshore/offshore division), which gives it a competitive edge over its peers. It has a wide geographical coverage, with a strong presence in the subsea installation market in the North Sea (where it is the joint market leader), Brazil (market leader), the Gulf of Mexico (GoM) (a top three player) and West Africa (a top three player).

• It has a strong technology and engineering focus, including a leading market share in flexible pipe systems for field development and expertise in floating LNG (FLNG) – both of these product areas are expected to see strong growth due to strong E&P spending in deepwater/ultra-deepwater capex.

• We forecast that Technip’s sales and EBITDA will grow at a three-year CAGR of 14% and 16% respectively over 2012-15. We expect this growth to be supported by a strong project bid pipeline in both West Africa and Brazil, which are its core markets. Pricing improvement in hardware should also support earnings momentum.

• The stock is de-rated, despite its strong financial performance, and is trading at a 12-month forward P/E of 10.8x, which is well below the five-year historical average of ~14x. Our DCF-based price target of EUR106 offers an upside of 31%.


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We have Hold ratings on Petrofac and Saipem and believe they are fairly valued in light of their respective evolving risk-return profiles.

Petrofac is strongly positioned in the mid-tech downstream arena in the Middle East, North Africa and central Asia, and also has upstream equity exposure and a strong position in the management of offshore infrastructure in the UK North Sea and Asia-Pacific. Our Hold recommendation on Petrofac is based on the following.

• Petrofac has a risky capex-heavy growth strategy to enter the SURF market. Given that Petrofac does not have any execution track record or competitive advantage and also lacks local content, we feel it will be difficult for the company to penetrate the SURF market. Furthermore, following the entry of several new players (which between them will introduce 12 new high-end vessels by 2016), we think profitability in the SURF market will come under pressure in the medium term.

• Petrofac has excessive exposure to the Middle East and Africa (c57% of onshore E&C construction sales) where margins are structurally decreasing due to tight competition. This makes margin contraction likely over the medium term if Petrofac is to reverse backlog erosion on a sustainable basis. We forecast an EBITDA margin drop of 0.25% for 2012 versus 2015.

• The higher capex commitment being made by Petrofac to build up its offshore fleet, and the resultant cash flow and balance sheet stress, could compromise growth in its high-margin Integrated Energy Services (IES) division, which will also be undergoing a heavy capex phase over the next three years. We forecast gearing (net debt to equity) will rise to 46% by 2015 compared with the net cash position at the end of 2012.

• We forecast that Petrofac’s ROCE will decline from 30% in 2012 to 16% by 2015 as a result of 1) margin compression in onshore E&C and 2) the high start-up investment needed to enter the SURF segment over the next five years.

• Trading at a 12-month forward P/E of 9.5x for 2014, Petrofac does offer value (a 27% discount for 12-month forward to the historical average) but given that a) the outlook for profitability in its core business (onshore E&C) is negative and b) the aggressive capex plan will put pressure on ROCE and the balance sheet, we remain cautious about the stock.

Saipem is one of three oil services contractors with a global coverage and has a diversified offering comprising offshore and onshore engineering and construction as well as drilling services. Our Hold recommendation is based on the following.

• Saipem is positioned at the low-tech end of the value chain, which is seeing an increase in competition. In onshore, it has lost market share and is struggling to compete with cost-efficient South Korean peers which have access to the Asian value chain. This has led to a sharp erosion in the backlog and margin compression. We think margin improvement will be at the expense of growth.

• In offshore, it has poor exposure to the high-margin deepwater subsea installation market, at which an increasing proportion of future E&C capex is likely to be aimed, especially with the maturation of the subsea factory concept. It has stuck to shallow water trunklay and platform installation work using an ageing vessel fleet which demands high maintenance capex.


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• Saipem also lacks flexible pipelay installation capability, which is Petrobras’s preferred field development method in a region where Saipem intends to grow. While non-core, its drilling division has performed well, but growth will be limited as the capex programme is largely complete.

• We expect sales and EBITDA to grow at a three-year CAGR of 0.8% and -5.1% respectively, which is lower than consensus over 2012-15. Our DCF-based valuation of EUR14.2 implies a downside of 1%.

Investment recommendations

Source: Berenberg estimates

Key issues

Macro framework and oil price outlook: The OFS sector has historically had a high correlation with the oil price as its earnings stream is driven by investment in greenfield projects and in redeveloping existing infrastructure in mature basins. The price of oil affects the overall capex cycle through a transmission mechanism linked to the cash flow of oil and gas producers. However, above an oil price of USD100/bbl, changes in E&P capex decouple from changes in the price of oil. This is because most projects, even those which are technically challenging (ie in ultra-deepwater or the Arctic), are sanctionable when the oil price is above USD100/bbl. This explains why growth in E&P capex has remained strong (at 20%+) over the last two years amid stable oil prices.

Based on IEA projections for global oil demand and non-OPEC oil supply (the two structural determinants for the oil price level) for 2013-15, we estimate that the Brent oil price will largely trade sideways over the medium term and average in the range of USD104-112/bbl (please see table below).

Significant upside to the current oil price is limited for the following reasons.

1) Oil demand weakness: IEA projects that global oil demand will grow at a three-year CAGR of 1% over 2012-15, compared to the 10-year CAGR of 1.4% during 2000-10. Concerns about a slowdown in China and a flagging recovery in OECD economies are lowering expectations for oil demand growth.

2) Rising non-OPEC oil supply: Non-OPEC supply is increasing as a result of the re-start of closed fields in the North Sea and Brazil, production ramp-up in Brazil and increased drilling activity in mature basins such in the GoM, the

Companies

Market

capitalization

(local bn)

Recommen

dation

Target

price

Share

priceUpside P/E

EV/EBIT

DAEV/EBIT

Aker Solutions (NOK) 22.5 Buy 115 82 40% 7.4 5.2 6.8

Technip (EUR) 9.1 Buy 106 81 31% 10.8 5.9 7.3

Subsea 7 (NOK) 37.8 Buy 146 108 36% 8.3 3.7 5.0

Saipem (EUR) 6.3 Hold 14.2 14.3 -1% 13.7 7.2 13.4

Petrofac (GBP) 4.3 Hold 13.7 12.5 9% 9.6 6.8 8.1

Sector average 23% 9.9

Sector weighted average 14%

Based on Berenberg 2014 est.


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North Sea and Asia-Pacific. In the long term, this trend is being helped by rising unconventional oil supplies, especially from the US (shale) and Canada.

3) Weakened OPEC flexibility: OPEC spare capacity has declined since 2010. Furthermore, a rise in fiscal spending has implied an increase in the break-even oil price for OPEC countries over the last five years (in 2008, the break-even oil price for Gulf Cooperation Council (GCC) countries was USD46 per barrel, which increased to USD75 per barrel in 2012). The greater fiscal needs and reduced profit per barrel, imply limited flexibility for OPEC countries in terms of oil production.

Macro assumptions

Source: Berenberg estimates, IEA

Demand dynamic: Globally, the wave of E&P spending has occurred in tandem with a steep rise in the price of oil. Despite our projections of sustained weakness in the price of oil, we expect E&P spending to remain high for the next five years. This is based on the following three factors.

1. Reserve replacement requires high investment: Oil companies are struggling to grow reserves despite record capex outlays over the last five years and their reserve replacement ratios (RRRs) have remained stagnant. The sector is basically spending more and more just to replace used oil. This incentivises high E&P spend to forestall reserve attrition.

2. Production targets are aggressive: In the face of declining/stagnant RRRs, integrated oil companies (IOCs) and national oil companies (NOCs) have aggressive production targets over the next five years. Most of this investment would likely flow into offshore fields driven by investments in Brazil, the NCS, West Africa and deepwater Asia.

3. Long-term capex commitments are high: The capex budgeted for 2013 has been raised by ~10% compared to that budgeted in 2012. Long-term capex plans are even more robust, especially for the NOCs. For example, Petrobras will spend USD147bn over 2013-17 in E&P capex. These long-term capex commitments of the major oil and gas companies will ensure the continuity of the capex cycle.

We expect subsea (deepwater/ultra-deepwater) exploration to be one of the biggest growing areas of global E&P spend over the next five years. Infield projects that the global subsea market will grow at a CAGR of 15.4% over 2012-17. From a regional perspective, West Africa and Brazil will drive global subsea spend (Infield expects an 18%/12% CAGR respectively for Africa and Latin America) followed by the North Sea and the GoM. Infield also projects that subsea capex in Asia-Pacific will grow at a 25% CAGR over 2012-17 as a result of the large amount of investment to open up the so far largely unpenetrated deeper water basins of the region. From a client perspective, Petrobras and Statoil along with international oil companies such as BP, Total, Exxon, Shell, ENI and Chevron will drive offshore and subsea capex.

2012 2013E 2014E 2015E

IEA projections

Global oil demand (mn bpd) 90 91 92 93

Non OPEC Supply (mn bpd) 49 50 51 52

Implied Brent Oil Price (S/bbl) 112 104 107 112


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Supply: The supply side has responded well to the demand for vessels and equipment generated by offshore E&P spending. In terms of offshore installation, both first and second tier players are adding installation capacity while new entrant Petrofac is also building its subsea installation fleet. By 2016, around 12 new top-tier vessels will have entered the market and will likely increase competition. In addition, companies such as EMAS and Heerema are introducing a new generation of flowline installation vessels which will have removable rigid pipe reels and will thus be able to carry out pipe installation faster and at a lower cost. This technological shift will also limit the need for expensive deepwater spool bases, which will lower entry barriers and spur competition in the high-end subsea installation segment in the long term (after 2016/17).

However, top tier players such as Subsea 7 and Technip should be well placed to deal with rising competition based on their global footprint, their local content, their strong associated infrastructure of spoolbases, yards and manufacturing plants, and their technical expertise and established track record. For complex deepwater and ultra-deepwater projects, these factors are extremely important – a case in point being poor attempts by shallow water player Saipem to expand its presence in Brazil.

Vessel additions up to 2016

Source: Berenberg

In hardware, leading players FMC, Cameron and Aker have been adding capacity, particularly in Asia, Brazil and Europe. Aker recently announced plans to construct a new subsea manufacturing plant in Brazil, which will double its subsea capacity in the country. Capacity additions by the major players have been prompted by large frame agreements for equipment supply. Aker’s new plant in Brazil, for example, follows a NOK4.6bn frame agreement for subsea hardware from Petrobras. Considering the current strong global offshore E&P spend, we do not think that asset utilisation (of new added capacity) will be a problem for subsea hardware companies such as Aker.

Vessel Contractor Type Delivery yearLift capability

(tons)Speed (knots) Pipeline Capability Storage (tons)

Water depth

(m)

Castorone Saipem Pipelaying vessel 2013 600 14 20000 3000

Seven Waves Subsea 7Contruction and Verical

Flexlay2014

Deep Orient TechnipFlexible-Lay &

Construction2013 250 13 flexlay cant find 3000

2*550t PLSV TechnipFlexible-Lay &

Constructionn.a. Cant find Cant find vertical lay cant find 2500

ST 261 TechnipFlexible-Lay &

Construction2014 400 13 n.a. 2000t 3000

Deep Energy Technip Rigid Reel lay & J lay 2013 150 20 Reel lay and J Lay 3000

Lay Vessel 108 McDermot Rigid and flexible lay 2014 Reel lay 3048

DLV 2000 McDermot Heavy lift and S lay 2015 2000 13.5 S lay 3000

Aegir HeeremaDeep water construction

vessel2013 4000 J, Reel Lifted reels 3500

Pieter Schelte Allseas Heavy lift & trunklay early 2014 48000 14

Lewak Constellation EMAS Reel and flexible lay 41852 3000 Reel & Flexible lay Lifted reels

DLV 5000 Petrofac Heavy lift & Rigid pipelay 2016 5000 2000


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Subsea tree manufacturing capacity (2011)

Source: Infield Subsea Market report to 2016

Bottom-up modelling indicates earnings recovery: Based on our proprietary model for companies in our coverage universe, we have modelled revenues and profitability by individual contracts. Our analysis suggests that margins for most of the companies within our coverage universe will likely increase from 2014 onwards based on three factors.

Projects won in the poor contracting environment of 2009-2010 are now in the late execution phase. The phasing out of these contracts will have a positive margin impact.

The pace of new contract awards is picking up and the new contracts being won have better pricing. The quality of the order book is thus gradually improving.

Project phasing will also have a positive margin impact, as better margin projects won in 2011-12 will be entering the late execution phase in 2014 and 2015. Companies such as Subsea 7 and Technip book most of their profits in the late execution phase and hence they will tend to benefit the most.

Project phasing will have a positive margin impact


113

166

43

249

119

Aker Solutions Cameron Dril-Quip FMC GE

0

50

100

150

200

250

300

# of tree p.a.

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

2013E 2014E 2015E

Engineering Procurement Construction/ Installation


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Stock selection framework: Our stock preferences are based on a three-point rating system. We have compared our coverage universe on exposure to high-growth sectors, regions and clients to assess the quality and sustainability of earnings. Based on these criteria, Aker Solutions, Subsea 7 and Technip have the best risk-reward profiles. We explain our stock selection in greater detail on page 49-55.

