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Global Entrepreneur: The King of Chinese Drilling

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The Kingof Chinese Drilling

Source: Global Entrepreneur, March 2014 Author: Gao Yang

Introduction: Advanced offshore drillequipment has long been absent inChina, but later comer Zhang Mi has taken a big leap to catch up to competition

If you fly over Qidong City in Jiangsu, one of the most impressive sightsthat comes into view is a tight array of shipyards that lay along the northernbank of Yangtze River, and wind power generators that resemble the view of asteel forest. On the northern bank where Yangtze River meets the sea, “Hong Hai Hao” a 50-storytall gantry crane, stands tall like Optimus Prime himself.

At 150 meters above ground, Sui Shaoyuan stood atop the steel beast “Hong Hai Hao” and toldGlobal Entrepreneur: "Any seam that wasn't welded right would turn thismonster into a pile of scrap metal." Aged 55, Sui Shaoyuan was theperson-in-charge. With a tall, thin build, Sui Shaoyuan was quite talkativedespite standing standing at -8 degrees Celsius. He said that building anoffshore drill rig was much more difficult than what people have imagined.

“Hong Hai Hao” is the largest and most advanced mobilecrane the world has seen so far. It was built by an emerging drill manufacturer fromSichuan, called Honghua Group Limited (Honghua Group), and now publicly listedin Hong Kong. The purpose of building “Hong Hai Hao” is to hoist an offshore drill rig thatweights tens of thousands of tons directly onto water. This seemingly simpleoperation was never thought to be possible given the weight and heightrestrictions of machinery used in the past. This enormous steel structure,which cost around RMB 360 million and used more than 11,000 tons of hightensile steel, will be completed in mid-year this year. It consists of aparallel array of two 150-meter high, 124-meter wide gantry cranes capable oflifting 22,000 tons. It has 11 times the capacity when compared to the world'slargest equipment of similar category and can easily lift a 20-story highbuilding and quickly move along its 300-meter rail. To provide support, a300-million dollar, 46-meter deep steel reinforced concrete foundation playsits critical role. This depth is equivalent to Shanghai Tower, the world'ssecond tallest building (and the tallest in China) about to be built, while thetension of the concrete foundation is even stronger than that of the Three GorgesDam.

Yangtze River Delta, the location where “Hong Hai Hao” is situated, has some of busiest shipyardsin the world. Due to the fact that this place had recently been struck by thelongest recession of the marine business in history, ship builders are nowlooking towards building offshore drill rigs as their way out. Headquartered inChengdu City, Sichuan Province, Honghua Group signed an investment agreementwith Qidong City Government as early as 2009, which also signified its steptowards the offshore rig business. However, what set Honghua Group apart fromits neighbors was that the company was specialized in land drills and had noprior shipbuilding experience whatsoever.

The rationale behind this bold move was that the drilling core accountsfor more than half of the cost of a multi-billion U.S. dollar offshore drillrig. From Honghua Group's perspective, they are the ones most suitable for thebusiness. Today, Honghua Group has become China's largest and the world'ssecond largest oil and gas drill supplier. It exports nearly 90% of its drillsper year, and has capital invested by Carlyle, the world's largest privateequity fund. In addition, oil/gas extraction giants such as Schlumberger,Halliburton, Baker Hughes, and Nabors Industries are all long-term partners ofHonghua Group. Nabors Industries had even once signed a contract to purchase 63drills in 2005, an order that remained unmatched even till this day. With suchextensive experience at the support, Honghua Group sees no difficulties in shiftingits drilling expertise onto the sea.

China's largest land drill manufacturer, Honghua Group Limited, venturesinto the sea: a show of confidence or arrogance?

"Do you like this view?" asked Sui Shaoyuan with his arms opentowards the sea. Looking into the direction he gestured, a few container shipswere barely visible while the water appeared muddy in dark blue. He said thatthey were living a simple life far away from the city, away from TVentertainment and Internet experiences that many others were enjoying. Butthere are some once-in-a-lifetime opportunities that are too great to bemissed.

