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Diamond Offshore Drilling, Inc. (NYSE:DO)

Q3 2008 Earnings Call Transcript

October 23, 2008, 10:00 am ET

Executives

Les Van Dyke – Director of IR

Larry Dickerson – President and CEO

Gary Krenek – SVP and CFO

John Gabriel – SVP, Contracts and Marketing

Analysts

Dan Boyd – Goldman Sachs

Arun Jayaram – Credit Suisse

Waqar Syed – Tristone Capital

Mike Urban – Deutsche Bank

Thomas Curran – Wachovia Capital

Ian Macpherson – Simmons & Co.

Jud Bailey – Jefferies & Co.

David Smith – JP Morgan

Mike Drickamer – Morgan Keegan

Operator

Good morning, my name is Lynn and I'll be your conference operator today. At this time, I would like to welcome everyone to the third quarter 2008 results conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. (Operator instructions) Thank you. Mr. Van Dyke, Director of Investor Relations, you may begin your conference.

Les Van Dyke

Morning. Thank you for joining us. With me on the call today are Larry Dickerson, President and Chief Executive Officer; Gary Krenek, Senior Vice President and Chief Financial Officer; and John Gabriel, Senior Vice President Contracts and Marketing.

Before Larry begins his remarks I should remind you the statements made during this conference call may constitute forward-looking statements and are inherently subject to a variety of risks and uncertainties that could cause actual results to differ materially from those projected. Forward-looking statements include but are not limited to discussions about future revenues and earnings, capital expenditures, industry conditions and competition, days that drilling rigs will enter service, as well as management's plans and objectives for the future.

A discussion of the risk factors that could impact these areas and the company's overall business and financial performance can be found in the company's reports filed with the Securities and Exchange Commission. Given these concerns, investors and analysts should not place undue reliance on forward-looking statements. The company expressly disclaims any obligation to release publicly any updates to any forward-looking statements to reflect any change in the company's expectations or any changes in events, conditions or circumstances on which any forward-looking statement is based. And with that, I'll turn the meeting over to Larry.

Larry Dickerson

Thank you, Les. And welcome everyone to our third quarter conference call. I'm sure, I'll be making some opening remarks about Diamond Offshore and the quarter and I will be followed by Gary Krenek, who will go through some of the details numbers that are behind that, with emphasis, I guess, and looking forward to the fourth quarter.

I'm sure in the overall macro-environment, where people are concerned, obviously, about the price of oil and the price of not only our shares but the entire oil field services complex and entire stock market, that those are the big macro questions that I'm sure we will take. I'm not sure that I can specifically address those but I can talk about some of the positive things that are going on at Diamond Offshore which might give you some viewpoint of how we view the particular market.

Obviously, let me start with our dividend and I'll return to that in a minute but the increase that we made in our dividend is a continuation of what we've emphasized as our dividend strategy. So the combined $2 a share dividend, which is a 46% increase over the combined dividends that we paid in the previous four quarters, was something that we were able to make and it's based, to a large degree, upon where we are in the market, that we have over $11 billion worth of backlog, and that we continue to see positive indications of demand for drilling rigs that we possess. Obviously, the market is ensure and you – and the decline in the price of oil will have some impact, but if we look – we announced in the press release a new contract at what for us is a record day rate for a deep water unit, the Ocean Valiant, which would be heading over to Angola in West Africa for Total, signed a minimum two-year commitment and this was signed this Monday. We had received an LOI several weeks before that but we wanted to make sure that we made the announcement at the point in time that we had the complete contract in place since there were some open issues there.

But I think that that shows that, certainly for the majors, at least for Total, that their programs are such that they are willing to go forward and willing to go forward with strong commitments. As we indicated in our press release, the opening day rate, which you can do the math and see that it's in excess of – well in excess of $600,000 a day, the day rate can decrease if they take that commitment and go from either a two-year commitment to a two and a half year commitment or a three-year commitment.