Stock selection scorecard: Aker is the top pick


Berenberg versus consensus

Source: Bloomberg, Berenberg estimates

Points out of

10Rating

Total score out (1

to 30; 30 being the

highest)

Saipem Hold 13

Technip Buy 23

Subsea 7 Buy 20

Aker

SolutionsBuy 26

Petrofac Hold 13

5

10

5

Exposure to

growth sectors

Exposure to

growth regions

8

8

5

5

8

8

8

3

Exposure to

growth clients

5

8

3

8

2013E 2014E 2015E 2013E 2014E 2015E 2013E 2014E 2015E

Aker Solutions

Revenues 50,558 57,415 64,602 47,911 52,985 57,091 6% 8% 13%

EBITDA (adj.) 4,718 6,184 7,148 4,625 5,916 6,642 2% 5% 8%

EBIT (adj.) 3,363 4,733 5,647 3,294 4,488 5,157 2% 5% 9%

EPS (adj.) 7.88 11.20 13.77 7.4 10.6 12.6 6% 6% 9%

Subsea 7

Revenues 6,790 7,536 8,328 6,648 7,313 7,940 2% 3% 5%

EBITDA (adj.) 1,017 1,731 1,905 1,042 1,497 1,710 -2% 16% 11%

EBIT (adj.) 625 1,295 1,431 659 1,048 1,275 -5% 24% 12%

EPS (adj.) 1.05 2.16 2.41 1.1 1.9 2.3 -4% 12% 4%

Technip

Revenues 9,540 10,831 12,139 9,435 10,659 11,595 1% 2% 5%

EBITDA (adj.) 1,158 1,462 1,611 1,180 1,433 1,592 -2% 2% 1%

EBIT (adj.) 913 1,187 1,313 945 1,172 1,337 -3% 1% -2%

EPS (adj.) 5.0 6.6 7.3 5.4 6.7 7.7 -8% -2% -6%

Petrofac

Revenues 7,206 7,852 8,478 6,460 7,236 7,883 12% 9% 8%

EBITDA (adj.) 1,000 1,074 1,133 1,020 1,216 1,404 -2% -12% -19%

EBIT (adj.) 846 899 889 848 1,011 1,164 0% -11% -24%

EPS (adj.) 1.94 1.96 1.86 1.9 2.2 2.5 2% -12% -26%

Saipem

Revenues 13,500 13,498 13,713 13,318 13,327 13,811 1% 1% -1%

EBITDA (adj.) 725 1,608 1,888 775 1,783 2,131 -6% -10% -11%

EBIT (adj.) 19- 866 1,168 61 1,008 1,364 -131% -14% -14%

EPS (adj.) 0.60- 1.06 1.54 0.70- 1.28 1.86 -14% -17% -17%

Bloomberg Consensus Berenberg Difference


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Sector performance – oil beta has lowered

Over 2000-2009, the EU oil services sector sharply re-rated and outperformed both majors and the wider market. This re-rating occurred in a lock-step fashion with the structural rise in the price of oil. This strong correlation with the oil price made the OFS sector an ideal one for fund managers to add greater oil price leverage to an equity portfolio. This cyclicality and oil price sensitivity arose as a consequence of services companies’ capex-derived revenue streams, where E&P spend is directly linked to cash flow and, in turn, oil prices.

The European OFS sector has significantly outperformed the oil majors and the wider market over the last decade

Source: DataStream

The EU OFS sector’s more recent performance has not been very impressive; indeed, it has underperformed EU majors and the market. Since the start of 2011, the sector has de-rated by 26% while the Brent oil price has risen by 14%. Most of the de-rating has occurred since the start of 2013 on the back of negative earnings momentum in the sector. Companies have struggled to grow earnings due to losses on contracts won in the tough operating environment in 2009-10. Within our coverage universe, we think that Aker and Subsea have been penalised excessively on losses which are one-off in nature. We think an upwards revision in the consensus earning estimates for the two companies would lead to a stock re-rating back to prior levels.


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Earnings revisions versus share price performance

Source: Bloomberg

We expect the Brent oil price to trade sideways over 2013-15. This means that earnings momentum will remain the key driver for sector performance. We have a positive view on the sector and expect it to re-rate back to prior levels (ie 2012) on the back of an earnings recovery from 2014 onwards. Our positive view on the sector is based on strong structural demand for subsea field installation and for associated hardware. This would not only translate into sustainable top-line growth but also lead to better pricing and margins on new contracts, thereby improving the quality of the order book. At the same time, based on our proprietary bottom-up revenues and profitability models for companies within our coverage universe, we forecast margin recovery due to positive project phasing.

Oil beta for the sector has declined; the sector is more a function of earnings momentum

Source: DataStream

Saipem

Technip

Subsea 7Petrofac

Aker

-60%

-50%

-40%

-30%

-20%

-10%

0%

-60% -50% -40% -30% -20% -10% 0%

YTD change in 2014 EPS

YT

Dch

an

ge in

the sto

ck p

rice

-50%

0%

50%

100%

150%

200%

250%

300%

Change over last 10years Change over last 2 years

OFS EU index Brent Oil Price


15

E&P capex decouples from oil price at above USD100/bbl

Within the oil services value chain, E&C is the largest subsector by market capitalisation. The European oil services companies – Technip, Saipem and Subsea 7 – are leaders in offshore and subsea construction. E&C contractors have both upstream and downstream exposure, although the relative importance of downstream for European OFS earnings stream has declined and contractors are losing market share to Asian competitors.

The sector is driven by investment in new capacity and the redevelopment of existing infrastructure in mature basins. This is financed either by the cash flows and balance sheets of international oil and gas producers or externally through, for example, the equity markets. Larger E&Ps and integrated companies prefer internal financing while smaller ones or those with weak balance sheets tap the equity or, to a lesser extent, debt markets. The price of oil tends to have a strong bearing on the overall capex cycle because the cash flows of E&Ps are tied directly to it. This makes OFS revenues a second derivative of oil price. However, the sensitivity of OFS earning streams to oil prices varies according to the stage of capex that the company caters to (seismic and front-end engineering businesses are early-cycle businesses that are linked to the final investment decision of a oil project; offshore installation, on the other hand, is a late-cycle business linked to the development of an oil field).

Within the oil services sector, the exploration and seismic segments are early-cycle and hence are the first to feel the effects of a downturn, while E&C and capital equipment manufacturers are late-cycle. The capex of relatively small independent E&P companies is the most sensitive to changes in the oil price, followed by the capex of international oil companies and NOCs. NOCs’ investment decisions are more strategic in nature and are driven by long-term considerations of demand and supply. They are, therefore, the least sensitive to oil prices. In 2009-10, Middle Eastern NOCs initiated a number of projects so they could benefit from the depressed contracting environment caused by low oil prices.

Strong historical relationship between E&P spending and oil price

Source: Bloomberg

y = 4x + 21R² = 0.86

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Rig count versus the Brent oil price: offshore activity is directly correlated to the oil price

Source: Bloomberg

The European oil services sector has sharply re-rated over the last decade on the back of a wave of oil and gas capex, especially on the offshore side, in which the Europeans specialise. Higher capex has persisted despite the 2008-09 financial crisis and the growth slump in OECD countries. Sustained growth momentum from population centres in developing Asia and Latin America has kept the energy demand buoyant and provided a floor to oil prices.

However, over the last two years, oil prices have moved sideways, with the Brent oil price fluctuating around USD100/bbl. E&P capex growth, on the other hand, has remained strong at above 20% pa. This highlights that E&P capex decouples from the oil price above USD100/bbl.

E&P capex has decoupled from changes in the oil price

Source: Bloomberg, Berenberg estimates

The reason for this decoupling is that most oil and gas projects are sanctionable at prices above USD100/bbl. The following graph gives the break-even oil price needed for different types of projects ranging from onshore Middle Eastern projects to deepwater and Arctic projects. As can be seen, even the most technically demanding and hence expensive projects are sanctionable above USD100/bbl. A 10% decline in the Brent oil price does not change the picture a lot. Apart from Arctic and unconventional shale oil, most other projects would still be sanctionable.

y = 4x + 21R² = 0.86

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Sanction oil price by projects

Source: Infield Subsea market report

Oil price outlook

Over the last decade, the boom-bust cycle for oil has been demand-led. The underlying theme has been rising energy use in OECD countries, where energy per capita is converging with that of developed countries as a result of the rapid economic transformation they are experiencing. The volatile movement in oil price over the last two years has been due to structural changes occurring on both the supply and demand fronts.

A slowdown in growth among BRIC countries, along with demand weakness in OECD countries, has dimmed the outlook for oil demand. On the supply side, the oil production of non-OPEC countries is gradually rising, especially unconventional shale oil supply from the US. The long-term outlook seems healthy considering the rejuvenation of exploration and drilling activity in mature, non-OPEC basins such as the GoM, the North Sea and Asia-Pacific. Production is also set to ramp up in Brazil, although this will be sporadic. As per revised estimates, Petrobras will be producing 2.75mbd by 2017, up from 2mbd in 2013. IEA projects that non-OPEC oil supply will grow to 52mbd by 2015 compared with 49mbd in 2012. On the demand side, IEA projects global oil demand to rise to 93mbd by 2015 versus 90mbd in 2012.

We have used oil demand growth and non-OPEC supply projections given by IEA for 2013-15 to estimate the implied Brent oil price. Our multiple regression-based estimation methodology and projections are given in the table below. The implied Brent oil price based on IEA projections comes out in the range of USD104-112/bbl. This price level is not markedly different from the level it has been trading at.

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Brent oil price projections based on IEA estimates


Brent oil price projections based on IEA estimates

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Global oil demand (mn bpd) 90 91 92 93

Non OPEC Supply (mn bpd) 49 50 51 52

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Brent Oil Price Model - estimation methodology

Multiple Regression relationship => Y=c*X1^(a)*X2^(b)

Y Variable Brent Oil price ($/bbl)

X1 Global Oil Demand (mn bpd)

X2 Non-OPEC Supply (mn bpd)

LogY = 13.2LogX1 - 7.2LogX2 - 11.6


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Demand – offshore capital spending to remain strong

All players, from NOCs and IOCs to independents, have invested in exploration and the development of new fields. This has occurred in tandem with the steep overall rise in the price of oil. But the question is: will the prevailing weak oil price, which is a trend that we think will persist, affect the E&P capex on which the earnings of the services companies so largely depend?

The sensitivity of E&P capex to fluctuations in the price of oil depends on the type and the size of the oil and gas company. As the graph below shows, E&P spending by IOCs was largely unaffected by the plunge in the oil price in 2009 (at the height of the financial crisis). In contrast, NOCs, especially those in the Middle East, increased spending so they could benefit from the depressed contractor market during the period. Investment by smaller independents is the most sensitive to oil prices. This is visible in the fluctuations of their E&P capex during the period.

E&P spending IOCs and independents

Source: Bloomberg

We expect E&P spending to remain strong for the next five years, even in a range-bound oil price environment. Our positive outlook for E&P capex is based on three key factors.

Reason #1: reserve life and RRR stagnant The metric that is most commonly used as a lead indicator for upstream production growth is the RRR. With the difficulty in accessing new reserves now considered to be one of the key challenges facing Western oil companies, a decline in the RRR would suggest a slowdown in the growth of earnings, cash flows and hence dividends. This will clearly affect the ability of the companies to grow. For example, the typical proven reserve life (reserves/production ratio – R/P) for the industry is around 10 years. Companies experiencing an RRR of less than one for subsequent years (five years and beyond) will be prompted to spend more to reverse reserve attrition.

The following chart gives the combined RRR for a group of IOCs, NOCs and independents. Despite record capex outlays over the last five years, the RRR has been declining over the last decade. Large discoveries have been few and far between, and are usually in harsh deepwater or remote environments. The result of the declining RRR is that the reserve life has not improved during the period and the sector is spending more and more just to replace used oil. This will incentivise

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large integrated players to spend more just to replace the natural depletion of their current reserves.

Organic RRR has been declining Average reserve life has remained stagnant despite high E&P spending

Source: Bloomberg

Reason #2: aggressive production targets In the face of declining/stagnant RRRs, IOCs and NOCs will have to invest to meet aggressive production targets over the next five years. Most of this investment is likely to flow into offshore fields: Petrobras in Brazil, Statoil in the NCS, Total in West Africa (Angola) and Shell in the Arctic region (exploration initially). These companies have aggressive production growth targets despite the high depletion rates of their mature fields, especially those in the North Sea.

The North Sea and Brazil: By 2020, Statoil plans to increase its production of oil and gas from 2mboed in 2012 to 2.5mboed through the fast-track development of greenfields and redevelopment of brownfields. It aims to raise the recovery rate to 60%. Similarly, Petrobras has a production target of 2.5mboed by 2015 and 4.2mboed by 2020, from its current level of 2mboed. Petrobras will develop 38 new projects over 2013-20 to support these targets.

West Africa: Total also has an ambitious production target of 3mboed by 2017 from 2.5mboed in 2012. It plans to meet its target through new projects – most of which are in West Africa (Nigeria and Angola) and Russia/central Asia – and by reducing the decline rate to 3-4%. This includes major projects such as Block 32 (Kaombo) in Angola, Egina (Nigeria), Moho North (the Congo) and Project TEN (Ghana).

The GoM and central Asia: BP, on the other hand, is focused on increasing its exposure to high-margin areas – such as Angola, Azerbaijan, the GoM and the North Sea – while divesting non-core low-margin positions. The company plans to launch 15 major projects by 2014. Its larger projects include Shah Deniz, two in Azerbaijan, Angola B31 SE, the Khazzan tight gas project in Oman and the Tangguh LNG project in Indonesia.

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Subsea capex is projected to grow at 15.4% CAGR over 2012-17; all primary regions to show strong growth

Source: Infield Subsea report 2017

Reason #3: large-scale investment budgeted The high production targets are being supported by aggressive E&P capex. The following graph shows the capex guidance for selected IOCs and NOCs for 2013. The capex budgeted for 2013 has been raised by ~10% compared with that budgeted in 2012. These capex plans are long-term in nature, especially for the NOCs. For example, Petrobras will spend USD147bn over 2013-17 in E&P capex. Organic upstream capex for BP is budgeted at ~USD20bn a year over 2014-20. Statoil will invest USD21bn a year over 2013-16, while Exxon plans to spend USD38bn a year over 2013-17.

The long-term capex commitments of the major oil and gas companies ensure the continuity of the capex cycle, in our view. In addition, the large integrated majors are mainly financing their high capex internally and the reinvestment rate is increasing and averaging around 80% for the largest five IOCs. We think this also reduces the credit/interest-rate risk for investment.

Raised budgeted capex to support production targets

Source: Bloomberg

In the following section, we discuss our view on demand dynamics for each individual subsector of the oil service value chain.

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Sum (exc. Petrobras) 228.3 207.9 20.4


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Subsea hardware

The share of offshore in E&P capex has gradually risen over the last 20 years as a result of improved technology for deepwater drilling and seismic equipment, vessels capable of carrying infield development and equipment capable of bearing high pressures at great depths. This trend (the rise in deepwater E&P spend) is further strengthening as a result of technological progress in subsea oil and gas processing. What this means for the oil services sector is that higher field complexity will increase demand for high-specification equipment, which is both expensive and requires a long lead time.

Key subsea hardware includes trees to channel and regulate the flow of oil and gas from a subsea well, subsea control modules to send instructions to subsea equipment, flowlines to link up different wells to manifolds, and trunklines to transfer hydrocarbons to processing facilities. The subsea hardware market is consolidated and has very high barriers to entry because of proprietary technologies and complex manufacturing infrastructure. This means that the high margins in the sector will likely persist in the long term, in our view.

