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Interview With Vice Chairman And President

(*extracted from Annual Report 2016)

1. How would you describe market conditions in 2016?

The uncertainties surrounding oil price recovery continued to haunt the offshore and marine (O&M) market in 2016. Oil price had stayed below the US$50 per barrel mark until OPEC and other oil producing countries got together in November 2016 and decided to cut output. However, there was too much over-capacity with too few orders for the O&M sector. The market slowdown in the past 2 to 3 years has led to over-capacity in major rig building establishments.

In the dry bulk shipping and ship building sectors, conditions remained highly challenging. The oversupply of vessels and stagnant trade growth continued to depress both markets. While China had expanded its dry bulk imports, shipments of iron ore and coal into Asian and European countries slipped.

Continued anemic global economic growth and slow trade, combined with oil price volatility, made 2016 a very difficult year for the Group.

2. What affected COSCO Corporation's performance the most?

The continued drag on oil price had forced offshore oil producers to make bigger cuts or to suspend their capital expenditure in the face of the unceasing market unpredictability.

As we had reported earlier, in 2015 and 2016 the Group experienced delivery extensions and order cancellations for several of its projects.

Another factor affecting our performance is inflationary pressures on our efforts to control cost and maximise yield from our projects. Material costs and other expenses have been rising rapidly these past years, while our projects have been secured at lower prices in a highly competitive market.

We delivered 18 projects in 2016 compared to 21 for 2015. Among those delivered were two Super 116E jack-up drilling rigs, three BigRoll Series MC–class module carriers and four oil tankers.

The Group's gross order book, which stood at approximately US$6.4 billion at 31 December 2016, also includes several offshore and marine engineering projects which have been substantially completed in construction but are yet to be delivered due to customers' requests for extension.

3. What are the efforts made by COSCO to address the challenging market conditions?

The Group has over the years been focusing its effort across the shipyard value chain to increase productivity and production execution efficiency to maximise yield from every project. We target skills development for our workers, production process improvements, wastage reduction and cost saving measures, as well as stringent quality control.

We will continue to pursue fervently our "Customer-centric, Service-oriented" approach to doing business to build relationships and promote our shipyard capability, including applying our expertise for constructing other marine products.

In addition, we also have continued to develop our in-house research and development (R&D) capability to support customers' product design needs.

These efforts are aimed at ensuring that our shipyard group will have the capability to build valued products and meet increasingly more stringent standards and more sophisticated product needs from our customers in the years ahead.

4. What are your concerns about the market, going forward?

Our main concern is whether oil prices will continue to hold above the US$50 level. This will depend on how committed are the OPEC members and other oil producing countries in reducing the output they had agreed to at the end of 2016.

The oil price volatility has caused producers and exploration companies to make very deep cuts in their capital expenditure over the last three years contributing to increasingly difficulties for the O&M sector. Our concern is when will confidence return to the market and spur these companies to start spending again. Even if oil prices recover to a sustainable level, it would also take some time before offshore exploration and production companies start spending again on new equipment and support vessels.

Reports have said that American shale oil companies that have become leaner and more efficient are resuming drilling as they see the rising price of oil as viable. All eyes are now focused on the North American shale producers, as the market is very concerned about the threat of resumption in shale oil drilling, which can upset the rebalancing that had begun to take place after OPEC members and other oil producing countries had joined hands to cut their output. Revival of shale oil production activities will not help the O&M sector. Instead, increased shale oil output flooding the market could re-ignite the global supply glut, leading to further market uncertainties.

Another concern is the pace of global economic growth, which remains fragile with protectionism rearing its head. The International Monetary Fund (IMF) in its update report on World Economic Outlook released in January 2017 flagged its concern, saying "there is a wide dispersion of possible outcomes around the projections, given uncertainty surrounding the policy stance of the incoming U.S. administration and its global ramifications".

Finally, borrowing costs have been going up, and companies would have to learn to adjust as it could contribute to higher operating costs. The IMF had raised its concern about the growing size of the global debt and had suggested that it "raises the risk of unprecedented deleveraging that could hamper growth worldwide." Any tightening of credit availability and rise in financing cost could affect the ability of customers to meet their financial obligations in relation to their contractual agreements with the Group. This could adversely impact the Group's financial position.

Our teams at COSCO will continue to work harder and more productively to overcome the pressing challenges of the weak and uncertain market.


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