Dayrates skyrocket across the globe
Drilling contractors are making hay while the sun shines. After a downturn in drilling activity that saw many rigs leaving the Gulf of Mexico and many more looking for fewer and fewer contracts, there is suddenly more than enough work to go around. Rig utilization numbers are on the rise, and day rates are rapidly escalating.
Commodities prices have reached historic levels and seem destined to remain there for the foreseeable future, which has convinced oil companies to release the death grip they’ve held on their E&P purse strings. The situation that creates for drilling contractors is one of opportunity.
Jon Marshall, president and CEO of GlobalSantaFe, talked withOffshore about the current drilling market and its implications for contractors.
“I think there are a lot of differences between this market and anything we’ve seen in the past,” Marshall says. This is the first time, for example, that OPEC supply has been at such low levels - around 600,000 b/d, all of which is sour, a fact that poses refining challenges, according to Marshall. Recent numbers indicate that OPEC has the least spare capacity that it has ever had. And the demand engine, the world economy, is stronger than it has ever been.
OPEC capacity has remained flat for 30 years.
“In fact, it’s the first time we have seen significant hydrocarbon demand growth coming from the emerging markets,” he says, “evidenced by historically low reserve replacement ratios.”
OPEC capacity has remained flat for 30 years, Marshall says. There is very little non-OPEC supply growth, and although Russia is increasing production, the country’s rate of production increase began declining last August.
The reason OPEC is producing at capacity is that the world needs the additional supply in winter months. “If OPEC does not produce everything it can now and get it into inventory, there is a good chance that inventory will fall below historic norms this winter,” Marshall says, “and prices will go crazy.”
His biggest concern in this market is the potential disruption of supply that would cause a price spike that could create a systemic change in demand like the US natural gas market in 2001, when gas went to $10. “At that time, we had a structural change in demand that has persisted to this day,” Marshall says.
Oil company stock prices have risen based on commodities prices, he explains. When that price either stabilizes or moderates down, operators will no longer have this price-driven mechanism. At that point, the only option is organic growth, some of which can be achieved through M&A activity, Marshall says, but the bulk of which will have to come through the drill bit.
“I see a market with more moderate oil prices in which world demand would be extremely robust, and contractors would be even busier than in 1996 and 1997,” Marshall says. At that time, drilling was not driven by commodities prices, but by volumetric concerns. There was a need to meet oil demand that was growing at 2.5% a year, with OPEC having less than 2 MMb/d of spare capacity, a situation that present conditions far exceed, he says.
The equity markets have demanded return on capital from oil companies, which has made oil companies conservative about their spending. They have increased dividends and bought back stocks, and this has been rewarded by the equity markets, he says.
“When oil price stabilizes or moderates, the equity markets are going to demand a measure of organic growth, and that’s when our business is really going to get busy.”
Unless they are growing, oil companies become liquidating trusts or royalty trusts, he says. “And royalty trusts do not get anywhere near the multiples the E&P companies are currently getting on their stock prices.”
If Marshall is right, the future looks very promising for drilling contractors.
Undeniably, companies like Noble Drilling, with its fleet of 60 rigs, 80% of which are deployed in international markets, are banking on a sustained high level of drilling activity globally.
James Day, president and CEO, believes the company’s distribution of assets is working well. “In the mid 1980s, Noble was primarily a domestic, land based company,” Day says. “We started moving rigs internationally in 1988 and 1989 because the geology in the US GoM began to decline. Our philosophy was to move rigs into an area and stay, and that philosophy has been successful.”
Day believes Noble is well placed to take full advantage of the current upswing in the drilling market.
“I’ve been in the energy business since the mid 60s, and I’ve never witnessed a market like we have today. There has been consolidation in the industry. Clients are in great financial shape and have invested capital wisely. That would lead one to believe that this upswing will be sustained,” Day says.
Day believes that Noble is uniquely positioned to make the most of the high end of this drilling cycle. “We invest and re-invest irrespective of commodity prices because our return on capital is the highest among the drilling contractors. We earn twice the next competitor,” he says.
Though Noble is not building any new rigs, the company has been investing in its assets. “We consistently have had major upgrade projects going on around the world,” Day says. Despite the fact that no newbuilds are on the books, Noble is growing.
“We’ve grown our fleet over the last five years by approximately 20%. We are a growth company, so our fleet will not stay at 60,” Day says. “We have been very consistent. We’ve grown from two offshore units in 1985 to 60 today, and we’ve grown irrespective of what the cycle was doing. We firmly believe that if things make economic sense, it doesn’t matter if the market is up or down.”
Noble’s challenge, and that of all of the drilling contractors, Day says, is outfitting the rigs with qualified personnel. “We look at training and developing people. Demographically, this industry still faces a challenge. If we expect strong growth, we need to have people replacing people who are near retirement age.”
The personnel shortage, which has been a thorn in the side of the oil and gas industry for years, is the only dark cloud on the horizon.