In 2013-17, consultant Infield expects subsea capex to grow at 15.4% pa. We think that this growth will have a positive pricing impact and will benefit pure subsea hardware manufacturers, especially those with a high-end focus, such as Aker, and those which are vertically integrated in hardware manufacturing, like Technip.

Christmas trees The Christmas tree segment has been the fastest growing category in the subsea sector over the last three years. The following graphs present the historical split of subsea tree orders by water depth. As can be seen, the share of trees able to work in depths of more than 400 feet has been rising. We think that this trend will continue as the deepwater regions in Brazil and West Africa are developed. Brazil is the largest subsea market and hence is expected to generate the highest demand for subsea trees. Interestingly, we expect strong demand for trees in Asia-Pacific as the region’s relatively unpenetrated deepwater areas are explored. We believe Petrobras, Total and Statoil will provide the greatest demand for trees over 2012-16 to service their projects in Brazil, West Africa and the NCS.

The share of deepwater trees has risen over the last decade

Brazil, West Africa, Asia and the North Sea will generate strong tree demand

Source: Quest Offshore, Bloomberg

Aker is well placed in the NCS, Brazil and Asia. Its subsea equipment manufacturing capacity will double in Asia-Pacific and Norway this year and now it is preparing to double its capacity in Brazil. We believe that its strong asset base and longstanding NOC relationships will help it to capture a large chunk of the tree business globally.

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Trees (4001-7500 fsw) Trees (7501+ fsw)

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Tree awards by largest client – strong rise Number of tree awards during 2010-Q1 2013


Manifolds The following chart provides a global manifold order history for 2005-2012, as compiled by consultant Quest Offshore; it also includes projected orders to 2017. After falling sharply in 2010-11, the number of manifold orders rose in 2012. Over the next five years, Quest Offshore expects manifold orders will rise to 81 units pa, from 52 units pa in 2012.

Aker has an 18% market share and is ranked third in the manifold segment. We believe the increase in manufacturing capacity will place it in a good position to fulfil the higher demand.

Number of manifold awards Number of manifold orders during 2010-Q1 2013


Control systems The number of control modules is directly proportional to the number of trees required, as each well has its own subsea control system. The following graph provides details of global order history/projected orders for 2005-2017 for control systems. As might be expected, the graph mirrors that of subsea trees. The number of control system orders is projected to rise to 650 units in 2017 compared to 60 units in 2012. Aker and FMC are the market leaders in control systems and have an edge over GE and Cameron in terms of their ability to fulfil future demand.

Subsea Tree awards 2007-11 2012-16 % Change

Petrobras 531 639 20%

Total 113 211 87%

Statoil 84 212 152%

BP 81 192 137%

Shell 101 154 52%

Chevron 63 175 178%

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Number of subsea control modules Number of control orders in 2010-Q1 2013


Umbilicals The umbilicals supplier market is also concentrated and is shared by Aker, Oceaneering and Technip. As an increasing amount of oil and gas production and now processing equipment is being moved from the platform onto the sea bed, there is a rising need for umbilicals to transfer digital signals and chemicals to subsea equipment. The following graph shows projected umbilicals lengths for installation between 2013-17 in offshore fields. Demand for umbilicals is expected to double during the period. Technip and Aker are well placed to tap into this demand because of their strong market position and technological edge over the competition.

Length of umbilicals installed in km Umbilicals sale during 2010-Q1 2013


Rigid pipelines Technip and Subsea 7 are the leaders in deepwater flowline installation. As can be seen in the graph below, the two companies have had a more than 60% combined share of the market over the last three years. Flowline installation is expected to grow strongly over the next five years, according to Quest Offshore. While Technip and Subsea 7 will enjoy good demand growth thanks to strong demand in offshore installation of flowlines, we expect to see an increase in competition in this space due to the entrance of new players such as Petrofac and an increasing presence of second-tier players such as McDermott and EMAS.

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Flow-pipelines in km Deepwater pipelay by vessel hours


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Profitability and growth: a sector headed towards earnings recovery

In our view, earnings growth and earnings quality will be the core value drivers. In the oil services space, revenue visibility is limited to the revenue cover conferred by the backlog. Considering the duration of the contracts (two to three years for offshore and three to four years for onshore), a rise in order intake is required to replenish the order book and sustain top-line growth.

Based on our analysis of supply demand dynamics, we expect E&P capex to remain strong, with growth tilted towards developing deepwater and ultra-deepwater fields. Infield expects that capex on deepwater and ultra-deepwater fields will grow at a brisk five-year CAGR of 16% over 2012-17. However, mature shallow water basins are suffering from a high decline rate, and hence incremental capex will likely grow at a slower pace. Strong capex growth to develop frontier regions will create strong demand for oil services contractors which specialise in subsea installation or in the manufacture of the hardware required to develop subsea fields. Market consolidation and high entry barriers in the two market segments also means that incremental demand would translate into better pricing.

The following chart gives the combined backlog maturity for companies within our coverage based on project stage – ie engineering, procurement and installation. Apart from Saipem, the companies in our coverage universe book the bulk of their profits in the late installation/construction phase. Hence, a greater percentage of projects in the late execution phase would provide a positive margin skew to companies within our coverage universe from 2014 onwards.

Project phasing will have a positive margin impact


In addition, the quality of the backlog is also gradually improving as the low-margin contracts won in the bad contracting environment of 2009-10 are phased out. As can be seen in the chart below, the number of large contract awards – ie those above half a billion dollars – has tripled since 2009. As the numbers of projects has increased, terms have also improved. These better quality projects will be in late execution phase from 2014 onwards, which will also provide a positive skew to margins.

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The number of large contract awards has risen – new contracts at better margins


Based on this bottom-up modelling of both revenues and profitability for the individual contracts of each company in our coverage universe, we expect a strong margin recovery in 2014 and 2015 after a slump in 2013. This would result in an improvement in the sector’s return on capital employed.

ROCE should rise in tandem with earnings recovery from 2014 onwards


Geographic exposure: Within the sector, companies with high geographic exposure to the MENA region and to downstream projects have faced tough competition and order backlog attrition. IOCs have been redirecting their investment towards upstream projects due to the downturn in demand for end-products in the OECD market. Thus downstream projects have been concentrated in growth regions such as the Middle East and Asia.

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Poor margin contracts won in 2009 and 2010 will be in execution phase in 2013. Margin recovery in 2014 onwards should generate earnings momentum for the sector

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Revenue split 2012: Technip is geographically the most diversified while Aker is the least


Top-line growth: Petrofac and Saipem have experienced a sharp fall in orders and in margins in their onshore business over the last two years. The graph below details the book-to-bill ratio (order intake divided by revenues) for our coverage universe over the last three years. Technip, Subsea 7 and Aker have shown the most consistent growth in backlog in the last two years, with the book-to-bill rising and consistently above one. Technip’s strong exposure to Brazil and vertical integration into hardware has helped support strong order intake. The same is true for Aker, which has experienced sustained demand for drilling and subsea field infrastructure equipment. Subsea 7 has won important contracts in West Africa and the North Sea based on its large vessel fleet. This provides strong earning visibility for the three companies, and along with a strong bid pipeline, underpins our forecasts that their top lines will grow at a three-year CAGR of 14% (Technip), 10% (Subsea 7) and 13% (Aker) over 2012-15.

Petrofac, we think, will be able to sustain its top-line growth, which we expect will be at an average 10% CAGR over the period, by diversifying in offshore capital projects and upstream equity investments through its IES division. Similarly, on the onshore side, we think that it will have to compromise on margins to reverse backlog attrition. However, we believe Saipem’s growth will suffer as it will likely adopt a more selective bidding approach after the sharp cuts in earnings guidance for the year, which has unnerved the markets. Hence margin improvement would come at the cost of growth. We expect the company to grow at only a 1% CAGR over 2012-15.

We are bullish about the subsea segment’s capex over the next five years and consider Subsea 7 to be the best-placed to capitalise on the projects which are likely to be executed over the medium to long term. This is based on its sector-leading vessel fleet, strong technology, long track record and market share. The company’s book-to-bill ratio has remained above one over the last three years.

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Book-to-bill over 2010-2012: Technip, Subsea 7 and Aker have shown the most consistent order growth, which provides them with strong earning visibility

Source: Bloomberg

Margins: We expect Subsea 7’s and Aker’s margins to expand over the next three years. Subsea 7’s low-margin contracts in Brazil and the North Sea will be completed by 2014, which should give a boost to margins. In Aker’s case, rationalisation of quality costs (costs linked to execution of the order book) and improved pricing for hardware will be the two main drivers for margins, in our view.

We forecast that Technip will experience stable margins over 2013-15. Weak pricing on the onshore side will be balanced by an increased share of the subsea installation and hardware market, we believe. Compared with average operating margins over 2010-12, we expect Petrofac and Saipem to experience margin compression of 1.6% and 3% respectively over the next three years. Petrofac’s higher-margin offshore capital projects and IES projects will partially offset reduced margin on its onshore portfolio. Saipem’s high-margin drilling division, however, is suffering capacity constraints and hence it will not be able to boost margins significantly over the next three years.

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Operating margin: Subsea 7 and Aker likely to experience margin expansion

Source: Bloomberg

ROACE (return on average capital employed): We expect Subsea 7, Aker and Technip to achieve higher ROACE over 2012-15 – up by 4.1%, 1.7% and 1.5% respectively. Technip is partnering on the offshore side with Heerema instead of developing its own heavy-lift capability, and its capex programme is now largely complete. It is also focusing more on its early-stage engineering and technology offering in both offshore and onshore applications. This focus on engineering, and hence on asset-light future growth, underpins our expectations that its ROACE will improve.

We expect Petrofac will experience the highest ROACE compression of the five companies by 2015. Its high-capex growth strategy, its market entry into the SURF segment and weakness on the onshore side will all contribute to lower ROACE, in our view.

ROACE: Technip and Aker to likely show high and improving ROACE post-2013

Source: Bloomberg

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The supply side responds

Assets, be they human capital or fixed capital (vessels/spool base and manufacturing plants), are the most important and integral part of the business model for an oil services company. In this section, we analyse the supply of key assets for the oil services industry.

Asset intensity

There is a material difference between offshore and onshore services with regards to asset intensity. Onshore, we feel, is an asset-light business model as a) oil services companies mainly provide engineering services to the E&P sector which in itself is an asset-light business (as it mainly involves people) and b) most of the construction work in onshore is generally subcontracted. Offshore, on the other hand, is a more asset-heavy business, as most companies need to own a vessel fleet for the purpose of installation and construction. In the following chart, we highlight the asset intensity (ie the relative asset-heaviness or asset-lightness) of subsectors along the oil services value chain.

Value chain of oil service and asset intensity

Source: Berenberg

Offshore assets

Access to the right assets in the right region is one of the most important attributes of a successful EPIC (engineering, procurement, installation and commissioning) contract for any offshore oil services company. A broad asset base (be it vessel-based or manufacturing plants) improves oil services companies’ ability to execute contracts; it also creates a barrier to entry to new competitors, particularly if the asset has a technological edge over its competition. The nature/type of asset depends on the range of services provided by the oil services company. A broad vessel fleet combined with spool base/yards (preferably in the client’s country) is of crucial importance to an installation company. For their part, hardware companies need to have a technologically-advanced asset base with material room for de-bottlenecking if they are to be competitive.

Vessels and spool bases Technip, Subsea 7 and Saipem dominate the global market for offshore installation. While Saipem is a strong player in heavy pipe (trunk-lay) installation, Technip and Subsea 7 are predominant in flexible pipe installation. All three companies boast strong and diverse vessel fleets along with well distributed spool/yard bases to support their installation projects.

Given the asset intensity of EPIC contracts, the keys to profitability in offshore projects are a) vessel utilisation and b) vessel rates. In the majority of cases, oil


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services companies bid on a full EPIC contract basis, which makes it difficult to quantify each vessel’s day rate. Nevertheless, in our view, a vessel’s day rate is as important as vessel fleet utilisation in terms of the profitability of the project. While vessel utilisation is somewhat dependant on external factors such as weather conditions, it is mainly demand/supply that determines the utilisation level and this in turn is also the most important factor determining the rate per day.

Vessel supply Following the strong growth in subsea capex in the last decade, the supply of vessels for field development, inspection maintenance/repair and well intervention projects is expected to grow significantly over the next five years. External consultant Douglas Westwood forecasts that subsea vessel capex will grow from USD11.3bn in 2012 to USD20.3bn in 2016, even though there has already been a significant increase in new capacity in the vessel market over the last five years, with c170 new vessels joining the market, implying a capacity increase of 60% between 2008-12.

This increase in capacity has been across almost all the various subsea vessel asset classes. There are two different categories of offshore subsea vessels:

a) diving support vessels (DSVs) – these are mid-sized vessels which are mainly used to support the key enabler vessels;

b) lay support vessels (LAYSVs) – these are lay support or driverless construction support vessels and are generally also classified as “enabler” vessels if they form a key part of a fleet.

There was a brief slowdown in overall shipbuilding in 2009/2010 due to the financial crisis, but there has since been a rebound in demand. While a lot of companies are taking a conservative approach and arranging long-term contracts to hedge rates for new capacity, in our view rates in general are expected to remain soft as much of the capacity from the 2008 boom period is due to be delivered between 2013-2014. The total subsea vessel fleet stands at 325, of which 70 or so vessels are working in adjacent markets. Demand (for vessels) is expected to be c200-230 vessels over the next five years, implying that adjacent markets (such as wind-farming) need to remain healthy for rates to be maintained.

There has been a brief pause in the order book over the last two years. The 2011 order book stands at 43, a yoy drop of 44 vessels. While at least seven of those vessels are for Petrobras, there is over-capacity in vessels that are not worldwide ships (key enabler vessels which tend to work on a global basis) or are either built at a lower specification to entice price-sensitive clients or are designed for specialist roles. These will be competing with worldwide-capable vessels for regional tonnage (job-work) over the next few years, especially in Asia.

DSVs (diving support vessels) The DSV sector is the most fluid in terms of demand/supply, and has been fairly robust over the last two years, especially in the North Sea. Due to structured fleet management and a contracting process that does not welcome third-party ships on a speculative basis in the spot market, the North Sea is much less of a spot market for the DSV fleet and rates are fairly stable. Outside of the North Sea, the market is more unbalanced, with many vessel owners chasing work, and utilisation across the board fairly low. Of the new capacity additions, none is targeted for the North Sea, which in our view will put additional pressure on global rates. This in general is positive news for integrated oil services companies which undertake projects on a lump-sump basis.


