The offshore rig market is going through a rough patch and, while oil prices are showing some signs of improving, this will continue for at least another year, writes Ed Reed
Low oil prices are driving consolidation across the sector, including among the offshore drilling companies. The number of rigs waiting for work, though, continues to be high and can only be solved through large-scale scrapping. Utilisation and day rates have declined, making it a perfect market for those looking to carry out opportunistic drilling – although such demand is thin on the ground.
There is, therefore, something of a perfect storm for drillers. Low oil prices and low demand have cut off prospects for much offshore drilling. While the outlook for onshore work is slightly better, largely in the US, pricing is still stubbornly low.
The offshore will remain challenged until prices go above US$60 per barrel, according to a recent report from Moody’s rating agency. It went on to warn that revenues for offshore service companies would “continue to decline as customers offer low-margin contracts, or avoid contracts altogether, while overcapacity in the offshore segment takes several years yet to clear”.
Crunching the numbers Pricing has been fairly resilient in the upper end of the rig market, with Transocean reporting average rig rates of around US$501,000 per day in the first half of 2017, flat on US$500,000 recorded in 2013. While rates have remained fairly static, though, utilisation rates have plunged, from 92% in 2013 to 37% in 2017. Commenting on this, Transocean’s representative, Pam Easton, noted that “many of our rigs are on contracts that were negotiated a number of years ago”.
While the company’s deepwater floaters appear to have held on to activity levels – at around 67% in 2017 – this disguises the fact that it has slashed its fleet numbers. In 2013, it had 14 of these floaters, but by early 2017 this figure had dropped to just three. Furthermore, prices have fallen from US$353,300 per day to US$195,500.
It seems that not even price cuts can sustain activity with inelastic demand. As a result, rig companies have cut rig numbers, making the utilisation rates something of a moving target. Transocean, four years ago, had a fleet of 82 rigs, excluding those under construction, whilst as of February this year it had 56 rigs.
Some regions have fared better than others over the last four years. Africa has shrunk the furthest, from 36 rigs in 2013 to 12 currently. Angola has fared particularly badly, going from 11 in 2013 to two currently. Latin America has also fallen substantially, in a large part because of a slowdown in Brazil, which has slumped from 41 to 12, and Mexico, which fell from 35 to 15.
The Middle East, meanwhile, is flat when considering 2013 and 2017, and even gained rigs in the intervening years, reaching 50 in 2015 and 2016. Abu Dhabi added rigs over this period, contributing to the 2015-16 peak, while China has also done an impressive job of holding on to rigs over the four-year stretch.
“New rigs with higher specifications tend to hold onto pricing better, they have a competitive advantage in tough markets. It’s sometimes better to have a job – even at a low price – rather than no job at all. Rigs capable of working in harsh environments have tended to do better in recent years,” Rystad Energy’s senior oilfield service analyst, Oddmund Føre, told NewsBase Intelligence (NBI).
Economies of scale When the outlook is tougher, companies tend to band together, hoping to squeeze margins through cutting costs and relying on economies of scale. The two most notable transactions under way are Ensco’s purchase of Atwood Oceanics and Transocean’s purchase of Norway’s Songa Offshore. The Songa rigs are significant in that these are being upgraded, with Statoil, in pursuit of greater automation. The Transocean deal follows the company’s sale of its jackup fleet to Borr Drilling, for US$1.35 billion. Transocean is in the process of buying Songa Offshore, which has four rigs under contract with Statoil in Norway, for US$1.2 billion.
Overshadowing Transocean’s deals is Ensco and Atwood. The move was announced in May, with Ensco making an all-stock merger offer, which would give Atwood shareholders a 31% stake in the new company. The deal values Atwood at around US$860 million.
The move has attracted a number of naysayers. One London-based asset manager, Arrowgrass Capital Partners, in a public letter described the deal as coming at a high cost, with “inopportune timing and excessive risk”. It went on to describe the move as an act of charity on the part of Ensco, “when financial flexibility to withstand distressed industry conditions should be the primary strategic consideration”.
In response, Ensco has maintained that such a move will reaffirm its position and that it is paying US$222 per million per floater, covering four drillships and two semi-submersibles, “significantly lower than values for comparable asset opportunities”.
Perhaps the most innovative of such plans was that from Rowan, in November 2016, about teaming up with Saudi Aramco on a 50:50 joint venture. Rowan contributed three jackups to the venture, with plans for more as they come off contract in the country, while Aramco provided two of its own. Saudi is the top market for jackups in the world, Rowan explained, and the venture may order up to 20 more rigs over the next 10 years.
Consolidation among companies can be seen as a sign that buyers are confident of improving prospects and intend to position themselves to seize these opportunities. Considering sellers’ motivation does not cast such a cheery light on the sector.
