Global services firms have been caught in a storm. Engineering, procurement and construction (EPC) focused companies have been squeezed by tough contract terms, battered by inflation and haunted by legacy commitments.
After a lost decade following the 2014 oil price crash, these service providers are seeking ways out of the pit – aiming to reclaim bargaining power and prop up finances. Could the tide be turning in their favour?
Rystad Energy senior supply chain analyst Chinmayi Teggi pointed to the 2014 oil price crash as setting service companies up for difficulties. “There was not a lot of negotiation, pricing power essentially always was with operators,” she said.
Signs indicate a turnaround. Service companies are having more challenging conversations with operators, including new areas like carbon capture and storage (CCS) and offshore wind.
New opportunities are providing new leverage to these established players.
Old model
The power imbalance often led EPC contractors to agree to lump-sum contracts. These shifted the risk from operators to service providers.
“So if anything happens, if anything goes wrong, then it’s all on the EPCs,” Teggi said. “They’ll never be able to get good margins carrying that sort of risk. Those are the kinds of contracts that these companies have been working through.”
These contracting challenges worsened other difficulties these companies may face.
For instance, Petrofac faced challenges at its Thai Oil Clean Fuels project, won – with Samsung and Saipem – on a lump-sum basis in 2018. A corruption scandal involving Unaoil has also cast a shadow over Petrofac’s plans.
In December, the EPC company launched a restructuring process and expects to see results in April.
Wood Group is another EPC firm facing challenges. It acquired Amec Foster Wheeler in 2017, but had to settle various issues, including legacy contracts and corruption investigations. The Aberdeen-headquartered firm is still awaiting the result of a review of its accounts by auditor Deloitte related to a series of “exceptional contract write-offs” from the AFW deal.
Solving for services
These are clear challenges, but Daniel Slater, energy analyst at Zeus Capital, struck an upbeat tone. Both Wood and Petrofac are quality names that have found “themselves on the wrong side of some contracts”.
Despite the quality and size, cash flow and working capital issues are unmissable red flags for investors.
“It makes people nervous. If you need a debt for equity swap, or have to do a massive value to equity raise to bail you out from challenging contracts then investors can lose lots of money awfully quickly,” he said.
“Investors are very alive to the potential for a turnaround in both of those names. It’s just a question of when exactly that happens.”
While Petrofac has focused on restructuring, Wood is under discussion again as a bid target. Apollo Global Management was in the running in 2023. Lebanon’s Sidara was interested and is back considering its options.
In 2024, Sidara offered 230p per share. After revealing some of its challenges, Wood’s share price fell 60% in November. Since mid-February, it has been trading below 50p. If Sidara is serious, it must provide a firm bid by March 24.
Slater noted sector differences. The analyst was optimistic on Hunting and described Gulf Marine Services as “certainly exposed to oil and gas industry spending, but it has been doing very well and has just been renewing contracts on ever higher day rates, which has been very positive for them”.
Cutting costs
Industry consolidation offers another option for struggling EPCs, beyond acquisitions or restructuring.
Other options exist. In February, Saipem and Subsea7 proposed a merger. The new Saipem7 would have a £36 billion backlog, with Subsea7 providing £8.7bn.
“There’s a lot of synergies talked about as the reason for putting those two companies together,” Slater said. “You only go around chasing those when you’re not driving enough margin as a standalone company.”
Teggi noted that only a “handful of EPC players” remain, only limited additional mergers are possible. “There are other ways of joining forces, such as via a joint venture.”
She continued, “The new Saipem7 is attractive given high inflation, low capacity and a challenged supply chain. It can operate throughout the whole supply chain. That’s good for the company, as the supplier, but also for the operator as they can strip out unnecessary costs.”
Contract challenge
EPC companies need to resolve their internal challenges, but they also need to address their customers.
“Driving this are capacity constraints. If operators go to a supplier who’s busy already, they will need to pay more – or find other points of negotiation,” Rystad’s Teggi said. “But also it’s just about all of them taking the same stance, who say they will not do lump sum anymore. They can’t.”
Inflation has driven this shift. When raw goods prices are stable, a lump-sum approach can appeal. But when prices start to rise, due to global problems stemming from COVID-19 and then by Russia’s invasion of Ukraine, it adds volatility.
Teggi said that following the Ukraine invasion, things had not gone back to normal. “There are all these geopolitical uncertainties, so they also add up,” she said.
For Slater, as long as oil and gas prices hold up, the sector should do well. “With oil in advance of $70 [per barrel] the sector is in a good position to progress projects, potentially engage in a bit of M&A and return cash to shareholders as well.”
EPC contractor consolidation may have an impact on pricing, but there is an amount of inevitability, he continued. “If pricing is so low that those companies do disappear, it probably needed to change anyway,” he said.
Price may be the most apparent pressure point between operators and EPCs, but there are others. For instance, the Rystad analyst said that the service companies want to be involved from the concept stage “to even consider a project”.
Entering early gives the EPC more ability to craft the project design to align with its own capabilities and more certainty over contract duration.
Best domicile
Sidara is eyeing Wood and Nesma & Partners bought out Kent in 2023. Would a shift to the Middle East – or other hydrocarbon-friendly destination – benefit troubled EPCs?
“Not necessarily,” answered Zeus’ Slater. “No, I think the British stock market understands oil services very well. There have been some very successful oil services names that have historically been taken out.”
He referenced Kent, Cape and Wellstream for good returns. He said investors appreciate EPC companies as part of their portfolio. “They often have wide appeal and they can speak to a wider audience than an upstream E&P company.”
Slater argued for more public listings of service companies in the UK.
“There are an awful lot of upsides to floating,” he said. Liquidity, access to capital and publicity are among those benefits. “As the UK IPO market continues to recover, which we think it will, to some extent in 2025 and going forward, I think you will see new service companies coming to the market.”
Teggi broadly agreed. While the Middle East is a substantial part of the energy industry’s future, companies should not just “go to one geography and bet it all, they need to to look at different markets.”
A complicating factor to a focus on the Middle East is the growth of energy transition options.
“EPCs should not just focus on oil and gas. We think the spending peak may have passed when it comes for oil and gas,” Teggi said. There will be hotspots of activity, but “what are you going to do 20 years down the line? It’s a good time to pivot. Success in that depends on management.”
Navigating the storm
EPC companies face challenges, but a common thread emerges: the need to reconsider business models.
Companies that can renegotiate contract terms and ensure financial discipline will thrive in this new landscape. The right options for geographic and sector diversification will vary by company.
Company leadership is crucial. As Teggi and Slater emphasised, today’s management decisions on contract structures, geographic focus or transition strategies will determine which companies emerge stronger from this upheaval.
EPCs remain crucial to global energy infrastructure delivery and the market supports those with sound strategies. The post-2014 power dynamics are evolving, creating risks and opportunities.
Executives, especially those with legacy issues to navigate, face rough waters ahead.