33

After a weak 2010, the global DSV market has seen two solid years, with demand up to 52 vessel years, which, compared to the supply of c64 vessel years, suggests a utilisation of 82% due to very strong demand in the North Sea. However, with the expected capacity expansion, we expect utilisation rates for DSVs to fall to below 80% over the next three years. While the North Sea market has been fairly tight from a demand-supply point of view, the market outside the North Sea is long (over-supplied). In terms of the competitive landscape, Technip and Subsea 7 still control most of the DSVs in the North Sea while Bibby, ISS and Saipem tend to operate on more short-term contracts elsewhere.

DSV fleet size of the three biggest players

Source: Company data, Berenberg estimates

LAYSVs This is a fairly broad (and the most important) category of vessels for subsea installers. LAYSVs are construction vessels that are involved in the installation of equipment in subsea projects. In general, most vessels in this category are manufactured to the owner’s specifications, leading to a high degree of specialisation. This market has been long in the last couple of years, and with the new capacity expected to hit the market in 2013-2014, we expect this market to remain so with utilisation of around c75-80%.

0

1

2

3

4

5

6

7

8

9

Subsea 7 Technip Bibby

No. of DSVs


34


Source: Berenberg, Upstream, Company data

This market is now fairly consolidated, with Technip, Subsea 7 and Saipem being the three key players. While there is a lot of market debate about the additional capacity and new market entrants, industry leaders Technip and Subsea 7 have maintained that there is a shortage of key enabler vessels, which is why both these companies have added capacity to their already elaborate fleet of vessels in the last two years and have plans for more capacity additions in 2013-2014.

The large players are adding capacity Subsea 7 has the biggest fleet of vessels (40) in the subsea market. The company has just completed a fairly elaborate capex programme, spending USD1bn+ to add global enabler (key vessel) Seven Borealis and Seven Waves (for Brazil). The company is still contemplating adding at least two additional vessels, as it feels there are pockets of the market which need new capacity.

Subsea 7 is planning to install technologically-advanced kit/hardware on its vessels to increase its advantage versus its competition. Technip, the other large player in the subsea market, has also been busy with regards to fleet enhancement, both organically and via the acquisition of Global Industries and its alliance with Heerema (this is a five-year collaboration on ultra-deepwater projects). Technip already has a fairly balanced and elaborate fleet of vessels (28 vessels, with five more under construction). The company has added two construction vessels, Deep Orient and Deep Energy, to its fleet recently, and will also add the 142m-long subsea construction vessel STL-261 to its fleet in 2014, along with two PLSVs for the Brazilian market.

Vessel Contractor Type Delivery year

Lift

capability

(tons)

Speed

(knots)

Water

depth (m)

Castorone Saipem Pipelaying vessel 2013 600 14 3000


Flexlay2014 0 3000


Construction2013 250 13 3000


Constructionn.a. 2500


Construction2014 400 13 3000

Deep Energy Technip Rigid Reel lay & J lay 2013 150 20 3000

Lay Vessel 108 McDermot Rigid and flexible lay 2014 0 3048

DLV 2000 McDermot Heavy lift and S lay 2015 2000 13.5 3000

Aegir HeeremaDeep water

construction vessel2013 4000 3500

Pieter Schelte Allseas Heavy lift & trunklay early 2014 48000 14 3000

Lewak Constellation EMAS Reel and flexible lay 41852 3000 0 3000

DLV 5000 PetrofacHeavy lift & Rigid

pipelay2016 5000 0 2000


35

Saipem and Allseas are the two dominant players in the heavy trunkline installation sector. Both companies operate large S lay barges – the Castoro Sei (Saipem) and the Solitaire (Allseas) – and both have allocated even more capex in this area, with Saipem investing USD1bn in its Castorone vessel (to be delivered in March 2014) and Allseas spending USD2bn on its Pieter Schelte LAYSV (to be delivered in H2 2014).

Competition is coming The attractive margins and expected growth in deepwater capex is attracting several new players into what is currently a fairly consolidated market. On one hand, second-tier players such as McDermott, EMAS and Heerema have major plans to upgrade their vessel fleet; on the other, there are several new entrants such as Ceona (previously known as the Installation Group) and Petrofac, which also plans to enter the SURF market with key enabler vessels. In the table below, we provide an overview of the most enabler vessels that are expected to come to market in the next five to six years.

Using a hammer to kill a fly A strong demand outlook, high margins and a consolidated industry structure has prompted several new players to add capacity in the high-end vessel installation market. There are currently 35 key enabler vessels catering to the high-end installation sector, but as of 2015 we expect to see an additional 12 vessels joining the market thanks to the capacity increase plans of existing industry players and possible new entrants (please see table below).


Source: Berenberg

Only Subsea 7 and Technip currently possess a comprehensive fleet of vessels (ie key enabler vessels plus support vessels). Mid-tier competitors such as EMAS and McDermott are adding capacity in the high-end installation market, but these companies need the support of players such as Bibby Offshore and Offshore Installation for DSVs. Given that the market for support vessels is generally long (on a global basis), most of the new entrants (second-tier competition such as EMAS and completely new entrants such as Petrofac) are trying to add capacity only at the high end of the market. Their strategy to target the high-end installation market (via high-end installation vessels) and subcontract support vessels may

Vessel Contractor Type Delivery yearLift capability

(tons)Speed (knots) Pipeline Capability Storage (tons)

Water depth

(m)

Castorone Saipem Pipelaying vessel 2013 600 14 20000 3000


Flexlay2014


Construction2013 250 13 flexlay cant find 3000


Constructionn.a. Cant find Cant find vertical lay cant find 2500


Construction2014 400 13 n.a. 2000t 3000

Deep Energy Technip Rigid Reel lay & J lay 2013 150 20 Reel lay and J Lay 3000

Lay Vessel 108 McDermot Rigid and flexible lay 2014 Reel lay 3048

DLV 2000 McDermot Heavy lift and S lay 2015 2000 13.5 S lay 3000


vessel2013 4000 J, Reel Lifted reels 3500

Pieter Schelte Allseas Heavy lift & trunklay early 2014 48000 14

Lewak Constellation EMAS Reel and flexible lay 41852 3000 Reel & Flexible lay Lifted reels

DLV 5000 Petrofac Heavy lift & Rigid pipelay 2016 5000 2000


36

appear to be a sensible strategy on paper, but in our view the fundamental issue is that most of these new entrants are trying to adopt this same strategy.

In our view, we see three risks to this strategy, which may have a fundamental impact on long-term profitability.

Current capacity not fully utilised: The fundamental thesis for capacity addition for high-end installation vessels is that current capacity is probably just about enough to cater to the current project pipeline. This implies that future potential awards of mega-projects would need new installation capacity at the high end. To understand this in more detail, we have looked at the vessel schedule of current enabler vessels based on announced projects.

Vessel schedule of main enabler vessels up to 2016

Source: Berenberg

Country Client 1Q13 2Q13 3Q13 4Q13 1Q14 2Q14 3Q14 4Q14 1Q15 2Q15 3Q15 4Q15 1Q16 2Q16 3Q16 4Q16

Saipem 3000Girassol and Dalia FPSOs Angola Total 100%

Bonga North-West field Nigeria Shell 100%

OFON2 - D030 contract Nigeria Total 100% 100% 100%

FDS2Sapinhoa Norte & Cernambi Sul Brazil Petrobras 100% 100%

Gas export pipeline Lula NE - Cernambi Brazil Petrobras 100% 100%

(1) Liwan 3-1 Field – Deepwater EPCI, (2) Guara & Lula-

Northeast gas export pipelinesChina & Brazil

(1) Husky Oil

China Ltd, (2)

Petrobras

100% 100%

Lula field: Gas export trunkline Rota

CabiúnasBrazil Petrobras 100%

Saipem 7000

Vladimir FilanovskyRussia/

Caspian SeaLukoil 100% 100% 100% 100%

UK sector of the North Sea UK/ North Sea 25% 100% 100%

Platforms & marine facilities: UK & Norwegian North SeaNorway & UK/

North Sea, GoM100% 100% 100%

Norwegian and British sectors of the North SeaNorway & UK/

North Sea100%

2 platforms as part of the Greater Ekofisk Area Development

project

Norway/

North Sea

ConocoPhillips

Petroleum100%

CastoroneIchthys LNG Project: Gas Export Pipeline Australia INPEX 100% 100%

US sector of the Gulf (400km New Orleans) GoM 100% 100%

Walker Ridge export pipeline GoM Chevron & Shell 100%

Lula field: Gas export trunkline Rota

CabiúnasBrazil Petrobras 100%

Seven BorealisErha North Field Nigeria 100% 100%

Line 60 Project in the Bay of Campeche Mexico 100%

CLOV development projAngola/ West

AfricaTotal 100% 100%

Martin Linge DevelopmentNorway/

North SeaStatoil 100%

Line 60 Project in the Bay of Campeche Mexico PEMEX 50%

Seven OceansLaggan Tormore UK/ North Sea Total 100% 50%

Guara LulaBrazil/ Santos

basinPetrobras 100%

Lianzi field offshore: EPIC SURFAngola/ West

AfricaChevron 100% 100%

Deep BlueCardamom field development GoM Shell 50%

Contract for the Jack & St-Malo fields GoM Chevron 100% 30%

Walker Ridge development GoM Enbridge 100% 50%

Subsea equipment installation at Hadrian South

DevelopmentGoM Exxon 100%

Deep Orient

Balnaves oil field development.Australia/ Asia

PacificApache 50%

Supply & installation of pipelines & umbilicalsChina/ Asia

PacificCNOOC 50% 100%

Prelude FLNGAustralia/ Asia

PacificShell 50% 50%

EPIC contract for two new gas-export lines at the Laila and

D12 fieldsMalaysia Shell 50% 50%

Deep Energy

Bøyla field development. Norway/

North Sea

Marathon Oil

Norge 100% 100%

Prelude FLNGAustralia/ Asia

PacificShell 50% 50%

Apache IIQuad 204 UK/ Europe BP 100% 50%

Golden Eagle development.Scotland/

North SeaNexen Petroleum 100% 100%

Vilje South field and Visund North developmentsNorway/

North SeaStatoil 50% 50%

EPIC contract for the Juliet project UK/ North Sea GDF SUEZ 50%

EPIC contract for the Gannet F Reinstatement project UK/North Sea Shell 50%

Global 1200

Starfish fieldTrinidad and

TobagoBG 100% 100%

Marsical Sucre development Venezuela PDVSA 100% 100%

Pipeline installation contract for Discovery’s South Timbalier

Block 283 Junction Platform projectGoM Discovery System 100% 100%

EPSCI and pre-commissioning for the Moho Nord

development projectCongo Total 100% 100% 100% 100% 100%

Global 1201

Woodside GWFAustralia/ Asia

Pacific

BHP Billiton

Petroleum, BP,

Chevron, Japan

Australia LNG,

Shell

100%

South West Fatah and Falah fields Malaysia Shell 50% 100% 100% 50%


37

Based on the vessel schedule of current enabler assets from Technip and Subsea 7, we feel there is room for new orders. Considering that we may see as many as 12 new high-end installation vessels joining the market in 2014-2017, there would need to be a significant uplift in project awards in the next 12-15 months to sustain healthy capacity utilisation. Furthermore, due to weakness in the oil price and inflation in the oil service chain, projects awarded in recent quarters have faced postponement and delays. In the following table, we give an overview of projects which have been delayed in the last 12-15 months.

Recent upstream project delays

Source: Upstreamonline, news reports

Pricing under pressure: The subsea installation market is fairly consolidated, with three dominant players (Subsea 7, Technip and Saipem). Second-tier players such as EMAS and McDermott have been confined to the Asian market so far, but given the strong demand outlook for deepwater/ultra-deepwater projects in Brazil, West Africa and the GoM, these players have been investing in vessel capacity to target these regions. Furthermore, with the entry of new players such as Petrofac, we expect to see an increase in the capacity of enabler vessels from 2017 onwards. A combination of factors such as a) a delay in project awards and b) the addition of new capacity in enabler vessels from second-tier players will make the market more competitive, in our view.

Any work is not necessarily good work: The key enabler vessels that serve the top end of the installation market are often referred to as “Swiss army knife vessels” due to their versatility. The best use of these enabler vessels is in EPIC projects in harsh environments such as Brazil, West Africa or the GoM. But due to the lumpiness of large EPIC contracts, installers may be forced to use enabler vessels in shallow water to maintain capacity utilisation. This is not good for operators’ profitability, as the implied day rate on a shallow water EPIC contract will be much lower than that of a deepwater EPIC contract (due to competition in the shallow water EPIC market).

Spool bases Spool bases are one of the main barriers to entry to the subsea flowline installation business along with installation vessels. The spool bases have to be strategically located so that they are able to offer deepwater access for larger SURF vessels, such as Borealis (Subsea 7), which work in deeper waters. In addition, spool bases should be near to oil and gas basins, as installation vessels have to return to base for re-spooling after using up the spooled reel.

However, the SURF market is about to experience a technological shift which will reduce the importance of spool bases in field development projects. Heerema and EMAS are both set to introduce a new generation of SURF vessels which will feature removable spooled reels. Instead of having to make the return journey to base to load up a new reel and lose valuable time, the new Aegir (Heerema) and Lewak Constellation (EMAS) vessels will be able to continue working by replacing the empty reel with a new one brought out to them by a barge which is on much lower day rates.

Project Country Operator

Browse gas project Australia Woodside

Mad Dog 2 GoM BP

Hadrian GoM Anadarko

Brass LNG Nigeria NNPC, Total

Shtokman Russia Gazprom


38

Thus not only will field development projects take less time to complete, but spool bases will not be required to offer deepwater access as barges will be used to transfer the spooled pipes to the installation vessels. Hence EMAS and Heerema will gain a competitive advantage, and they will be able to bridge the expertise gap between second-tier players and Subsea 7/Technip. We expect installation margins to compress after 2017 once these new vessels have entered the market.

Conclusion

Based on our detailed analysis of the supply landscape for subsea vessels over the next three years, we have come to the following conclusions.

Significant growth (15% CAGR over the next five years) in subsea capex for deepwater/ultra-deepwater field development and the prospect of high profits is attracting new entrants: We expect the current consolidated market structure to see a gradual increase in competition in the long term.

With spool bases in regions such as Brazil, West Africa and Asia, the current industry leaders Subsea 7 and Technip have an advantage in terms of local content. However, once new reeling/spooling technology is delivered, second-tier competitors such as EMAS and McDermott will be able to slightly lower this competitive advantage.

