COLUMN | Changing course: McDermott restructures (again); Siemens Gamesa bleeds (again); UK wind auction fails [Offshore Accounts]

Sometimes the inevitable needs to happen before things can change. Failure can be a catalyst for action. At other times, it can just be part of a repetitive cycle of doom. This week, we look at the world's ugliest offshore construction company, which faces more grief, a wind turbine manufacturer whose woes we predicted 18 months ago, and the latest shock to rock the renewables industry.

McDermott hits the buffers – again

Well, that didn't take long.

Two weeks ago, we highlighted the dire financial situation in which offshore construction player McDermott International has found itself. The Houston-based company had lost a US$1 billion arbitration over a disastrous refinery upgrade in Colombia, it had seen BP suspend payment on a pipelay project off Mauritania due to poor performance of its J-lay vessel Amazon on a deepwater gas project, and Saudi Aramco had cancelled the award of shallow water construction and installation contracts worth US$1.8 billion, apparently because McDermott could not provide the necessary performance guarantee. All these happened in a matter of weeks. Ouch.

So, three years after emerging from Chapter 11 restructuring in the US, with US$4.6 billion of debt eliminated and the creditors owning the company, McDermott announced last Friday that it was…. carrying out another restructuring, and asking its lender for better terms to avert a crisis.

There must be a phrase in French to describe this situation.

Break-even target

Even after emerging from restructuring in 2020, McDermott's position was fragile. We'd heard unsubstantiated rumours of issues late last year, but we couldn't report upon these because of a lack of corroboration. We did note that in 2022, McDermott had set the ambitious goal of break-even at an operating cash flow level, so that whilst it would lose money when taking depreciation on its assets and its interest payments into account, its core business would be not be burning cash. Yes, McDermott aimed for EBIDTA (earnings before interest, depreciation, taxes and amortisation) of zero in 2022.

Wow. Given that the oil price hit US$120 per barrel last year, this was not an especially ambitious target. Indeed, rival offshore construction company Subsea 7 reported net operating income of US$149 million for 2022, up from US$72 million in 2021, and generated free cash flow of US$255 million. Even Saipem reported EBITDA of over US$550 million in 2022, although it still reported a net loss.

Efforts to vacate sound like a vacant threat to us

Faced with the triple whammy of awful events set out above, McDermott decided to try to appeal its two legal defeats on the Cartagena refinery project. In addition to the disastrous arbitration decision issued by the International Chamber of Commerce (ICC) in New York, McDermott had also suffered a legal defeat in Colombia where the Contraloría General de la República had also found against the company.

In its press release, McDermott says it "opposes each claim on the merits; the company strongly disagrees with and has petitioned to vacate the decision of the ICC and is engaged in arbitration and in-country proceedings to challenge the Contraloría action as improper, and without jurisdiction over the Company."

I am not a lawyer (Spoiler alert!), but just because you disagree with an arbitration award against you, that's not sufficient grounds to have a second chance to argue your case. Indeed, one of the attractions of international arbitration is the finality of awards rendered in the process, rather than facing time- consuming, multiple appeals up the legal ladder in national courts.

And McDermott and its aggrieved Colombian customer took their case to the ICC. Scrutiny is a distinctive feature of ICC arbitration. No ICC arbitration award is issued without the ICC court's approval, as, after the closing of the proceedings, the arbitral tribunal draws up a draft award that is submitted to the court for final review before being released.

McDermott may be talking tough in front of its lenders about its appeal, but I just don't see it happening at the ICC. And I can't speak about Colombian legal process, but overturning that local award may also prove an uphill struggle, given that the state oil company, Ecopetrol, is the party whom McDermott's subsidiary is alleged to have wronged.

Shareholders have to pay in a quarter of a billion US dollars

Given the imminent lack of funds, McDermott needed to call upon its shareholders to bail it out. Having lost billions when the company defaulted on their debts in 2020, the shareholders cannot have been pleased. They stumped up US$250 million in new capital to "support its ability to operate its business, deliver on existing projects, and expand backlog with new client projects."

If you have a vessel on-hire with McDermott, and we understand that both Tidewater and Britoil have such exposure, this new infusion of funds into the company will be a great relief. It averts a cash crunch and stabilises the business. But for how long? Without better execution of its projects, the same problems will arise again.

Amend and extend

Additionally, McDermott's lenders will amend and extend the terms of their loans to the company, and the Letters of Credit facilities they provide it, for three years through to mid-2027 with no change in pricing. Lenders choosing to amend and extend is rarely a sign of a positive situation; it just kicks the can down the road.

