The floating rig market is preparing for the most challenging year ahead. Leslie Cook, of Quest Offshore, explains.
Noble Corp. announced in Q1 it would retire the Noble Discoverer drillship after supermajor Shell suspended its Arctic drilling program offshore Alaska. Image from Shell.
In the wake of a prolonged downturn, drilling contractors are looking for ways to secure backlog and reduce costs associated with idle time as they come face-to-face with excessive oversupply, declining demand, and customers with heightened sensitivity for increased value in their drilling programs.
Before oil prices began to collapse in late 2014, the drilling market was in a state of euphoria. Within seven years, 140 new high-specification, sixth generation rigs had been delivered. Marketed utilization in early 2014 was over 90% for all floating rigs with average day rates of US$450,000. New rigs were nearly 100% utilized and average day rates were nearing $550,000.
The sixth generation marvels were designed specifically for the emerging deepwater market and rivaled previous generations in terms of capability, size, and efficiency. Upgrades included water depth capability exceeding 7500ft, advanced instrumentation, expansive deck space, and increased hoisting capacity. All the players were in. Large existing contractors expanded their fleets, new competitors emerged as deepwater purebreds, and contractors with strong positions in the jackup space took the plunge into deepwater. Expansion of the floating rig fleet during the mid-2000s appeared to have all the right ingredients for drilling contractors: reasonable internal rate of return, increased revenue efficiencies, higher operating margins, strong utilization, and increased market share opportunity by offering a new kind of asset needed for new drilling environments. Who could blame them for such aggressive expansion?
The wake-up call
Overshadowed by the exuberance of a successful sixth generation launch, some alarming signals had begun to emerge by late 2013. Operators were beginning to grumble about the excessively high costs associated with drilling – most notably the ballooning day rates. Reductions in 2014 exploration and production budgets among major operators were considered to be in part a strategic maneuver to put pressure on drilling contractors to reign in some of the excessive pricing that had risen sharply over the previous quarters. On the demand side, exploration drilling from floating rigs was beginning to decrease, leading to fewer wells being drilled in key deepwater regions. By 2014, exploration drilling in West Africa and Brazil had declined nearly 45%. As part of the Golden Triangle both regions were considered critical to continued demand growth in the deepwater rig market. On the supply side total floating rig supply had grown by 40% and rigs in the ultra-deepwater category grew by 70%. Drilling contractors were adding new rigs, but not removing old rigs. Then came the wake-up call: the fall in oil prices.
By December 2014, the over-supply situation had become painfully obvious. Despite a drop off in new fabrication awards there were still another 42 new rigs to be delivered in 2015 and only half of those units had secured initial contracts. Operators were once again planning to cut exploration and production spending, which meant further decreases in drilling were inevitable. Rig contractors with large fleets reacted quickly by scrapping or putting up for sale 48 rigs they considered non-core assets. The majority of retirements occurred in 1H 2015 (90%) but then soon tapered off under the hope that oil prices would rebound and stabilize by year end. The two largest contractors, Transocean and Diamond Offshore, were responsible for nearly 70% of the initial rig retirements.
Throughout 2015, rigs were increasingly idled and the pile of warm stacked units grew from 40 to 71 pushing marketed utilization down to 70%. While rig contractors placed heavy emphasis in 2015 on reducing operational and stacking costs, they remained reluctant to retire older rigs, which still accounted for 30% of working supply and 60% of idle supply. Current demand estimates through 2020 suggest that a vast majority of generation 2-4 rigs will not be able to secure work and will continue to age in idle status.
The final countdown
Currently, there are 120 floating rigs out of work and 75% are classified as warm stacked, which means they are part of marketed supply. Nearly 50% of the unemployed rigs are older generation units that will likely never work again. Another 25 fifth generation rigs are currently stacked with six additional units rolling off contract in 2016. These rigs will be unable to compete against the newer units for at least the next 18-24 months and possibly longer. Every quarter in every region rigs will be reaching the end of their contract terms this year. Forecast demand is expected to drop another 30% as major operators slash exploration and production budgets again for a third straight year in a row. The top five drilling contractors account for 50% of the stacked plus near- term roll-off units while a few smaller drilling contractors will see over 75% of their small stealth fleet sidelined in 2016. Leading edge day rates at the high end have dropped to $350,000 putting them at or near below break-even, and over the next 24 months over 70% of rigs currently working under legacy high rates above $500,000 will roll off contract.
The challenges that drilling contractors face this year cannot be overstated. So far this year, four rigs will either retire or be put up for sale. In reality, there are at least 85 floating rigs in the global fleet that should be considered non-core assets based on vintage alone. Demand recovery will be gradual and it is still unclear when it will even begin. Attrition will play a critical role in the supply demand balance post-2016. Drilling contractors so far have shown the will and ability to cut costs, offer flexibility in contracts, and design new stacking processes for core assets. Re-evaluating what is non-core and reducing global supply must happen this year in order to preserve the long-term vitality of the floating rig market.
Leslie Cook is a senior research consultant for Quest Offshore Resources responsible for forecasting and analysis of the deep water drilling market. She has a degree in Commerce from the University of Virginia and is currently pursuing her MBA in Energy Management from the Bauer School of Business at the University of Houston.