We expect capacity utilisation for low-end diving and support vessels to fall from the current level of c82% to below 80% over the next three years due to an increase in supply, especially outside the North Sea. We expect utilisation of key enabler vessels to remain high, but given the increase in supply from second tier players and new entrants, we feel pricing for big projects may come under pressure from 2017 and beyond.

Subsea hardware

Thanks to strong growth in subsea capex for deepwater and ultra-deepwater offshore projects, hardware companies such as FMC, Cameron and Aker have also seen a strong growth in their order book in last few years. Indeed, hardware has been the tightest of all segments in the value chain in terms of demand-supply (the lead time for Christmas trees has risen from one to two years). This is despite capacity expansion at all the main hardware players. For example, Aker’s subsea equipment manufacturing capacity at its Norwegian and Malaysian plants will double by the end of this year and it has also announced plans to double its capacity in Brazil by 2015. Similar capacity additions have been implemented by both FMC and Cameron in recent years. The following graph details global subsea tree manufacturing capacity by major manufacturer.

Capacity additions by the major players have been prompted by large frame agreements for equipment supply. Aker’s decision to develop a plant in Brazil follows a NOK4.6bn frame agreement for subsea hardware from Petrobras. Considering the strong global offshore E&P spending, we think that manufacturers would find the demand to fill new capacity. Infield projects that subsea capex will grow at 15.4% CAGR over 2012-17 and expects ultra-deepwater development to comprise 48% of the capex. This highlights that demand will remain strong for manufacturers of high-end subsea hardware that can be operated under high pressure circumstances and in extreme temperatures.


39

Subsea tree manufacturing capacity (2011)


Utilisation versus lead time anomaly In the hardware business, leading players FMC, Cameron and Aker have been adding capacity, yet the overall utilisation rate has been low for all these players. This is especially true for Aker, which had a tree manufacturing utilisation rate of only ~40% in 2011. Despite the low rate, prices for subsea hardware have been increasing, and at the same time the lead time has been rising. This anomaly can be explained by the structural change in the type of equipment being demanded by the industry. As fields become more remote, harsh and complex, and as regulatory safety requirements rise, equipment suppliers have been forced to develop subsea systems which work in difficult environments.

Hence, unlike other industries which are gradually moving towards mass production to lower costs, the reverse is happening in the subsea sector, and equipment is becoming increasingly customised. This has led to a rise in lead times for all types of high-end equipment, be it Christmas trees, umbilicals or blowout preventers. As the thrust towards frontier regions such as the Arctic continues and subsea processing technology matures, the hardware supply chain will have to keep on evolving and innovating to meet industry requirements. This in our view should translate into a continued improvement in pricing for equipment for deepwater and ultra-deepwater fields.

Subsea tree manufacturing capacity utilisation (2009-11)


113

166

43

249

119


0

50

100

150

200

250

300

# of tree p.a.

0%

10%

20%

30%

40%

50%

60%

70%



40

The value chain

The oil industry is highly complex in nature, with different requirements at different stages of field development. The location of the field (onshore/offshore) and the nature of hydrocarbons (gas/oil) also add further complexity to the nature of the service required. The significant growth in offshore (and more importantly deepwater) oil exploration in the last 15 years has led to strong growth for peripheral oil services. In the same way that a rising tide lifts all boats, almost the entire oil services value chain has seen strong growth in the last 15 years, thanks to the significant increase in capex linked to offshore exploration.

The value chain As is the case with most supply chains, the oil services chain has some early-cycle businesses (ie exploration/seismic companies) and late-cycle businesses (ie installation companies). In the following table, we illustrate a typical investment process with regards to offshore field development for an oil company.

Investment process for offshore field development

Source:http://www.decisionframeworks.com/documents/Win00_Decision.pdf?bcsi_scan_6a9fa56

c171475da=0&bcsi_scan_filename=Win00_Decision.pdf

Given the level of complexity and specialisation required at each stage of field development, oil companies tend to forge partnerships with specialised oil services companies. In the following table, we provided an overview of the main differences between the various elements of the oil services supply chain.


41

Oil supply chain characteristics

Source: Berenberg

Capex versus opex It is often very difficult to determine the extent of the capex versus opex split for a particular oil field due to the complexity and diversity of different influences such as a) the size of the field, b) the depth of the field, c) whether it is onshore or offshore, d) the nature of the particular hydrocarbon in question, and e) the geology of the field. Apart from these technical factors, one key swing factor is whether the FPSO (floating production and storage unit) is owned or being leased by the oil company.

Conservations with industry experts lead us to believe that the rule-of-thumb capex/opex split for a particular deepwater offshore project would be 50/50. The capex basket would comprise costs linked to seismic studies, exploration drilling, the installation of infrastructure for field development and hardware installed on the sea bed (such as pipes and Christmas trees). The opex basket would include lease costs for the FPSO, the maintenance of the oil field, labour and energy costs.

Porter’s five forces The high degree of cyclicality and the early-/late-cycle nature of the value chain make it difficult to analyse the sector using the Porter’s five forces framework at any given point in the business cycle. However, given the diversity in the business models of companies in the oil services value chain, we feel that Porter’s five forces – see below – provide a solid platform for analysing the value chain.

First, the customer is king: This is a true statement for most industries, but is certainly true of the oil industry, given the concentrated nature of the customer base. Indeed, the customer’s bargaining power becomes yet greater if one takes into account the regional demand aspect (eg Petrobras is by far the biggest and most important customer in Brazil). Given the degree of concentration, the big IOC/NOC companies enjoy very good bargaining power from a fundamental point of view. But we also need to take into account the demand-supply aspect when judging customer’s bargaining power. With the exception of Brazil (Petrobras), we feel that in most regions customers’ bargaining power will depend on the extent of projects that are being developed at any given time (in 2009, there were hardly any new projects in West Africa, which meant that oil services companies had to accept a significant price discount for the execution of the CLOVE project for Total in Angola).

The other factor which determines the bargaining power of customers is the nature of the service/product which is used in field development. As a rule of thumb, oil companies are willing to pay a higher price for technologically

Siesmic Drilling EngineeringOffshore

InstallationHardware Downstream

Asset intensity High High Low High High Low

Position in the

value chain Early

Early and

midMid late Late Late

Type of

contractDay rate Day rate

Cost

reimbursableLumpsum Lumpsum Lumpsum


42

advanced solutions (subsea field development) across the value chain. In our view, the biggest scope for performance improvement via technology is within the hardware space, and given the lack of technological differentiation, we feel onshore engineering and low-end installation are areas where customers (ie oil companies) enjoy significant bargaining power.

Competitive forces: The competitive structure within oil services is fairly diverse, with significant consolidation at the top end and fragmentation at the low end. In terms of offshore, the market is fairly consolidated across the board, whether in terms of EPIC contractors (Technip, Subsea 7 and Saipem dominate this space) or hardware companies (FMC, Cameron and Aker). However, we have noted a significant increase in competition in onshore field development with the emergence of south Asian competitors (eg Hyundai, Daewoo). This has led to significant pricing pressure, especially in strong NOC-dominated regions such as MENA.

Market share by product category

Source: Quest offshore, Bloomberg

New entrants: The asset-light model coupled with low barriers to entry have lured several new players to the onshore market. In the last 10 years, we have seen a gradual shift in this industry, with market players from Asia and the Middle East gaining market share at the expense of European players. The offshore field development space has been a fairly consolidated market for several decades. High barriers to entry such as a) the need for local content, b) the high degree of capital intensity, and c) access to technology have ensured that this offshore field development market has remained consolidated. But

Offshore market share over 2010-12Flexibles Deepwater rigid Trunklay Heavy lift

Hardware market share over 2010-12Trees Umbilicals Control modules

Onshore market share in MENA region Projects under execution by contractor as at Sep'12 Contract won during Jul'11-Jun'12

Allseas3%

Saipem73%

Technip24%

Heerema39%

McDermott

15%

Saipem18%

Seaway Heavy Lifting

6%

Subsea 722%

EMAS11%

McDermott

3%

Subsea 772%

Technip14%

Allseas11%

Helix14%

Saipem6%

Subsea 726%

Technip43%

Oceanearing

28%

Aker Solutions

33%

Technip22%

Prysmian9%

Nexans8%

Aker Solutions

18%

Cameron21%

Dril-Quip1%

FMC42%

GE18%

Aker Solutions

32%

Cameron14%

FMC Technolog

ies35%

GE Oil& Gas

19%

Samsung Engineering

14%

Daelim12%

GS E&C10%

JGC Corporatio

n10%SK E&C

9%

Saipem9%

Petrofac6%

Hyundai E&C5%

Tecnicas Reunidas5%

Technip5%Tecnimont

4%

CTCI Corporation3%

McDermott3%

NPCC3%

Daewoo E&C2%

Daelim23%

Samsung Engineering21%

Petrofac10%

GS E&C9%

SK E&C8%

Tecnicas Reunidas

8%

Saipem6%

Tecnimond5%

Toyo Engineering5%

JGC Corporation5%


43

due to the attractiveness of returns, offshore is attracting capital. While we certainly do not expect the extent and magnitude of competition to be similar to onshore, given that there is increasing investment activity especially in the installation segment, we feel there will be a gradual increase in competition in offshore in the mid-term.

What about the suppliers? The oil services industry is fairly concentrated when it comes to suppliers, especially at the high end of the value chain. Although the bargaining power may lie with the customer, especially for big projects, we feel that in new technology offerings, suppliers do have a bargaining tool. Whether it relates to installation in harsher environments, cutting-edge technology on flexible pipes, or new edge subsea trees, we have seen IOCs rewarding service companies for delivering cutting-edge technology.

Threat of substitutes: The risk-averse nature of the oil industry brings limited room for substitution of products, but in our view there are two main areas where we see a threat arising from product substitution.

a) Flexible versus rigid pipes: Flexible pipe systems are increasingly being used in deeper waters and offer better performance over rigid pipes because of higher corrosion resistance and relatively faster installation and de-commissioning. The primary market is currently limited to Brazil but demand is growing in other regions such as West Africa, the North Sea and Asia. Improved technology is increasing the depth level at which flexible pipes can operate and could replace rigid pipelines in deepwater and ultra-deepwater field development applications.

b) Tie-backs: Technological progress is enabling ever longer subsea production and processing tiebacks to existing infrastructure. This is the preferred strategy adopted by Statoil to develop fast-tracked smaller fields in the NCS without recourse to developing expensive processing platforms (fixed or floating). The use of heated pipes in pipe technology is allowing the industry to carry out long tiebacks to existing pipelines and processing platforms. This lowers the requirements for the shallow water platform construction vessels in which companies like Saipem specialise.

The exposure In the context of the value chain, we have tried to analyse the product portfolio of those five companies on which we are initiating in part two of this report. With the exception of Subsea 7, all these services companies share a common theme across their product portfolios: diversification. They have exposure to at least two areas of the oil service value chain. In our view, such well diversified portfolios are a big plus as they reduce the cyclicality of the top line/bottom line to oil price shocks. Within our coverage universe, we see Technip as the most diversified player, while Subsea 7, with its almost 100% exposure to offshore installation, is the most pure-play company. In the following table, we provide an overview of our coverage universe’s exposure to the oil service value chain.


44

Exposure to oil service value chain


Drilling EngineeringOffshore


Technip Nil. High High Mid Mid

Subsea 7 Nil. High High Nil. Nil.

Saipem High Mid High Nil. High

Petrofac Nil. Mid Nil. Nil. High

Aker Solutions Nil. Mid Low High Nil.


45

Technology matters

Given that the oil industry is one of the most mature industries and fairly resistant to change, it is hard to gauge the importance of technology. Almost all followers of the industry in the financial markets ignore the technology issue as more importance is placed on exploration and production capex. But with increased regulation following the recent Macondo accident, and with the rise in exploration in deep/harsher waters, increasing emphasis is being placed on technology both by IOCs (the customers) and oil services companies (suppliers).

The two main drivers for the increasing importance of technology, especially in offshore field development, are as follows.

a) Stricter regulations: There has been a significant emphasis on technology in the NCS region over the last decade, including stricter norms for field development and operations. Restrictions on the use of divers for field maintenance and the trenching of land post-pipe-installation are examples of stricter regulation in this region. This has, of course, prompted IOCs to focus on technology to ensure further mechanisation in field development and operations. Statoil (as the leading NCS company) is at the forefront of using technology to enhance its options on field development.

b) Harsher environments: Over the last 50 years, the world has developed most of the so-called “easy oil” (onshore oil). Almost of the new frontier oil source regions are in deepwater areas (Brazil, West Africa, the Arctic, Asia), so it will become increasingly difficult and more complex for oil companies to extract oil in future. The industry thus has to come to grips with highly specialised installation/construction vessels and significant advances in hardware technology (subsea trees, manifolds, control systems, pipes and umbilical sets).

Statoil is the thought leader Statoil is the most technological advanced oil company in our view among the IOCs. The company has always been at the forefront when it comes to implementation of new technology. In recent years, Statoil has also been working on the concept of a subsea factory.

Oil services companies have invested significant resources in improving their technology footprint for deepwater oil exploration purposes. While the most visible technology advances have been on the hardware side, there have also been improvements in installation with the arrival of new vessels from Subsea 7 and Technip. In the following section, we discuss some key technologies that we feel are very important for deepwater offshore development in the coming years.

Technology #1: bundling The Subsea 7 pipeline bundle product incorporates the flowline, water injection, gas lift, chemical injection and control systems necessary for any subsea development within a steel carrier pipe. At each end of the pipeline are attached the towhead structures which include equipment and valves designed specifically for the requirements of the field. The system, which is fully function-tested onshore, is then launched and transported to its offshore location using CDTM (controlled depth tow methodology) technology. The CDTM technology was pioneered and developed by Subsea 7 and involves the transportation of pre-fabricated and fully tested pipelines, control lines and umbilicals in a bundle configuration suspended between two tugs. Once launched from the onshore site, the bundle is transported to its offshore location at a controlled depth below the


46

surface. On arrival at the field, the bundle is lowered to the seabed and manoeuvred into position, and the carrier pipe is flooded to stabilise the bundle in its final location.

This concept is a major product offering of Subsea 7 and provides an economical, reliable and timely solution for its clients. This approach is mainly used in areas with congested sea beads, and in diverless deepwater operations. The current bundle product offering can be used in up to 700m of water, and the Wick site in Scotland can produce a single pipe of up to 7.8km in length. Subsea 7 has invested considerable capex in its Wick site in recent years, thanks mainly due to its strong order book.

