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Ensco (NYSE:ESV)

Q4 2012 Earnings Call

February 21, 2013 11:00 am ET

Executives

Sean P. O'Neill - Vice President of Investor Relations & Communications

Daniel W. Rabun - Chairman, Chief Executive Officer and President

Kevin C. Robert - Senior Vice President of Marketing

James W. Swent - Chief Financial Officer and Executive Vice President

John Mark Burns - Chief Operating Officer and Executive Vice President

Patrick Carey Lowe - Senior Vice President of Eastern Hemisphere

Analysts

David Wilson - Howard Weil Incorporated, Research Division

Douglas L. Becker - BofA Merrill Lynch, Research Division

Judson E. Bailey - ISI Group Inc., Research Division

Robin E. Shoemaker - Citigroup Inc, Research Division

Robert MacKenzie - FBR Capital Markets & Co., Research Division

Ian Macpherson - Simmons & Company International, Research Division

Gregory Lewis - Crédit Suisse AG, Research Division

Darren Gacicia - Guggenheim Securities, LLC, Research Division

Andreas Stubsrud - Pareto Securities AS, Research Division

Operator

Good day, everyone, and welcome to Ensco plc's Fourth quarter and Full Year 2012 Earnings Conference Call. [Operator Instructions] Please note this event is being recorded. I will now turn the call over to Mr. Sean O'Neill, Vice President of Investor Relations, who will moderate the call. Please go ahead, sir.

Sean P. O'Neill

Thank you, operator, and welcome, everyone, to Ensco's Fourth Quarter 2012 Conference Call. With me today are Dan Rabun, CEO; Mark Burns, our Chief Operating Officer; Jay Swent, CFO; Kevin Robert, our Senior Vice President of Marketing, as well as other members of our management team.

We issued our earnings release, which is available on our website at enscoplc.com.

As usual, we will keep our call to 1 hour. Any comments we make about expectations are forward-looking statements and are subject to risks and uncertainties. Many factors could cause actual results to differ materially. Please refer to our earnings release and SEC filings on our website that define forward-looking statements and list the risk factors and other events that could impact future results.

Also, please note that the company undertakes no duty to update forward-looking statements.

As a reminder, our most recent Fleet Status Report was issued earlier this week.

Now let me turn the call over to Dan Rabun, Chairman and CEO.

Daniel W. Rabun

Thanks, Sean, and good morning, everyone. I will start by covering highlights for the year and fourth quarter, as well as a preview of what we see in 2013. Kevin will then comment on the state of our markets, and Jay will review our financial results and provide a detailed outlook for the year ahead.

First though, as we look back on 2012, it was a remarkable year for Ensco. We achieved record revenues and earnings and reinvested $1.8 billion back into our fleet, an all-time high. 3 new ultra-deepwater rigs were delivered, and I congratulate our capital projects team for successfully delivering them on time and on budget.

ENSCO 8505 commenced its initial term contract with a repeat customer. And ENSCO 8506, the final rig in the series, was delivered and is now working in the U.S. Gulf of Mexico.

In the most recent quarter, our 8500 series rigs achieved 99% utilization for rigs working at least 6 months, highlighting the many benefits of standardization.

ENSCO DS-6, our newest ultra-deepwater drillship, recently commenced drilling operations in Angola, beginning a 5-year contract for BP.

ENSCO DS-7, our fifth Samsung DP drillship, was recently awarded a contract by Total, also for work in Angola. The initial rate at $615,000 per day, predetermined rate increases will make the average day rate approximately $648,000 per day over the life of the contract, plus mobilization. We expect drilling operations to commence in the fourth quarter after the rig is delivered later this year and mobilization, sea trials and acceptance testing have been completed. ENSCO DS-7 is the third drillship contracted by Total.

We are also excited about the delivery of 2 ultra-premium jackups later this year: ENSCO 120, which has been contracted with Nexen and is expected to commence operations in the fourth quarter; and ENSCO 121.

These 3 2013 deliveries and the 3 additional rigs scheduled for delivery in 2014 will continue to provide long-term revenue and earnings growth well into the future.

Investments that we have made in our fleet are a key element of Ensco's continuous high-grading strategy and so were sales of less capable rigs. We sold 3 jackups, 1 floater and a barge rig during 2012, and the proceeds have been reinvested into our newer rigs.

All of our actively marketed jackups are contracted and marketed utilization was 92% in the fourth quarter. As utilization remains strong, we have benefited from rising average day rates for our jackup segment. Ensco has the largest number of active premium jackups as the leading provider of these rigs worldwide.