The Gamble

Climbing up the scaffolds onto the top of “Hong Hai Hao” on a cold January morning was such anuncomfortable experience. It was easy for people to neglect thehistory-changing work that is happening right under their feet. In fact, withexception to the beam and the support, this structure is built with countlessnumbers of hollow bars that are welded together using 7mm steel plates. Thebars varied in length and are attached together at all angles that resembledthe look of a cob web. This is referred to as a trussed structure on which “Hong Hai Hao” is built. Itmeans that all pressure points need to be properly welded to support theweight. The equipment has tens of thousands of seams to weld, and the qualityof this job determines the success of this project.

Sui Shaoyuan assured that quality has always been his top priority; “This is thepart that matters the most," he said. Having served more than 30 years inthe drill business, and having once been employed by the world's largest drillmanufacturer - National Oilwell Varco, Sui Shaoyuan said: “Although it was tough to find the exactnumber of welders with the skill level we desired, we did our best to selectthe capable few using stringent standards, and assigned sufficient number ofquality inspectors to make sure that jobs are done right. To be honest, even wewere nervous when the project began.”

However, it was the enticing prospects of the sea that made the companywilling to bear such risks, explained Zhang Mi, 57-year old Chairman and CEO ofHonghua Group, during his recent interview by Global Entrepreneur in his100-square meter office located at northern Chengdu. His office featured aRococo-style white couch, dark-grey carpet, and a 15-square meter world mapwith visible hills and basins. "This is the largest map you can buy on themarket," said Zhang Mi. At medium height, he spoke with humble confidenceand humor. "See how much blue there is," said Zhang Mi, pointing tothe dark blue areas of the map.

Ever since the global financial crisis of 2008, the world's shipbuilding business was downto the point where it was almost non-active. China, which once prided itself asthe world's largest shipbuilder, was forced to find new breakthroughs. Thesearch for high-margin marine equipment manufacturing opportunities with robustdemands thus became a popular topic of discussion. During the search, offshoredrill rigs presented itself as the most technology-intensive and the highestvalued business. For example, consider the P-52 platform owned by Brazilian companyPetróleo Brasileiro that operates at Campos Basin. Being one of the world'slargest offshore drill rigs, the P-52 platform was completed in 2007 with atotal investment of more than USD 1 billion. It has a main deck that is biggerthan two football fields, and features a water discharge capacity of 81,000cubic tons that even surpass Queen Mary 2 (currently the world's largest andmost luxurious cruise liner). This platform is semi-submersible, which makes ita gigantic hydrocarbon structure that floats above the sea. The vessel drawsits power by making use some of the natural gases it produces. Its generator iscapable of generating 100 trillion Watts of power, enough to supply a city of300,000 people. A 180-man team works 12-hour shifts (three week's rest forevery two week's work) to keep oil pumping out 24 hours a day.

This is a floating factory. It incorporates a variety of functionalitiessuch as drilling, mobility, communication, navigation, safety and livingfacilities, which makes it much harder to build than what people imagine. Infact, Korea, Singapore, Norway and the United States are the only ones capableof building such a wonder. Currently, Norway and the U.S. supply corecomponents, while Singapore has dominance producing jackup rigs (suitable forshallow waters). To operate deep underwater, the world mostly relies onsemi-submersible rigs produced by Korea. Meanwhile, Singaporean and Koreanshipbuilders are too maxed on production capacity to satisfy the needs ofrising energy giants such as Petróleo Brasileiro. Due to the limitationspresented on hand, Petróleo Brasileiro had no choice but to outsource theconstruction of its USD18-billion offshore drill rig to four inexperiencedBrazilian shipbuilders in 2011. According to estimations made by Maersk,offshore drill rigs and vessels are valued at more than USD 44 billion peryear.

