Deepwater rig companies do everything bigger and better than OSV companies. Their rigs are physically huge, their day rates dwarf those of anchor handlers and platform supply vessels, usually by a factor of ten or twenty, and their senior officers and drilling crew command day rates, even in the downturn, which surpass those of the captains and chief engineers on the vessels supplying and supporting them.
The barriers to entry to operate deepwater floaters are high, both in terms of capital cost, experience and safety standards. The clients are demanding – typically only the super majors, the elite of the state owned oil companies, and a few well capitalised independents venture to drill in deepwater.
This is a segment where consolidation has already begun, with Transocean buying Ocean Rig in 2018, and Ensco and Rowan merging to form Valaris this year, after Ensco had already bought Atwood in 2017.
Whereas the OSV industry is dogged by zombie companies under judicial management, court appointed restructurings or the de facto control of their banks, the major drillers have either passed cleanly and quickly through Chapter 11 to wipe off their debts (Seadrill and Pacific Drilling), or have sufficient cash to buffer them through the next few years (Transocean, Diamond Offshore, and Noble Corporation). All these structural factors would point to deepwater drilling being a leading indicator of recovery in the offshore market.
Unfortunately, it's not. This last couple of weeks has seen several events that suggest that industry-wide recovery may be further away than expected. It's not that recovery isn't happening, it is just that it is happening at a glacial pace, even in the deepwater segment.
Take Noble Corporation, which operates twelve floaters and thirteen jack-ups. The company posted a net loss of $152 million for the three months to June, results that included both a $100 million litigation charge relating to the spin-off of the now bankrupt Paragon Offshore in 2014, as well as a net US tax gain of $34 million.
But even stripping out the exceptional items, the company still made a loss. And what Noble reported as good news in its results could actually be perceived as bad for the drilling sector as a whole, and for the OSV industry. Noble's contract drilling revenue for the second quarter came in at $275 million, up from $271 million in the first quarter and up from $247.6 million in the year-ago period. This is not exactly surging growth.
"Total fleet operating days in the second quarter were 13 per cent better than the first quarter due to the addition of the Noble Johnny Whitstine and the completion of a reactivation program on the Noble Sam Croft," Chief Executive Julie Robertson declared, before adding, "The increase in operating days raised our total fleet utilisation to the highest level since the industry downturn began, with the jackup fleet reaching an industry-best 98 per cent in the quarter, while our floating rigs, excluding three-cold-stacked units, improved to 89 per cent."
Noble's total utilisation increased to 82 per cent in the second quarter compared to 76 per cent in the first quarter (when it also made a loss). But even at 82 per cent utilisation, the company lost money.
Few, if any, OSV companies are operating at those levels of utilisation. Few other rig companies are operating at 82 per cent utilisation either. Pacific Drilling has only two out of its seven rigs working at the time of writing, as shown here. But even at 82 per cent utilisation, Noble was losing money.
Several of its rigs remain fixed at historic rates on long-term contracts well above current market levels. When these contracts expire, the company's profitability will deteriorate. For example, Noble Globetrotter I and Globetrotter II are contracted to Shell on long-term contracts through 2022 and 2023, respectively, with what an analyst has described as, "a flexible market-based day rate with a floor of $275,000".
Let's put that in context. The most recent Seadrill deepwater floater contract was announced on September 4 for the drillship Libongos in Angola at a day rate of $204,000 for 495 days. So, rates have to increase 35 per cent from current levels for Noble just to match the floor day rates on its similar Globetrotter units when they come off contract. So far, deepwater rig rates have increased only 30 per cent from their trough two years ago.
The flattering effect of legacy contracts is a wider issue. Pacific Drilling represents the apogee of this. It has the youngest fleet in the entire deepwater drilling segment, with an average age of 6.5 years. Its unit Pacific Sharav was still on a day rate of $551,000 per day with Chevron in the second quarter of this year. That contract ended in August.
Suddenly, around $200 million of revenue per year disappears from the company, and over $100 million even if the unit can be contracted in 2020 at market rates. One might ask why Shell and Chevron were signing such long term contracts at such high rates for rigs, given the collapse in rates and utilisation which has occurred, but hindsight has twenty-twenty vision, and there's no fool bigger than a super-major with reserves to replace in a hurry.
On Friday, Baird Maritime reported that Transocean would relinquish interests in two drillships under construction – Ocean Rig Santorini and Ocean Rig Crete – to Samsung Heavy Industries.
