This article first appeared in The Edge Malaysia Weekly on May 20, 2019 - May 26, 2019

THE mood at Velesto Energy Bhd’s (formerly known as UMW Oil & Gas Bhd) office in KL Sentral is upbeat. A couple of men are talking to a Velesto employee on charter rates, payment terms and other issues; other members of the staff are walking around with purpose, some clutching files and documents as they stride along the walkways; while the receptionist seems to be getting a lot of calls.

This is quite a different picture from a year ago, when the situation was glum and there was virtually no activity and  the office was quiet and lacking in vibrancy.

When asked about the difference, Velesto president and executive director Rohaizad Darus bursts into laughter. “It’s obvious, isn’t it? I think it’s quite true ... morale has been excellent and things are looking up,” he says nonchalantly during an exclusive interview with The Edge.

In February, the company bagged a US$38 million (RM155 million) 18-month contract extension from Hess Exploration and Production Malaysia BV for a high pressure, high temperature jack-up drilling rig, the Naga 8, for work on the North Malay Basin, offshore Peninsular Malaysia.

Then last month, it secured four drilling contracts for its jack-up rigs Naga 2, Naga 3, Naga 5 and Naga 6, with a combined value of US$104.6 million from Petronas Carigali Sdn Bhd — a unit of Petroliam Nasional Bhd — for a one-year charter and two one-year extensions.

The contracts indicate that tenures have improved and the average charter rate has gone up.

Longer tenures, higher charter rates

“Previously, the situation was more on an ad hoc basis. There would be programmes for three months or programmes for eight months,” Rohaizad says of the longer contract tenures.

TA Securities, in a report last month after Velesto won the contracts, says, “To recap, the average daily charter rate for Velesto’s fleet was US$68,000 in FY2018. Therefore, the new contract wins, with daily charter rates of US$70,000 to US$76,000, translate into decent growth of 3% to 12%. Furthermore, the rates are substantially higher compared with the regional daily charter rates of US$55,000 to US$60,000.”

TA Securities has a “buy” call on Velesto, with a target price of 40 sen, which is at a 43% premium to last Thursday’s closing price of 28 sen. At 28 sen per share, Velesto had a market capitalisation of RM2.26 billion.

“Velesto’s earnings visibility has improved on the back of healthier daily charter rates and fleet utilisation. This is driven by the resilient oil price momentum, which has catalysed a revival in oil and gas exploration and production activities,” says the brokerage house.

The Petronas Activity Outlook report for 2019-2021 indicates that the national oil major requires 16 to 18 jack-up rigs this year, and 17 to 19 in 2020 and 2021. This is in stark contrast to the fourth quarter of 2018 when nine or 10 jack-up rigs were deployed in Malaysian waters.

At present, Velesto, with seven jack-up rigs, is the dominant player while Perisai Petroleum Teknologi Bhd, which owns Perisai Pacific 101, is the only other player with jack-up rigs, which would indicate that there could be an uptick in utilisation.

Apart from the seven jack-up rigs, Velesto also has a fleet of four hydraulic workover units used to repair wells, perform sand clean-outs and repair casing leaks, among others.

According to Rohaizad, things are looking up globally as well. “It’s good when you look at global activities ... there’s an increase in activity. We are currently bidding for 24 international contracts.”

For its financial year ended Dec 31, 2018, Velesto suffered an after-tax loss of RM20.4 million on revenue of RM573.8 million. Excluding an impairment, the company would have posted an after-tax loss of RM9.1 million for FY2018. This is in contrast to an after-tax loss of RM1.13 billion from RM573.8 million in sales for FY2017.

Nevertheless, for the financial year ended Dec 31, 2018, Velesto had accumulated losses of RM2.18 billion.

As at end-December 2018, the company had deposits, cash and bank balances of RM229.92 million. On the other side of the balance sheet, it had long-term debt commitments of RM1.1.34 billion and short-term borrowings of RM97.15 million.

The analyst fraternity is expecting Velesto to turn the corner this year, buoyed by better utilisation of rigs. In FY2017, the average utilisation rate was 73%, and is slated to go up to as high as 85%.

TA Securities, for instance, expects Velesto to chalk up a net profit of RM16 million on revenue of RM597.4 million for FY2019.

Better utilisation of rigs

Rohaizad says having a rig without a charter contract would require the company to fork out considerable sums of money to keep it in working condition while still paying for loan instalments.

To put things in perspective, Velesto paid RM85.18 million in finance costs in FY2018.

“But the reverse is true — when there is utilisation, you don’t spend at all as the funds required to maintain the rig during utilisation are from the client. On top of that, you make a small profit, so any increase in utilisation rate will impact your bottom line,” says Rohaizad.

For the four contracts secured last month, Petronas has opted to return to the terms and conditions prior to the downturn in oil and gas industry and is absorbing all mobilisation, demobilisation and other such costs.

In a nutshell, Velesto has a high utilisation rate, increased day rates and better terms and conditions.

Also working out in Velesto’s favour is companies scrapping their rigs. Last year, more than 30 rigs were scrapped while in 2017, more than 20 were done away with.

While there is no indication how many jack-up rigs are operational, market intelligence outfit IHS Petrodata puts the number of jack-ups, semi-submersibles and drillships as at May 10 at 756 units.

According to Rohaizad, as many as 50% of operating jack-up rigs are more than 25 years old. Much of the trepidation is because of the need for rigs to undergo recertification every five years, which could cost US$10 million or more.

Older rigs will have to factor in the additional cost of recertification, and owners could end up forking out a large sum to get them in working order.

This predicament is tied to the daily charter rates as well. According to Rohaizad, the average daily charter rate should be in the region of US$100,000, which is about 25% higher than the current levels.

“If the day rates don’t improve, why should I [as a rig owner] spend that sort of money (a minimum of RM10 million on recertification) as I have to recoup it in five years? So, if the rates do not improve, I’m not going to do that (get a rig recertified), and it is happening now ... a lot of rigs are left idle or scrapped as nobody wants to spend US$20 million to US$40 million [when they are] unsure whether the rates will go up,” he says.

So, to cut a long story short, Rohaizad says, “People (oil exploration companies) will scramble for new rigs and these will last for another five years before recertification comes in again … so, this will cause a severe contraction in the rig business.

“To avoid this contraction, rigs that are 10 to 15 years old have to be recertified, but if the rates do not go up, you will have to rely on brand new rigs — which make up only half the global fleet, [so there will be a shortage of rigs].”

Last Thursday, West Texas Intermediate was trading at just below US$63 per barrel, compared with US$110 in September 2013, and US$145 in early July 2008, when oil and gas counters were in vogue. The run, however, came to an abrupt end in September 2013, when prices went into a free fall, hitting a low of US$26 per barrel in mid-February last year.

Save by subscribing to us for your print and/or digital copy.

P/S: The Edge is also available on Apple's AppStore and Androids' Google Play.