With exploration and production increasingly taking place in offshore fields, the oil and gas industry’s demand for support vessels will continue to increase. The typical deepwater worksite is 100 miles to 150 miles offshore, which presents logistical challenges related to transporting personnel and cargo to and from oil rigs and connecting these installations to onshore processing and distribution systems.

The world’s leading provider of helicopter services to the oil and gas industry, Bristow Group (NYSE: BRS) stands to benefit from increased activity in deepwater exploration and production. The transportation company boasts a fleet of 550 aircraft, roughly one-third of the helicopters that service the more than 8,000 offshore production installations in the world and the more than 600 exploratory drilling rigs. Bristow is the No. 1 or No. 2 operator in a number of key international markets, including the North Sea, the Gulf of Mexico, Australia, West Africa and Brazil.

Long-term growth in deepwater activity should provide a nice tailwind for Bristow: The typical deepwater worksite is 100 milrs to 200 miles offshore and houses a crew of 150, compared to the average shallow-water facility that’s 20 miles offshore and includes a crew of 20. The firm shuttles these crews to and from the installation on a weekly, biweekly or monthly basis.

Helicopter services are required throughout a deepwater well’s lifetime, from exploration to abandonment. Bristow usually generates about 60 percent of its annual revenue from servicing production-related facilities, 20 percent from supporting exploratory activities and 10 percent from well development.

Bristow’s cash flow is also relatively insulated against a decline in oil and gas prices: Monthly capacity reservation fees, which the company receives regardless of whether the customer requires its services, account for about 65 percent of the firm’s revenue. The remaining 35 percent of sales comes from fees that vary based on flight hours.

Over the past several years, management has positioned the company to capitalize on this uptick in deepwater activity. Fleet upgrades and sales of older aircraft have lowered the average age to twelve years, while the large and midsize helicopters that are becoming the industry standard comprise roughly 75 percent of Bristow’s fleet.

In the near term, the company stands to benefit from a tightening supply-demand balance for heavy helicopters. During a conference call to discuss Bristow’s results in the fiscal third quarter ended Dec. 31, 2011, CEO William Chiles noted that increasing demand for high-specification helicopters–especially in the North Sea, Brazil and West Africa–and manufacturers’ ability to supply these aircraft has tightened the market:

There is continued pressure in the business across the oil service space. Based on the number of outstanding tenders, the supply and demand balance for new technology helicopters is tightening, there’s no question about it. We believe our option order book is aligned to meet the demand. However, we’ll need strong market signals to confirm this revenue growth in making sure that we’re going to push these returns higher.

We like that management plans to be judicious with its options to build additional capacity. At the end of its fiscal third quarter, Bristow had 16 large helicopters on order and options for 28 more.

Mark Duncan, Bristow’s senior vice president of commercial operations, also told analysts that demand could approach levels last seen during the boom years of 2007-08, when elevated oil prices prompted exploration and production companies to ramp up activity in deepwater fields:

The significant thing is the demand is all happening at the same time in multiple occasions. And as a global player, we’re able to look at that and see the tightening demand-supply balance. And that is resulting in significant price increases and tenders that are open and public to us, and we think it’s going to continue on up from there based on this demand continuing.

And the demand is accelerating forward as the industry goes back to work and rigs come online and go to work. Europe [primarily the North Sea] and Australia have significant tenders right now–under preparation and in negotiation right now. And Brazil has a major tender with Petrobras where we’re fairly certain they’re going to contract up to 10 aircraft all starting in calendar year 2012. So, it’s supply-demand tightening, prices going up, it all is very encouraging and we are focused very much on it now.

Rising demand for helicopter services, coupled with a tight market for newer aircraft, could enable Bristow to push through some cost increases to its customers. Brazil furnishes Bristow’s best opportunity: Petrobras’ (NYSE: PBR A) internal forecast for helicopters alone would throw supply and demand conditions out of balance, while requirements that only Brazilian pilots be used impose further supply constraints.

Bristow in May 2009 took advantage of attractive valuations in the wake of the financial crisis to pick up a 42.5 percent stake in local helicopter owner, Lider Aviacao,  and gain entrée to the Brazilian market. Management expects Brazil’s national oil company to award a major contract for up to 10 aircraft within the next few months.

Europe’s ongoing financial problems also provide a growth opportunity for Bristow. In February 2012 the firm won a four-year contract from the UK Dept for Transport to provide search-and-rescue (SAR) services in the North of Scotland. With the cash-strapped UK government seeking to outsource SAR operations to avoid costly helicopter upgrades, Bristow’s contract win gives it pole position in an upcoming tender for a 10- to 15-year contract to provide helicopter SAR services from 10 bases in the UK. The lucrative contract is expected to come up for bid in summer 2012.

Bristow also made a major strategic shift over the past year that should pay off for shareholders.