The other thing I would point out would be that we've seen continued strength in the jack-up market. I think recently Rowan announced a number of commitments that went from a number of their (inaudible) rigs, which is an area that we don't participate in, on through some of the 300 and 350 foot units in the Gulf of Mexico which we do participate in. And we have also seen commitments that are at increasing day rates and those have been signed and committed in the last four to six weeks. So, again, even in the face of declining product prices and the uncertainty out there we see strength.

Certainly, let me return to the one thing that people were concerned about when we, in our previous fleet status report, indicated that an LOI that we previously received and had disclosed as a future commitment was not carried forward to contract status. The customer in that case indicated to us that due to cash flow disruptions from both Gustav and Ike to their facilities and the pipeline serving those facilities, their cash flow did not permit them to carry forward with that particular commitment. And so, we got that data out the door as soon as possible to make sure the market was aware of that. And that we have not disclosed the customer but it was not, I repeat, was not the current contracted customer Anadarko.

And the Ocean Stars will be finishing up its current drilling well sometime toward the end of the year and this will be the first available 6,000 foot unit, in quite in – looking quite sometime in the future, that will be available for re-contracting and we've had terrific interest on this from a number of customers. So, this closed the, obviously, the concern that people have about cash flow impacts in this particular market but again, it's the type of rig that we see lots of our strength.

So those are the general positive market comments. Let me talk a minute about some of the occurrences within the quarter. Our quarterly results were burdened by two items that certainly were not things that we looked at when we went into the quarter. One, hurricane Ike caused some damage to the jack-up Ocean Tower. Ocean Tower was very close in a path in the Vermillion area where Ike apparently caused free jack-ups to sink. But in our particular case, the derrick and the cantilever drilling package went over the side. I was on the rig yesterday afternoon, and the rig looks great except for not having a derrick and drilling package, and its astounding to all of us that cranes and other parts of the rig on the surviving hull were largely unaffected yet the derrick went over the side. Of course, we had no one on board, so we don't have a precise understanding at this point. We did have some data gathering which we will be analyzing.

But, any case that caused a $6.3 million loss. We had a very low net book value for the equipment that was still on the rig of approximately $2.6 million and then we accrued $3.7 million towards our deductible for removal of wreck. Next spring, when the weather settles down, we expect to return to the site and lift up the damaged pieces.

The Ocean Tower itself is scheduled for repairs. We are in the midst of bidding those repairs out so I can't tell you an exact price. Our effective deductible on that unit was right at $70 million. So that would be the maximum that we will spend and I would expect it would be well towards that number if not over that number but I can't give you any details on that at this point.

The unfortunate thing is that due to all the activity in the sector for new builds across-the-board, the derrick manufacturers are backlogged and we will not be able to receive a derrick for eight or nine months and then we'll go through an installation period. So, we look at that rig as being off contract for approximately a year. Surprisingly enough, the rig was not actually drilling at the time that was engaged in some hurricane recovery operations for Chevron, and so they continued use the rig even absence drilling package for a portion of September and on into October. It is idle at the moment and they paid us a rate of $75,000 a day for the rig in its current state, but we don't see much opportunities like that to come into the future. So, we will be preparing the rig for the modifications it will make to get it back to service.

And then the final thing that we had not anticipated is our currency loss, and Gary can go through more details on that but our currency loss for the quarter was just a hair under $30 million – $29 million. We have taken forward contracts on our key currencies for about the past three or four years and with the gradual decline in the dollar, although we're not with hedge accounting and therefore we recognize currency gains or losses, we typically will have been recognizing a slight gain in each quarter. For the two and a half years, that had been about $30 million of gain, however that was offset, or had attempted to offset each quarter's pick up in the cost of our drilling expenses which were denominated in those underlying quarters. So, there was sort of a matching procedure that went on there but what has happened with the huge improvement in the value of the dollar relative to these currencies, and the currencies that we deal with are UK pounds, the peso from Mexico, Australian dollars, and Brazilian p-eyes [ph], and a little bit of Norwegian krone.