Last year has also seen the successful integration of our acquisition, solidifying Ensco's global presence. The acquisition has continued to yield benefits beyond our expectations. Economies of scale have helped with purchasing, rig construction, shore-based operations and vendor relationships, including responsiveness when downtime issues occur. As a result of these benefits, we exceeded our targeted expense synergies of $100 million in 2012.

In addition, our expanded geographic scope gives us greater advantages in terms of contracting our rigs since we can be even more selective in choosing the highest margin opportunities.

Scale also gives us benefits in terms of hiring and training personnel. We can recruit from more talent pools and provide career opportunities in more places around the world.

2012 was a truly remarkable year for Ensco, and we want to carry this momentum forward into 2013. As a result, we recently launched our go beyond campaign. We are rededicating ourselves to our vision and values, in particular, safety, operational excellence and success for employees, customers and shareholders. The campaign focuses on exceptional actions by employees who go beyond their job responsibilities to achieve an even higher level of safety and operating performance, which, in turn, lead to even higher levels of customer satisfaction. The campaign has generated a lot of enthusiasm among our employees, and we look forward to delivering results to both customers and investors.

Now I'll turn it over to Kevin to discuss the state of our markets.

Kevin C. Robert

Thanks, Dan. This morning, I will recap some of our contract signings that occurred during the quarter, and present our outlook for the floater and jackup markets. Overall, the fourth quarter was very positive as tender and inquiry activity continue to be strong. Worldwide, we received about 60 inquiries for our jackups and floaters, marking the fifth consecutive quarter with this level of activity. Unfortunately, we had to no bid about 25% of these opportunities due to lack of rig availability.

Starting with the U.S. Gulf of Mexico. We continued to enjoy a strong jackup market as ENSCO 86, 90 and 99 all obtained 6- to 9-month contracts at $110,000 per day level. This was an increase of $25,000 to $30,000 per day from their previous contracts. They are the highest rates for 250-foot independent leg cantilever jackups in the U.S. Gulf of Mexico since mid-2008.

We also obtained a 1-year contract for the 400-foot independent leg cantilever ENSCO 75 in the high $130,000 per day level.

We expect the U.S. jackup market to remain strong in 2013 as drilling activity continues to be bolstered by strong oil prices and the lack of available rig capacity.

In the U.S. Gulf, as noted in our recent Fleet Status Report, Anadarko exercised their priced option to extend ENSCO 8500 for 1 year, and Noble extended ENSCO 8501 for 1 year at $525,000 per day, an increase of about $150,000 per day from its fourth quarter rate.

We expect the floater market in the U.S. Gulf to remain very active during 2013; more than a half dozen clients are looking for rigs to drill programs starting this year. With limited rig availability in the region, we believe the availability of ENSCO 8502 and 8503 will continue to attract a lot of attention from clients.

Looking further out, we expect the U.S. Gulf deepwater rig demand to continue increasing in 2014, and we believe we're well positioned to participate in this growing market with our ultra-deepwater drillships and semisubmersibles.

In Mexico, we expect the strong jackup market will continue as Pemex plans to add 6 to 8 incremental jackups to its fleet of rigs currently under contract and in the process of direct negotiation. Pemex's increasing demand for jackups enabled us to extend all 4 of Ensco's 250-foot independent cantilever jackups working in Mexico at rates in the low-90s. More importantly, ENSCO 83, 89, 93 and 98 contracts were for multiyear terms, ranging from 930 to 1,350 days. Pemex is also planning to add to their midwater fleet as we expect them to soon tender for 1 or 2 midwater floaters for long-term contracts.

Moving to Brazil, we finalized a 1 year extension for ENSCO 6000 in the mid-270s, an increase from the low-200s. And we mobilized ENSCO 5005 to a Singapore shipyard. We expect to extend ENSCO 6001 and 6002 beyond mid-2013 as we're in the final phases of negotiations with Petrobras. We cannot make any further comments on this issue until after all approvals are received. Petrobras continues to focus on maintaining production in their historic basins while ramping up drilling for pre-salt. With the continued geologic success Petrobras and foreign operators are experiencing in Brazil, we anticipate Brazil will continue to be a strong, long-term market for floaters even though we expect it will be some time before there's a need for incremental floater capacity.

Other South American activity continues to emerge as there are opportunities for midwater rigs in Peru, the Falklands and Brazil and jackup opportunities in Argentina and Venezuela.

