Dual-Gradient Drilling Positions Pacific Drilling For The Future

| About: Pacific Drilling (PACD)

The two articles that I recently published on Seeking Alpha regarding Pacific Drilling (NYSE:PACD) and the desirability of modern ultra-deepwater drilling rigs saw an interesting discussion ensue in the comments. This discussion revolved around the unique ability that four of Pacific Drilling's rigs have to perform dual-gradient drilling. Dual-gradient drilling is a relatively new technology pioneered by Chevron (NYSE:CVX) that has a number of advantages over the standard single-gradient drilling technique. Pacific Drilling's capabilities in the area could prove to be a competitive advantage for the company, particularly in areas such as the U.S. Gulf of Mexico.

First, let's discuss dual-gradient drilling and why it is so much better than the single-gradient drilling method that has been the industry standard for years. Offshore Magazine wrote and published a very good article about the technology in an issue awhile back and I will do my best to explain how this technology works and why it is better than the conventional method of drilling an ultra-deepwater well. Stated simply, in a conventional drilling operation, the marine riser (a pipe that connects the deepwater platform to the sub-sea wellhead) is filled with a weighted drilling fluid that exerts hydrostatic pressure on the wellbore. This method severely impacts the casing design and creates numerous downhole difficulties, including technical difficulties controlling the well. In dual-gradient drilling, the marine riser is filled with sea water instead of drilling fluid. The drilling fluid is used exclusively in the wellbore. This results in much less downhole pressure upon the well, removing some of the technical complications and making it much easier to control the well. This vastly improves safety.

Oil and gas giant Chevron is at the forefront of oil companies looking to adopt and use dual-gradient techniques in their deepwater and ultra-deepwater development projects. Safety is one of the primary reasons for this. As I discussed in my previous articles (linked above), governments around the world have been increasingly tightening their regulatory requirements on offshore wells since 2010. Additionally, the oil and gas companies that operate these wells have become increasingly concerned about the safety of their offshore projects, possibly out of fear of becoming the next BP (NYSE:BP). Therefore, the improved safety offered by dual-gradient drilling compared to conventional methods looks very desirable.

Dual-gradient drilling also offers a few other advantages over conventional drilling techniques that make it desirable to operators. According to Ken Smith, dual-gradient drilling project implementation manager for Chevron North America,

"It's easier, safer, better for the environment, less expensive, the risks decrease, and the outcomes are more predictable. I think it will be the way we drill deepwater wells in the future."

Mr. Smith's statement that dual-gradient drilling is less expensive than conventional methods is an interesting one. Dual-gradient drilling was first developed in the late 1990s and early 2000s and hailed as a game changing technology. However, the technology was then shelved for a decade because it was not cost effective. The industry trends and characteristics are different now than in the early 2000s and that makes the technique much more economically viable than it was then. The cost problems with the technology in the early 2000s was that the cost of mobilizing and demobilizing the dual-gradient drilling kit was extremely high, particularly if the rig was not actually built to be DGD-capable (which none were at that time). Given that most contract lengths at that time were for 12 to 18 months, it did not make economic sense to modify a rig to be dual-gradient drilling capable when the operator would only get two or three wells out of the rig. Today, contract lengths are much longer and so the operator can spread the mobilization and demobilization costs out over multiple wells which makes the economics much more attractive. The actual costs of drilling the well are cheaper when using dual-gradient drilling than when using conventional deepwater drilling techniques. Thus, the more wells that the operator can drill and spread the mobilization and demobilization costs to, the more cost-effective this technique becomes.

In my previous article, I stated that oil companies are very interested in improving the cost-effectiveness of their ultra-deepwater wells. Dual-gradient drilling used over a multi-well drilling program is one way to do this. Thus, a drilling company that can offer the ability to use this technique may have an advantage on competing for rig contracts.

There is current only one drilling company with the equipment to perform dual-gradient drilling. That company is Pacific Drilling. Pacific Drilling has four rigs that are dual-gradient drilling capable, one of which will not be completed until 2014.

Source: International Hedges

Earlier in this article, I stated that dual-gradient drilling is more cost effective when it is used with rigs that are designed for it. That is what is meant by stating that rigs are DGD-capable. If an oil company wants to use dual-gradient drilling in an ultra-deepwater project then the company could simply add a kit to one of these rigs (the oil company and not the drilling contractor provides this kit). If the oil company wants to use dual-gradient drilling with any other rig from any other contractor then the oil company will need to pay a tremendous amount of money to modify the rig to be dual-gradient drilling capable. Thus, using one of these four rigs is by far the best solution for an oil company looking to take advantage of the safety and economic benefits of dual-gradient drilling.

Currently, Chevron is the only oil company that is using dual-gradient drilling techniques in some of its ultra-deepwater wells. However, that fact does not make Pacific Drilling beholden to or dependent on Chevron. All four of these rigs are capable of performing conventional drilling operations if the operator so chooses. Thus, Pacific Drilling can shop these rigs around to get the best contracts that it can just as any other driller would do.

The DGD-capability of these rigs also positions Pacific Drilling well should other oil companies decide to use this technique. Given the advantages of dual-gradient drilling, that is certainly a possibility. These are the only four rigs in the world that are designed for dual-gradient drilling. As already discussed, there are significant economic advantages to using a rig that is designed for dual-gradient drilling should the company want to use it. Therefore, if dual-gradient drilling catches on, Pacific Drilling should become the preferred contractor to the industry relatively quickly. This could result in these rigs commanding a premium price due to the extra demand and thus proportionally benefit Pacific Drilling with revenues in excess of what it would otherwise earn.

Disclosure: I am long PACD. 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.