We had to, in effect, mark-to-market all of our future hedge positions which stretch out to the middle of next year. So, the current quarter's loss chiefly reflects all of those future losses having been mark-to-market. Theoretically, if the dollar stayed in that particular level, then we would offset that in the future quarters by a decrease in our foreign currency denominated expense, but obviously, the currency can move one way or the other and in fact, for the first couple of weeks of October, it has continued to – the dollar's continued to strengthen. So, that's where that is, but that's essentially we think a mark-to-market timing difference that would be offset by decreases in our drilling expense although all that could reverse it if the dollar moves in a different direction and I have no idea which way that's going to go.

So that kind of covers what's happened in the quarter and how we see the market, and again, I'll come right back to the dividend, I think, our decision to raise the dividend, I think, is a very strong reflection of the strength that we see in Diamond Offshore's position. So, Gary?

Gary Krenek

Thanks, Larry. As before, I'd like to spend a little time on the results we just reported on the third quarter and as Larry said, to give some guidance on what we expect to see financially in the fourth quarter. With regards to the third quarter results, Larry talked about two of the three more significant items are casualty loss and the hurricane and the currency loss. So, I'm not going to really spend any time on that since he went through that. The only thing I would add is on the repairs for the Ocean Tower, as Larry said, we expect to spend as much as $70 million. When we spend those moneys in 2009, those will be capital expenditures so they will not hit P&L but will be accounted for as capital. The other significant item that many of you may have a question about is contract drilling expenses which were $314 million for the quarter. That is higher than the $273 million that we had previously reported last quarter but below the $335 to $340 million that we guided to in our last conference call.

The increase over Q2 was due to cost incurred by seven of our rigs which spent part of the third quarter in shipyards undergoing planned regulatory surveys. However, because of the timing, approximately $15 million of the cost that we had anticipated and guided to did not occur in Q3 but rather or will now be rolled over and spent on the fourth-quarter. The remaining favorable variance comparing our previous guidance to actuals can be mainly attributed to our ongoing efforts to control costs.

Now looking forward with respect to contract drilling expenses in this upcoming quarter, we gave out an average annual per day cost that we expect to incur by rig class and location at the beginning of the year. To remind everyone again that we said because these rights were the expected cost for the entire year in a rising cost environment, we expected to incur costs slightly below those rates during the first half of the year and slightly above those rates on the second half in order to reach that average cost. And at this point, it appears that that guidance was accurate and that is what is occurring. So, in order to compute normal daily operating cost for the fourth quarter, you need to use those annual rates that we gave out earlier but escalate them slightly for Q4.

Now, in addition to these normal daily operating costs, we expect to incur a combined total of approximately $50 million in additional survey and related cost to complete the surveys For the Ambassador, Valiant, Drake, and Rover which we've begun in the third quarter, and also for survey cost related to the Ocean Nomad and Ocean Princess which will be done in their entirety in Q4.

This $50 million is inclusive of the amounts that we have previously expected to spend in Q3 but have now been rolled over into Q4. These rigs are expected to spend a combined total of 266 days off day rate doing the survey work in this upcoming quarter. We also expect to incur another $3 to $5 million above and beyond normal operating cost for two additional rigs that will spend time in the shipyard for non-survey related work, and we'll also book and additional $11 million related to amortization and differed mobilization cost. All told, this totals to approximately $335 million to $340 million of contract drilling cost which we expect incur in the fourth quarter.

Having said that, this estimation, of course, will change if there is a change in our rig survey time and has happened in this previous quarter. And I'd like to take this opportunity to remind everyone that we file an update of rig status report on our website every two weeks. Changes in survey downtime, dates, contract rollover dates, etc., can be found in that report. I would also like to point out that what I've been talking about with regard to contract drilling cost is the line item in our income statement that is labeled exactly that and does not include reimbursable expenses which is a separate line on the P&L statement. Reimbursable expenses are driven by the amounts of consumables we were asked to purchase by our customers and are offset by approximately the same amount of reimbursable revenues.

And in quickly, depreciation and interest expense which we normally discuss should remain relatively flat going into the next quarter, and we expect our tax rate to end the year somewhere between 29.5% and 30%.

