From solar panels to consumer electronics to shipping, it seems that China tends to quickly carve a niche in every high-margin market China gets into. The lucrative world of oil rig building isn’t immune to the unique Chinese combinations of low-cost, friendly financing, and quick delivery. (Let’s leave all discussions of comparative quality aside.) Indeed, China has quickly cornered 40% of the global market in oil rigs – a market worth tens of billions of dollars annually. Thanks to discount pricing, China quickly left its regional low-end or shallow rig-building rival, Singapore, in the dust. Well, China’s foray into rig building has a significant industry in China’s overall economic portfolio exposed to the continuing slump in global oil prices. As more and more drillers announce cutbacks in their capital expansion plans, Chinese rig builders are quickly finding themselves in the lurch. Due to aggressive pricing and rock bottom financing (1% down payments are not uncommon), China’s shipbuilders-cum-rig specialists are facing a serious financing crunch. Many are leveraged to the gills and rig prices aren’t bouncing back. In fact, rig projects continue to be canceled at an accelerating pace.
Industry observers believe that the Chinese oil rig industry will see a familiar trend: price cuts. This can plague the industry’s profit margins for much longer than the actual oil slump. How? Even if the overall level of oil exploration picks back up after oil recovers, since there is a glut of cheap pre-made rigs, there won’t be much impetus for new rigs. Companies are building rigs before there are even buyers for them. Considering that each mid-range rig has a price tag of approximately $200 million, it’s not hard to see the fiscal headache shipbuilders are developing.
To make matters worse, the total industry slow down might last a long time as drillers soak up remaining cheap inventory. Indeed COSCO Corporation, on the largest shipyards in China announced it will no longer be building an offshore oil platform due to a lack of buyers.
All these developments in what was once one of the Chinese economy’s brighter hot spots further clouds the prospect of China racking up its decades-strong comforting economic growth numbers. Given that China is the world’s second largest economy, any softness here might point the way for a rough landing for global equities markets as a whole. Keep an eye on emerging markets’ economic fundamentals.