This article first appeared in The Edge Malaysia Weekly on May 18, 2020 - May 24, 2020

RECENTLY, integrated oil and gas outfit Sapura Energy Bhd booked a massive RM3 billion impairment on its assets, owing to the collapse in crude oil prices, triggering talk that its peers may follow.

Nonetheless, analysts are not expecting large impairments to become the norm, simply because many O&G companies had already bit the bullet in the previous downturn.

“I think the situation will not be as bad as in 2014 to 2018. Those who had undertaken impairments on their assets in the last cycle are unlikely to do so in this round,” Maybank Kim Eng Research analyst Liaw Thong Jung tells The Edge.

But this also does not absolve the O&G firms of risks, he says, as the bigger concern is order book destruction and provision for potential contract revision or termination.

In hindsight, contract halts also played out in 2015 as oil majors tightened their belts by cutting capital expenditure (capex) and operating expenditure (opex).

Case-by-case impairment

Most analysts believe that Sapura Energy took a massive impairment in its fourth quarter ended Jan 31, 2020 (4QFY2020), because it did not make enough provisions in the last cycle. It had previously recognised a RM2.13 billion impairment in 4QFY2018.

In the just-ended quarter, Sapura Energy booked an impairment charge of RM3.04 billion on goodwill on consolidation, and RM240.9 million on assets. The latest write-off still leaves it with RM4.93 billion of goodwill on consolidation at end-January 2020.

Last month, Malaysia Marine and Heavy Engineering Bhd (MHB) had also warned of a potential impairment on its assets, although analysts say the size is unlikely to be as chunky as that of Sapura Energy.

The impairment risk comes on the back of a challenging outlook and disruption from the Covid-19 pandemic, MHB said in its filing with Bursa Malaysia on April 28.

The company has two heavy engineering yards and three dry docks, one of which is under construction. Property assets totalled RM1.75 billion, while right-of-use assets are valued at RM225.62 million.

Shipping company MISC Bhd, controlled by Petroliam Nasional Bhd (Petronas), has not been spared the provision risk, no thanks to the current weak demand for liquefied natural gas (LNG), from which it derived 58% of its FY2019 operating profit. It also has goodwill of RM869.5 million in its books.

Other O&G players likely to be hit by provisions include upstream player Hibiscus Petroleum Bhd. Most oil producers have incurred write-offs on lower carrying amounts of the O&G assets because of lower prices.

Hibiscus has eight producing fields, five discovered fields and two exploration licences, with intangible assets totalling RM1.47 billion. Interestingly, it has secured offtake for North Sabah output of 750,000 barrels at US$35 per barrel, targeting a production cost of US$15 per barrel.

Asset-heavy companies that largely provided for asset impairments in the last downturn include jack-up drill operator Velesto Energy Bhd as well as vessel operators Icon Offshore Bhd and Alam Maritim Resources Bhd.

Meanwhile, analysts have little concern over floating production, storage and offloading (FPSO) operators such as Yinson Holdings Bhd and Bumi Armada Bhd as well as storage tank operator Dialog Group Bhd.

That is because the FPSO assets in question are generating adequate cash flow while tank storage businesses such as Dialog’s are currently booming amid the supply glut in 1H2020.

Risk of order book destruction looms

A bigger risk looming over the entire O&G industry is the provision for contract revision or termination, which has played out in the past down cycle.

Given the current oversupply glut that has sent oil futures contract prices to sub-zero, it is hard to convince oil majors to continue their spending on capex as usual.

Already, projects have been cancelled in places such as the Middle East, and analysts see more cancellations in the months to come as oil majors, from Saudi Aramco to China National Offshore Oil Corp and Brazil’s Petroleo Brasileiro SA (Petrobras), have cut capex by up to 30% from their initial projections.

These moves will affect a wide array of service contracts, beginning with drilling, followed by offshore support vessel (OSV) charter and maintenance works. On top of that, oil majors are likely to cut opex to lower costs, which will in turn squeeze the margins of supportive service providers.

“What has been locked in for 1H2020 is likely to remain intact, but we may see the situation change in 2H2020.

“The next year is going to be worse. Be reminded that FID (final investment decision) may not go ahead for another year,” an analyst said.

For example, Sapura Energy has undertaken RM438.8 million provision in anticipation of project delays, including an engineering project that was cancelled in Qatar.

Earlier, Yinson also announced the cancellation of a long-term FPSO vessel charter in the Pecan field offshore Ghana, valued at more than US$2 billion ($8.7 billion).

The saving grace for some companies that have secured umbrella contracts is that they have been prudent not to include the contracts under projection, except for the portions that have been locked in.

An executive with an OSV operator group with high exposure to the domestic upstream segment points out that, so far, there has been no mention of long-term contract revisions by Petronas.

New contracts to dictate industry outlook

Learning from the past, industry players want to maintain the long-term contract structure, which helps secure financing, especially when times are tough.

On the home front, Petronas has said it will strive to maintain its capex target of RM26 billion to RM28 billion this year despite the recent price collapse.

Some quarters are not that optimistic. “Services companies are always at the mercy of oil majors. Looking back, the last price crash started in 2H2014, but company earnings diminished only in 2015,” says an industry observer.

Those looking for an indication can keep an eye on the upcoming long-term contract awards once the current ones expire.

In a recent note, CGS-CIMB Research said Petronas’ continued employment of four rigs — a leading indicator of the health of the industry — owned by Velesto is now in question.

This is considering the earlier termination of one contract in March. The four rigs are due for the optional one-year contract extensions this year.

In its Activity Outlook, Petronas underlined many contracts due for re-tendering in 2020 to 2022. This year, the indicated re-tender includes well services such as fishing and production enhancement, drilling, select equipment and pipeline maintenance.

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