“The market is unique right now,” Day says, and Noble is making the most of a very promising situation.
Diamond Offshore’s fleet of 45 rigs is also active all over the world. Though Diamond has 14 jackups, most of them in the GoM, the company’s focus has been deepwater floaters. According to Larry Dickerson, president and COO, “All of our recent activity has targeted adding deepwater capacity to our fleet. We purchased two existing semis three to four years ago, and they are now at work off Australia and Norway. Those two rigs in conjunction with our Victory class have really been our focus for our deepwater fleet.”
Diamond’s newly upgradedOcean Baroness and Ocean Rover have gone to work offshore Indonesia. And the company recently moved another Victory class rig, Ocean Endeavor, into a Singapore yard for a significant upgrade that will transform the rig and boost its earning potential, Dickerson says.
Dickerson sees investing in upgrades as sound business. “There is a shortage of deepwater rigs. We can deliver our upgraded rigs in two years instead of investing in a newbuild, which takes three to four years to build.”
Diamond is also adding through acquisition and newbuilds. Its latest purchase is theGarden Banks, a semisubmersible the company is buying from Newfield Exploration, which had cold stacked the rig in the GoM. According to Dickerson, the Garden Banks was the only Victory class rig in the world not owned by Diamond. The company plans to take delivery in September. “That brings Diamond’s floater fleet to 31 semisubmersibles and one drillship,” Dickerson says.
Diamond is also building two new 350-ft jackups, designed specifically for the deep gas market in the GoM, Dickerson says, noting that there is applicability for the rigs to drill in a variety of international markets as well.
The drilling market is taking off, and Dickerson believes continued market improvement is imminent.
“This is the most dynamic market that I’ve ever seen. In one year’s time, we have gone from fairly low demand to full utilization in virtually all classes of equipment. The velocity of this demand has caused day rates to increase at an unprecedented rate,” he says.
In the past, Dickerson says, oversupply has killed the market, and a collapse in commodities prices has done significant damage. In the present cycle, neither seems likely.
“Although there are some jackup rigs entering the market, in the floating deepwater market, which is where we predominately participate, there are not any meaningful asset additions scheduled at this time,” Dickerson says. “And on the product price side, projected demand in countries such as China and India is so great that it is unlikely that production will increase sufficiently to lower prices. It seems likely that there is room for product prices to decrease substantially before operators begin decreasing their current amount of drilling activity.”
Overall, Dickerson believes Diamond’s planning has placed the company well to capitalize on the current market.
Paul Bragg, president and CEO of Pride International, is making sure his company gets its share of the booming market.
“We’re re-pricing our rigs to the prevailing market prices and increasing the market price wherever possible,” Bragg says. “We’re not expanding our fleet, but we’ve re-activated three jackups that were cold stacked.”
Much of Pride’s fleet has been working outside the GoM since day rates fell off a couple of years ago, Bragg says. “Pride now has only 10 jackups in the US GoM and eight platform rigs. Everything else is outside the Gulf,” he says.
The company has a significant presence in the Mexican Gulf, holding about 40% of the market, according to Bragg. Pride also has a considerable presence offshore Angola and Brazil.
Many of the big opportunities in these areas are in deepwater, Bragg says, and Pride is in a position to take advantage. “The least risky expansion is to grow around primary operations. We would love to expand those areas if we had the right opportunities,” he says.
In the present investment climate, opportunity could already be knocking.
Big exploration budgets and high commodities prices are creating a lot of investment possibilities. Bragg sees the current upswing in the cycle as unique and very positive to drillers. “I think this upswing is different in that I think we have better fundamentals than we’ve seen at any point in time,” he says. “We have a better chance of a sustained high level of activity than we’ve ever had.”
A less obvious part of the drilling picture is excess capacity in terms of oil production, Bragg explains. “And we probably have more deliverability issues with natural gas than we’ve ever had. There isn’t any quick fix for either issue,” he says. “We’ve had underinvestment for so many years that even at putting the rig supply at full utilization doesn’t build back the infrastructure fast enough.”
Another dark cloud on the drilling horizon, according to Bragg, is the influx of jackups over the next few years. “There are studies that say the market will be able to absorb the new releases although there is not enough demand to absorb it now,” Bragg says. “I’m not so confident that is the case. I think 32 jackups coming on in a very short timeframe will create problems. It is probably more than the market needs,” he says.
Not only are there likely to be more jackups than necessary when these rigs come online, Bragg says, their entry into a tight market also raises the problem of staffing. “We are suffering from a chronic situation of not having enough of a workforce today,” he says. More rigs compound the problem.
“That many rigs constructed quickly could throw the market out of balance,” Braggs says, “but jackups are really only one segment of the market. The overall market is still quite positive.”
Juggling assets in an industry with so many ups and downs is a unique challenge to contractors, Bragg says. Regardless of the point of the cycle, he explains, “You still have to realize that it remains a cyclical industry.”
