We all know that the crude oil prices do not affect a servicing company’s revenue like how it affected the upstream oil producers. Servicing companies gain their revenue from a fixed contract rate even though it is unprofitable to produce oil.

But still, we can’t escape from problems like what Bumi Armada is currently facing. A major cancellation could spell a bigger trouble even if there is a huge compensation from Woodside.

This is just a simple note to clarify why the market is punishing the stock so hard that the cancellation of one contract out of six operational FPSOs deserves a 20% price correction.

Firstly, we have to understand that the oil and gas players like Armada have huge capital investments to make before they could start their operations. This includes but not limited to buying a ship, hiring experts and establishing land facility.

All that requires debt financing and would be repaid over the years with cash generated from operations. Simple case…

The problems comes in when assets are lying dead on water with no revenue to offset some of the fixed cost. Even if the project is making losses, the revenue contribution would still pay for employee’s wages and loan payments compared to making zero revenue from a contract termination.

Worse is that in Armada’s case, it seems that there might be no compensation after all.

The primary contract was a 4 years servicing which starts in 2011 and another 4 year option. This being the case and with unknown content inside the drafted contract we could only assume that Woodside isn’t out of its mind to be in the position of getting sued by Armada.

I guess this checks the box on investor’s ultimate fear when the oil price crashes. Assets of oil and gas servicing companies are just floating at dock doing nothing creating zero revenue and still have monthly loan payments to commit to.

It definitely changes the broad fundamental of the company and could be the igniter to more problems ahead. It could happen to Armada and it could happen to many of the smaller sized contractors if oil would to stay at unprofitable production prices.

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