Analyst Info
INDEX
| 1: IMS past achievements and future opportunities |
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i. Norgas ii. Small Scale LNG ii. Aframax market |
| 3: Financial Risks |
2.1 IMS Group –Revenue & Profit drivers
The core business segments that the Group is engaged in are transportation petrochemical gases (ethylene, propylene, butadiene, vcm) as well as LNG and LPG through Norgas, marine transfer activities through SPTand our activities in China
(including newbuilding through SMC). The legal and corporate charts provide a brief overview of the company structure.
IMS had a steady operational performance in challenging times as characterized in 2009. Despite the down-cycle in the markets, the company captured positives from risk mitigating initiatives; such as higher contract coverage gained over many years in all segments lowering volatility in earnings, exposure to resilient emerging market demand from our customers (especially ethylene demand has held up good due to strong growth in Asian consumption) and trough relentless focus on lower cost and high service level. In 2009 34 % of revenues and 86% of the EBITDA were generated from the gas activities (Norgas).
I.M. Skaugen has an acceptable contract coverage for 2010 for our business units and we estimate that currently about 70% of our expected revenue base, within our business segments, is covered with contractual agreements with clients.
Business overview:
Norgas continues to hold a position at the forefront of the petrochemical transportation industry – serving our client’s worldwide through offices in Singapore, Houston, Bahrain, Shanghai and Oslo. The company is one of the largest exporters of Ethylene in the Middle East and currently enjoys a high contract coverage. By investing in new tonnage, Norgas will be able to increase competitiveness and maintain its market position. The office in Bahrain was opened up in early 2009 in order to move even closer to our core customers and nurture the good relationship we have established with the Middle East exporters.
In terms of volume, approximately 40% of the products lifted by Norgas during 2009 were ethylene. The standard size of vessels transporting Ethylene from the Middle East region is 8-12 000 cbm.
The company operates in the semi-refrigerated gas carrier market with a total of 16 vessels at year end, with all having ethylene carrying capability. In 2009 Norgas Pan and Cathinka were delivered. These are two of the first vessels from the wintergas series which are capable to combine ethylene and chemicals. They are especially designed for intra Asia trades. Norgas Innovation, the company’s first advanced multi-gas ship (capable of carrying LPG, Ethylene and LNG) was sucessfully delivered in January 2010. Additionally 6 vessels are under construction and planned for delivery in 2010 and 2011, which will provide Norgas a young and flexible fleet. For further information regarding the Norgas fleet please view the fleet list.
The semi-refrigerated market is primarily demand driven and highly dependent on consumer spending and industrial growth. As in the graph on the right hand side, Norgas Monthly TC Earnings- historical size adjusted- is somewhat correlated to the Real GDP Growth . During 2009 the world GDP experienced a sharp downturn due to the financial crisis which had an impact on total revenue, but less so than what one could expect from the steep drop seen in GDP. We believe that our risk mitigating initiatives has made our earnings less volatile than they have been historically.
Supply & Demand (SR & Ethylene tonnage):
Demand:
Over the last decade we have seen a growth in ton miles for ethylene vessels beyond the growth in product demand. The key element of this development is a change in trading patterns, as the low cost of production of ethylene in the Middle East has led to a massive capacity buildup in the region and subsequent oversupply of cheap products exported to other regions.
The Middle East can produce ethylene at a far lower cost than other regions and the gap is increasing with higher oil prices. Over time this has created a trend where the region captures more and more of the world exports of products. These producers are able to add on the transport cost, still being able to provide ethylene at a more competitive price than other regions. We believe that this development will continue and that it will create positive tonmile dynamics for those shipping companies operating out of the Middle East.
The main driver of growth in product demand lies in Asia. With China as the largest contributor, where ethylene consumption has grown by 12% annually over the last decade. As many of the emerging markets are still in an early stage of industrialization we do expect this trend to continue and create solid demand for the products that we transport.