With that, I'll turn it back over to Larry.

Larry Dickerson

Okay, so I think, we're ready for questions which we will take. Operator, we're ready to begin our questions.

Question-and-Answer Session

Operator

(Operator instructions) Your first question comes from Dan Boyd with Goldman Sachs.

Larry Dickerson

Good morning Dan.

Operator

Dan, your line is open.

Dan Boyd – Goldman Sachs

Can you hear me? Hello?

Larry Dickerson

(inaudible) Dan, thanks.

Dan Boyd – Goldman Sachs

Sorry about that. You mentioned that you're seeing a lot of opportunities for the Ocean Star. Is there any reason to expect the day rate lower than what you just received on the Valiant?

Larry Dickerson

I'll let John address the market.

John Gabriel

Than the Valiant? I suspect that there are some differentials between the international market in the Gulf of Mexico. I suspect that rate will be, at least in the near term, consistent with what we are looking at on the Ocean – on the Star as originally committed somewhere in that range similar to the America and the Victory, at least in the near term.

Dan Boyd – Goldman Sachs

Okay. Within the floater market, everything seems to be strong so far and actually rates is, in some cases, increased. Are there any regions that you would consider to be most vulnerable to oil below 65?

Larry Dickerson

Well, I don't know that we've seen the impacts of oil below 65 yet. We'll sort of see that as budgets come out. Certainly, I think, deeper water has larger reservoirs in general. This is what the customers seems to tell us. So I think that that provides protection and I would expect that your vulnerability would come from your smaller – trying to take advantage of smaller scale opportunities. And so that takes place in the variety of some of the more mature markets in the world.

Dan Boyd – Goldman Sachs

This is for the US Gulf of Mexico, North Sea, potentially?

Larry Dickerson

Yeah but I mean for deep water in the Gulf of Mexico, that is still largely a new area.

Dan Boyd – Goldman Sachs

Okay. Over the past couple of quarters, you've also talked about looking for different opportunities to grow the company's deep water fleet. Has this changed given the current market conditions or do you still think that that you're going to have opportunities over the next 12 months?

Larry Dickerson

Well, I would – certainly there's going to be opportunities out there on the rig construction side because you got, as you know there are parties involved in construction that may not be as well capitalized as you need to be in this current market. So those will provide opportunities whether or not we chose to acquire rigs and there would weigh up on a large number of factors but probably the price that we could obtain that rig at will be one of the largest factors.

Dan Boyd – Goldman Sachs

Today, it's pretty safe to assume though that if the market remained at current levels, you would be – you look forward to an opportunity to take one of those shipyards lots that has an early delivery dates, say, 2010 or even into 2011?

Larry Dickerson

Well, I mean, early delivery is an advantage. If the market stays where it is and we can get a discount and we're fairly comfortable about our prospects getting a contract, and then that improves the odds.

Dan Boyd – Goldman Sachs

Okay. Thanks. I'll turn it over.

Operator

Your next question comes from Arun Jayaram with Credit Suisse.

Arun Jayaram – Credit Suisse

Hi, guys.

Larry Dickerson

Good morning.

Gary Krenek

Hey, AJ.

Arun Jayaram – Credit Suisse

Larry, I was wondering if you could comment – Brazil's an important market for Diamond and obviously you have very good visibility there, but there's some concerns that maybe a lot of the new build that they've just agreed upon may not get done with their current owners owing to financing situation. I was wondering if you've had a lot of conversation with Petrobras? Has there been any changes from the way they are looking at the market or how they are thinking about contracting existing rigs and other opportunities potentially for some replacements if these rigs don't get done in a timely manner?

Gary Krenek

There's probably opportunities and we talked and Petrobras but I don't that's in any hard signals as to what changes they're going to make in this situation. I think you've pretty well outlined the situation and the facts on the ground but what adjustments they're going to do, I don't know.

Arun Jayaram – Credit Suisse

Okay. That's fair. Second question. Can you give us your CapEx number for 2009, inclusive of some of the $70 million?