McDermott said that this would "increase the company's liquidity, and discharge certain legacy legal liabilities." The company also announced it would begin procedures in the Netherlands under the Dutch Act on Confirmation of Extrajudicial Plans, which is similar to a Chapter Eleven restructuring process. Meanwhile, in the UK, one of the McDermott subsidiaries that was a party of the ICC arbitration, CB&I UK, will initiate a Restructuring Plan under Part 26A of the Companies Act 2006 (UK) in England. Following the completion of the Netherlands and UK processes, McDermott said it would "make a voluntary filing in the United States to secure legal recognition of the international court decisions."

Bad news comes wrapped in corporate guff

The worse the news, the more Orwellian the corporate announcements, as we saw with the nauseating corporate speak deployed by Maersk Supply Service when it recently announced mass redundancies. Given the abject failure of McDermott over the last five years since the ill-fated Chicago Bridge and Iron acquisitions, the Chapter Eleven filing, the SEC investigations into its former CEO and CFO, and the massive legal defeat over the Cartagena refinery, followed now by emergency funding from its shareholders, the tone of the comments by Michael McKelvy, the President and CEO of McDermott is quite remarkable.

"Over the past 24 months, our executive leadership has made transformative progress in resetting and implementing our business strategy by leveraging the strength of our operating business and tailoring our approach to our core clients," said McKelvy. "We are pleased to have reached this agreement with our key stakeholders, which demonstrates their confidence in the long-term strength and sustainability of our business. These proactive steps ensure that McDermott is strongly positioned to deliver on our growing number of client projects as we continue our important work of accelerating the energy transition in our industry."

If you and I had made such "transformative progress" that the companies we work for required a US$250 million rescue from their shareholders and an extension of all their loans at a time when every other player in the industry is prospering, it is unlikely we would keep our jobs for long. However, at McDermott, repeated failure is never grounds for the management to be held accountable.

I can't see the shareholders being as understanding again in a year or two if another cash crunch arises. Surely the company is in the last chance saloon now?

Sometimes, "you must be proud, bold, pleasant, resolute, and now and then stab as occasion serves," as Christopher Marlowe put it in his play Edward II.

McDermott's directors should take note.

Siemens Gamesa: restructuring again!

We have covered over and over how various offshore wind farm operators are facing financial pressures. The whole supply chain has been squeezed by the cost pressures ignited by the Russian invasion of Ukraine. Shipping, steel, wages, and installation prices rose painfully, but wind farm operators found themselves wedded to long-term supply contracts, and many of their suppliers were stuck with fixed prices equipment contracts where they made losses. Turbine makers are losing money and are now trying to charge their customers a little more to staunch years of losses and low margins. It's a zero sum game.

In February 2022, we reported how turbine manufacturer Siemens Gamesa announced that Jochen Eickholt would replace Andreas Nauen as CEO on March 1 of that year. Siemens Energy, which owns 67 per cent of Siemens Gamesa, promptly set about painting a rosy image of Herr Eickholt to give the impression that he had a track record of restructuring struggling businesses and therefore could fix the issues that had plagued Siemens Gamesa in 2021.

"[Eickholt]'s proven ability to turn around underperforming businesses and his vast leadership experience will be key elements to successfully implement the necessary changes and improvements at Siemens Gamesa," commented Siemens Energy's Chairman Joe Kaeser in the statement issued at the time.

In September 2022, the company announced 2,900 redundancies. In early 2023, Siemens Energy bought out the minority shareholders, and the stock was delisted from the Spanish stock exchange.

We wrote nineteen months ago that we disagreed with Mr Kaese, quoting Warren Buffet's aphorism that, "when a management with a reputation for brilliance tackles a business with a reputation for bad economics, it is the reputation of the business that remains intact."

We said that, "the European wind turbine makers face inexorable pressure from China. Mr Eickholt will struggle to overcome the hit from high commodity prices and pricing pressure from the People's Republic in 2022 and 2023."

Billions of dollars of write-downs for Siemens Gamesa

Guess what? When Siemens Gamesa announced its third quarter results, they were awful – McDermott-level dreadful. Siemens Gamesa reported €2.2 billion (US$2.36 billion) of write-downs, which "relate mainly to quality issues of certain onshore platforms as well as increased product costs and ramp-up challenges in the offshore business."

It turns out that Siemens Gamesa had sold turbines that were unreliable, and the company was paying unexpectedly large warranty costs to fix the defects.

The forecast was even bleaker. In light of the developments at Siemens Gamesa, its parent company said that it now expected its full-year profit margin to be between negative eight per cent and negative 10 per cent, and that it would report a net loss for 2023 "of around €4.5 billion" (US$4.82 billion with a "b"). Free cash flow was also projected to be negative, with the company expecting to burn through hundreds of millions of dollars this year.

