COLUMN | Petrofac-ed, the Wood Group and Petroserv: restructurings and transformation [Offshore Accounts]

COLUMN | Petrofac-ed, the Wood Group and Petroserv: restructurings and transformation [Offshore Accounts]

"Fix the balance sheet before you fix the business." This was the sage advice we gave two weeks ago when we compared Tidewater to its moribund and indebted competitors.

We noted that Hornbeck, Bourbon, and Edison Chouest still have some way to go in resolving their balance sheet problems. But if you thought they had problems, this week we discuss how British-listed oilfield services company Petrofac is facing the abyss, and how its rival the John Wood Group is also trying to escape its toxic legacy.

2021 marked a fresh start, allegedly

<em>Photo: Petrofac</em>
Photo: Petrofac

In late 2021, Petrofac raised US$275 million in a rights issue, where it sold new shares to raise new capital priced at £1.15 per share (US$1.46).

"I am pleased to support today's fund raise which, after more than four difficult years, puts the company squarely back on the path to recovery," said Ayman Asfari, Petrofac's largest shareholder and founder. "I look forward to Sami [Iskander, the CEO] and his leadership team restoring Petrofac to its greatest potential."

"Petrofac has a tremendous opportunity over the coming years to grow and re-establish itself as one of the world's leading providers of critical services to the energy industry," Sami Iskander himself said. "Following a quieter period during the pandemic, we see activity in our markets increasing significantly at a time when the full potential of our business has been unlocked – in recent years we have refocused on compliance, rebased our cost competitiveness, and now we are re-energised under a new team and a new strategy. The completion of the financing will cement a fantastic platform from which I am confident that we will deliver significant shareholder value over the coming years."

Sadly, Sami Iskander stepped down as CEO last year, and the US$275 million raised in the capital raising has all been squandered spent.

Today, Petrofac is no closer to achieving its greatest potential, except as a case study in bad management. In fact, shareholder's equity looks more at risk than ever.

Petrofac's positive spin

Eleven months ago, Petrofac was assuring investors, customers, and employees that it had put its troubled past behind it when it reported its 2022 full year results.

That year was a dreadful one for Petrofac, which reported a cash outflow of US$205 million – a drastic increase on the outflow of US$28 million the company suffered in 2021. Its net debt rose to US$349 million up from US$144 million at the end of 2021.

With the company achieving in US$2.5 billion in revenues for 2022 and an order backlog of US$3.4 billion, and with the oil price firming, one might have thought that Petrofac was well-placed for recovery. The company posted guidance reporting that it expected neutral free cash flow for 2023, and advised that there was an upside potential from what it described as "working capital unwind".

With demand for oilfield services rising, customers awash with profits, and all the problems blamed by management on "legacy" engineering and construction contracts that had been interrupted by Covid, it was possible to be optimistic. Indeed, having been blacklisted for bribery in the Emirates, Petrofac could proudly announce that, in 2022 it "returned to bidding in core markets: UAE."

Petrofac said that it expected to face a tax charge of US$25 million to US$35 million in 2023, and tax payments of US$70 million to US$80 million. This seemed strange to me, given the company's consistent run of losses. Companies that are losing money tend not to pay much tax.

It also said that it would face interest payments of US$80 million, which also seemed strange for a company claiming to be cashflow neutral, and having less than US$400 million in debt as this implied a 20 per cent interest rate.

Had the company borrowed hundreds of millions on one of the director's Amex cards?

Past conviction for bribery

A small footnote in the results slides highlighted that the company had paid fines and restitution to the Serious Fraud Office (SFO) in the UK, totalling US$104 million in the first half of 2022, after the corruption conviction. Petrofac was pleased to inform investors "no further amounts are payable, and the investigation is concluded."

As we reported at the time, in 2021, Petrofac had admitted seven counts of failing to prevent its former employees from offering or making payments to agents in relation to projects awarded between 2012 and 2015 in Iraq, the Kingdom of Saudi Arabia, and the UAE. The company confessed that it had violated the UK Bribery Act 2010 between 2011 and 2017, but reassured investors that "all employees involved in the charges have left the business." (here). The SFO claimed that Petrofac paid US$44 million in bribes to secure the Middle Eastern contracts worth over US$3 billion.