In our view, Subsea 7’s margin on these projects can be as much as 35% simply because: a) it has a very strong position in this market; b) bundled technology enables projects to be completed faster than normal and especially in congested/diverless environments; c) in normal cases (in the North Sea), operators have to trench the pipe after the laying job is finished, which adds to the cost of the project, but with this bundling technology, trenching can be avoided because the pipe is coated with a layer of protective paint; and d) even though Subsea 7 may price the project as a normal EPIC contract, because vessel usage using this approach is much less than in a normal EPIC project, margins benefit.

Current projects: Subsea 7 has been using this technology for the last 30 years and has completed 60+ projects based on this technology.

Table of bundling projects

Source: Berenberg, company data

In our view, the Knarr project is a highly profitable project for Subsea 7 as it is one of the highest value bundling projects ever undertaken by the company.

Technology #2: lifted reels Lifted reels is a new technology adopted by privately held companies such as Heerema (in its heavy-lift vessel Aegir) and EMAS (in its pipelay vessel Lewek Constellation).

Project Country Date wonValue

($m)Comments

Montrose Area Redevelopment

ProjectUK 27/02/2013 285

Project management, engineering, procurement,

fabrication and installation of two 5km pipeline

bundles which will tie back the Cayley field to the new

Bridge-Linked Platform at the Montrose facility. The

contract scope also includes the procurement,

fabrication and installation of a 17.5km production

pipeline, water injection pipeline, gas lift pipeline and

control umbilical

Fram oil and gas development North Sea 21/01/2013 136

Engineering, procurement, fabrication and installation

of a 4.5km pipeline bundle of approximately 44inches

in diameter, with integrated manifolds and tie-in

structures

Western Isles development

projectUK 04/01/2013 300

EPCI of two 2.5km pipelien bundles and 11km gas

export pipeline

Knarr field: SURF contractNorway/

North Sea02/07/2012 400

Engineering, procurement, construction and

installation of a 4.5 km flowline bundle

North Sea: Pipeline systemNorway/

North Sea19/06/2012 95

Project management, engineering, procurement,

fabrication and installation of a 7.5km pipeline bundle


47

In any normal rigid reel pipelay vessel, the loaded reels (of pipe) are light enough to be lifted out from the vessel on to the spool base to be re-reeled with new pipe. However, in order to reduce the number of trips needed between the offshore location and the spool base, some vessels carry additional pipe capacity in their carousels. Given the weight of these carousels (3,000 tonnes or more), these units are fixed on to the vessel. In the J/S lay pipelay format, the pipe is welded on the vessel, which reduces the need for a spool base. In reel lay format, however, there is no welding facility on the vessel and the pipe has to be joined onto an onshore spool base, which means that when the vessel runs out of pipe, it has to return to the spool base to take on a new supply. For any normal vessel, the time taken to move pipe between the oil field location and the spool base is an important component of overall amount of time the vessel is required on the job.

Under the new lifted reel pipelay concept, contractors do not need to take the vessel to the spool base to refill the pipe. Under this technology, the reels can be decoupled from the main vessel and transported on a third-party barge.

This technology has two key advantages.

Reduction in transit time: Due to the advantage of lifted reels, vessels do not need to go back to the spooling base to refill with pipe. EMAS has claimed that this technology can save about 20-25% of transit time compared to normal vessels.

Flexibility with spool base: Conventional vessels for deepwater/ultra-deepwater applications require specialised spool bases (equipped to port vessels that are able to work in deep water – ie in depths of 1000m and below). Given the shortage of yard space in regions such as the North Sea, West Africa and Brazil, building a specialised spool base can be challenging, especially for new players. Thanks to this technology, installers can use barrages to bring the refilled pipe reels to the vessels. Given that the technical requirement for bringing a barrage to the port is much less complicated (compared to deeper-water vessels), this allows flexibility in terms of spool base usage (as most land near beaches can be converted into a spool base).

In the following table, we present an overview of two vessels that will use the lifted reel technology.

Vessel details

Source: Berenberg

Technology #3: pipes Pipeline technology is fast-evolving and has helped improve flow rates and minimise corrosion in oil fields (both externally and internally) in cold, deep waters and for difficult crude (ie with a high sulphur and high concentration of heavy hydrocarbons). Both Subsea 7 and Technip are leading the charge, along with specialist companies such as BUTTING Group.

Technip is the market leader in flexible pipes and offers a range of pipe solutions

Vessel Contractor TypeDelivery

yearROV's

Lift

capability

(tons)

Pipeline

Capability

Pipe diameter

(inches)

Water

depth (m)Regional focus


vessel2013 2 work class ROVs 4000 J, Reel 32 inches 3500

Asia Pacific/

Intercontinental

projects

Lewak Constellation EMAS Reel and flexible lay 41852 none 3000 Reel & Flexible lay16inch Reel &

24inche Flexible lay


48

using thermoplastic sheaths in manufacturing; these increase corrosion resistance and are ideal for colder waters and high-temperature hydrocarbons. There are a number of additional benefits which flexible pipes offer over rigid pipes. First, the laying speed is much faster (500m per hour) and the flexibility of the pipe means that it can be laid on an uneven seabed. Secondly, the manufactured pipe can incorporate umbilicals and heat tracing and monitoring sensors which make the all-in-one solution ideal for deepwater applications or remote, harsh environments like the Arctic.

Flexible pipes have been installed at water depths of up to 2,140m and are able to bear pressures at even higher depths. However, Technip, along with other industry players like NKT Flexibles and GE, are investing in R&D to enable the pipes to withstand yet greater pressure and temperature extremes. As this superior technology evolves at lower cost than standard pipes and makes ultra-deepwater applications possible, traditional rigid pipe systems will become increasingly obsolete.

For its part, Subsea 7 is the leader in rigid integrated pipeline bundle technology which incorporates valves, controls and structures in one pre-assembled system, which saves on installation time. In addition, the system uses tow installation and hence expensive installation vessels are not needed.


49

Preference and selection framework

Our stock selection framework is based on a three-point rating system. We have analysed the companies in our coverage universe by exposure to best sectors, regions and clients. From a sector perspective, we prefer market segments with high barriers to entry and resultantly higher margins. We tend to prefer subsea installation and field development along with hardware manufacturing over downstream engineering and construction and shallow water field development. Our preference hence is for market segments which demand high technology content and hence are likely to retain high margins in the medium to long term.

From a regional perspective, the key subsea markets would be Brazil and West Africa. According to external consultant Infield, capex in these two regions will account for nearly 55% of global subsea spending over 2013-17. Infield also projects a rejuvenation of exploration and drilling activity in mature basins such as the GoM, the North Sea and Asia-Pacific. Growth in these relatively smaller markets is projected to be strong over the next five years. The strongest growth is expected to be in Asia-Pacific where the deeper water basins are still largely under-penetrated. We prefer exposure to these markets but our preference is for West Africa, Brazil and the North Sea, in decreasing order of importance. This is because both Asia-Pacific and the GoM are highly fragmented markets with a high level of competition from a large number of local companies.

From a client perspective, our preference is for larger NOCs and IOCs rather than smaller independents. This is because larger integrated majors are less sensitive to changes in the oil price and have longer-term capital commitments.

We have used this system to compare our coverage universe in order to assess the quality and sustainability of earnings. As part of the process, we have assessed companies’ exposure to high-growth regions, business segments, the value chain and clients.

Stock selection framework


SectorsCapex growth

2012-17Regions

Capex growth

2012-17Clients

Subsea capex 2013-

15 ($ bn)

Growth over subsea capex in

2008-12

Subsea 15% Africa 18% Petrobras 30.1 100%

Subsea

hardware14% Asia 25% Shell 12.5 109%

Shallow water 11% Europe 16% BP 11.1 74%

Deep water 16% Latin America 12% Chevron 8.8 106%

Ultra deep water 16% North America 9% Total 8.7 8%

ExxonMobil 6.9 212%

Score Card

Points out of 10 RatingTotal score out (1 to 30;

30 being the highest)

Saipem Hold 13

Technip Buy 23

Subsea 7 Buy 20

Aker Solutions Buy 26

Petrofac Hold 13

Exposure to growth clients

5

8

3

8

8

8

5

5

8

8

8

3

5

10

5

Exposure to growth

regions

Exposure to growth

sectors

Exposure to growth

sectors

Exposure to growth

regions

Exposure to growth clients


50

Offshore exposure

Key criteria:

ultra-deepwater;

deepwater;

shallow water.

Offshore exposure

Source: Berenberg

All the companies within our coverage universe have offshore exposure, although the relative importance of their offshore exposure varies: Subsea 7, for example, only has offshore installation, while Petrofac has a small but growing offshore presence. Within offshore, margins vary by the type of work, barriers to entry and associated competitive pressures. Ultra-deepwater and deepwater field development work, be it installation or hardware, commands higher margins compared with shallow water platform installation, pipelay and hardware. This is due to the relative complexity of the projects and the supply position.

Only two main ultra-deepwater installation players – Technip and Subsea 7 – have the high-end subsea field development vessels that can work in harsh environments. Saipem’s ultra-deepwater subsea field development fleet is comparatively limited, and instead it specialises in heavy-lift work for shallow water platforms and large diameter trunklines and offshore to shore export lines. Thus, historically, Saipem’s operating margins have trailed those of Subsea 7 and Technip, although they have been more stable. Saipem also possesses a high-end deepwater and ultra-deepwater drilling rig fleet which contributes to the company’s margins.

Flow-pipelines installed in km Deepwater pipelay by vessel hours


Saipem Technip Subsea 7 Aker Solutions Petrofac

Ultra deep Deep Shallow

Saipem Low Mid High

Technip High High Mid

Subsea 7 High High Low

Aker

SolutionsHigh High Low

Petrofac Low Low High

Theme

0

2000

4000

6000

8000

10000

2005 2007 2009 2011 2013E 2015E 2017E

Flowline/Pipelines (As of Feb. 14, 2013) 0

1000

2000

3000

4000

5000

2010 2011 2012

Allseas

Helix

Saipem

Subsea 7

Technip


51

Aker also offers an offshore service, but its expertise lies in providing high-end subsea equipment such as Christmas trees and umbilicals control systems, which are able to perform effectively in cold and harsh environments. Similarly, it also specialises in the manufacture of deepwater/ultra-deepwater drilling packages and has the second-highest market share after NOV. The pricing for high-end subsea equipment and that for ultra-deepwater drilling systems has improved since 2009 – pricing for Christmas trees improved by 14% for the 2010-2012 period as a result of new offshore E&P capex which is skewed towards deepwater/ultra-deepwater projects, especially for the international oil companies.

Tree awards by largest client – strong rise Number of tree awards during 2010-Q1 2013


Subsector exposure

Key criteria:

installation;

hardware;

onshore;

upstream equity investments.

Subsector exposure

Source: Berenberg

Within subsector exposure, we tend to prefer hardware and installation over onshore downstream services. This is because of the low barriers to entry in the onshore segment, where historically high margins have been competed away with the arrival of aggressive Asian oil services companies.

Aker Solutions

18%

Cameron21%

Dril-Quip1%

FMC42%

GE18%


Installation hardware onshore Upstream

Saipem High None High Nil

Technip High Mid Mid Nil

Subsea 7 High Low Nil Nil

Aker

SolutionsLow High Nil Nil

Petrofac None None High High

Subsector


52

Oil and value chain by asset intensity, stage and contract structure

Source: Berenberg

Offshore hardware and installation have relatively higher barriers to entry and the markets are consolidated due to high asset intensity (ie fleets, yards, spoolbases, manufacturing plans), which require a high level of upfront investment in addition to expertise. However, between hardware and offshore installation, we tend to prefer hardware because it has additional technological barriers to entry which in our view are the most difficult for smaller players and new entrants to surmount. This explains the highly consolidated nature of the hardware business, especially for high-spec, high-end subsea equipment.

On this criteria (subsector exposure), Aker and Technip clearly stand out. Aker offers a solid exposure to the hardware business which is experiencing growing demand, rising prices and minimum risk to new entrants. Technip, on the other hand, offers both leading subsea installation exposure as well as leading technology and hardware exposure through its expertise in flexible pipes and umbilicals.

Petrofac is unique among our coverage universe due to its differentiated service offering, especially through its IES division, which provides NOCs with production enhancement services for their brownfield projects and also develops greenfield sites on risk service contract terms. It will also gain installation exposure by 2016-17 when its SURF vessel is expected to enter service. However, despite the high-margin upstream exposure, we are bearish on Petrofac because of its high dependence on downstream onshore projects, which still contribute nearly 70% of total revenues.

Subsector exposure

Source: Berenberg

Siesmic Drilling EngineeringOffshore


Asset intensity High High Low High High Low

Position in the

value chain Early

Early and

midMid late Late Late

Type of

contractDay rate Day rate

Cost

reimbursableLumpsum Lumpsum Lumpsum

Drilling EngineeringOffshore


Technip Nil. High High Mid Mid

Subsea 7 Nil. High High Nil. Nil.

Saipem High Mid High Nil. High

Petrofac Nil. Mid Nil. Nil. High

Aker Solutions Nil. Mid Low High Nil.


53

Oil services value chain

Source: Berenberg

Geographic reach

Key regions:

West Africa;

Brazil;

the North Sea;

the GoM/North America;

MENA.

Geographical reach

Source: Berenberg

Brazil, West Africa and the GoM, widely known as the “golden triangle”, represent the most important region for offshore exploration with a particular skew toward deepwater/ultra-deepwater exploration. The North Sea – the traditional offshore exploration region – has seen a revival of growth with new tie-back offshore exploration projects. While shallow water exploration in Asia is a mature market, deepwater exploration there is new. On the onshore side, the main region of focus is MENA, an area which has seen increased competition in the last five years.

In offshore, Subsea 7 and Technip dominate the installation market with a broad fleet of vessels (Subsea 7 has 40 vessels followed by Technip at 34 vessels). Saipem is the third-largest installer but is mainly focused on the shallow water market. In the last five years, we have also seen second-tier players such as McDermott, EMAS and Heerema gain importance and market share as they add new high-end vessels to serve the deepwater market. In the hardware space, the market is highly concentrated for subsea equipment with FMC, Cameroon, Aker and GE oil and gas dominating the market. Petrofac and Saipem have the highest onshore exposure among our coverage.