Gary Krenek

Not at this time. We are in the process of doing our budgets and we will be prepared to give that out at a later date. At this point, rely on what he had said earlier and then add approximately $70 million. But, again, that could change as we go through our budgets.

Arun Jayaram – Credit Suisse

Okay. And last quick question is just on the operating cost line, given the 20% increase in the US dollar versus a lot of different foreign currencies. What kind of impact, Gary, would that have on the operating cost line item on a percentage basis, the stronger dollar?

Gary Krenek

We spend probably 20%, I would guess, in foreign denominated currencies on our expenses. So, we'd – loss that we had of $29 million for the third quarter would be spread over 6 to 9 months. So, most of our current foreign currency contracts go all the way in to June of next year. And so, if the dollar had remained consistent at as what it was on September 30th, you could take that $29 million and spread it over to nine-month period.

Arun Jayaram – Credit Suisse

Okay. That's very helpful.

Larry Dickerson

Just to give you kind of a rough idea of what it is.

Arun Jayaram – Credit Suisse

Okay. That's helpful, guys. Thanks a lot.

Operator

Our next question comes from Waqar Syed with Tristone Capital.

Waqar Syed – Tristone Capital

Good morning, Larry. Could you comment on the contract? There's certainly a view on the street about the strength of these contracts whether they're going to be re-negotiated or canceled. In case commodity prices come into pressure, could you kindly give us a view – your view – on how strong these contracts are and what's the language and what are the outs for NP [ph] companies in these contracts?

Larry Dickerson

Our view is that these contracts are very strong. They have been tested, I think, in the past on cancellations. We try to work with our customers and serve their needs but at the same time when we chose to, we and they chose to go long on rigs, then I think both parties expect that they'll live with that. There are standard outs for non-performance issues, as with almost any contract, but in general there are not outs in the particular contracts for that kind of market issues. Now, maybe the Pemex contracts have some outs in there, or there's some outs in law in those particular jurisdictions. Other than that, most of the negotiated contracts are pretty strong.

Waqar Syed – Tristone Capital

Okay. Let's just take a theoretical scenario, like oil prices come fall below $60 go down. Companies find that their deep well projects are not worth anything, would you be willing to renegotiate day rates again and change the terms of the contracts? And what's the record on that?

Larry Dickerson

You know, I'd like to help you but I can't. If I comment theoreticals, I just don't know where we would be at a particular point in time. As I indicated, what we view ourselves as a prime supplier of our customers and we want to serve their needs but we try to maintain the interests of our shareholders, clearly, and the fact that then we chose in these cases to go long on the drilling services and the rates, that would be our position.

Waqar Syed – Tristone Capital

And then just on the special dividend, obviously everybody is pretty excited about the dividend going up and after, the board has kept the dividend flat for a long time and what is the thinking behind raising it at this stage? You feel much better about the backlog or you see the earnings ramping up quickly, that is why? What is the thinking about raising it now?

Larry Dickerson

Well, I think we disclosed in the announcement the factors that the board looks at and I would just tell everybody to look at what our history has been of increasing dividends, match sort of with the increase in our cash flow. When we switch to quarterly dividends, we kept that same quarterly dividend in place for four quarters. And as, during that – as the dividends stays flat, our earnings and our cash flow continually grew, so there was obviously if we're committed to using dividend and using cash to enhance shareholder value that way then you would expect at some time for some increase.

Waqar Syed – Tristone Capital

Right. And then, one last question on the Gulf of Mexico jack-up market, are you seeing any – you signed some good contracts but are you seeing any hints from MP [ph] companies about changing the plans though?

John Gabriel

This is John Gabriel. No, not yet. We've looked at our jack-ups right now in the gulf, we got seven of them here and we're committed anywhere from 60 days to 6 months out on each one of them. We haven't seen anybody of any significance pull back from the market yet. It's important to note that we're down to about 21 Independent Leg Cantilevers here in the Gulf of Mexico and that's positive for that class of rig. And basically, the market is holding steady to rigs being slightly up on the high-end and we don't see any evidence of that changing right now.

Waqar Syed – Tristone Capital

Right. Thank you very much.

