Hercules Profits on Shallow Water Rig Shortage in U.S. Gulf

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April 25, 2013

A Hercules Offshore jackup under tow. Photo: Offshore Towing Inc.

By David Wethe

(Bloomberg) — A growing shortage of shallow-water rigs in the Gulf of Mexico is providing an unexpected profit boost for Hercules Offshore Inc. and Ensco Plc as customers move farther offshore in the hunt for oil.

Hercules, the largest provider of rigs in the shallow Gulf, is seeing the biggest benefit from surging rental rates as explorers compete for the few rigs available in the region. The company has 29 of its 38 rigs devoted to the Gulf, which helped lift it to a first-quarter profit after a loss a year earlier.

The total number of rigs operating in the near-shore Gulf of Mexico has dropped by 74 percent since mid-2000 as oil companies focused their efforts in deeper waters offshore and rig owners moved many shallow-water rigs to more lucrative markets overseas. There are 34 rigs contracted this month, according to data provided by Stephens Inc.

“You’re seeing a renewed interest in the shallow-water Gulf of Mexico,” John Keller, an analyst at Stephens Inc. in Houston who rates the shares a buy and owns none, said today in a telephone interview. “It’s being driven again by high oil prices, similar to what we’ve seen in a lot of these older basins on land, like the Permian.” The Permian Basin is in Texas and New Mexico.

Moving to take advantage of higher rates, Hercules said today it is considering reactivating a second mothballed rig in the Gulf at a cost of $20 million, 42 percent higher than it forecast in an earnings call in February, due to more electrical repairs needed.

Reversing Gains

Shares dropped more than 8 percent on the announcement, reversing earlier gains, on concern the extra expense would eat away recent profit-margin improvement in the Gulf. Shares were down 2 percent to $6.92 at 1:30 p.m. in New York after rising as high as $7.55.

The company increased operating income for its drilling rigs in the Gulf to $39.5 million from $1.8 million a year earlier. The gross profit margin of 49.5 percent beat the 44.5 percent expected by Wells Fargo analysts. Before one-time items that included a gain related to its 2011 purchase of rival Seahawk Drilling Inc., the company beat by 2 cents the average of 25 analysts’ estimates compiled by Bloomberg. Sales climbed 43 percent to $205 million.

Hercules, which has climbed 46 percent over the past year before today, yesterday announced it had obtained two new contracts at higher rates for its rigs in the Gulf of Mexico. Diamond Offshore Drilling Inc. said it obtained a contract at one of the higher rates for a rig that had been idled.

Planning Ahead

The tighter supply of shallow-Gulf rigs means customers must plan ahead and contract rigs further out, David Smith, an analyst at Johnson Rice in Houston, said in a telephone interview.

Hercules will lease out one of its rigs at rates greater than $116,000 a day for a total of six months next year. Rates were expected to be closer to $90,000 a day, analysts at Wells Fargo wrote today in a note to investors. The longer contract times are giving rig owners a better handle on forecasting income over the year.

“That kind of visibility is very, very rare for the commodity-type rigs in the Gulf of Mexico,” Keller said.

Even the threat of hurricanes blowing through the Gulf of Mexico this summer are not expected to deter “robust” customer interest, Chief Executive Officer John Rynd told analysts and investors today on a conference call.

Hurricane Pause

Based on the company’s experiences after Gulf Hurricanes Rita and Katrina, “if the rig market is tight, people will drill through hurricane season because they don’t want to get out of the queue,” Rynd said. “If the rig market is weak, they know they can take the hurricane season off and get access to rigs in the fourth quarter.”

Ensco, whose eight rigs make up the second-largest fleet of shallow-water rigs in the Gulf, has seen day rates for its more premium-equipped rigs nearly double over the past 12 months, Sean O’Neill, a spokesman at the London-based company, said in a telephone interview.

“It’s a fantastic time for companies, employees and customers to do business in the U.S. Gulf of Mexico,” he said. “Three or four years ago, I would not have been as ebullient as I am now.”

Even so, rates and length of contracts for comparable rigs remain better for contractors elsewhere around the world.

“You’re not leaving those markets to come back to the Gulf of Mexico,” Rynd told investors in March at an energy conference in New Orleans. “The Gulf of Mexico is as good as it’s ever been.

But it pales in comparison to the returns you can make outside the U.S. Gulf of Mexico.”

Copyright 2013 Bloomberg.

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