This opportunity is too large to pass by for China. No matter which way wesee it, China has already emerged to become one of the world's most importantshipbuilders and is ready to expand its influence. About 10 years ago, manyanalysts believed that China's rapidly expanding shipyards would take over mostof Korea's and the world's shipbuilding sales, if not all, in the near future,just like what the Koreans did to European shipbuilders at an earlier time. Inthe last five years, approximately 30 Chinese shipbuilders have announced theirnew involvement in marine engineering equipment manufacturing, with 20 of whichclaimed to have possessed the ability to build large offshore drill rigs.

But things did not progress as they have imagined. Although China hasreceived more sales orders than ever before in terms of tonnage, Korea hasproduced 76.2% more vessels per year than China in value terms as of July 2013.In addition, those who have tried making use of their excess container shipproduction capacities to produce advanced offshore drill rigs found themselvescompeting in what is already a tight market. The critical problem that led tothis result was that offshore drill rigs present too large an investment to behanded to inexperienced builders.

Enticing prospects of the sea was what made Zhang Mi (4th from left),Chairman and CEO of Honghua Group, willing to bear the risks of industrytransformation

In other words, Chinese manufacturers returned home empty handed afterbetting everything they had. And neither did Zhang Mi receive any productionorders for offshore drill rigs. He has invested more than RMB 2 billion only toreceive orders for a few barges (small vessels that are used to move suppliesto offshore drill rigs) and a project named "Tiger." Project Tiger isa drilling vessel jointly developed between Singaporean company OPUS OffshorePte Ltd and Shanghai Shipyard Co., Ltd. to work in depths between 900 and 1500meters, for which Honghua Group has provided a 300-million dollar drill core.Zhang Mi was excited by this prospect as it may open the door to the market. Heknocked on his desk and said: "This is a huge breakthrough for China."Before then, National Oilwell Varco monopolized the supply of drill coresneeded by offshore drill rigs and vessels, with a market share as high as 90%.

"Hong Hai Hao" is Zhang Mi's ace. It exists for a simplepurpose: to hoist vessels onto water so that ships can be built on land insteadof occupying precious spaces at the shipyard. He was not the first to come upwith this idea. Instead, Hyundai Heavy Industries was the first in the world toput this idea into practice in year 2000, but due to limitations of the craneequipment, a ship can only be hoisted onto water in multiple pieces. Later in2008, Yantai CIMC Raffles Shipyard Limited, with its advanced ability inmanufacturing marine equipment, built the world's largest gantry crane with a20,000-ton capacity that greatly improved the efficiency of this progressiveshipbuilding process. However, it still needed to occupy a shipyard because itwas immobile. "As for me, I don't even need a shipyard," said ZhangMi.

Joining the competition

Zhang Mi was born at a gas field 210 kilometers outside Chengdu City. Itwas the first mass-produced natural gas field in China. From as far as he couldremember, his family had been using natural gas for all their at-home energyneeds. His elder brother Zhang Cong later joined the drill workers, and ZhangMi often followed him a dozen meters up on the stand to watch workers extractgas. These experiences ultimately led to Zhang Mi's decision to join the gasbusiness.

But before then, he went through a rather depressed adolescence. Becauseof his father's association with Chinese Nationalist Party in early years, hisfather was constantly discriminated during the Cultural Revolution. This causedZhang Mi to lose his opportunity to high school education. Despite havingachieved top grades and built sound reputation among classmates, Zhang Mi wasnever commended for his achievements in his rather limited time at school. Thistorment had a profound influence to the rest of his life. "I eventuallyrealized that I lone had to work hard to gain respect." said Zhang Mi.After graduating from junior high school, Zhang Mi stayed home andsingle-handedly supported the family for three years. He did not stop learningduring the three years, and took the effort to transcribe the "ChineseDictionary" three times. "His writing was anything but neat,"said Zhang Cong to Global Entrepreneur. Later, Zhang Mi enrolled to study oilmechanics in the workers' college, and was assigned to work as a technician atthe drill workshop.