Following the aftermath of the financial crisis during 2008 and 2009, the price of petrochemical commodities has jumped to record levels during the last 1.5 years, mainly due to Asian-led recovery in manufacturing activity. The surge in petrochemical demand is often associated to a cyclical recovery for the broader economy. Asian petrochemical demand is increasing exponentially.
The surge in naphtha - used as feedstock for ethylene production, was mostly led by China, where the demand rose nearly 75% year on year in late 2009. The jump in consumption has driven prices higher. Since January 2009, the price of ethylene has doubled and the cost of polyvinyl chloride also showed a significantly rise.
Continuous increasing pressure on domestic private consumption in China will lead to higher demand on different goods including the petrochemical commodity as Ethylene – main source of creating ethylene oxide, ethylene dichloride and polyethylene. The last mentioned was the key material for all types of plastic products. We believe that China is the key player of this market.
Supply:In 2009, seven new S/R vessels where ordered (none of these Ethylene) while two vessels were scrapped. The existing fleet of 326 vessels has an order book of 39 vessels (382 000cbm capacity) or about 15% of capacity to be delivered before end of 2011. Norgas has seven new ships or 73,600cbm capacities to be delivered in this period and that is about 43% of the ethylene capacity to come in this period.
Mostly due to the financial situation in general with lack of financing sources we envision some delays/ postponements compared to what is reported to the market for all types of newbuildings including gas carriers. The growth in the fleet will be mitigated by ship recycling in the period and with 88 ships equal to 21% of capacity that are now above 25 years and thus eligible for recycling or alternative uses in the coming years. The normal age of scrapping of such vessels has been in the period between 27 and 30 years of age.
Outlook:
On longer term we foresee a positive structural outlook for the ethylene business in the Middle East. The positive impact from growth in ton mile demand as more products are moved longer, combined with strong growth in product demand from emerging markets and especially Asia will tighten markets and by 2011/2012 combined with a moderate increase in supply, we could very well see a shortage of ethylene vessels in this period.
2.2.2 Small scale LNG – New business area
It is costly to use petroleum for transportation, heating and power generation. Today about 60-70% of all petroleum is used for these purposes and it should primarily be used for petrochemical products and for pharmaceutical needs where it is superior. Gas is an alternative and with abundant reserves from both traditional and new non-traditional sources like shale-gas, the availability of more cost efficient gas will continue to increase. Adding gas’ superior environmental properties with much lower emissions compared with all other fossil fuels – gas will become the preferred fuel of the future.
Small-scale LNG will enable industrial users and power plants in these stranded markets to switch to cost efficient and environmental friendly gas. LNG has the potential to become the dominating fuel for the shipping industry in many regions in the years to come. Running the ships on natural gas will reduce emissions of CO2, NOx, SOx and particles significantly as shown in the chart below.
With the emergence of additional supply of NG we have seen a decoupling from the oil price which is another incentive for faster development of small scale LNG markets.
The heart of the operation is the sea-borne transportation of small-scale LNG - is provided by our unique and innovative Multigas carriers. In addition to LNG, the vessels are able to carry a wide range of other liquefied gas cargoes, including ethylene, LPG and vinyl chloride monomer (VCM). When LNG is being carried, an innovative Mini LNG plant will be utilized to reliquefy all natural gas boil-off.
SMC is currently building 6 Multigas carriers for Norgas, one of them was finalized in January 2010, and 4 more vessels await for final confirmation to be built. These ships are designed with full flexibility and capacity to link the hubs where pipelines are not able to reach.
The Mini LNG plants patented and licensed technology was developed by I.M. Skaugen in cooperation with SINTEF Energy Research in Norway. The flexibility inherent in the cargo handling system enables the Mutligas carriers to switch between the LNG, LPG and petrochemical gas trades as commercial circumstance dictate. However, it is the ability to transport LNG at cryogenic temperatures (-163°C) that makes these ships particularly notable.
