Brazilian shipyards: industry in crisis or growing pains?

Demand for vessels in the Brazilian offshore oil and gas industry is booming.  State-controlled oil company, Petrobras, needs 70 new floating production platforms by 2030 to develop its huge pre-salt oil reserves; not to mention the drillships, shuttle tankers, installation vessels and other support vessels that will be required to support this massive undertaking.  Petrobras’ latest business plan anticipates placing orders of US$ 100 billion with Brazilian shipyards by 2020.  Surely then, Brazil’s shipbuilding industry must be entering another golden era?

In fact the newspapers reveal news of a different Brazilian shipyard facing financial or operational difficulties, on an almost daily basis.  The number of shipyards and sector related companies with problems is alarming. Between 2012 and 2013, more than a dozen national shipyards and EPC contractors passed though financial difficulties and at least four engineering firms involved in important projects either sought bankruptcy protection or were declared bankrupt. These difficulties have continued in 2014 and the question now being asked is whether this is an inevitable part of the industry’s steep learning curve or whether there are more fundamental issues affecting the sustainability of the sector in the long term.
A look back in history shows us that this is not the first time this sector has thrived and then faced problems.  In the 1970s, Brazil boasted the world’s fifth largest merchant marine fleet and a shipbuilding industry with the world’s second largest order book, supported by demand from domestic giants like Vale and Petrobras and employing over 40,000 workers directly and 100,000 indirectly. The success of the sector, at that time, was due to a combination of domestic orders and government support and incentives, given to encourage small shipyards to increase capacity. The industry then collapsed during the 1980s, with incentives drying-up and financing becoming too expensive and, by 2000, Brazilian shipyards employed fewer than 1000 people.

More recently, however, Brazilian shipbuilding has experienced a renaissance off the back of Brazil’s offshore oil and gas industry and, again, a substantial amount of government support. This has included cheaper financing through an improved Merchant Marine Fund (Fundo da Marinha Mercante – FMM) and stringent local content rules, as well as other measures designed to protect and stimulate growth in the local industry. The Brazilian Special Registry (REB) is a case in point. It was created to make Brazilian shipyards more competitive by reducing import and other taxes which would otherwise by payable on the importation of parts and components by national shipyards in the construction, maintenance and/or upgrade of a vessel. Vessels registered with the REB also have other benefits relating to financing, insurance and crewing.  To register a vessel, the owner should be a Brazilian navigation company, authorized by the Brazilian Agency for Water Transport (ANTAQ), and the vessel generally has to be registered under the Brazilian flag.

Petrobras concerns

Whilst the sector is now growing strongly again, widespread delays and financial difficulties have prompted speculation regarding whether Petrobras will continue to push such a high proportion of its demand to national shipyards or whether some of those orders will start going outside Brazil. Petrobras is increasingly concerned with the impact of construction delays on its strained cash flow and ability to hit ambitious production targets. The construction of the oil tanker, ‘João Cândido’ illustrates the point. This was the first order placed by Transpetro, a subsidiary of Petrobras, with the Atlantico Sul shipyard (“EAS”) and the vessel was delivered 21 months late and suffered a cost overrun of 23%. Such delays have been common over the past few years and consequently, Petrobras is taking a more active role in the supervision of projects, with critical parts, such as hull conversions, being done outside Brazil in some cases.  There is also concern among national shipyards that this might lead to local content rules being relaxed.

In a number of recent letters to one of Brazil’s business newspapers, Valor, Petrobras has sought to allay such fears by denying that there is a threat to the sector’s long term future and confirming that it is in the company’s interests to have a local and competitive industry close to its operations. However, earlier this year, the president of the state company, Maria das Graças Foster, also stated that the priority to increase production is above that of placing orders with national shipyards.

Shipyard challenges

Whilst each shipyard is undoubtedly subject to a unique set of circumstances, it is widely recognised that Brazilian shipyards are uncompetitive relative to Asian competitors, due to a combination of factors, including high labour costs and a shortage of skilled workers, low productivity and a lack of cutting edge technology and management techniques. The shipyards are facing these problems associated with the rapid growth of the industry, while undertaking large and technologically challenging projects against tight deadlines. Analysts say that austerity measures introduced by Petrobras have also had a serious impact, with some payments being delayed and variation orders subject to increased scrutiny.