West Africa Brazil North Sea GoM/ Nortg AmericaMENA

Saipem High Low High Nil High

Technip Mid High High Mid Low

Subsea 7 High Mid High Low Nil

Aker

SolutionsMid High High Low Low

Petrofac Low Nil High Mid High

Region


54

Subsea capex projected to grow at a 15.4% CAGR over 2012-17; all primary regions to show strong growth

Source: Infield Subsea report 2017

Infield projects subsea capex to remain strong and grow at a 15.4% CAGR over 2012-17 with ultra-deepwater projects expected to capture nearly half of the capex. It expects the strongest growth will be in Asia (a 25% CAGR for next five years) due to a low base, and that it will move to develop the under-penetrated deepwater basins. West Africa follows in terms of growth and is projected to grow at an 18% CAGR for the next five years. Angola and ultra deepwater regions such as Ghana will drive this growth. The North Sea is expected to see strong growth of 16% in the next five years, with Statoil investing heavily in enhanced field recovery and to explore the arctic region. In the GoM, activity is picking up, with a sharp increase in the number of offshore drilling permits issued in 2012. Infield projects a 9% CAGR growth for the North American region over 2012-17.

Revenue split by geography (2012)

Source: Berenberg

Based on our regional growth outlook combined with regional market positioning, we expect Technip and Aker to have the strongest top-line growth, followed by Subsea 7. Given the muted growth outlook for onshore exploration coupled with increased competition in MENA, we are more conservative about Saipem and Petrofac growth.

0

5

10

15

20

25

30

35

40

2007 2008 2009 2010 2011 2012 2013E 2014E 2015E 2016E 2017E

$ b

n

Africa Latin America North America Europe Asia ME & Caspian

Subsea capex projected to grow at 15.4%cagr

0%

20%

40%

60%

80%

100%

Saipem Subsea 7 Technip Petrofac AkerSolutions

West Africa

North Sea

North America

Asia pacific

Middle East &North Africa

Central Asia

Brazil


55

Client exposure

Key criteria:

NOCs;

international oil companies;

independents.

Client exposure

Source: Berenberg

The resilience of E&P spending to external financial shocks and changes in the oil price vary by client type. NOCs such as Saudi Aramco, Petrobras and Adnoc have deep pockets and access to government financing. Their investments tend to be more strategic and based on long-term supply demand considerations. Hence, their spending patterns can even run contrary to short- to medium-term oil price trends. For example, Middle Eastern NOCs sanctioned a number of upstream and downstream projects during the financial crisis/oil price slump in 2009-10 in order to benefit from the low pricing environment. Within our coverage universe, Saipem, Petrofac and Aker have the greatest exposure to NOCs. While Saipem and Petrofac rely greatly on NOCs in the Middle East and North Africa (MENA) region for oil- and gas-related projects. Aker, on the other hand, is dependent on Statoil and Petrobras.

E&P spending by international oil companies depends on medium-term oil price trends; and considering that internal cash generation is their primary funding source, any sustained oil price weakness will prompt them to curtail non-strategic spending, especially early-cycle capex such as seismic and exploration drilling. Technip and Subsea 7 have the most diversified exposure of the coverage universe to international oil companies.

Smaller independents’ spending has the highest sensitivity to external financial shocks and changes in the oil price. This is because of the low balance-sheet strength of these companies and their dependence on external funding and internal cash flows. Saipem, Technip and Subsea 7 have a limited exposure to independents.


NOC IOC Independents

Saipem High High High

Technip Mid High Mid

Subsea 7 Mid High Mid

Aker

SolutionsHigh High Low

Petrofac High Mid Low

Client


56

Valuation and performance

We rate Aker, Subsea 7 and Technip as Buys, and Saipem and Petrofac as Holds. Within this universe, Aker is our top pick and our preference is based on the three-point set of criteria detailed in the previous section. In summary, we think Aker has the strongest potential for margin improvement and top-line growth based on its sectoral, geographic and client exposure.

We think that Saipem and Petrofac are fairly valued based on their respective evolving risk-return profiles. We highlight the uncertainty surrounding the success of Petrofac’s subsea growth strategy and its ability to regain lost ground on onshore E&C. This in our view puts its earnings quality and sustainability at risk. Saipem, on the other hand, is structurally ill-placed in commoditising segments in our view, which makes us bearish about its long-term margin and growth potential. We think that the company is lodged in a period of consolidation as it regains balance sheet strength and re-strategises its long-term growth path.

Investment recommendations

Source: Berenberg estimates, Datastream

All our price targets are based on DCF. For the five companies, we have taken 10 years as the high growth phase followed by a terminal growth stage.

Companies

Market

capitalization

(local bn)

Recommen

dation

Target

price

Share

priceUpside P/E

EV/EBIT

DAEV/EBIT

Aker Solutions (NOK) 22.5 Buy 115 82 40% 7.4 5.2 6.8

Technip (EUR) 9.1 Buy 106 81 31% 10.8 5.9 7.3

Subsea 7 (NOK) 37.8 Buy 146 108 36% 8.3 3.7 5.0

Saipem (EUR) 6.3 Hold 14.2 14.3 -1% 13.7 7.2 13.4

Petrofac (GBP) 4.3 Hold 13.7 12.5 9% 9.6 6.8 8.1

Sector average 23% 9.9

Sector weighted average 14%

Based on Berenberg 2014 est.


57

Peer multiples

Multiples by subsectors

Source: Berenberg estimates, Datastream

Considering that the OFS sector is fairly diverse, with clear subsectors which have exposure to different stages of the capex cycle, we have carried out a peer multiple comparison at the subsector level. Hardware, being a consolidated sector with high entry barriers and better pricing, trades at a premium to offshore E&C players. Similarly, offshore E&C companies trade at a premium to those companies which specialise in onshore downstream projects. Petrofac is the only one of the five with equity investment exposure, but because of its high dependence on onshore E&C, we would more readily compare it to companies in that segment.

Hardware Aker has historically traded at a discount to the sector in general and its two peers, FMC and Cameron, in particular, on price earnings multiples. On an 12-month forward P/E multiple, Aker’s discount to the EU Oil Equipment & Services Index has expanded by 17% to 24% since the beginning of 2013. In our view, Aker’s attractive market position in Europe, its capacity expansion in Asia, its high opex exposure (recurrent revenues) and its restructuring benefits would lead to a narrowing of the recent enlargement in valuation discount.

Hardware E&C peers

Market

capitalization

(local bn)

PriceYTD

change

12M

Forward PE

EV/EBIT

DAEV/Sales EV/EBIT Dividend yield (%) EBIT Margin (2013) EBIT margin (2014)

Aker Solutions (NOK) 22.62 82.55 -27% 9.01 8.46 0.59 6.73 4.85 7% 8%

FMC Technologies (USD) 13.36 56.34 32% 21.40 17.84 1.69 12.24 0.00 11% 13%

Cameron (USD) 15.67 63.16 12% 14.34 12.71 1.38 8.50 0.00 13% 15%

National Oilwell Varco

(USD)30.70 71.85 5% 11.71 8.02 1.24 7.00 1.45 16% 17%

Offshore E&C peers

Market

capitalization

(local bn)

PriceYTD

change

12M

Forward PE

EV/EBIT


Technip (EUR) 9.22 81.55 -6% 13.30 8.45 0.87 7.61 2.06 10% 11%

Subsea 7 (NOK) 37.82 107.50 -19% 11.55 5.36 1.01 6.61 3.24 9% 15%

Saipem (EUR) 6.23 14.11 -52% 28.33 7.01 0.91 12.07 4.82 0% 7%

McDermot (USD) 2.02 8.55 -22% 12.41 5.08 0.59 6.00 0.00 6% 9%

Onshore E&C peers

Market

capitalization

(local bn)

PriceYTD

change

12M

Forward PE

EV/EBIT


Petrofac (GBP) 4.28 12 -24% 8.84 9.58 1.01 6.98 3.00 13% 14%

Saipem (EUR) 6.23 14 -52% 28.33 7.01 0.91 12.07 4.82 0% 7%

Tecnicas Reunidas (EUR) 1.99 36 2% 12.77 7.22 0.46 7.96 3.80 6% 6%

Maire Tecnimont (EUR) 0.23 1 -27% 5.56 0.00 0.21 6.60 75.82 4% 3%


58

Aker’s 12-month forward P/E versus peers

Source: DataStream

Offshore installers Saipem has historically traded at a relative discount to Technip and premium to Subsea 7. However, due to the sharp one-off drop in 2013 earning expectations, Saipem’s 12-month forward P/E has moved on to share premium relative to its offshore competitors. Based on consensus 2014 and 2015 figures, Saipem is trading on a discount to Technip and a premium to Subsea 7. We think that these multiples are more suitable compared with the 12-month P/E figures which are distorted by 2013 results which the market believes are one-off.

12-month forward P/E of offshore installers

Source: DataStream

Onshore E&C Petrofac’s closest peers in the onshore E&C space are Tecnicas Reunidas and Saipem. On 12-month forward P/E it has historically traded at a premium to Tecnicas Reunidas primarily because of its strong cost advantage in the MENA region due to low tax incidence, as well as offshore and upstream exposure. However, since announcing its plans to enter the SURF installation business, Petrofac has sharply de-rated and is now trading at a significant discount to its onshore E&C peers. We think that the market is adequately discounting Petrofac’s high-risk growth strategy.

0

5

10

15

20

25

30

2011 2012 2013

Aker FMC Cameron NOV

8

10

12

14

16

18

20

22

24

2011 2012 2013

Technip Subsea 7 Saipem


59

Petrofac’s historical premium to onshore E&C peer Tecnicas Reunidas has changed into a steep discount on 12-month forward P/E

Source: DataStream

0

2

4

6

8

10

12

14

16

18

20

2011 2012 2013

Petrofac Tecnicas Reunidas


60

Risks to thesis

Our positive investment thesis for the sectors and for three companies within our coverage universe is based on the assumption that there is limited downside to the price of oil, which we expect to remain range-bound over the next three years. This in our view would entail strong E&P capex growth which along with positive project phasing will drive earnings momentum from 2014 for the sector.

In our doomsday scenario – in which there would be a supply glut caused either by a higher-than-projected supply from unconventional sources or a sharp drop in global energy demand due to an economic crisis in important BRIC and OECD economies – the outlook for oil prices, E&P capex and performance of the cyclical oil services sector will be substantially different from what we are anticipating.

In this grim scenario, there would be a persistent 30%+ drop in the Brent oil price, many of the expensive and technically demanding projects, especially offshore (deepwater and ultra-deepwater) and unconventionals (shale oil), would become uneconomical. In this case, we would tend to prefer companies with more onshore and shallow water exposure and asset-light business models such as Technip, Saipem and Petrofac. This translates into a stock preference for lower operational gearing and lower oil beta.

In the chart below, we detail our estimates for operational gearing and oil beta for companies within our coverage universe. As can be seen, Technip, Petrofac and Saipem clearly stand out. However, we would point out that Petrofac is clearly moving towards a more asset-heavy business model with exposure to offshore EPIC contracts. In this doomsday oil price scenario, Technip and Saipem offer the best defensive characteristics, in our view. Oil Beta versus operational gearing


Subsea7

Technip Saipem

Aker

Petrofac

0.60

0.70

0.80

0.90

1.00

1.10

1.20

1.30

1.40

1.50

0.50 0.70 0.90 1.10 1.30 1.50 1.70 1.90

Operational leverage

Sto

ckB

eta

vs

Oil

Growth

Defensive


61

Contacts: Investment Banking

Equity Research E-mail: [email protected]; Internet www.berenberg.de

BANKS ECONOMICS MID-CAP GENERAL

Nick Anderson +44 (0) 20 3207 7838 Dr. Holger Schmieding +44 (0) 20 3207 7889 Gunnar Cohrs +44 (0) 20 3207 7894

James Chappell +44 (0) 20 3207 7844 Dr. Christian Schulz +44 (0) 20 3207 7878 Bjoern Lippe +44 (0) 20 3207 7845

Andrew Lowe +44 (0) 20 3465 2743 Robert Wood +44 (0) 20 3207 7822 Anna Patrice +44 (0) 20 3207 7863

Eoin Mullany +44 (0) 20 3207 7854 Stanislaus von Thurn und Taxis +44 (0) 20 3465 2631

Eleni Papoula +44 (0) 20 3465 2741 FOOD MANUFACTURING

Michelle Wilson +44 (0) 20 3465 2663 Fintan Ryan +44 (0) 20 3465 2748 OIL & GAS

Andrew Steele +44 (0) 20 3207 7926 Asad Farid +44 (0) 20 3207 7932

BEVERAGES James Targett +44 (0) 20 3207 7873 Jaideep Pandya +44 (0) 20 3207 7890

Philip Morrisey +44 (0) 20 3207 7892

Josh Puddle +44 (0) 20 3207 7881 GENERAL RETAIL & LUXURY GOODS REAL ESTATE

Bassel Choughari +44 (0) 20 3465 2675 Kai Klose +44 (0) 20 3207 7888

BUSINESS SERVICES John Guy +44 (0) 20 3465 2674 Estelle Weingrod +44 (0) 20 3207 7931

William Foggon +44 (0) 20 3207 7882

Simon Mezzanotte +44 (0) 20 3207 7917 HEALTHCARE TECHNOLOGY

Arash Roshan Zamir +44 (0) 20 3465 2636 Scott Bardo +44 (0) 20 3207 7869 Adnaan Ahmad +44 (0) 20 3207 7851

Konrad Zomer +44 (0) 20 3207 7920 Alistair Campbell +44 (0) 20 3207 7876 Sebastian Grabert +44 (0) 20 3207 7834

Charles Cooper +44 (0) 20 3465 2637 Daud Khan +44 (0) 20 3465 2638

CAPITAL GOODS Louise Hinds +44 (0) 20 3465 2747 Ali Khwaja +44 (0) 20 3207 7852

Frederik Bitter +44 (0) 20 3207 7916 Tom Jones +44 (0) 20 3207 7877 Tammy Qiu +44 (0) 20 3465 2673

Benjamin Glaeser +44 (0) 20 3207 7918

William Mackie +44 (0) 20 3207 7837 HOUSEHOLD & PERSONAL CARE TELECOMMUNICATIONS

Margaret Paxton +44 (0) 20 3207 7934 Jade Barkett +44 (0) 20 3207 7895 Wassil El Hebil +44 (0) 20 3207 7862

Alexander Virgo +44 (0) 20 3207 7856 Seth Peterson +44 (0) 20 3207 7891 Usman Ghazi +44 (0) 20 3207 7824

