Sovereign Oilfield

Source: Energy Digital

Date :11/04/2008 16:07:27

Why the Aberdeen based group has decided to divest its drilling operations and concentrate on fabrication services

Written by John O’Hanlon and Produced by Alex Smith

Neither Graham Burgess nor I could believe that nearly a year has passed since we last reviewed the progress of the AIM-listed company that he and Peter Felter established in 2003 and took public in 2005. It has been a year of solid consolidation amid global economic conditions that have sometimes been favourable, sometimes challenging but never dull.

The group was conceived in a highly entrepreneurial way to take advantage of the demand from oil and gas companies for integrated fabrication and drilling services as a kind of two-pronged approach to meeting these customers’ prime operational requirements. From the start, the strategy was to build the company by acquisition: the pre-and post-flotation acquisitions are detailed in my June 2007 Exec article*.

Bedding in

Early 2007 saw a flurry of acquisitions, facilitated by a £50 million line of credit extended by the group’s bankers Merrill Lynch. Dunfermline-based Forfab, purchased in January, was followed in March by RDT Precision Engineering of East Kilbride and, in April, by Labtech Services and Vertec Engineering, both of Aberdeen.

Together these companies represented a large chunk of fabrication capacity, and while Sovereign has a policy of allowing its subsidiaries a fair amount of autonomy, they took a while to bed in, as Graham puts it: “We went through a quiet period during which we held back deliberately from making any further acquisitions. As a policy, when we add a company to the group we put in management teams and keep open the lines of communication but we don’t try to integrate two management teams into one. We’d look upon amalgamating the businesses as a waste of resources.”

For example, Labtech and Vertec both manufacture and fabricate accommodation modules, engineering cabins, engineering cabins for wellheads, for the ROV industry and for mudlogging in the oilfields for companies like Baker Hughes, Schlumberger and Halliburton. If they were to be amalgamated, they would probably lose 25 percent of the combined market share they command – far better to allow them to continue to operate independently and even compete, each contributing valuable resources and skills to Sovereign’s global fabrication capacity, Graham believes.

Rough winds

These darling buds of May 2007 withstood the rough economic winds of 2007, and business has grown strongly. However, the said winds did shake the group’s further acquisition plans. It had been Sovereign’s intention to add two more drilling services businesses, but the credit squeeze put the wind up the banking backers and these deals had to be abandoned.

The consolidation period is complete now, and the group has been reorganised into two divisions, a Fabrication Division with seven operating subsidiaries, and a Drilling Division with five subsidiaries. The Fabrication companies have done particularly well over the last year, and recently announced a number of significant contracts totalling £7.35 million.

OIL Engineering Limited, specialists in structural and pipework fabrication services, has been awarded two contracts. One for the manufacture of manifolds for the North Sea Victoria Project at a value of £1 million, and the other for the manufacture of lifting and handling frames for Acergy Norway AS – value £0.5 million.

Vertec Engineering, designers and manufacturers of specialised fire protected cabins and local equipment rooms for the oil and gas, renewables and transport industries, has been awarded contracts totalling £2.85 million. These include a contract with FMC Technologies Inc for £1.2 million for the manufacture of a VSD Module, and a contract with Saipem America Inc for the manufacture of A60 workshop/control vans at a value of £0.65 million.

Forfab has been awarded contracts estimated to be in excess of £1 million for the design and manufacture of storage and pressure vessels for export to the Middle East.

Labtech Services, which designs, manufactures and hires containerised and skid mounted equipment, has been awarded a contract to design, fabricate and install an accommodation module onboard a North Sea drilling rig. This contract is valued at £1 million.

Meanwhile, Oil Engineering Middle East LLC, based in the Group’s new facilities in Abu Dhabi, has been awarded a contract for the fabrication of two accommodation modules for FPSOs currently under manufacture in the Middle East. The contract value is estimated to be in excess of £1 million.

Unique in the North Sea

Graham is understandably delighted at these successes: “The Fabrication Division is now a major force in international manufacturing services,” he says. He is also pleased with the drilling companies though it’s here, if anywhere, that there have been setbacks. Three of the companies have been trading strongly. One experienced a delay in the delivery of some contracts, so has not achieved the revenue hoped for in the period. Another company, Diamant Drilling Services (DDS), however has resisted efforts to move it into profit. In line with a strategic decision taken last year, DDS is now on the market, having not achieved profitability by September.

There’s no lack of interest in DDS, which has sound and innovative technology, says Graham. However a more fundamental change in the structure of the group will take place when the remainder of the Drilling Division is sold out of the Group, so that the quoted company Sovereign Oilfield Group will become a large and profitable focused fabrication business.

“Because the fabrication businesses are trading strongly we’d expect that division to be profitable going forward, and so we would be able to return some value to the shareholders,” he explains. The split has been approved, and will take place later this year following a further reorganisation of banking facilities.

The background to the business, against which it was conceived, has of course grown stronger with increasing global demand for oil and gas and rising prices. In the eyes of the public, and even in the investor community, there seems to be a tendency to conflate the price of the commodity with the profitability of the companies that service the industry.

The industry is struggling to meet demand, and the only way to do that is by more drilling and more intervention, which is Sovereign’s core business. And when the oil prices went up, the market expected to see an immediate rise in profits of related companies - which didn’t and doesn’t happen, because there’s no direct link.

Comprehending complexity

The Stock Exchange for its part struggles to understand the oil services industry, says Graham, especially when it is as complex as the Sovereign Oilfield Group, so he has learned lessons from the larger Abbot Group and its CEO Alasdair Locke. “It was only when they focused on a single business stream, which in their case was drilling rigs, that they started seeing value moving into their shares. I think we are moving in the same direction now by focusing on fabrication.”

Sovereign Fabrication Services is now unique in the North Sea area in that it can deliver a full range of fabrication services from general fabrication to subsea structures, to pressure vessels to pipework, right through to cabin work and accommodation modules, Graham says. “We are now chasing larger contracts where delivery can be shared between group companies but the whole structure is delivered by the SFS with each of the subsidiary companies contributing the part that is its specialisation.”

Chasing larger integrated contracts is the company’s main priority. Close on its heels is the goal of replicating its North Sea success, focused in Aberdeen, at Abu Dhabi, a single facility that focuses the skills of all the companies in one location. Abu Dhabi has also performed strongly over the last year and is currently working on a large accommodation module.

Geographical expansion

That operation is a huge success already, and the model for future expansion in other geographical areas. Next on the list will be West Africa where discussions are currently taking place – Graham is confident of having a site and a local partner by the end of this year.

After West Africa, Sovereign wants to establish integrated fabrication facilities in Norway and Brazil. In the case of Norway, the route of choice would be via acquisition, so the timing for that option could yet be dependent on the availability of capital. Brazil and West Africa can be established with a local partner and therefore don’t need the same level of new investment. With an order book worth some £30 million and a burgeoning market, Sovereign is in a good place even without the expansion that the entrepreneurial and impatient Graham Burgess needs to make happen.

I should end by making it plain that, despite the impending DDS divestment, the Drilling Services Division is no basket case. On the contrary, it holds some brilliant technology and should have a great future after it has been acquired by Claymore Investments Limited, a company controlled by Graham Burgess, Peter Felter and Julie Cowie, all directors of Sovereign – but that is another story.

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