David Lufkin, Petrofac's former Head of Sales, was handed a two-year custodial sentence and suspended for 18 months after he pleaded guilty to 14 counts of bribery and admitted making corrupt payments between 2011 and 2018 to influence the awarding of contracts to the Petrofac Group. The SFO also confiscated around US$170,000 from him.

We observed that the SFO had interviewed the company's founder and largest shareholder Ayman Afsari in May 2017 about the corruption, just days after he made a large donation to the ruling Conservative Party in the UK. It is a matter of public record that in total, Ayman Afsari and his wife Sawsan donated over a million US dollars to the Conservative Party between 2009 and 2017 (here).

Mr Afsari remains a director of the company, but stepped down as CEO. We should make it clear that he has not been accused of any wrong-doing.

More charges

Petrofac itself has put the case behind it. However, on February 16, the SFO announced that it had charged two more of Petrofac's former senior executives, Marwan Chedid and George Salibi, with bribery.

Mr Chedid and Mr Salibi had worked in various senior roles within the Petrofac Group and were based in the UAE.

"From 2012 to 2018, the SFO alleges that between them, Mr Chedid and Mr Salibi were involved in offering and paying agents over US$30 million to influence the awarding of contracts worth approximately US$3.3 billion in Petrofac's favour. The contracts related to oil facilities in the UAE, including one for the infrastructure and design of the second largest oil field in the Gulf – the Upper Zakum Field Development Project."

Upper Zakum is the fourth-largest oilfield in the world and is operated by 60 per cent shareholder ADNOC, the Abu Dhabi state oil company. ExxonMobil (28 per cent) and INPEX of Japan (12 per cent) are the minority shareholders.

Some strange points to consider

We highlight again how odd it is that nobody in the UAE appears to have been charged with receiving the bribes. US$30 million in bribes was clearly paid by Petrofac – the company has admitted as much – but to whom? The same in Iraq.

We also highlight that it seems odd that only the ex-sales manager and two former UAE-based staff have been charged, given the scale of the bribery (literally tens of millions of dollars) and the fact that it spanned several other countries.

Was no-one at board level paying any attention or was this a case of extreme decentralistion of responsibility, which might suggest a failure of control in the headquarters? In SBM Offshore, similar cross-country malfeasance resulted in not one, but two of the company's former chief executives being convicted for their roles in bribe-paying.

At Petrofac, however, the SFO seems to have taken an approach that only the "bad apples" in the barrel are culpable, not the cooper who made the barrel.

Good news and more bad news

In Petrofac's first half of 2023 results, which it reported in August, there was some good news. Petrofac reported a major increase in its contract backlog, which rose to US$6.6 billion and this continued through the year.

In October last year, Petrofac announced that it had won a US$600 million contract from ADNOC to provide engineering, procurement, and construction services for a new gas compressor plant at the onshore Habshan carbon capture project. The contract involves the delivery of carbon capture units, associated pipeline infrastructure, and a network of wells for carbon dioxide recovery and injection.

Located at the Habshan gas processing plant, 150 kilometres southwest of Abu Dhabi, the project is part of ADNOC's self-professed "accelerated decarbonisation plan," even as the company increases its targeted oil output.

Petrofac was also awarded a major contract by TenneT for the engineering, design and construction of six-platforms under a framework agreement in the offshore-wind market in the Dutch-German sectors of the North Sea.

But future contracts mean nothing, if they are not profitable, or if the company cannot execute them. Unlike McDermott, Petrofac has been able to continue to obtain the performance bonds required by its customers in order for it to be able to trade.

Half year results showed snowballing debt and cash outflows

However, the positive guidance in April 2023 appeared to be a little off. Petrofac's situation had gone from bad to worse by August. The company suffered free cash outflow of US$225 million in the first half of last year – it was bleeding over a million dollars a day, which it blamed on "delayed commercial settlements."

It said that it expected these to reverse in the second half of the year and that "broadly" (a word that is doing a lot of heavy lifting in the forecast), it expected to be cash flow neutral for the full year, implying that the million dollars a day of outgoings would be replaced by a million dollars a day of incoming cash from July to December.