Robert L. Long, president and CEO at Transocean Inc., the world’s largest drilling contactor, acknowledges the cyclical nature of the industry, but looks at the high rig demand as a golden opportunity.
“Demand for all major categories of offshore rigs has continued to increase, and dayrates that are currently being discussed are, frankly, higher than I ever would have anticipated,” Long says. “We’re negotiating with customers on seven of our high-specification floaters for dayrates in the $260,000 to $350,000 range. The difference in this cycle so far in the floater business has been that the operators are almost price insensitive. They’ve driven rates well past what would be considered a newbuild rate,” Long says.
Some of Transocean’s recent contracts are for at least two years in duration and do not start until next year, according to Long. “We should see some very good rates at a number of rigs going out until 2008.”
Contractors, in general, have been aggressively trying to push day rates, Long says. And that will continue until they reach the point where operators say, “No.” Present levels promise to be profitable for some time.
“These rates would provide a terrific return on capital, and if we could lock them in for five years, it would be a very good thing for us,” Long says.
Long, like other contractors, is optimistic about the possible longevity of this upswing in the cycle.
“We seem to have very good visibility for demand for two to three years in the high-specification floater segment,” he says, “and the industry has very limited ability to add capacity in that time. Going past the 2008 time frame, the outlook depends primarily on exploratory success over the next couple years. But with all the different prospective deepwater plays around the world, we think there’s a very good chance that supply/demand remains favorable even out past 2008.”
Sustained high commodities prices are working in the contractors’ favor, Long says. “I think the current demand for the second- and third-generation floaters is being driven to a large extent by high oil prices. My guess is that we will continue to see high demand for the next couple of years for the second- and third-generation rigs. But beyond that, I’m not sure that either the prospectivity in the mid-water areas or oil prices will be good enough to sustain this high level of activity.”
Oil prices in the range of the low $20s placed many fields in an uneconomic range for development. With prices in the $50s, those fields are clearly economic, he says.
The deepwater outlook overall is encouraging, but Long is concerned about the large number of newbuild jackups coming out of Southeast Asia.
“While the optimists think that demand growth and attrition of older rigs will allow the industry to absorb those new rigs without negatively impacting day rates, I’m frankly not so sure,” Long says. “If additional jackups continue to be ordered, I fear that we’ll see a softening in jackup rates by 2007.”
Unlike most of the other contractors, Transocean has not been carrying out a lot of major upgrades. The primary reason for this, Long says, is that most of the opportunities did not require them. The company, instead, has been reactivating stacked rigs, and the economics associated with reactivation are simple.
“If we get a contract that’s long enough or that has a provision for the operator to provide enough up-front money to justify the reactivation, then we’re doing it,” he says.
In fact, today’s rising utilization numbers will probably leave very few rigs unemployed.
Other contractors, like Rowan Companies, are already signing contracts for rigs that are still under construction.
In late March, Rowan signed a contract with McMoRan to put its second Tarzan class jackup, theBob Keller, to work in the GoM this September. Currently, the derrick and legs are being installed in anticipation of the upcoming christening on Aug. 27 in the company’s Sabine Pass, Texas, yard.
Danny McNease, Rowan’s chairman and CEO, says the order is significant because it proves Rowan’s unique position in the deep drilling market on the GoM shallow shelf.
“We believe that Rowan is well positioned to take advantage of expected growth in this market, having the only four jackups with the capacity to handle the drill string required to reach this depth,” McNease says.
“The timing for our introduction of the Tarzan Class jackup into the marketplace could not have been better,” he says.
David Russell, vice president of Rowan’s worldwide drilling operations, agrees, noting that a third Tarzan rig is already under construction and that a fourth could well follow.
The company has been preparing for the up-cycle for several years, Russell explains, because Rowan follows a continual fleet renewal and new construction program. “We made a commitment to have cutting edge technology,” Russell says.
According to Russell, the foreseeable future looks bright. “The whole world is in balance,” Russell says, and customers’ higher cash flows are translating into higher day rates for Rowan.
Though Rowan has targeted the shallow shelf in its newbuild program, Russell expects the company’s high-end harsh-environment rigs to stay busy as well. Russell sees potential for the Gorillas and Super-Gorillas to migrate out of the Gulf as jackup demand increases internationally. The market for Rowan’s high-end jackups is quite good. The company is pushing day rates to a higher level and striving to obtain long-term contracts, he says.
Russell credits Rowan’s philosophy of continually upgrading its fleet and taking care of its personnel as its greatest marketing tools and believes his company is uniquely positioned to staff its assets with qualified, trained personnel.
The sustained up-cycle holds a lot of promise for Rowan’s Gorillas and its new Tarzans, according to Russell.
This industry is a rollercoaster, Russell says, and the latest upswing will challenge contractors beyond anything in recent history. It may be difficult to sit tight, he says, “But it’s going to be a very exciting ride!”•