Proof of concept - Nordic LNG: Gas for stranded customers
One of these vessels will be employed by Nordic LNG when services commence at the new LNG plant near Stavanger in late 2010.
Nordic LNG is a newly build energy chain for the Scandinavian market, constructed to supply stranded customers with clean LNG. Lyse Energy is building a liquefaction plant in Risavika Stavanger, while I.M.Skaugen is providing the innovative ships. Aga is construction a receiver terminal in Nyneshamn in Stocholm and the partners of Nordic LNG are currently constructing a receiver terminal in Øra Fredrisktad. Total investments in the value chain are about USD 500 million, and about 50% of the plant’s capacity is contracted to industrial users.
We will continue to play a pioneering role in the local and regional distribution of small-scale LNG at a time when the demand for gas is growing strongly and the natural gas supply chains are extended to provide remote communities and industries with access to this clean-burning fossil fuel and capitalize on our investment in the Multigas vessels.
SMC is responsible for the management of the IMS new building activities in China. As a pivotal part in implementation of the IMS cost & service leadership strategy, it has successful delivered and sold three ships from the Summergas series and given further credence to our unique managed shipbuilding concept.
SMC has a primary goal of building more competitive and innovative ships. It is an EPCS contractor which delivers advanced ships to Norgas at an advantageous cost. Clarkson’s newbuilding index indicates that prices are in fact decreasing somewhat after a steep run up in previous years. We note that there are very few, if any new orders in 2009 for tonnage relevant to our ships.
Among all the ships that were built, Norgas Pan / Cathinka (delivered in 1Q / Q3 09) and Norgas Innovation (delivered January 2010) were two of the most complex ships historically in China. The operational performance of the WG vessels post-delivered to Norgas has been quite good. The first three LPG carriers were sold and the other three are currently in operation. SMC delivered an EBITDA of USD 0.9 millions in 2009 and it is currently building vessels only for Norgas.
2.3.2 Shenghui Gas & Chemical Systems
.PNG)
Shenghui Gas & Chemical Systems (Zhangjiagang) Co.,Ltd. is a manufacturer of non-standard pressure vessels, spherical tanks, cryogenic steel structures and gas cargo plant systems for the refinery and petrochemical industry. Shenhui is the most important supplier to our newbuilding program of gas carriers. IMS is a co-owner with 50% of its ownership. I.M. Skaugen bought into the company in 2006 as a strategic supplier of cargo tanks and cargo systems to our newbuilding program.
In 2009 our orders accounted for 30% of the revenues nevertheless this might slightly decline going forward. In order to visualize the values creating in this company, an IPOin China as per agreement with the other co-owners will be facilitated by IMS during the fore coming years.
2.4 Marine transfer activities
SPT is the leading marine transportation service company in the field of marine transfer of crude oil and LNG, serving the energy sector for over 20 years. It has expanded its presence in the recent years from the US Gulf to the entire world.
In 2009 SPT was able to post an acceptable financial performance in an extremely challenging market. The EBITDA for 2009 was USD 6 millions (on 100% basis). Existing contracts were able to provide higher returns compared to depressed market charter rates for Aframax tankers.
The tanker market is believed to recover from a turbulent year as 2009. SPT is expected to reach a steadier state of the revenue growth with the strategy of expanding its network globally. For further information regarding the SPT fleet please view the fleet list.
During 2009, SPT has worked hard to develop strong growth in global support operations, increasing both the geographic spread and the range of services. It has placed particularly much emphasis on cost control across the business to ensure strong future financial performance. The support services is basically lightering without the vessels. Knowledge and competence built up in this business unit will be a key contributor and supplier of transfer services in the small scale LNG markets, e.g. floating storage, bunkering services etc.
The crude oil tanker markets struggled throughout the past year due to the global economic downturn, increased numbers of fleet due to new building deliveries, a combination of weak crude/product demand and poor refining margins in the US. However during the fourth quarter, the tankers experienced a modest market improvement.
