Another withdrawal! Russia's massive order becomes a "time bomb" for South Korea's shipbuilding industry

Daewoo Shipbuilding & Marine Engineering (DSME) has canceled an order for a $290 million ice-class LNG carrier from Russia due to non-payment. This is the second such cancellation in just over a month, with a third cancellation likely imminent. The $8 billion order for ice-class LNG carriers, originally intended for the Arctic route, is now becoming a new "time bomb" for South Korean shipbuilders as the Russia-Ukraine crisis continues.

Daewoo Shipbuilding & Marine Engineering Cancels Second Russian Ice-Class LNG Carrier Order

On July 1, DSME announced the termination of a contract for an ice-class LNG carrier signed in October 2020 with a European shipowner. DSME stated that the contract was unilaterally terminated due to the shipowner's failure to make an interim payment within the contractually stipulated timeframe.

DSME explained the reason for the contract change as follows: "Due to the shipowner's failure to fulfill the obligation to pay for the construction of an LNG carrier within the deadline, and in order to protect the company's rights and proceed with subsequent procedures, the company has notified the termination of the contract."

According to South Korean industry insiders, the shipowner is Russian energy giant Novatech. This is less than a month and a half after DSME announced on May 18 the termination of the construction contract for one of three ice-class LNG carriers for the Arctic LNG 2 project signed with Novatech.

Following the outbreak of the Russia-Ukraine conflict, Western sanctions against Russia, including its removal from the SWIFT international payment system, prevented Novatech from making payments. Therefore, DSME announced on May 18 that it had unilaterally terminated the construction contract for one ice-class LNG carrier under construction. DSME's announcement stated that the contract for three LNG carriers signed on October 9, 2020, with a European shipowner, was changed to two, reducing the contract amount from 1013.7 billion KRW (approximately $872 million) to 675.8 billion KRW (approximately $581 million). As of the end of March, the construction of the vessel was 19.6% complete.

According to the contract signed in 2020, the delivery deadline for these three LNG carriers was July 31, 2023.

According to South Korean industry sources, the canceled contract was for the second of three ice-class LNG carriers. Since the third vessel is also nearing its first interim payment deadline, and the possibility of Western sanctions against Russia being lifted in the short term is low, it is expected that the termination process for this vessel will also begin soon.

Russia's $8 Billion Order Could Become "Bad Inventory" for South Korean Shipbuilding Industry

The South Korean industry states that the cancellation of the contracts will not immediately reflect in the losses of the shipbuilding companies. Ownership temporarily belongs to the shipbuilding companies, but because they are not yet fully completed, they will be considered inventory assets (work in progress) according to enterprise accounting standards.

However, the South Korean industry is concerned that these ice-class LNG carriers, capable of traversing the Arctic Ocean, are expensive specialized vessels custom-built by Russia for oil and gas resources near the Arctic Ocean. Therefore, finding third-party shipowners and reselling them will be very difficult, and these canceled vessels may ultimately become "bad inventory" for DSME.

Relevant South Korean industry insiders said: "Although the LNG carrier market has entered a super-boom cycle in recent years, the only demand side for ice-class LNG carriers is Russia, which has Arctic routes. Therefore, it will be difficult for the three major shipbuilders to resell these new ships to shipowners in other countries. If sanctions against Russia are prolonged, the losses for South Korean shipbuilding companies will be unavoidable."

It is reported that Samsung Heavy Industries has not announced the termination of shipbuilding contracts with Russian shipowners, but is negotiating with the shipowners regarding payment issues. Previously, Samsung Heavy Industries postponed the delivery of two polar ice-class Aframax crude oil tankers originally scheduled for delivery in March.

This is because the shipowner, the Russian state-owned shipping company Sovcomflot, has been included in the list of sanctioned companies, and since March 13, major Russian financial institutions have been excluded from the SWIFT payment system, blocking the path to financial settlement. The construction contracts for these two vessels were signed in November 2019 for 187.5 billion KRW (approximately $160 million). It is estimated that Samsung Heavy Industries has yet to receive approximately 50% of the total contract amount.

According to statistics, including the above orders, the total value of Russian orders currently held by the three major South Korean shipbuilders is as high as 10.3 trillion KRW (approximately $8.05 billion), including $5 billion for Samsung Heavy Industries, $2.5 billion for DSME, and $550 million for Hyundai Heavy Industries Group. Currently, the South Korean shipbuilding industry is most concerned about the potential risks posed by new Russian ship orders that have officially entered the construction phase and are scheduled for delivery within one year. According to South Korean industry insiders, among all the new Russian ship orders received by the three major South Korean shipbuilders, the number of ships that have already begun construction may be as high as 60%. For this reason, South Korean shipbuilders have already invested a considerable amount of money in raw materials and labor.

Relevant South Korean shipbuilding industry insiders said: "If the financial sanctions against Russia are dramatically resolved, the situation may reverse. However, South Korean shipbuilders must now prepare for the contingency of setting aside provisions for construction losses."

An anonymous South Korean shipbuilding industry insider urged: "The three major shipbuilders previously undertook a large number of Russian orders, largely in line with the government's "New Northern Policy," and many cooperating companies (subcontractors) were also involved, with a wide-ranging impact. Therefore, the government needs to formulate precise policy support measures."

"The New Northern Policy" is a strategy formulated by the South Korean government aimed at promoting cooperation and connectivity between the Korean Peninsula and Eurasia. The South Korean government hopes to achieve the goals of improving South Korea-Russia economic and trade cooperation, reducing dependence on China, and attracting North Korea's participation. South Korea-Russia cooperation on shipbuilding, ports, and the Arctic route is considered a highlight of South Korea-Russia cooperation in the new century. However, due to the escalation of the Russia-Ukraine conflict and the subsequent comprehensive financial sanctions imposed by Western countries on Russia, the South Korean government's "New Northern Policy" has suffered a major setback, and the three major shipbuilders may also have to swallow the bitter fruit. (Wang Chu)