By David Wethe
(Bloomberg) — Offshore oil-drilling contractors, who last year were able to charge record rates for their vessels, are now under pressure to scrap old rigs at an unprecedented pace.
The recent five-year low in oil prices is threatening an industry already grappling with a flood of new vessels and weakening demand. More than 200 new rigs are scheduled to be delivered in the next six years. That’s a 25 percent jump from the number currently under contract.
To cope, many rig owners will try to keep revenue up by culling older vessels to balance supply and demand.
“The older assets, particularly those built before the 2000 time period, are really less desired by the industry,” James West, an analyst at Evercore ISI in New York, said in a phone interview. Those vessels “are only causing the customer base to use those rigs against higher quality rigs to get pricing lower.”
About 140 older rigs would need to be scrapped to make way for the new vessels scheduled for delivery by 2020, according to Andrew Cosgrove, an analyst at Bloomberg Intelligence. That pace would double the number scrapped in the previous six years and even eclipse the 123 vessels retired since 2000, according to data compiled by Bloomberg.
Booming offshore exploration earlier in the decade encouraged a flurry of rig orders. That’s now leading to a potential market crash in a global industry pegged to generate revenue of $61.5 billion this year. Low oil prices are compounding the problem, alarming investors.
Three of the five worst performers in the Standard & Poor’s 500 Index this year are offshore rig contractors: Transocean Ltd., Noble Corp. and Ensco Plc. Hercules Offshore Inc., the largest provider of shallow-water rigs in the Gulf of Mexico, has fallen 84 percent as producers consolidated and drilling was postponed.
“There is an old saying: If our customers get a cold, we get pneumonia,” John Rynd, chief executive officer of Houston- based Hercules, told investors this month. “We’re getting pneumonia right now.”
Next year may be worse. Explorers and producers are expected to cut offshore spending by 15 percent, with “grievous” cuts coming for exploration, Bill Herbert, an analyst at Simmons & Co., said in an e-mail.
Earnings for the world’s five biggest offshore rig contractors are expected to fall an average of 18 percent, according to analysts’ estimates compiled by Bloomberg. Only one company is seen increasing profit in 2015: Seadrill Ltd. The third-biggest offshore rig contractor by market value has 75 percent of its rigs backed by contracts next year, the highest among the five largest drillers, according to BI.
Retiring older equipment that no longer meets current standards also eliminates a cash drain. Floating rigs left idle in a harbor can cost as much as $12,000 a day to sit “cold stacked,” meaning they’re not part of the supply of rigs being marketed for new work.
The contraction is already under way. Transocean, owner of the biggest fleet of offshore drilling rigs, said in a statement last week it will scrap seven “floaters” in addition to the four it previously announced and will take a fourth-quarter charge in the range of $100 million to $140 million as a result. Floaters, typically for deep-water jobs, are distinguished from “jackups,” which have retractable legs that moor onto the seafloor until drilling is done.
Transocean and Hercules are expected to scrap the most vessels in the near term, according to BI. Hercules has seven shallow-water rigs, all in the Gulf of Mexico, that have been cold-stacked for an average of five years.
A spokeswoman from Vernier, Switzerland-based Transocean declined to comment about further plans to decrease its fleet and referred to last week’s statement, which said “additional rigs may be identified as candidates for scrapping.”
Hercules and Noble Corp. didn’t return phone and e-mail messages seeking comment, and an Ensco spokeswoman had no immediate comment.
In addition to killing off older rigs, drillers are taking other steps to preserve cash. These include suspending dividends and share buybacks, delaying construction of new rigs already ordered and deferring costly five-year maintenance checkups wherever possible. Some companies are even delaying tugging new rigs halfway around the globe from construction shipyards in Asia to defer mobilization costs.
The immediate future may not be totally bleak. While Rynd may be concerned, he sees the current downturn shaping up better for his company than the last one, in 2009, because Hercules has better liquidity this time around.
“Am I scared? No,” Rynd said.
For producers, lower drilling vessel costs may help encourage them to push ahead with exploration despite oil’s drop. Houston-based oil producer Noble Energy Inc. says this is a good time to lock up relatively inexpensive leases on rigs.
“In kind of a backwards way, pullbacks like what we’re seeing today are good” for explorers, Noble Energy Chairman Charles Davidson told investors Nov. 13 at an energy conference. “Why wouldn’t you drill in deep water? I like $300,000 a day versus $500,000 a day, any day.”
Rig owners will essentially be at the behest of their customers next year, said Luke Lemoine, an analyst at Capital One Financial Corp. in New Orleans.
“Price doesn’t necessarily drive demand,” Lemoine said in a phone interview. “Demand generally drives the price.”
If the industry is to return to “a healthy state,” older rigs will have to be scrapped, not spun off into separate companies as has been the case, Seadrill CEO Per Wullf said last month.
Rig owners including Transocean, Noble Corp. and Pride International Inc., which was later bought by Ensco, have spun or sold off older rigs that never got scrapped.
“This industry has a long history of value destruction,” Wullf said on a conference call. “Today’s environment is presenting the perfect opportunity for the industry as a whole to focus on creating value rather than try to manage through the sub-standard fleets.”
Copyright 2014 Bloomberg.