After investing heavily in replacing older helicopters with modern aircraft, the firm has decided to reduce capital expenditures and return more cash flow to investors in the form of share repurchases and dividend increases. Management has indicated that the company’s reliable cash flow could enable the firm to grow its dividend by 10 percent to 15 percent annually. Although the stock currently yields only 1.2 percent, the prospect of a rising dividend could attract investors.

Moreover, the firm plans to rely more on sale-leaseback financing over the next several years to improve liquidity. At present, Bristow owns about 93 percent of its fleet. By entering into sale-leaseback financing deals on 20 percent to 30 percent of its helicopters in the next three to four years, Bristow will free up additional funds for organic growth projects.

Management has also established criteria that should make the company more judicious about the contracts it accepts. The firm will also focus on shifting capital expenditures to the areas of highest return. We may see this plan in action during the company’s 2012 fiscal year if margins and demand in the Australian market don’t improve.

With the oil and gas industry’s demand for helicopter services rising, Bristow Group rates a buy when the stock dips below 42. We will continue to track this stock in the Energy Watch List.

Teekay Offshore Partners LP (NYSE: TOO), a master limited partnership (MLP) spun off from Vancouver-based ship owner Teekay Corp (NYSE: TK) in 2006, owns and manages three types of offshore vessels: shuttle tankers (59 percent of 2011 revenue); floating production, storage and offloading vessels (20.5 percent); conventional tankers (12 percent); and floating storage and offtake units (8.5 percent).  

In 2011 the MLP grew its distribution by 5.3 percent to $0.50 per unit, fueled primarily by drop-down transaction from its general partner, Teekay Corp. Teekay Offshore Partners generated distributable cash flow of $41.6 million in the fourth quarter, up 55 percent from year-ago levels. This cash flow covered the MLP’s fourth-quarter payout by a 1.1-to-1 margin.

Management has recommended that the board of directors approve a distribution increase in the first quarter of 2012, though CEO Peter Evensen declined to provide any guidance during a conference call to discuss fourth-quarter earnings.  

Shuttle Tankers

Producers in the North Sea use shuttle tankers as “floating pipelines” to transport crude oil and condensate from offshore production sites to onshore processing and distribution systems. Leasing these vessels involves far fewer headaches than building a pipeline system and enables production to come onstream much faster.

These tankers are outfitted with dynamic-positioning systems and other advanced equipment that maximize maneuverability and handling in difficult conditions. Check out this animation of one of Teekay Offshore Partners’ shuttle tankers receiving a payload from one of its floating, production, storage and offloading (FPSO) vessels.

The global fleet of shuttle tankers consists of 67 vessels, of which only 59 are in the same class as Teekay Offshore Partners’ 36 operating ships. The MLP owns 27 of these tankers outright, as well as a 50 percent interest in six vessels and a 67 percent stake in three tankers.

Including four newly built shuttle tankers slated for delivery in 2013, the MLP’s fleet boasts an average age of 11 years and an average contract duration of 5.6 years. These agreements, the majority of which are with either Petrobras or Norway’s state oil company Statoil (Oslo: STE, NYSE: STO), guarantee forward revenue of $2.7 billion.

For many years, Teekay Corp and its daughter MLP dominated the global market for shuttle tankers, particularly in the key markets of Norway and Brazil. Teekay Corp has operated in Brazil for more than a decade and has built a workforce that includes more than 150 locals. This contribution to Brazil’s economy, coupled with the firm’s long track record of reliable operations, gives Teekay Corp and Teekay Offshore Partners a competitive advantage.

At the same time, the depressed market for conventional tankers has prompted some ship owners to add shuttle vessels to their fleet. According to Clarkson’s (LSE: CKN) research division, 29 new shuttle tankers are slated for delivery through 2015, though more than one-third of these vessels are already booked under contracts to Petrobras or Transpetro, a fully owned subsidiary of Brazil’s national oil company. This contract coverage should prevent a slip in prevailing day rates.

Petrobras has sought to diversify its base of suppliers, with most of the competition coming from privately held Norwegion outfit, Knutsen Shipping. More recently, however, Brazil’s national oil company has granted 15-year contracts for two shuttle tankers each to Malaysia-based AET Tanker Holdings, Greece-based Tsakos Energy Navigation (NYSE: TNP) and Denmark-based Elka Shipping. All three firms have little to no experience ordering and operating shuttle tankers.

These new entrants reflect two factors: the dire state of the market for conventional oil tankers and Brazil’s growing demand for shuttle tankers to support its ambitious offshore oil production.

However, these new competitors shouldn’t erode the Teekay family of companies’ position in the Brazilian market.

For one, this diversification may furnish Teekay Corp and Teekay Offshore Partners with acquisition opportunities once conditions improve in the market for conventional oil tankers.

Petrobras will continue to drive demand for many offshore vessels. But Growth Portfolio holding BG Group (LSE: BG/, OTC: BRGYY) and other international energy companies with a stake in deepwater concessions offshore Brazil are also in the market for shuttle tankers. Teekay Offshore Partners in June 2011 secured 10-year fixtures for four newly built shuttle tankers to support BG Group’s activity offshore Brazil. When these contracts begin in 2013, the MLP’s Brazilian operations will have an annual base of roughly $450 million in contract business.