The tanker order book currently stands at 31% of the total dwt. The phase out of single hull crude oil tankers may have a positive impact ( 4.3% of the fleet, however 3.2% can still sail until 2015). A global recovery on oil demand following improving economic conditions should be able to provide support on demand.
SPT has managed to fix a certain portion of its tankers on long-term contract, currently having two of the seven tankers on time charters of one-year or longer duration. SPT tonnage not committed to contracts will continue to be commercial employed into the Teekay managed pool of Aframax tankers. This will allow SPT to benefit from the global nature of the pool and for SPT to continue its focus on the core business activity – marine transfer operations.
We have achieved historical high contract coverage for the petrochemical gas carriers of Norgas for the year of 2010 and the balance of the days are subject to spot market returns. The contract coverage also has the flexibility between agreed high and low volumes and the difference will affect the levels of utilization. These fluctuations will dictate how we utilize the capacity. We have, for most of our other business units, achieved lower contract coverage ratios for the assets than within the Norgas Gas carriers. This is where we subject to various degrees of market related risks that will influence the returns we can generate form the services we offer. The change in price levels of the commodities we transport may affect the volumes offered for transport thus the demand for our services. The most relevant of the commodities we transport are crude oil and natural gas as well as LNG. The four key petrochemical gases - especially ethylene, propylene, vcm and butadiene as well as LPG and the naphtha prices, they all need to be monitored. On an operational level we are subject to changing costs for the services we require related to the operation of the vessels and for the shipbuilding activities, including the sourcing of raw materials and labor as well as procurement of components. Again, a significant part is related to the oil and bunker prices, of which the fluctuations in prices will affect our operating costs. For some contracts we have achieved a contractual coverage against such changes. Fluctuations in steel and metal prices also affect the newbuilding programs.
We carry insurances that will protect us from losses or damage to our ships or for other ships if we damage them, as well as damages to the environment and accidents causing harm to human beings. We carry insurances to cover for the potential losses related to the pirate activities in the Gulf of Aden and similar places. In all cases, we carry a higher deductible than many others to ensure lower costs due to the well functioning management of the company. This has paid off historically.
From a financial market risk point of view, the main risk areas are the USD interest rates related to our mortgage debt and bond portfolio, the currency risks associated with USD/RMB, USD/Euro as well as USD/NOK fluctuations mostly related to our newbuilding program and, to some extent operational cost. Most of our revenues are in USD or in currencies effectively tied to the USD.
In addition, we are closely monitoring covenants in our debt portfolio and our cash management activities at all levels, as a normal part of our business. Risk management includes maintaining both sufficient cash and the availability of funding through an adequate amount of committed credit facilities.
The group is also exposed to counter party risks regarding financial matters. However, it trades only with recognized and creditworthy third parties. We have had very few disputes, if any, only with our clients regarding payment and performance that have caused a loss to the company.
In connection with the Group’s shipbuilding projects the Group has entered into sales and leaseback agreements to sell three of the newbuilding vessels to Teekay LNG Partner L.P, upon delivery in 2010 and 2011. We have also entered an agreement with a banking syndicate to fund four of the newbuildings of the “MG series”. Both types of agreements depend on certain conditions being met, which are customary of the trade. These also rely on the counterparties being willing and able to fund their obligations. We are quite confident that we have chosen the correct counterparties for these transactions. The key risks we focus on today are the possibility of delays of these newbuildings beyond the “cancellation date” of the leases, the availability of bank financing, as well as the possible reduction in value of those ships subject to bank finance. Such reductions is expected and may require the Group to pledge additional capital in the future for those ships.
As a global business, we are also subject to political risks associated with disruptions in certain geographical areas of the world and the current pirate activities in the Gulf of Aden, which is a risk that we must take countermeasures against.