In the U.K. North Sea and Denmark, jackup supply remains tight. Our 8-rig jackup fleet in this region is mostly contracted into 2014 and beyond, and we are seeing multiple tenders for work commencing in late 2014 to mid-2015.

Regarding ENSCO 121, our next available high-spec newbuild jackup, customer interest remains high as we bid on multiple opportunities during the fourth quarter. Plus, we've seen a number of new tenders entering the market this year, indicating a continued high level of activity, rigs of this caliber.

The U.K. floater market remains in balance, and we expect there will be opportunities for a growing harsh environment fleet in the region over the next few years.

In the Middle East, all but 1 of Ensco's 9 marketed jackups are under contract into 2014 or beyond. We expect 2013 to be another active year as we see the potential for another 8 to 10 requirements in the Middle East region.

In India, we will soon start up ENSCO 54 after mobilizing the rig from the Middle East and forecast incremental rig requirements of 6 to 10 jackups in India in 2013.

Turning to the West Africa floater markets. We continue to see high levels of tender activity for floaters commencing operations into 2015. Final approval for ENSCO DS-7 in Angola was received this month. This contract is unique in that the day rate will average in the high $640,000 range over the 3-year term. The contract will commence as $615,000 per day, plus mobilization, and features pre-agreed increases in the day rate starting 90 days after commencement and every year thereafter. We agree with the client on the day rate in the third quarter of 2012, and it took some time to receive all the necessary approvals.

Looking ahead, we believe Angola still has unfulfilled demand of 4 to 6 floaters and expect other countries in West Africa to pick up 3 to 5 rigs in 2013.

In the Asia-Pacific region, we continue to increase in jackup day rates as evidenced by contracts we obtained on our premium rigs. ENSCO 105 obtained a 9-month contract at $150,000 per day, and ENSCO 109 achieved a contract in the mid-190s. We also added backlog on our standard fleet with ENSCO 67 and ENSCO 85, both getting rates in the mid- to high $130,000 range.

We contracted ENSCO 107 to OMV in New Zealand in the Maari Field development at a rate of $230,000 a day, plus mobilization and demobilization. This is a significant contract for many reasons.

First, the outstanding performance of ENSCO 107 and its crew was recognized by OMV as they direct negotiated the contract with us as their preferred drilling contractor. This is a great example of our focus on operational excellence and exceeding customer expectations.

Second, the presence of ENSCO 107 in New Zealand is expected to attract other operators to utilize the rig, resulting in a longer-term stay in the country than the initial 10-month term.

And last, the day rate is a leading-edge rate for this rig class and approaches the peak rate achieved during the last market upcycle, which bodes well for the future jackup market in the region.

We expect the Asia-Pacific jackup market to remain tightly balanced in 2013 even after considering 34 competitive newbuild jackups delivered this year since we believe the majority of these rigs are already committed.

In the quarter, we announced a significant deepwater contract for ENSCO 5006, with Inpex for development drilling on the Ichthys LNG Project located on the Northwest Australian Shelf. This project is a major gas to LNG project as the field contains about 13 trillion cubic feet of gas and more than 500 million barrels of condensate. The initial drilling phase of the project is estimated to take 40 months, with potential for a second phase that could take another 60 months. ENSCO 5006 was preferred by Inpex because it offers a very large deck area and is specifically designed for development and completion work. Inpex is further enhancing the rig by finding a major upgrade to make it fit-for-purpose for the project.

The day rate will begin in the low $460,000 range and average in the low $490,000 range over the 40-month program, a significant increase from the high $280,000 day rate this rig earned during the fourth quarter. Additional revenue from capital upgrades, mobilization and the shipyard stay will be incremental to this day rate. Inpex will mobilize the rig from the Eastern Mediterranean to the shipyard late this year.

The Asia-Pacific region has always been an active floater market and is now showing some deepwater growth. We just added 27 months of backlog on ENSCO 8504 with Shell. The rig will go to the Philippines for about 5 or 6 months before going to Malaysia for about 22 months. ENSCO 8504 has had excellent performance since starting operations in Brunei and was rewarded with a long-term contract and a day rate increase of approximately $100,000 per day over the current rate. We expect incremental deepwater requirements in Indonesia, Malaysia and Australia to materialize during the year.

In summary, we continue to have a very bullish outlook in terms of customer demand for both deepwater and shallow water offshore markets. We expect that visible demand should keep the market fairly balance for the foreseeable future even in the increase in the rig supply resulting from newbuild deliveries. You have to remember in the jackup market, in particular, a significant number of aging rigs face retirement, thereby reducing the available future supply. Approximately 45% of all jackup rigs are more than 30 years old.