Transocean will no longer make any payments to the yard and will walk away from the units, which it can do as Samsung has no guarantees from the company to compel it to continue the payments. The reason was simple. Transocean argued that future costs for delivering and commissioning the pair of drillships would have been $1.1 billion.
What's especially alarming is that most of those payments would not even be due until 2023 and 2024. This tells us that the industry leader in deepwater has little confidence that further investment in the segment will be profitable in the medium term and that cutting its losses is better than spending the billion dollars on the hardware.
This decision also shows us what a travesty Transocean paying $2.7 billion to buy Ocean Rig was. At the time of the acquisition, Transocean put out a statement about Ocean Rig Santorini and Ocean Rig Crete, saying, "These are two of the high specification assets in the world. And so, we have every intention of acquiring those because the financing terms that we have on those aren't due until 2023 and 2024. We certainly believe that the market is going to recover by that timeframe and that these rigs will be in high demand earning a very nice premium day rate."
This has a huge impact on the recovery of the OSV market. These kind of deepwater rigs are at the heart of global PSV demand. If Transocean doesn't believe that the market is going to recover by 2023 to warrant new investment, then Solstad, Swire, Tidewater, Edison Chouest and Bourbon ought to be very afraid.
Transocean's Chief Executive Jeremy Thigpen might also be afraid for his job, as the Ocean Rig transaction has proved a gamble that has badly misfired. At the time of the acquisition of Ocean Rig in September 2018, Thigpen was quoted in the Wall Street Journal justifying the purchase by saying, "We believe in an imminent recovery in the ultra-deepwater market."
Since then, recovery has been anaemic and Transocean managed a loss of over $200 million in quarter to June. Worse, Transocean has raised its reactivation cost estimates for the cold stacked Ocean Rig drillships it acquired.
Initially, Thigpen and his team of crack bean-counters believed that each Ocean Rig floater in lay-up would cost between $25 million and $50 million bring back into service. The company now foresees a cost of up to $100 million for each of the cold stacked floaters, twice the estimate. Analyst Vladimir Zernov has described the acquisition as "a disaster" and it is hard to disagree.
Two new builds from Ocean Rig have now been abandoned at the shipyard in Korea, two more Ocean Rig units have been scrapped at a loss to Transocean, and just four out of nine of the remainder are working. Along with McDermott's calamitous acquisition of CBI, the Ocean Rig acquisition by Transocean deserves to go down in history as one of the most misguided of this millennium.
If recovery does finally arrive, perhaps Transocean will be vindicated, but the decision to cut its losses at Samsung suggests that Transocean no longer believes that will be any time soon. OSV owners should beware.
The third warning light on top of the disappointing financial results, and Transocean's decision to abandon the new-build Ocean Rig units, was the failure of the auction of the Petrobras drillship Vitoria 10000.
On paper the rig looked a bargain. Vitoria 10000 was built at Samsung in 2010 and Petrobras claimed that it was warm stacked in Brazil, almost ready to go drilling again. The sellers set a minimum price for the rig of $47.5 million, a 92 per cent discount on new built price, and 80 per cent off the comparable price paid by Transocean for Ocean Rig units last year. What a bargain!
So, what happened? Nothing. Nobody turned up and made a bid. Petrobras could not sell the unit. It will continue to languish at anchor, rusting away. Petrobras' failure to sell the rig tells us all we need to know about confidence in the deepwater segment. And about the maintenance of equipment in Brazil (but that is another story). Investors are leery, and nobody wants to put fresh funds into the sector.
Despite the bad news and weak outlook in the sector, there's always someone doing well, even as roustabouts and marine crew find their pay squeezed, maintenance is cut back, and rigs are scrapped.
Noble Corporation revealed in September that its chief financial officer, Adam Peakes, had resigned, and that Mr Peakes would receive a cool $950,000 severance, and another $50,000 after entering a final release agreement with the company, waiving, amongst other things, the right to make a claim for age discrimination. A cool million dollars working for a company whose principal cash flow was a legacy contract with Chevron signed half a decade ago. Well done, Adam. Enjoy your retirement!
But as always, Transocean is the true industry leader in deepwater drilling. In 2018, Jeremy Thigpen pulled in a cool $8.5 million in pay and compensation, $2 million of which was cash, despite the fact that the company lost $2 billion for the full year, and lost money in both subsequent quarters. See here for his pay breakdown.
In 2019 Transocean stock has lost over 60 per cent of its value, which is perhaps some consolation, since Thigpen was gifted millions in stock options. Just think how much more Mr Thigpen might make if only he could actually scrape together a profit at Transocean. Surely shareholders and employees deserve better than blatant self-enrichment in the C-suite? We'll see.
