Vard Holdings - Deepwater Becoming Marginalised

We expect shale oil all-in production costs to fall below that of ultradeep water on the global marginal cost curve, which makes the latter the highest-cost marginal producer in demand. Maintain SELL, with a lower SGD0.36 TP (21% downside, from SGD0.47) based on 0.6x P/BV. The economics suggest a prolonged period of asset price depression, asset under-utilisation and low global order flows as oil majors freeze (ultra)deepwater projects in favour of onshore/shallow-water ones.

Resistance is futile against macro factors
Globally, oil majors are cutting capex budgets and being more selective on green-lighting projects. The axe should fall hardest on the highest-cost, longest-time-tofirst-oil projects, ie ultra-deepwater exploration fields. Under-utilised ultra-deepwater assets are then likely to encroach into the deepwater bidding space and exert downward pressure on rates and overall asset utilisation, crimping long-term order flows for this market segment.

Survival of the fittest in the shale field
We see more scope for technological improvements in onshore shale drilling (re-fracking, increasing the number of fracture stages per well, multi-well directional drilling per well pad, etc, singly and/or in combination) leading to rapid growth in overall shale productivity. Marginal costs for shale were estimated at the USD50-80/barrel (bbl) (averaging USD62/bbl) range in 2014. We believe costs will fall as these technologies are adopted. Such a wide scope of improvement does not exist for deepwater, whose technology has been in existence for over 30 years. We believe marginal costs for shale may fall below that of ultra-deepwater, pushing the latter to become the global marginal cost producer in demand.

Technical Analysis
Daily Chart
Bleak long-term outlook for deepwater orders
We believe the global oil oversupply could decrease in 2016 before reaching a more balanced market in 2017, with our Brent price forecasts being USD65/bbl and USD80/bbl for FY16F/FY17F. At USD65/bbl, we believe few deepwater projects would get the green light, thereby severely restricting the likely order flow. A USD80/bbl price of oil is economic for deepwater work, but the asset market is likely to take additional time to balance out before orders are placed. We slash our previously street-low FY15F/FY16F earnings by 51%/64% as we trim our margin assumptions and order win forecasts. Maintain SELL, with a lower SGD0.36 TP based on 0.6x P/BV (from 0.7x). Key risks are lower order flows and EBITDA margins. (Read Report)

Source : RHB Research

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