Counter investments Where there is pressure, some see opportunities. Borr Drilling, which recently held an IPO in Norway, disclosed at the end of August that it held a 9.7% stake in Atwood Oceanics. The company increased its stake in August, it revealed, after fellow driller Ensco announced a merger plan with Atwood.
The Ensco offer values Atwood at a price of US$10.72 per share, while Borr, which holds its stake through forward contracts with a strike price of US$6.8-7.6 per share. The move has led some to suggest that Borr may be preparing to make a move on Atwood by itself, although this would require substantially more cash than the Norwegian company has to hand.
A counter-offer from Borr is not necessary, though the company may just consider this to be an attractive investment opportunity. This process of cross-holding continues, with Schlumberger having a 20% stake in Borr – making it the single largest investor.
Sidelined While companies wait for times to improve, rigs have been taken out of action and moored, waiting for an improvement in demand. Rigs can either be warm or cold-stacked. The first keeps systems ticking over and a reduced crew on board. If a swift return to work is needed, this is the preferred option – although as a result of the higher state of readiness it is a relatively expensive option.
Cold-stacking, meanwhile, involves shutting down systems, virtually abandoning the facility. The cost savings of such a move are substantial.
However, with greater savings come questions of to what extent a rig degrades. Many of the older rigs that have been cold-stacked are unlikely ever to be brought back into service, but newer rigs may still offer attractive options. Part of the problem is that this equipment is not intended to be shut down.
The question of how a company sees the future is essential in choosing whether to cold or warm-stack. A near-term recovery would suggest warm-stacking, while a more distant return would drive a cold stack decision. Bringing a rig back from being cold-stacked, though, will carry a substantial price tag. In this recent downturn, companies have talked of “smart-stacking”, supposedly a more sustainable way of cold-stacking a rig. While this carries an upfront cost, it is cheaper – per day – than warm-stacking. The true test of this technique will only become clear once demand for rigs picks up once more and companies attempt to restart idled equipment.
Scrapping Given the pressure on drilling companies, rigs are being scrapped at a remarkable rate – and yet utilisation rates still remain fairly low. According to data from IHS Markit, 86 floaters and 33 jackups have been taken out of service during this downturn, with the expectation that this decommissioning will continue into 2019. Ensco, for instance, said earlier this year that it intended to retire a semi-submersible and six more jackups. Since 2014, it has sold 11 jackups, six semi-submersibles and two drillships. While the company has been working to reduce its fleet count, it has also added newer rigs – in addition to its deal to acquire Atwood. While new rigs continue to be built, from the backlog ordered during the high-price boom, the process is becoming more strained. Owners who have contracted new rigs often seek ways to avoid having to collect the finished product, leading to a number of legal disputes. It is not just rigs that are being taken out of the market. A number of companies are facing pressure to restructure, with Seadrill announcing a plan on September 12 to overhaul its finances. Bonds – worth US$2.3 billion – will be converted into around 15% of equity. Meanwhile, holders of the company’s common stock will receive around 2% of the new equity. Bankruptcies alone do not remove capacity. Seadrill has said it has sufficient resources to continue payments to supplies even while it operates under Chapter 11. This is comparable to the way in which a number of shale producers went through restructuring, allowing them to wipe out debts but continue pumping.
Into the future Times are tough for drillers, but there are some signs that things are beginning to improve. Oil prices are beginning to show some signs of firming up, although this will be contingent on continued support from OPEC and the non-members who opted to cut production.
Rystad is taking a cautiously optimistic stance on the sector’s prospects. “We expect a challenging year with slight growth into 2018 and a recovery towards the end of the decade and beyond,” Føre told NBI. Improved oil prices will “provide companies with stronger cash flows and therefore the ability to finance exploration. Prices have also come down, making projects more economically viable. Mature fields should offer attractive opportunities for infill drilling.” Signs of improving prospects for the market would come in an increase in tendering, the Rystad analyst said. Other positive signs picked out by Føre would be operators taking longer-term contracts, which would suggest a desire to lock in capacity at low prices. “A really good sign would be the reactivation of cold-stacked rigs; this would need contracts at premium prices, in order to cover the restart costs.”
The Galaxy II One of the rigs sold by Transocean to Borr Drilling in the May transaction was the Galaxy II jackup, which has been cold-stacked in Scotland, next to its siblings, Galaxy I and III. The rig, which has been renamed Brage by Borr, was built in 1998 and can operate in 122 metres of water. The Galaxy II was cold-stacked in September 2015 – not the first of Transocean’s rigs to be put on hold but also not the last.
The harsh environment rig had been working for Engie in the UK North Sea, under a six-month contract at a US$192,000 day rate, down from US$214,000 under its previous contract. The Vanuatu-registered Galaxy II had previously been owned by Global Santa Fe, which struck a deal to merge with Transocean in 2007.