Felix Wienen +44 (0) 20 3207 7915 Stuart Gordon +44 (0) 20 3207 7858

INSURANCE Laura Janssens +44 (0) 20 3465 2639

CHEMICALS Tom Carstairs +44 (0) 20 3207 7823 Paul Marsch +44 (0) 20 3207 7857

John Philipp Klein +44 (0) 20 3207 7930 Peter Eliot +44 (0) 20 3207 7880 Barry Zeitoune +44 (0) 20 3207 7859

Evgenia Molotova +44 (0) 20 3465 2664 Kai Mueller +44 (0) 20 3465 2681

Jaideep Pandya +44 (0) 20 3207 7890 Matthew Preston +44 (0) 20 3207 7913 TOBACCO

Sami Taipalus +44 (0) 20 3207 7866 Erik Bloomquist +44 (0) 20 3207 7870

CONSTRUCTION Kate Kalashnikova +44 (0) 20 3465 2665

Chris Moore +44 (0) 20 3465 2737 MEDIA

Robert Muir +44 (0) 20 3207 7860 Robert Berg +44 (0) 20 3465 2680 UTILITIES

Michael Watts +44 (0) 20 3207 7928 Emma Coulby +44 (0) 20 3207 7821 Robert Chantry +44 (0) 20 3207 7861

Laura Janssens +44 (0) 20 3465 2639 Andrew Fisher +44 (0) 20 3207 7937

DIVERSIFIED FINANCIALS Sarah Simon +44 (0) 20 3207 7830 Oliver Salvesen +44 (0) 20 3207 7818

Pras Jeyanandhan +44 (0) 20 3207 7899 Lawson Steele +44 (0) 20 3207 7887

Sales E-mail: [email protected]; Internet www.berenberg.de

Specialist Sales Sales Sales Trading

BANKS LONDON HAMBURG

Iro Papadopoulou +44 (0) 20 3207 7924 John von Berenberg-Consbruch +44 (0) 20 3207 7805 Paul Dontenwill +49 (0) 40 350 60 563

Matt Chawner +44 (0) 20 3207 7847 Alexander Heinz +49 (0) 40 350 60 359

CONSUMER Toby Flaux +44 (0) 20 3465 2745 Gregor Labahn +49 (0) 40 350 60 571

Rupert Trotter +44 (0) 20 3207 7815 Karl Hancock +44 (0) 20 3207 7803 Chris McKeand +49 (0) 40 350 60 798

Sean Heath +44 (0) 20 3465 2742 Fin Schaffer +49 (0) 40 350 60 596

INSURANCE David Hogg +44 (0) 20 3465 2628 Lars Schwartau +49 (0) 40 350 60 450

Trevor Moss +44 (0) 20 3207 7893 Zubin Hubner +44 (0) 20 3207 7885 Marvin Schweden +49 (0) 40 350 60 576

Ben Hutton +44 (0) 20 3207 7804 Tim Storm +49 (0) 40 350 60 415

HEALTHCARE James Matthews +44 (0) 20 3207 7807 Philipp Wiechmann +49 (0) 40 350 60 346

Frazer Hall +44 (0) 20 3207 7875 David Mortlock +44 (0) 20 3207 7850

Peter Nichols +44 (0) 20 3207 7810 LONDON

INDUSTRIALS Richard Payman +44 (0) 20 3207 7825 Mike Berry +44 (0) 20 3465 2755

Chris Armstrong +44 (0) 20 3207 7809 George Smibert +44 (0) 20 3207 7911 Stewart Cook +44 (0) 20 3465 2752

Kaj Alftan +44 (0) 20 3207 7879 Anita Surana +44 (0) 20 3207 7855 Simon Messman +44 (0) 20 3465 2754

Paul Walker +44 (0) 20 3465 2632 Stephen O'Donohoe +44 (0) 20 3465 2753

MEDIA

Julia Thannheiser +44 (0) 20 3465 2676 PARIS PARIS

Christophe Choquart +33 (0) 1 5844 9508 Sylvain Granjoux +33 (0) 1 5844 9509

TECHNOLOGY Dalila Farigoule +33 (0) 1 5844 9510

Jean Beaubois +44 (0) 20 3207 7835 Clémence La Clavière-Peyraud +33 (0) 1 5844 9521 SOVEREIGN WEALTH FUNDS

Olivier Thibert +33 (0) 1 5844 9512 Max von Doetinchem +44 (0) 20 3207 7826

TELECOMMUNICATIONS

Julia Thannheiser +44 (0) 20 3465 2676 ZURICH CORPORATE ACCESS

Stephan Hofer +41 (0) 44 283 2029 Patricia Nehring +44 (0) 20 3207 7811

UTILITIES Carsten Kinder +41 (0) 44 283 2024

Benita Barretto +44 (0) 20 3207 7829 Gianni Lavigna +41 (0) 44 283 2038 EVENTS

Benjamin Stillfried +41 (0) 44 283 2033 Natalie Meech +44 (0) 20 3207 7831

Sales Charlotte Kilby +44 (0) 20 3207 7832

FRANKFURT BENELUX Charlotte Reeves +44 (0) 20 3465 2671

Michael Brauburger +49 (0) 69 91 30 90 741 Miel Bakker (London) +44 (0) 20 3207 7808 Hannah Whitehead +44 (0) 20 3207 7922

Nina Buechs +49 (0) 69 91 30 90 735 Susette Mantzel (Hamburg) +49 (0) 40 350 60 694

André Grosskurth +49 (0) 69 91 30 90 734 Alexander Wace (London) +44 (0) 20 3465 2670 CRM

Boris Koegel +49 (0) 69 91 30 90 740 Greg Swallow +44 (0) 20 3207 7833

Joerg Wenzel +49 (0) 69 91 30 90 743 SCANDINAVIA Laura Cooper +44 (0) 20 3207 7806

Ronald Bernette (London) +44 (0) 20 3207 7828

Marco Weiss (Hamburg) +49 (0) 40 350 60 719

US Sales E-mail: [email protected]

BERENBERG CAPITAL MARKETS LLC

Member FINRA & SIPC

Andrew Holder +1 (617) 292 8222 Burr Clark +1 (617) 292 8282 Kieran O'Sullivan +1 (617) 292 8292

Colin Andrade +1 (617) 292 8230 Julie Doherty +1 (617) 292 8228 Emily Mouret +1 (646) 445 7204

Cathal Carroll +1 (646) 445 7206 Kelleigh Faldi +1 (617) 292 8288 Jonathan Saxon +1 (646) 445 7202


62

Please note that the use of this research report is subject to the conditions and restrictions set forth in the “General investment-related disclosures” and the “Legal disclaimer” at the end of this document.

For analyst certification and remarks regarding foreign investors and country-specific disclosures, please refer to the respective paragraph at the end of this document.

Disclosures in respect of section 34b of the German Securities Trading Act (Wertpapierhandelsgesetz – WpHG)

Company Disclosures Aker Solutions ASA no disclosures Petrofac Ltd no disclosures Saipem SpA no disclosures Subsea 7 SA no disclosures Technip SA 5 (1) Joh. Berenberg, Gossler & Co. KG (hereinafter referred to as “the Bank”) and/or its affiliate(s) was Lead

Manager or Co-Lead Manager over the previous 12 months of a public offering of this company. (2) The Bank acts as Designated Sponsor for this company. (3) Over the previous 12 months, the Bank and/or its affiliate(s) has effected an agreement with this company

for investment banking services or received compensation or a promise to pay from this company for investment banking services.

(4) The Bank and/or its affiliate(s) holds 5% or more of the share capital of this company. (5) The Bank holds a trading position in shares of this company. Historical price target and rating changes for Aker Solutions ASA in the last 12 months (full coverage)

Date Price target - NOK Rating Initiation of coverage

10 July 13 115.00 Buy 10 July 13

Historical price target and rating changes for Petrofac Ltd in the last 12 months (full coverage)

Date Price target - GBp Rating Initiation of coverage

10 July 13 1370.00 Hold 10 July 13

Historical price target and rating changes for Saipem SpA in the last 12 months (full coverage)

Date Price target - EUR Rating Initiation of coverage

10 July 13 14.20 Hold 10 July 13

Historical price target and rating changes for Subsea 7 SA in the last 12 months (full coverage)

Date Price target - NOK Rating Initiation of coverage

10 July 13 146.00 Buy 10 July 13

Historical price target and rating changes for Technip SA in the last 12 months (full coverage)

Date Price target - EUR Rating Initiation of coverage

10 July 13 106.00 Buy 10 July 13

Berenberg distribution of ratings and in proportion to investment banking services

Buy 41.65 % 51.43 % Sell 19.19 % 8.57 % Hold 39.16 % 40.00 %


63

Valuation basis/rating key

The recommendations for companies analysed by the Bank’s equity research department are either made on an absolute basis (“absolute rating system”) or relative to the sector (“relative rating system“), which is clearly stated in the financial analysis. For both absolute and relative rating system, the three-step rating key “Buy”, “Hold” and “Sell” is applied. For a detailed explanation of our rating system, please refer to our website at

http://www.berenberg.de/research.html?&L=1

NB: During periods of high market, sector or stock volatility, or in special situations, the rating system criteria as described on our website may be breached temporarily.

Competent supervisory authority

Bundesanstalt für Finanzdienstleistungsaufsicht -BaFin- (Federal Financial Supervisory Authority), Graurheindorfer Straße 108, 53117 Bonn and Marie-Curie-Str. 24-28, 60439 Frankfurt am Main, Germany.

General investment-related disclosures Joh. Berenberg, Gossler & Co. KG (hereinafter referred to as „the Bank“) has made every effort to carefully research all information contained in this financial analysis. The information on which the financial analysis is based has been obtained from sources which we believe to be reliable such as, for example, Thomson Reuters, Bloomberg and the relevant specialised press as well as the company which is the subject of this financial analysis. Only that part of the research note is made available to the issuer (who is the subject of this analysis) which is necessary to properly reconcile with the facts. Should this result in considerable changes a reference is made in the research note.

Opinions expressed in this financial analysis are our current opinions as of the issuing date indicated on this document. The companies analysed by the Bank are divided into two groups: those under “full coverage” (regular updates provided); and those under “screening coverage” (updates provided as and when required at irregular intervals).

The functional job title of the person/s responsible for the recommendations contained in this report is “Equity Research Analyst” unless otherwise stated on the cover.

The following internet link provides further remarks on our financial analyses: http://www.berenberg.de/research.html?&L=1&no_cache=1

Legal disclaimer This document has been prepared by Joh. Berenberg, Gossler & Co. KG (hereinafter referred to as „the Bank“). This document does not claim completeness regarding all the information on the stocks, stock markets or developments referred to in it. On no account should the document be regarded as a substitute for the recipient procuring information for himself/herself or exercising his/her own judgements. The document has been produced for information purposes for institutional clients or market professionals. Private customers, into whose possession this document comes, should discuss possible investment decisions with their customer service officer as differing views and opinions may exist with regard to the stocks referred to in this document.

This document is not a solicitation or an offer to buy or sell the mentioned stock.

The document may include certain descriptions, statements, estimates, and conclusions underlining potential market and company development. These reflect assumptions, which may turn out to be incorrect. The Bank and/or its employees accept no liability whatsoever for any direct or consequential loss or damages of any kind arising out of the use of this document or any part of its content.

The Bank and/or its employees may hold, buy or sell positions in any securities mentioned in this document, derivatives thereon or related financial products. The Bank and/or its employees may underwrite issues for any securities mentioned in this document, derivatives thereon or related financial products or seek to perform capital market or underwriting services.

http://www.berenberg.de/research.html?&L=1

http://www.berenberg.de/research.html?&L=1&no_cache=1


64

Analyst certification I, Asad Farid, CFA, hereby certify that all of the views expressed in this report accurately reflect my personal views about any and all of the subject securities or issuers discussed herein.

In addition, I hereby certify that no part of my compensation was, is, or will be, directly or indirectly related to the specific recommendations or views expressed in this research report, nor is it tied to any specific investment banking transaction performed by the Bank or its affiliates.

I, Jaideep Pandya, hereby certify that all of the views expressed in this report accurately reflect my personal views about any and all of the subject securities or issuers discussed herein.

In addition, I hereby certify that no part of my compensation was, is, or will be, directly or indirectly related to the specific recommendations or views expressed in this research report, nor is it tied to any specific investment banking transaction performed by the Bank or its affiliates.

Remarks regarding foreign investors The preparation of this document is subject to regulation by German law. The distribution of this document in other jurisdictions may be restricted by law, and persons into whose possession this document comes should inform themselves about, and observe, any such restrictions.

United Kingdom This document is meant exclusively for institutional investors and market professionals, but not for private customers. It is not for distribution to or the use of private investors or private customers.

United States of America This document has been prepared exclusively by the Bank. Although Berenberg Capital Markets LLC, an affiliate of the Bank and registered US broker-dealer, distributes this document to certain customers, Berenberg Capital Markets LLC does not provide input into its contents, nor does this document constitute research of Berenberg Capital Markets LLC. In addition, this document is meant exclusively for institutional investors and market professionals, but not for private customers. It is not for distribution to or the use of private investors or private customers.

This document is classified as objective for the purposes of FINRA rules. Please contact Berenberg Capital Markets LLC (+1 617.292.8200), if you require additional information.

Third-party research disclosures

Company Disclosures Aker Solutions ASA no disclosures Petrofac Ltd no disclosures Saipem SpA no disclosures Subsea 7 SA no disclosures Technip SA no disclosures (1) Berenberg Capital Markets LLC owned 1% or more of the outstanding shares of any class of the subject

company by the end of the prior month.* (2) Over the previous 12 months, Berenberg Capital Markets LLC has managed or co-managed any public

offering for the subject company.* (3) Berenberg Capital Markets LLC is making a market in the subject securities at the time of the report. (4) Berenberg Capital Markets LLC received compensation for investment banking services in the past 12 months,

or expects to receive such compensation in the next 3 months.* (5) There is another potential conflict of interest of the analyst or Berenberg Capital Markets LLC, of which the

analyst knows or has reason to know at the time of publication of this research report.

* For disclosures regarding affiliates of Berenberg Capital Markets LLC please refer to the ‘Disclosures in respect of section 34b of the German Securities Trading Act (Wertpapierhandelsgesetz – WpHG)’ section above.


65

Copyright The Bank reserves all the rights in this document. No part of the document or its content may be rewritten, copied, photocopied or duplicated in any form by any means or redistributed without the Bank’s prior written consent.

© May 2013 Joh. Berenberg, Gossler & Co. KG

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