Operator

Your next question comes from Mike Urban with Deutsche Bank.

Mike Urban – Deutsche Bank

Wanted to follow-up on a couple of questions from earlier. A nice vote of confidence on raising the special dividends. Certainly speaks well of your view of the future. But does it make any comment or statement on your view on M&M [ph], I know you addressed earlier with respect to shipyards lots and potential acquisitions of existing rigs. Should we take this to mean that those are still too high? We haven't seen any pain? Or would you be able to potentially take on some of those lots or acquisitions without cutting the – having to cut the dividends?

Larry Dickerson

Well, we would always look at whatever options are in front of us or what are in the best interest of the shareholder. But I would just point out the fact that we – our debt levels are extremely low, far below our cash levels. We got a revolver in place and we've got the type of credit rating that even in this tight market, would allow us to potentially, we believe, tap the credit markets because the amount of equity people put into the deal. I don't know that the two of them are exclusive but if there was a deal that was big enough, we're going to weigh one versus the other but again, we say again and again that dividends, via the form of special dividends, are our means that we've chosen to enhance your holder value and we're going to stick with that philosophy.

Mike Urban – Deutsche Bank

Okay. Great. And something back to the jack-up market and most of the comments have been on the Gulf of Mexico market, and that's where most of your rigs are. Would you extend those to the international market or there's not enough of a sense of what's going on there given your limited exposure?

Larry Dickerson

Well, we've got over half of our jack-ups international now. What we've seen to date is there's been good pricing discipline in most of these markets. I think the real key is to look at the level of new build deliveries over the next two years versus where these rigs might be absorbed and I think the place is really to focus on or going to be in the Middle East with respect to (inaudible), maybe to a lesser extent the Mediterranean and another particular place to keep an eye on is going to be Mexico. So, we'll just see what kind of incremental demands comes out of those areas over the next few months to a year and that'll kind of tell us where the market's headed, I believe.

Mike Urban – Deutsche Bank

Great. Thank you.

Operator

Your next question comes from Thomas Curran with Wachovia Capital.

Thomas Curran – Wachovia Capital

Larry and/or Gary, I wanted to follow up on an earlier line of questioning regarding the potential for the renegotiation of contracts within the backlog. Could you tell us when was the last period where you engaged in a meaningful amount of that and then share some color on whether it was more weighted towards day rates or duration and provide some order of magnitude. Did you try to stick to decreases within a certain percentage range? Did you just mark to where the market seem to be at that time? If you could just share some color on when was the last time that happened and how it worked.

Larry Dickerson

Well, I would say that in our – in my experience, and with everyone else at the table, that there's been very few of that, maybe a customer, where we significantly renegotiate a contract when the market moves down. And in one case that I recall from a long, long time ago, we traded right relief [ph] for additional term. We took a two-year commitment and went to three and cut the right. And then some time in the late 90s, I recall where we – the issue was that the rig, that the customer was contracted for didn't exactly match their revised drilling program. So we enabled that customer to swap rigs and we measured rates and commitments and all that kind of stuff so that at the end of the day, we believe that we were preserving our economic interest but we served them. So, the two points is, one, there's never been in our history wholesale re-negotiations and they've always been for a trade where it's just not us giving relief but rearranging our contract commitment. And I think that pattern is held true also from our – for our competition.

Thomas Curran – Wachovia Capital

Okay. Thank you. That's helpful. Next question, as you look out across your fleet of floaters outside of the Gulf of Mexico, of those that are going to be rolling over earliest, are there any where you've seen a decrease in the level of visibility you would expect at this point or where a lack of visibility is in any way a source of concern right now?

Larry Dickerson

The short answer is “No”. Basically, our fleet in Southeast Asia is committed into 2010, our fleet in the North Sea is committed into 2010, both of our floaters in Mexico are committed that far out. In fact, the only rig that we – the only floater in our worldwide fleet that has any time prior to 2010 is the Ocean Star. We have not seen anything significant at this stage that would tell us that the markets are going to have to do anything but at least hold where they are, and possibly improve. There are still deficits in terms of rigs versus programs. Again, there's really no evidence to support anything like that.