Bondholders expect default

The market is not convinced. Petrofac's five-year bonds maturing in November 2026 now trade at less than 40 cents on the dollar.

The company's shares languish at 25 pence (US 31 cents) and the company's market capitalisation is only US$155 million at the time of writing. This suggests that investors anticipate few of the profits of what the company claims is an US$8 billion orderbook of March 2024 flowing to the shareholders.

The market is clearly anticipating a major restructuring ahead.

ESG – the fairy dust for financial failures

So, what does Petrofac do? It turns to ESG (Environment, Social, and Governance) issues. The company – which has bled cash for over two years and where the bonds are anticipating highlighting possible default – announced that "management incentives are strongly linked to ESG performance" and that "40 per cent average of senior leadership incentives" are tied to ESG.

Tying executive incentives to ESG goals at a company that is clearly struggling to survive is a joke. The targets themselves are lame and an embarrassment to the idea of governance.

Petrofac says it is committed to Net Zero in 2030 – how bonuses are awarded against that goal in 2024, I leave it to your imagination. This is a company that has been bleeding cash and where the bonds are priced for default.

Under the "Building diversity" target, Petrofac says it will reward its leadership team and CEO for achieving an "increased proportion of women in senior roles" from to 26 per cent in 2022 to 30 per cent in 2025. No pressure to make some token appointments based purely on sex not merit, then?

Finally, under compliance, it doesn't set the target of "not having any more managers charged for corruption and not paying any more bribes," which one might have thought might be a target. Instead bonuses will be paid for an "improvement in speak up statistics" to 1.5 per 100 employees, whatever that may be.

Let's be clear that when a company is in an existential crisis of the sort that Petrofac faces, bonuses should not be paid until the company has refinanced and avoided a wipeout of its shareholders. Using shareholder funds to pay bonuses for achieving ESG targets – which seem, to an outsider like me, to be eminently gameable by management – is a travesty given the parlous state of Petrofac's balance sheet.

Fix the business and then pay the bonuses.

Wood you believe it?

<em>Photo: Wood Group</em>
Photo: Wood Group

To be fair on Petrofac, its fellow UK-listed project management and operations services company the John Wood Group also had a shockingly bad 2021 and 2022.

Like Petrofac, the Wood Group had to pay massive fines for corruption and bribery. In the Wood Group's case, these related to the acquisition of what its subsidiary Amec Foster Wheeler Energy Limited (AFWEL) had to pay.

AFWEL had to pay a financial penalty and costs amounting to £103 million (US$131 million) in the UK, which formed part of the US$177 million global settlement with UK, US, and Brazilian authorities. The amounts to be paid by AFWEL in the UK include payment of the SFO's costs of £3.4 million (US$4.33 million) and payment of compensation to the people of Nigeria of £210,610 (US$268,127).

AFWEL admitted responsibility for ten offences of corruption relating to the use of corrupt agents in the oil and gas sector by the legacy Foster Wheeler business. The offences spanned from 1996 to 2014 and took place across the world, in Nigeria, Saudi Arabia, Malaysia, India and Brazil.

Unlike Petrofac, the Wood Group spread its payments out between 2021 and this year. Last year, it paid around US$35 million to the SFO, and in the first half of this year, it will make a final payment of circa US$30 million to close the Deferred Prosecution Agreement. The Wood Group is also plagued by legacy asbestos issues, which will cost around US$35 million this year.

Turnaround, bright eyes!

However, the Wood Group has been able to demonstrate a turnaround of the type that Petrofac needs to perform. Its latest investor presentation from January shows that it is now working almost completely on cost-plus, reimbursable contracts and that lump sum turnkey projects are now only one per cent of its revenue.

Unlike Petrofac, the Wood Group fixed its balance sheet by selling its Built Environment Consulting business in September 2022 (No, I have no idea what that business does, either.). Revenue was up five per cent in the first half of 2023.

The Wood Group now has a market capitalisation in excess of US$1.2 billion – eight times higher than Petrofac's. Wood's shares are down 25 per cent year on year, but Petrofac's are down 60 per cent.

