Seadrill's West Mira Contract Shows Strength In Ultra-Deepwater Market

| About: Seadrill Limited (SDRL)

Seadrill Ltd. (NYSE:SDRL) announced earlier this week that it received a Letter of Award for the use of the newbuild ultra-deepwater semisubmersible West Mira from Husky Oil (OTCPK:HUSKF). This five-year assignment will be in Greenland and Canada and will produce total estimated potential revenue of $1.18 billion including the performance bonus and mobilization fee. The rig itself is still under construction and is expected to be delivered in the fourth quarter of 2014. The rig will start work on this contract during the second quarter of 2015. This contract serves to illustrate the continuing strength of the offshore drilling market, particularly in the harsh environment and ultra-deepwater segments.

The West Mira is a 2014-built sixth-generation ultra-deepwater semisubmersible drilling rig. This makes the rig one of the newest in either Seadrill's fleet or anywhere in the world. The rig uses the Moss Maritime Moss CS60 design, the latest design in the widely used and respected Moss Maritime CS-series. Modified versions of CS-series rigs have proved their durability and versatility in special purpose platforms such as the SDX-1 radar platform used by the U.S. military. West Mira is capable of drilling wells up to 40,000 feet deep in up to 10,000 feet of water. This makes the rig not only one of the most technically capable semi-submersibles in Seadrill's fleet but one of the most technically capable rigs in the world. The rig is also equipped with sophisticated safety gear including two six ram blowout preventers. These devices should help to prevent disasters such as the 2010 Macondo oil spill in the Gulf of Mexico. The West Mira is also outfitted for operating in harsh environments such as the North Sea or Arctic regions. Harsh environment rigs are in extremely high demand according to companies such as Noble Corp. (NYSE:NE), which discussed this demand during its second quarter conference call. This wave of interest is being fueled by new developments in the North Sea as well as new discoveries in areas such as the Barents Sea and other Arctic areas. West Mira is one of ten such semi-submersibles in Seadrill's fleet. Eight of these are relatively new rigs that were built after 2008. These newer rigs are preferred by oil companies due to having better performance and safety equipment than older rigs.

As previously mentioned, the contract with Husky includes total potential revenue of $1.18 billion over the five year period. This works out to $646,600 per day. Please note that this is total contract revenue and is not, strictly speaking, dayrate. The actual contractual dayrate is lower. This is because that $646,600 figure includes both the mobilization fee and the performance bonus. The mobilization fee is intended to compensate the offshore drilling company for both the time and expense incurred in getting the rig into position and ready to operate. Thus, I view payments like this as reimbursement for expenses and not as new money coming into the firm in the same way that revenue for the rig's work would be. From an accounting standpoint, however, this difference does not really matter. The mobilization fee is amortized over the term of the contract so it is counted as revenue in the same way that dayrate is. The performance bonus is a variable amount that the oil company pays to the drilling contractor and is primarily intended as a way for the drilling contractor to share in the profitability of the oil well. As this is a variable payment, Seadrill has estimated the amount that it will receive from this bonus and included it into the $1.18 billion figure. If this performance bonus is lower than what the company expects then it will end up bringing in less than $1.18 billion. For these reasons, I would have preferred to see a breakdown of each of these three components in the contract announcement.

Regardless, it is almost assured that the actual contractual dayrate here for West Mira is in excess of $600,000 which would make it one of the highest earners in Seadrill's fleet. The only semisubmersibles in Seadrill's fleet with dayrates over $600,000 are the three Brazilian rigs and West Leo (starting in May 2013). If the $646,600 figure is used then only the West Taurus in Brazil is higher. This provides further evidence that the ultra-deepwater market remains tight and that is causing dayrates to rise. The three Brazilian rigs began their respective assignments in 2009 or 2010 and the contracts were signed prior to that during the previous industry cycle. Thus, the West Mira appears to have secured the highest dayrate for one of Seadrill's semisubmersibles in the last several years, reinforcing my conviction that the offshore drilling industry is strengthening.

The length of this contract provides further evidence for this conviction. The contract for West Mira will be in effect for five years. Noble stated in its third quarter conference call that lengthier contracts suggest that oil companies are concerned over rising rates and so are attempting to lock in rates now to avoid having to pay higher rates when the contract comes up for renewal. With that said, ultra-deepwater drilling rigs have always had longer contracts than other types of rigs so this may simply be reading too far into the contract length here.

Seadrill will not begin receiving this money until the rig begins work on its assignment in the second quarter of 2015. After that point, the rig will serve as a catalyst to grow earnings in the second and third quarter of 2015. The short-term nature of the market likely means that this is something that is not being considered by the market but it could be valuable knowledge to someone considering a longer-term position.

Seadrill Partners (NYSE:SDLP) could also stand to benefit from this contract. That is because the West Mira is one of the semisubmersibles that Seadrill Partners has the option of buying for its fleet. This would have the effect of greatly increasing Seadrill Partners' revenue and possibly dividend payout. Seadrill itself would also benefit from this scenario due to its ownership stake in Seadrill Partners.

Disclosure: I am long SDRL. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.