Thomas Curran – Wachovia Capital

Okay. And lastly, a longer term question here, as you look out across the countries that are poised to open up offshore acreage for the first time, such as Iceland, which of those are you guys most excited about in terms of potential 2010-2011 incremental demand?

Larry Dickerson

I think we're a ways away from some of these frontier places, like Iceland, getting out to actually awarding leases where oil companies begin contracting for us. I mean, we're most excited about just Southeast Asia, more countries that may have explored in the past that are ramping up production. We took a jack-up down to Argentina, the Ocean Scepter, which is first offshore rig to return there in some time. And we had President Kirchner come out and she came on board the rig, so it was a big deal for the country. And those are the kind of things that I see in 2010-2011. I just think we're a long ways away from east coast to the US, and Iceland and Falklands and those kinds of places.

Thomas Curran – Wachovia Capital

So, still primarily Southeast Asia and Latin America, it sounds like.

Larry Dickerson

Right.

Thomas Curran – Wachovia Capital

Okay. Great. Thanks for the color guys. I'll turn it back.

Operator

Your next question comes from Ian Macpherson with Simmons & Co.

Ian Macpherson – Simmons & Co.

Hey, good morning. Maybe just a quick follow up for John on the prospects for the Ocean Star. I guess that the rates still look closer to what you've booked recently in the Gulf of Mexico as opposed to the more recent vintage contract for the Valiant. What are your more long-term plans for that rig? Are you thinking about taking it out of the Gulf of Mexico if there appears to be some kind of geographic disparity between the day rates?

Larry Dickerson

Well, a lot of it – geographic disparity between day rates – is absorbed in cost differential as well. But I guess in a perfect world, my preference would be to keep the Star in Gulf of Mexico given the, in particular, the robust nature of the mooring system on that rig. That does not preclude us from looking at opportunities outside the Gulf of Mexico. We're actually looking at things for a rig of that class in West Africa, South America, two places in West Africa, actually, and they would involve potential term commitments of 2 to 3 years. These are mobile offshore drilling units and I think we'll take them where the opportunity is. If it's – again my preference from a marketing standpoint, I'd rather keep it here.

Ian Macpherson – Simmons & Co.

Okay. And then just to confirm, you think you have the opportunity to roll it off Anadarko into its next contract in December fairly seamlessly?

Larry Dickerson

I think so, and we've got some flexibility with respect to some other issues. I think, it would be fairly seamless.

Ian Macpherson – Simmons & Co.

Okay. Thank you very much.

Operator

Your next question comes from Jud Bailey with Jefferies & Co.

Jud Bailey – Jefferies & Co.

Thank you. Good morning. Follow-up on one of the contract questions earlier. Is it fair to say that outside of your contracts with Pemex that you have – are there no other early cancellation provisions for your long term contracts?

Larry Dickerson

Where they do exist, there is effectively a full payout in the contract.

Jud Bailey – Jefferies & Co.

And my second question is regarding Pemex, we saw them withdraw a tender before jack-ups and a deep water rig here recently. Do you have any color insight as to what Pemex's plans maybe for '09 and the reason for the tender being withdrawn?

Larry Dickerson

It's our understanding right now that that tender is going to re-emerge before the end of the year. It was a technical issue within their tendering process that caused it to be withdrawn. As best as we can tell, there will be – we think there'll be two tenders coming out with Pemex before the end of the year that will involve one deep water floater and a half a dozen jack-ups, one of which I believe is against an incumbent. Now, I don't know how many of the others may be against incumbent Mat [ph] rigs that they may be choosing to ship out of their fleet, but we still see Mexico as being active before the end of the year from the tendering side.

Jud Bailey – Jefferies & Co.

Great. That's all I've got. Thank you.

Operator

Your next question comes from David Smith with JP Morgan.

David Smith – JP Morgan

Hi, good morning.

Larry Dickerson

Good morning.