However, he was never an obedient employee. At that time, the drills madeand used in China were inefficient Russian replicates, and Zhang Mi came upwith his proprietary design of a new triplex pump that later became themainstream used at the mine field he worked with. He quickly earned his statusas China's most renowned specialist in that field of expertise, and was invitedto speak during industrial conferences throughout the country. Despite the famehe earned, Zhang Mi and his unit were too lowly ranked to sell his products tothe public. However, Zhang Mi never admitted defeat so easily. Eventually, thesolution he proposed received overwhelming responses during a nation-wideconference, and was used in industry applications on a large scale. From thenonwards, Zhang Mi was able to build his personal influence in China's oil drillbusiness.

The former Honghua Group was incorporated towards the end of the lastcentury. It was reorganized and privatized in 2006 with Zhang Mi takingposition as the Chairman and CEO. In 1998, the company had been able to inventChina's first 7000-meter drill in the first year of its establishment, but itwas not until 2001 when Zhang Mi participated in the development of China'sfirst DBS drill that gave Honghua Group its industry leadership. The purpose ofthis equipment was to turn existing mechanical drills into computer-controlleddrills, for greater operating ability and efficiency. Zhang Mi has always puthimself in the front line of technology. He had even subscribed mechanicalmagazines for ten years as a means to self-study electrical automation."The country already had extensive research in electrical locomotives, andthis technology should be applied on oil drills," said Zhang Mi.

The DBS drill ultimately won the favor of U.S. oil and gas extractiongiant, Nabors Industries, with a purchase of 63 units, but the process had beenextremely challenging. Oil and gas extraction in China were tightly controlledbetween China National Petroleum Corporation and China PetrochemicalCorporation. These two companies owned nearly a hundred oil/gas equipmentmanufacturers between them, which sufficiently accommodated their own needs. Itwas difficult for a private company such as Honghua Group to gain its share ofthe local market. "Almost everything Honghua produces is sold to foreigncompanies," said Zhang Mi with slight regret.

However, he did after all find his point of breakthrough. With that, ZhangMi vouched to aim for the global market, and to compete against the UnitedStates at the pinnacle of the drill business. In 2002, Zhang Mi led HonghuaGroup to participate in the OTC Exhibition in the U.S., and received virtuallyno interests to Honghua's equipment. At that time, one of his Chinese peerstold him that it would take a miracle for Americans to buy his drills. Twoyears later, Zhang Mi established Honghua Group's first overseas factory andsales outlet in Houston, U.S., where leaders of the drill industry such asNational Oilwell Varco, Halliburton, and Baker Hughes gathered.

The Sichuan drill factory carries Honghua's dream of someday becoming ableto compete against the world

Even so, Honghua Group was unable to secure any production order in theU.S. To gain entry into the market, Zhang Mi offered customers to rent hisdrills at a relatively low price. Eventually, this strategy led to Honghua'sfirst drill sale into the United States. In 2004, the shale gas business boomedin the United States, which maxed out the production capacity of local drillproducers. Coincidentally, Honghua Group's DBS drills were especially suitablefor shale gas extraction, and coupled with competitive pricing, this newcompetitor from China was finally able to gain interests from NaborsIndustries. Soon after, Honghua Group was able to open its way into Russian,Central Asian, Middle East, and South Asian markets. Returning to the OTCExhibition for the second year, the U.S. media was already comparing HonghuaGroup to National Oilwell Varco, and commented that the former actually had thepotential to compete against National Oilwell Varco in the world arena in thenear future.

This marked the end of Honghua Group's struggle in the U.S. market, andmade Zhang Mi one of the few Chinese entrepreneurs who actually profited fromthe U.S. shale gas boom. This achievement also opened another window forHonghua Group, as reports showed that China had the highest amount ofextractable shale gas deposits in the world, even surpassing those of the U.S.This new knowledge astonished world's energy leaders and investors includingRoyal Dutch Shell and Exxon Mobil. It did not take long for them to come flyinginto Sichuan with bags cash, for they believed that this place held most ofChina's shale gas deposits.