Over the long term, the shuttle tanker business will also benefit as production activity ramps up at the major discoveries offshore Ghana, Sierra Leone and Angola. We discussed these deepwater plays at length in the July 20, 2011, issue of The Energy Strategist, Africa: Oil’s Final Frontier. 

FPSOs            

Although Teekay Offshore Partners’ shuttle tanker generated 59 percent of the MLP’s 2012 revenue, the firm’s growing exposure to the FPSO market should fuel cash flow growth in the near term and long term.

Typically ship-shaped, FPSOs are offshore production facilities that process raw oil from wells located in the seafloor, removing impurities such as water, gas, sand and stones and storing the crude until a shuttle tanker arrives to transport the output to an onshore refinery or distribution network. Flexible tubes called risers flow oil from the well to the FPSO above.

Consulting firm International Maritime Associates estimates that deepwater oil developments will require 100 to 140 FPSOs over the next five years, depending on prevailing commodity prices. Many of these installations will rely on shuttle tankers to transport their output to the shore. Teekay Corp estimates that about 15 North Sea oil projects currently in the planning stages could require an FPSO.

Whether newly constructed or a converted oil tanker, these facilities usually cost from $100 million to $1 billion to construct and are designed to operate in a specific field. For this reason, modifying an FPSO to operate in another field involves considerable expense.

Producers usually charter these vessels under long-term contracts that include a minimum day rate, as well as a production fee based on the volume of output, and a supplemental fee that reflects oil prices.

Teekay Offshore Partners’ fleet includes three FPSOs: Petrojarl Varg, which is under charter to Talisman Energy (TSX: TLM, NYSE: TLM) for 1.6 additional years, though the lessee has three options to extend the contract by three years; Cidade de Rio das Ostras, which has six years remaining on its current agreement with Petrobras; and Piranema Spirit (acquired in November 2011), which is contracted to Petrobras for at least another 6.3 years.

Teekay Corp owns a number of FPSOs that are likely candidates to drop down to Teekay Offshore Partners. The omnibus agreement between the parent and daughter stipulates that the MLP has the right to purchase any FPSOs at a fair market value from its general partner, provided that the vessel in question operates under a contract term of at least three years.

These terms, coupled with Teekay Offshore Partners’ roughly $430 million in liquidity, provide a clear path to future cash flow and distribution growth. The table below lists these candidates for drop-down transactions in the order in which they’ll be available.

Source: Teekay Corp, Teekay Offshore Partners LP

A number of recent moves by Teekay Corp also bode well for Teekay Offshore Partners’ long-term growth.

In May 2011 the parent company inked a joint venture with Brazilian industrial conglomerate Odebrecht to pursue FPSO projects, the first of which is the Tiro + Sidon that’s under contract to Petrobras and is slated for delivery in 2012. This agreement will enable Teekay Corp to meet local content requirements and win additional FPSO business from Brazil’s national oil company.

Teekay Corp in November 2011 purchased two FPSOs from Sevan Marine (Oslo: SEVAN, OTC: SVMRF), a Norway-based developer and owner of offshore vessels. As part of the deal, Teekay Corp also acquired a 40 percent stake in Sevan Marine for USD25 million and agreed to purchase future FPSO projects designed by the company.

Sevan Marine has pioneered a proprietary cylindrical-hulled FSPO that offers superior stability and can operate in harsh or benign waters to depths of 3,000 feet. Teekay Corp is particularly bullish on a number of higher-margin applications for this design, including a natural gas-fueled offshore power plant to support offshore drilling operations.

CEO Peter Evensen enthused about this long-term opportunity during a conference call on Feb. 24, 2012:

[W]e get a lot of requests for other types of projects. And I see a lot of scope for Teekay to move into some of these higher margin, higher growth areas. And so, those don’t fall specifically within the FPSO shuttle tanker, LNG, and tanker realm. So, I won’t be drawn on exactly what those are, Justine, but I think that the bondholders will be pleased with how we’re moving to higher margin assets.

The Verdict

With a supportive general partner and exposure to secular growth trends in offshore production, Teekay Offshore Partners represents a solid bet for investors seeking growth and income.

However, you should be aware of a potential challenges.

For one, contract expirations in the MLP’s oil tanker fleet will eat into growing cash flow from its FPSOs and tanker shuttles. Management will seek to extend the economic lives of these older tankers by converting them floating storage off take units (or “floating bathtubs in industry parlance”) that generate a steady stream of cash flow and require little maintenance expenditures.

The MLP also faces balloon payments of $244 million in 2013 and $600 million in 2014 on its credit lines. Management is working to address this financial challenge today, but the market’s concern about these looming payments could increase if more time goes by without a solution.

Units of Teekay Offshore Partners LP have rallied significantly in the new year; the stock rates a buy on dips to less than 27 in the Energy Watch List.