Offshore Drilling Bits
March 13, 1999
Number 32
Written by: Mike Simmons, Offshore Rig Broker and Consultant
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OK, NOW WHAT?
Be careful what you wish for -- you might just get it.
OPEC is giving us what we want -- production cuts. The newswires were
buzzing Friday with the reports of an agreement by OPEC to cut two
million barrels of oil per day effective April 1 (isn't that April
Fool's Day?).
Oil prices have moved higher over the past two weeks in anticipation
of OPEC cuts, but no one was expecting the announcement of a
production cut agreement prior to the scheduled formal meeting due
March 23. Is it real? Is OPEC just "testing" the market reaction
before heading in to the March 23rd meeting? Who knows?
Either the oil futures prices already had a two million barrel cut
factored in prior to Friday's announced "agreement", or oil traders
don't put much faith in the actuality of the cuts being adhered to.
Oil prices briefly slipped above $15, but ended the day only slightly
higher at about $14.50, up 19 cents. (Natural gas prices were DOWN 6
cents to $1.72.)
Now the oil patch has a significant OPEC production cut (at least so
they say). Oil prices have moved up nicely to the $14-15 area. But
will it do any good?
Not really. At least not yet.
The immediate beneficiaries will be oil companies whose current
production, and reserves, have enjoyed a 30% increase in value over
the past few weeks. But what OPEC giveth, OPEC can take away with as
little as a misplaced statement from an oil minister.
Oil companies will not grab the offshore drilling contractor hotline
and request more rigs based on what has happened so far. Those
exploration and production budgets aren't going to be ramped up during
the Monday morning meeting. One driller told me that oil companies
are almost trying to "one-up" each other about who has cut the most
from their E&P spending plans.
Investors in oil service sector stocks should not start chanting "The
Bear is Dead, Long Live OPEC". The oil service stocks have had a free
ride higher with oil prices. And even though the "It's The Oil Price,
Stupid!" mantra remains valid, the price of oil must be higher and be
sustained before fundamental health will be restored to the sector --
something like $18 oil + 6 months. We got what we want, but the
stairway to higher utilization and higher day rates has more than a
single step.
In the near term it appears there is nothing that will help the Gulf
of Mexico's slumping rig market. The rig count declined again last
week, by one rig, to 114, following a 12-rig decline the previous
week. That was one of the largest week-to-week declines recorded in
recent years. Rig demand in the Gulf of Mexico is now at its lowest
level since February 1995.
Current utilization of the 178-rig U.S. Gulf fleet is 64%. However,
only 106 of the 114 contracted rigs are actually working, pushing U.S.
Gulf working utilization down to 60%. (Some rigs may be under
contract to an oil company, and earning a day rate, but not currently
drilling.)
How far and how fast has the rig market declined? In March 1998 all
but five of the 176 rigs in the U.S. Gulf were under contract, and
utilization was 97.2%. Not a single U.S. Gulf rig was cold stacked at
that time. The only cries of woe in early 1998 were from oil
companies over the "unreasonable" day rates being charged by drilling
contractors. Now drilling contractors are faced with the realization
that business probably will get worse before it gets better.
Over the next 90 days, 61 U.S. Gulf jackups, or 46% of the U.S. Gulf
jackup fleet, will come to the end of current contracts with no
further work on tap. With day rates for some classes of jackups
already below $10,000, cold stacking may be the most economical option
for some drilling contractors. With the recent addition of semi FPS
LAFFIT PINCAY, 18 Gulf of Mexico rigs currently are cold stacked,
including 12 jackups, three semis and three submersibles.
What was that? Day rates BELOW $10,000? But isn't the daily direct
operating cost of a jackup in the Gulf of Mexico about $12,000? Yes.
Doesn't that mean the driller working for $10,000 per day is losing
$2,000 in hard cash every working day? Yes. But in some cases the
cost of keeping the rig idle and ready to work is greater than
operating at a loss. Some drillers choose to lose -- some choose to
stack.
While U.S. Gulf day rates have fallen below $10,000 for slot-type
jackups rated to drill in up to 250-ft. water, rates for
second-generation semis have fallen from the $48,000 - $115,000 per
day range in late 1998, to a range of $40,000 - $58,000 today. Even
top-of-the-line fourth-generation semis have seen the upper end of
their pay scale drop about $25,000 per day since December 1998.
Fourth-generation semis now are earning between $150,000 and $160,000
per day.
So far, the North Sea rig fleet has not seen a dramatic drop in
demand. However, that's about to change. The North Sea rig count
remained relatively constant throughout 1998 and into early 1999, with
only an 11-rig demand decline since the 1998 peak of 91 rigs.
Long-term contracts were a major factor in the North Sea's apparent
tolerance to oil and gas price declines.