Obviously, this is completely unsustainable. The solution is stark: Siemens Gamesa will need to radically raise its quality control to improve the performance of its turbines in service and reduce the repair and warranty costs. And it will probably need to raise the prices its customers pay, so that it is no longer burning cash and losing money on every sale it makes.

The only way forward is likely to be a consolidation with either Vestas or GE, or a state-owned Chinese turbine manufacturer might make an approach, which would probably be politically toxic in both Germany and Spain.

Either way, relying on the brilliance of a new CEO to fix structural problems in an industry is never well advised.

Overheating always causes cost pressures

Siemens Gamesa's problems are indicative of the problems of growth facing the whole offshore wind farm industry. When industries grow at an exponential pace, they always face cost pressures. Now that oil and gas is booming again, we see the first warning signs of overheating here, too. BW Offshore reported two weeks ago that "cost inflation impacting construction, commissioning, and installation phases" on the Barossa project floating production storage and offloading (FPSO) vessel, which it is constructing in Korea, were "expected to consume [spending] project buffers," although the long-term project lease and operate economics "currently remain intact."

But if oil and gas is facing some overheating, the offshore wind farm operators have really been caught in a squeeze. Last week, we reported how Denmark's Ørsted had reported US$2.3 billion of write-downs on its projects on the New England coast of the United States. Vattenfall has suspended a project in the UK as uneconomic, and in the US, Equinor and BP have been clamouring to get out of their long-term pricing agreements for their offshore wind farms and raise the prices of the electricity generated from their future developments there by over 50 per cent.

British wind farm auction failure

Also last Friday, the pressure on the wind farm operators reached its logical conclusion. The British government announced that it had failed to attract any bids whatsoever from offshore wind developers looking to build new wind farms in the UK. The auction – if an event that fails to attract a single bid can be called an auction – failed because developers said that the government was not offering enough pricing support for the electricity they would produce, given the rising costs they faced to build the wind farms.

As a result, it is highly likely that next year's round, which the Financial Times says will open in March 2024, will offer a more generous guaranteed maximum price for the electricity from the offshore wind farms built under those contracts. Dan McGrail, the chief executive of industry lobby group Renewable UK, told the newspaper that the offshore wind results should "set alarm bells ringing in government" and he urged ministers to take "urgent action to rebuild investor confidence."

The urgent action required is, of course, higher prices. The UK is second only to China in terms of the capacity of offshore wind power installed, and we can expect other countries to face similar demands in the coming years.

Different contracts for Difference, please

Under the British wind farm auction system, the government guarantees the companies that own the offshore wind farms a fixed price for the electricity they generate for fifteen years under "contracts for difference". For the last 17 years, electricity demand in the UK has been dropping due to energy efficiency measures and the decline in heavy industrial production in the country, so adding onshore and offshore wind was an easy measure as costs dropped. Offshore wind supplied about 11 per cent of the UK's electricity in 2021.

But now cost inflation threatens to hit that growth. As we have pointed out before when we looked at the overly optimistic expectations of TotalEnergies in Germany's last offshore wind auction, either wind farm operators accept lower returns, or they squeeze their suppliers harder to reduce costs and they raise their efficiencies, or they charge their customers higher prices.

Rising costs for turbines and labour and the calamity enveloping Siemens Gamesa rule out squeezing suppliers much more. The strike of bidders in the UK shows that operators are no longer willing to accept returns lower than their cost of capital. The rise of battery electric vehicles will increase demand for electricity after more than a decade of declining demand. In 2022, more than 265,000 new battery-electric cars were registered in the UK, a growth of 40 per cent from 2021. In 2023, there will be more than a million such vehicles on British roads. Higher oil and gas prices will support higher offshore wind pricing by making the alternatives more expensive, too. And I think that it will pave the way for oil and gas companies to spend some of their bumper profits on buying ailing wind farm operators.

Customers should brace themselves for higher prices. The electrification of transport and home heating across the world means increased demand for electricity. Invariably higher demand means higher prices. Where Britain leads in decarbonisation and wind power adoption, others will surely follow.

Background Reading

A rough, online guide to costing an offshore wind farm is here.

The World Economic Forum reckons that innovation, not higher prices, is the solution to the industry's challenges. Of course, they would say that, wouldn't they?

The Guardian noted the failure of the British wind farm auction is "the biggest clean energy disaster in years"

Despite the gloom about the industry, RWE is pushing ahead with its offshore Sofia wind farm in the UK sector of the North Sea, and last week, Prysmian's impressive cable layer Leonardo da Vinci began work to connect the turbine array to the national grid (here).

On Friday, Van Oord christened its new cable layer Calypso in Rotterdam, amid much festivity and champagne bottle-smashing. We love a good ship naming ceremony. Next time, please send us at Baird Maritime an invite!