David Smith – JP Morgan

If we look at the credit situation that's challenge from the new entrants, as well as the recent accidents with some of the younger contractors, are you seeing any change in the human resources department? If crews are more skeptical about leaving the established drillers?

Larry Dickerson

I'm not sure what you're referring to on the accidents. But –

David Smith – JP Morgan

We had a fire just recently as well as a rig that might be out for a little while because damage incurred during jacking up.

Larry Dickerson

We have had some folks leave us and then seek to come back because they just like the stability that we provide. I can't, you know – and we work that issue and emphasize that there's reasons to stay here. I haven't heard any specifics about, “Gee, I'm afraid for my life over there.” But, they know we're committed to safety, they know we're committed to retaining our crews, they know that because we're a large (inaudible) fleet, we offer lots of promotional opportunities. And then we stay with compared to pay package, and so we're very comfortable with our position.

David Smith – JP Morgan

And also, can I ask what you're hearing with regard to the credit situation affecting some of the startup companies and their ability to finance progress payments on their new builds?

Larry Dickerson

Well, I think the same thing that you've heard. I won't list the particular companies but I think it's widely known the ones that have debt, that there's not appearing and they've got progress payment coming up. So, there are some folks out there and I don't necessarily know the ones that we don't know about yet. But, clearly, it is a constraining credit environment and we know that there was a business model in this market where you put minimum money down and sought to finance the whole rig construction schemes, so we think there may be some opportunities that come from that.

David Smith – JP Morgan

Good. Thank you for your time.

Larry Dickerson

Let me take one more question and we'll let everybody get on to the next conference call.

Operator

Your next question is from Mike Drickamer with Morgan Keegan.

Mike Drickamer – Morgan Keegan

Hey, good morning guys. I guess, quickly then. If we look at 2009, I understand you haven't gone through your budgets yet so you're not giving any accounts yet for 2009, but do you think it's reasonable to assume then that with lower scale prices perhaps not as much pressure on labor cost, that the increase in '09 operating cost would be less and is that what you're seeing over the past couple of years?

Larry Dickerson

Well, there's a conference call going on right now with NOV that you need to get a report from there. No, seriously, I think in general we probably are not anticipating that inflation kicks it up another notch but there's still rigs that have to be manned so labor's half the cost, so that's a big part of it. And although steel prices have come down, that's primarily impacts the construction of rigs, it's more the service and the process steel and to date we're not seeing that those prices are coming down or anything.

Gary Krenek

The only thing I would add is that at the first quarter conference call, we had predicted that our cost would increase 18% for this year and that included additional work that we're going to do, adding additional rigs into the fleet, the new jack-ups, etc., so it wasn't all just inflation. And with our year to date cost through the third quarter, plus our projections in the fourth quarter, that increase is going to come out right at 19.5%. So, we were very, very close to the prediction we made in the first quarter.

Larry Dickerson

Okay. Let's emphasize that it's not 19% core inflation, that includes new rigs coming into the fleet –

Gary Krenek

Correct.

Larry Dickerson

(inaudible) backups, etc. that the underlying core inflation is –

Gary Krenek

Probably around 10% to 12%.

Larry Dickerson

10% to 12%.

Mike Drickamer – Morgan Keegan

Okay. Then, following up on the strengthening dollar one more. What kind of impact do you think the strength in the dollar could have on your capital spending for 2009?

Larry Dickerson

Well, it just depends on where we're spending it but a lot of our expenses are dollar based, US Dollar based. Our labor is US Dollar based, even if we have U.K., Australian, foreign nationals working outside their home countries, we pay them in dollars. A strong dollar helps on the margin but I don't think it's material.

Mike Drickamer – Morgan Keegan

Okay. Thank you guys.

Larry Dickerson

Well, I appreciate everybody listening in and we were pleased with our dividend and we're glad to share our reasoning behind that and our view of the markets with you. So, we'll join you again at year end, which will be some time in early February. Thank you very much.

Operator

This concludes today's conference, you may now disconnect.

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Source: Diamond Offshore Drilling, Inc. Q3 2008 Earnings Call Transcript
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