Reports from oilpro.com stated Wednesday afternoon that a federal court has suspended pre-salt drillships newbuilding contracts to Sete Brasil from Petrobras (PBR):
A temporary restraining order by a federal court in the city of São Paulo suspended the pre-salt drillships newbuilding contracts made by Petrobras with Sete Brasil, including any financing by the Brazilian Development Bank - BNDES to Sete Brasil ... A class action suit has been filed to put an end to the newbuilding contracts, on the grounds that they will likely bring heavy losses to the Brazilian finances, as Sete is heavily involved in Petrobras graft scandals.
Petrobras is reeling from a corruption scandal where executives were accused of approving inflated contracts to suppliers and subcontractors in exchange for kickbacks. Petrobras has cancelled certain contracts and payments to suppliers involved in the corruption scandal. It was also revealed that Sete, a financing vehicle 10% owned by Petrobras, paid kickbacks to a former Petrobras engineer pursuant to the shipyards in charge of the drillship's construction.
NOV's $3.3 Billion Contract Backlog Could Be At Risk
National Oilwell Varco's (NYSE:NOV) Q1 backlog ended at $10.4 billion (down 17% sequentially), as shipments out of backlog were $2.25 billion. $3.3 billion of that backlog is pursuant to 22 drilling equipment packages for floating rigs for Sete. A description of the drilling packages and vendors involved is below:
My previous article divulged that National Oilwell receives down payments and progress payments under these contracts, making the contracts cash positive or cash neutral. However, revenue could be at risk. On the recent earnings call management pointed out that the company recorded $172 million in revenue under the Petrobras drilling equipment packages in Q1:
During the first quarter, we recognized $172 million in revenues associated with the program, about 7% of total segment revenues, but this will slow substantially for at least the next couple of quarters, contributing to our lower guidance for Rig Systems Q2 revenues.
Management has already guided that revenue from rig systems will decline 30% sequentially. The suspension of the Petrobras drilling equipment deal could cause rig systems revenue to decline further.
Rig systems, which represents over half of National Oilwell's revenue, was also its best performing segment in Q1. Revenue for rig systems declined 1% sequentially versus a 16% decline in total. A decline in this segment next quarter and going forward, could be devastating to the company.
Should NOV Remove Its $3.3 Billion Sete Backlog?
The accounting standards for recording an asset impairment is that the impairment has to be both probable and estimable. This may be the standard National Oilwell applies when deciding whether or not to remove its $3.3 billion backlog related to Sete. Actions by Seadrill (SDRL) and comments from Rolls Royce related to Petrobras contracts are data points on how other companies have treated, or could treat their Petrobras exposures:
- In February Seadrill removed $1.1 billion of Petrobas-related contracts from its backlog. Seadrill no longer believed the contracts would be concluded in the time frame or on the previously approved commercial terms.
- A spokesperson for Rolls Royce (OTCPK:RYCEY), (OTCPK:RYCEF) had the following to say about the Petrobras contracts in February:
"We haven't received a formal cancellation or postponement of any contracts for now ... We're still committed to delivering on the agreement we have with our clients."
- Comments from the Rolls Royce spokesman imply that a postponement or cancellation of the Petrobras contracts could force Rolls Royce to take other actions.
Conclusion
A suspension of the Petrobras drillships contracts could impact National Oilwell's revenue going forward and its contract backlog. If the contracts are not honored, it could hamper the company's ability to meet estimated revenues for 2015 ($16.1 billion) or 2016 ($14.4 billion). I am short the stock.
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