A snapshot of a few of the shipyards recently in the news, includes:

IESA Oleo e Gas, which owns and operates a shipyard at Polo de Jacui, Rio Grande de Sul, has a US$ 720 million contract with Petrobras to supply 24 gas compression modules for its FPSOs (floating production storage and offloading vessels). The company has been in a grave financial situation for some time, resulting in difficulties paying suppliers and staff, strikes and a failure to meet production schedules. It is reported that a solution has now been found, with Brazilian construction group, Andrade Gutierrez, agreeing to step in and take a stake in the shipyard.

Estaleiro Ilha S.A. (EISA) has 26 contracts estimated to be worth a total of US$ 1.6 billion, including a contract to supply five container ships and two ore carriers to Log-In Logistica Intermodal, Brazil’s largest cabotage company. The shipyard is reported to have suspended operations in June this year amid serious liquidity problems resulting from poor administration and is now seeking to secure urgent funding from foreign investors.

Estaleiro Rio Grande (ERG), which is controlled by Engevix Construções Oceânicas (Ecovix), has an order book estimated to be worth US$ 6 billion including a US$ 3.5 billion contract with Petrobras to supply hulls for eight FPSOs by 2016. This project, however, is experiencing delays and there was talk of Petrobras transferring part of this project away from Ecovix to speed things up. In an effort to improve performance and raise capital, last year Ecovix concluded a joint venture with Mitsubishi Heavy Industries, which acquired a 30% stake in the company.

Of course, in 2013, OSX Construção Naval was also a daily news item, with it entering into bankruptcy protection and having to suspend construction of its shipyard in Açu, Rio de Janeiro state. OSX’s problems were linked to an over-reliance on contracts with sister oil company, OGX, which itself entered into bankruptcy protection, following major production difficulties at its offshore fields.

Potential solutions

There is always a danger with government incentives that they become protectionist and, if left in place for too long, inefficiencies will become entrenched because local companies have no need to become globally competitive. It is clear that Brazilian shipbuilding cannot yet compete on price with rivals in Korea or China, so there is a fear that the government will remove these protections and the huge investments in Brazil’s shipyards will become worthless.  If construction delays and increased costs threaten the development of the broader oil and gas industry, that is a real risk.  The Brazilian shipbuilding industry collapsed once before because it could not compete internationally, and although Petrobras demand may ensure shipyard employment in the medium term, policies need to be put in place to promote competitiveness, if shipyards are to thrive in the long term.

The growth of Brazilian shipbuilding over the last decade has been so dramatic, that some growing pains are inevitable. Solving these issues will require investment, time and ideally input from experienced players. In this regard, there is an encouraging trend, with local shipyards seeking out experienced and well-funded partners, to help them to deal with their operational and financial issues and become more competitive.

A number of shipyards are also investing heavily in productivity improvements, which is the case for EAS, ERG and Enseada Industria Naval in Bahia, which have invested a total of BRL 6.6 billion to create modern industrial parks.

Additionally, to help address the sector’s high labour costs, the government has introduced measures to reduce the burden of social security payments across a number of industries, including shipbuilding.  Instead of being required to pay social security contributions (INSS) on employee salaries, it is now only payable at a discounted rate on invoices for the sale of a vessel, which helps with cash flow. Although this measure was only supposed to apply for 2014, it was recently announced by Brazil’s president, Dilma Rousseff, that it will be made permanent.

Brazil’s demand for new build vessels should make its yards attractive for investment by foreign partners with the experience and management skills to turn them around and build competitiveness. The problems are certainly surmountable, as illustrated by improvements in more recent projects undertaken by EAS, since it entered into a joint venture with a Japanese consortium in 2013. Certain shipbuilders may fail, and a process of consolidation seems likely, but that process should result in a stronger shipbuilding sector, better placed to meet the needs of its oil and gas industry and to compete internationally.