But over the next 90 days, 18 North Sea rigs will come to the end of
their current contracts with no additional work lined up. Fifteen of
these rigs coming off contract are jackups. Mobile offshore drilling
unit utilization in the North Sea market may see the low 80% area by
mid-June.
Day rates in the North Sea have been relatively stable in recent
months, again primarily due to long-term contracts. Floating rig
rates in the region have eroded some in the last three months and
additional decreases are expected as new contracts take effect.
However, with 35% of the North Sea's jackup fleet coming to the end of
their contracts in the next 90 days, downward pressure on jackup day
rates will be significant.
According to World Oil's annual industry outlook, 1999 could be the
“worst drilling year in recent history.” The forecast predicts a drop
in worldwide offshore wells to 2,834, down 9.7 percent. Gulf of
Mexico drilling is expected to experience a 14.8 percent decline. In
a region by region forecast, offshore wells drilled will decline in
almost every area, with South America the standout with "no change"
projected.
If you are an investor in the sector, be careful. Don't be afraid to
take a profit. Don't get giddy and start feeling "bullet-proof" over
a few days of gains.
If you are in the industry, it's time to prepare for the worst and
hope for the best. But what's new about that?!
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CONTRACT CANCELLATIONS UNDERMINE CONFIDENCE
Rowan Goes To Court
Contract cancellations are like the Black Plague to drillers. Not
only do cancellations cost revenue and expected profits, but investor
and lender confidence in the industry is undermined.
If the "sanctity" of a term contract with a major oil company can not
be counted on, there will be a serious erosion of financial support
for drillers. One of the few threads holding up the stock prices of
some drillers is the backlog of term contracts. If the financial
community gets the mind-set that an oil company can step out of these
contracts "on a whim" (many of which were agreed to at day rates much
higher than current market rates), then driller stock prices will be
gravely damaged.
Reports indicate that at least one large institutional shareholder,
with considerable sector holdings, has sold out of sector stocks
across the board at least partly because they were nervous about the
damage that could occur if long-term contracts were increasingly
canceled.
This is serious stuff. Drillers are between a rock and a hard place
when such a contract is canceled. Do I sue my customer? Do I
renegotiate and lower my price? There are no "good" answers.
Oil companies may figure they can stop payments on the contract; and
if they get taken to court, so what? The court procedure will likely
take years and eventually settle with a payment that is less than they
would have paid if they continued the contract. Saving $150,000 a
day, or more, is a mighty appetizing prospect for any company. "Let's
just save it now and worry about it later".
Meanwhile the driller sits with a rig that is not only idle, but is
not generating revenue numbers expected by Wall Street. Every day a
rig doesn't work is a day of revenue lost forever.
The day will come (again) when oil companies are hot to trot for
drilling rigs. If contract confidence is eroded, the cost of capital
for drillers will be higher and the result will be even higher day
rates to oil companies -- who will sing the blues about high day
rates.
At least two drillers decided to go to court to enforce the contract,
the latest being Rowan. In Rowan's case the customer, Amoco, has also
filed a lawsuit over the canceled GORILLA V contract.
The two companies have filed separate actions in Texas and British
courts to settle their dispute stemming from cancellation of the
GORILLA V's contract to drill in the marginal Arbroath field in the
UK. The parties expect a decision in April on jurisdictional venue
since the suits are expected to be combined.
Amoco said it contracted the jackup to drill on Arbroath in 1998 and
1999 and expected the rig to arrive between August and October 1998.
Amoco said the rig did not arrive until late December and the BOP
control system was not operational. On that basis, an Amoco spokesman
said the company terminated the contract and subsequently filed suit.
Rowan's breach of contract suit was filed in Houston. Rowan said the
rig was about 60 miles from the field, waiting on weather, when Amoco
gave notice of the contract cancellation. The rig had been contracted
to drill five wells on the field. Rowan said the jackup has been
certified by the UK's Health & Safety Executive and was fit for duty.
BP Amoco said Arbroath partners are looking at options for the field
and have yet to charter another rig. The GORILLA V is idle in Dundee.
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TO WATCH FOR
The U.S. government's Minerals Management Service (MMS) issued the
final notice of sale for Central Gulf of Mexico Lease Sale 172; the
sale will be held March 17. The final notice covers 3,807 available
blocks in water depths ranging from 13 feet to over 11,200 feet.
In addition, the MMS began a three-year planning process for Eastern
Gulf of Mexico Lease Sale 181. The proposed sale area includes 1,033
blocks located at least 15 miles south of Alabama and at least 100
miles south of the Florida panhandle.
Sale 181 would be the first federal oil and gas lease sale in the
Eastern Gulf of Mexico planning area since 1988. The sale is
tentatively scheduled for December 2001, but the MMS is considering
changing the bid opening/reading to March 2002 and holding it in
conjunction with proposed Central Gulf of Mexico Lease Sale 182.
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