As the first Chinese company to engage in the production of new energyequipment and gain valuable experience in the U.S. market, Honghua Group's biggamble had finally paid off. Although the company was presented with anenormous opportunity, Zhang Mi soon found that the U.S. model was notapplicable in China, and therefore assembled a team of experts to developall-round solutions for shale gas extraction in Sichuan. They developed aproprietary flexible water tank to replace the old bulky water storage devices,and in the meantime reduced occupied areas by two-thirds. At Honghua Group'smain production facility in Guanghan City, a site coordinator named Hu Chaogangpointed to an array of ten-meter tall, convertible black rubber tanks and toldGlobal Entrepreneur that these were Zhang Mi's "wonderful ideas." Healso said that two of these devices have already been shipped to the UnitedStates. In the meantime, another critical breakthrough was happening on theother side of the globe, as the world's largest 6000-horse power fracturingpump was undergoing its final industrial tests by Baker Hughes in the U.S."Once it succeeds, we will have a complete shale gas solution," saidZhang Mi modestly tapping his fingers.

However, the real progress of extracting shale gas in China was ratherdepressing. Although China had set its goals to produce 6.5 billion cubicmeters of shale gas or 2% of total natural gas production by 2015, this goalwill prove hard to achieve. The reason was that the first shale gas fields werefar behind schedule. "At first, we all believed that this target could behit without much effort," said Lin Boqiang, an energy economist fromXiamen University, because the target was indeed relatively low. ZhangDongxiao, the dean of Peking University Institute of Clean Energy, told GlobalEntrepreneur that China is unlikely to hit its production goal set for 2015."China's shale gas production in 2012 totaled to merely 50 million cubicmeters. It is virtually impossible to increase production volume by 130 timesin just 24 months." Having been presented with such a difficulty, Zhang Mishowed no signs of concern as he said: "The opportunity will mature eventually;all you need to do is to be ready for it.

Of course, what he did was much more than waiting around for things tohappen. To address this situation, Zhang Mi established a company specializedin oil and gas services, which was exactly what Schlumberger and Halliburtonwere doing. Simply put, what he had assembled was a drill team. By the end of2013, Honghua Group had assembled more than 20 drill teams with a total headcount exceeding 1,000 workers. They are currently located in Xinjiang andShaanxi, while some teams have already been dispatched to Iraq. In themeantime, Honghua also created its subsidiary in Russia. Last year, they signeda cooperation agreement with Europe's VTB Leasing and Russia's OJSC SPCUralvagonzavod to jointly produce a USD400-million oil and gas extractiondrill. Honghua Group also secured other new key orders including: sale of 3desert drills worth USD 40 million to Kuwait Drilling Company, and sale of 4land drills to Serbia and Kenya. In fact, these international orders havealready made Honghua Group's land drill production facilities rather crowded.

Nevertheless, the open sea remains as Honghua Group's key focus today."Given Honghua's advantage in making land drills, drill cores, and thepresence of Hong Hai Hao, the company is able to reduce cost and time ofconstruction by 30%," said Zhang Mi. Very few of the new competitors inthis business truly possess the right expertise to last; most of which areeither operating at very slim margins or are at the brink of failure due to thelack of core skills. Zhang Mi admitted that the future does presentuncertainties, but said: "We have nothing to lose at this moment. Daringto try is the only way out.”

The other challenge that Honghua Group faces is from within. Havingventured into the offshore drilling business, Zhang Mi have actuallyreorganized Honghua Group. He needs talents, both in terms of head count andprofessional capabilities, to perform massive amounts of fundamental worksunder highly efficient management. Zhang Mi realized this weakness, whichprompted him to spend more efforts on building internal talent. "For manyyears, Honghua had grown based on shear passion and dreams, but these things nolonger suffice for the challenges ahead," said Zhang Mi.

Zhang Mi is not a talkative person, even when he speaks he does so slowlyin a low tone. Given his appearance, no one could imagine that he once fancieddriving a few years back. "Back then, I really enjoyed chasing cars on theroad because I saw myself as the only one overtaking and never the one beingovertaken," said Zhang Mi as he pointed to a dark green Porsche 911 parkedbelow.

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