Petrofac will likely have to copy Wood and sell a division to pay down debt. I believe that its future is smaller and less complex than its current unwieldy form spanning segments and geographies.

Tens of thousands of employees, hundreds of millions of losses

Wood Group has 35,000 employees, McDermott has over 30,000, and Petrofac around 8,000, plus thousands more subcontractors, especially on its Thai oil refinery project. Viewed alongside Petrofac and McDermott, the travails of the Wood Group suggest that the problems of the EPC sector are structural.

Margins are too small to support debt, contracts can be too risky, and schedules are often optimistic, causing cash shortfalls. There seems to have been a historic tendency to pay bribes to win work – a tendency that reached an extreme with Brazilian EPC player Odebrecht.

This poor risk management is the story of McDermott's calamities in its takeover of Chicago Bridge and Iron, which bled hundreds of millions on an ill-executed refinery project in Colombia, where it was also accused of extravagant bribery.

We saw how a similar combination of debt and low margins hit marine services company James Fisher and Sons hard and drove British onshore contractor the Carillion Group to insolvency. Longer term, we wonder whether a buy-out of all or part of troubled Petrofac would be in the interests of Wood.

Complicated, multi-billion-dollar projects are risky and require large amounts of cash. The oil and gas majors and national oil companies have benefited both upstream and downstream from the willingness of contractors like Petrofac, McDermott, and Wood to take on too much risk through turn key and fixed cost contracts. In the last decade, it has killed them and their shareholders have been hammered.

Both McDermott and Petrofac need immediate restructuring and sustained performance improvement.

Petroserv, served

SSV Catarina <em>(Photo: Bakac)</em>
SSV Catarina (Photo: Bakac)

Meanwhile, another rig owner has finally restructured.

Last week, Petroserv Marine (which operates as Ventura Petroleo in Brazil) announced that its two rigs and assets would be acquired by a consortium of unnamed financial institutions, which have set up a special purpose vehicle called PS Marine Holding for the deal. PS Marine expects the transaction to close in the second quarter of 2024.

PS Marine assured Petrobras, its primary customer, that it would continue operating its fleet with its existing management team and employees.

Petroserv is both an operator, and manager of offshore rigs. Founded in 1972, today, Petroserv owns and operates the semi-submersible drillship SSV Carolina and the deepwater drillship Victoria and additionally manages the operations of the semi-submersible SSV Catarina (currently laid up in Indonesia) and the deepwater drillship Zonda, which was abandoned by Pacific Drilling in the downturn, and is preparing for contract at the yard in South Korea. Zonda was awarded a long-term charter with Petrobras last year and will mobilise and start drilling later this year.

Victoria and Carolina are also both under charter to Petrobras for a period of 1,040 days on day rates of about US$200,000 per day, firm until the final quarter of 2025.

Fix the balance sheet and you can fix the business.

Eldorado makes good

Who could be behind PS Marine?

Well, SSV Catarina was sold in 2022 by Petroserv to a group of Norwegian investors headed by Harald Moraeus-Hanssen, as we discussed here. Zonda was a high-profile purchase by Mr Moraeus-Hanssen, together with countrymen Gunnar Hvammen and Petter Stordalen (art collector, philanthropist, and owner of downmarket hospitality chain Nordic Choice Hotels) last August through their vehicle, Eldorado Offshore.

The investors also bought the abandoned seventh-generation drillship West Dorado, which was originally ordered Seadrill at Samsung Heavy Industries in Korea, but was cancelled in 2018 when Seadrill went bust. That rig reportedly cost US$200 million and the "West" prefix was removed upon closing.

I think it is likely that Petroserv will be offering Dorado into Petrobras shortly, as the combination of Petroserv's track record and set-up and Eldorado's speculative Norwegian finance is a potent one. Good luck to all.

Background reading

We covered the Korean yards and their efforts to sell what were then Pacific Zonda, West Dorado, and (currently unsold) West Draco in 2021 here.

It is not just Petrofac that was busted for bribery in Iraq. Leighton Offshore and SBM were also charged in the notorious Unaoil affair centred on a Monaco-based middleman.

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