Now let me turn the call over to Jay.

James W. Swent

Thanks, Kevin. Today, I'm going to cover highlights of our fourth quarter results, our outlook for the first quarter and full year 2013 and our financial positions. Before I begin, let me point out 2 items noted in our earnings release.

First, we sold 2 additional rigs in the fourth quarter, bringing our 2012 total to 5. The gain or loss on all 5 rig sales in 2012, as well as their operating results prior to disposal, have been reclassified to discontinued operations.

Second, during the fourth quarter, we reassessed our operating segments under the relevant accounting standards and decided to combine our deepwater and midwater assets into a single floater segment. Our jackup and other segments remain unchanged.

Now let's start with fourth quarter results versus prior year. As noted in our press release, fourth quarter earnings per diluted share were $0.94 compared to $0.99 last year. Earnings from continuing operations were $1.04 per share, up from $0.97 a year ago.

Certain items influenced the comparisons. Fourth quarter 2012 tax provision included $75 million or $0.33 per share of discrete tax items. This related mostly to restructuring subsidiaries from our acquisition to achieve enhanced tax efficiencies and improve capital management flexibility, which I had indicated we might do on a prior conference call. This process is mostly complete, but there will be additional subsidiary restructuring in the quarters ahead designed to give us added benefits.

We do not currently expect significant costs associated with further tax restructuring. The discrete tax items in the fourth quarter caused our effective rate to be 17% for the full year 2012. And for the full year, 2013, we expect our effective tax rate to be approximately 12%.

Acquisition-related costs in fourth quarter 2011 also influenced the year-to-year comparisons, including $4 million or $0.02 per share of severance and relocation costs and contract drilling expense and $8 million or $0.03 per share of acquisition-related costs and general and administrative expense. Adjusted for these items, earnings per share from continuing operations increased 34% to $1.37 from $1.02. The strong operating results reflect the growth of our fleet, cost synergies from our acquisition and the benefits of higher day rates.

Adjusted for lower-than-expected revenues related mostly to the delay in commencement of ENSCO DS-1 following its shipyard upgrade project, operating results were in line with our expectation. Total revenue for the quarter was $1.1 billion compared to $973 million a year ago. Revenues grew 12% year-over-year. Other revenues increased $672 million from $610 million, growing 10% from the prior year due to full quarter of operations for ENSCO DS-5, which contributed to a 3 percentage point increase in utilization to 83%; addition of ENSCO 8505 to the active fleet; and an 8% increase in average day rates to $368,000 per day.

Jackup segment revenues increased 15% due to a 15% increase in the average day rate to $111,000. Utilization for the jackup fleet in the fourth quarter was 87%, down from 88% a year ago. As Dan noted, utilization for our marketed jackups, all of which are contracted, was 92% in the fourth quarter and unchanged from the prior year.

Fourth quarter contract drilling expense for all segments totaled $525 million, up from $498 million in fourth quarter 2011. This increase is mostly related to the addition of ENSCO 8505 to the active fleet and a 9% increase in unit labor costs. Fourth quarter contract drilling expense was lower than our prior outlook, mostly due to lower repair and maintenance costs and $11 million in warranty claim settlements.

General and administrative expense for the quarter was $35 million, down from $40 million last year. And note that last year's number included $8 million in professional fees, severance costs and other acquisition-related costs.

Now let's discuss the first quarter outlook. Based on our current outlook, first quarter revenues are expected to increase by approximately 7% from the fourth quarter. This includes the impact of replacing connector bolts manufactured by GE Oil & Gas on some of our floaters as outlined in our press release earlier this month.

Further segment revenue is projected to increase by approximately 11%, primarily due the commencement of contracts for ENSCO 8506 and ENSCO DS-6, as well as increased utilization for ENSCO DS-1 after spending the fourth quarter in the shipyard. Utilization is expected to increase 2 percentage points from the fourth quarter to 85%. Average day rates are also expected to increase 4% to $381,000 per day.

Jackup segment revenue is projected to increase slightly as day rates continue to rise.

From an expense perspective, we anticipate first quarter 2013 total contract drilling expense will be up approximately 11% in the fourth quarter due to higher repair and maintenance costs relating to the jackup shipyard stays and $11 million in warranty claim settlements that benefited fourth quarter results.

Depreciation expense should increase 4% to $149 million as ENSCO 8506 and DS-6 commenced drilling operations. We anticipate G&A expense to be on par with fourth quarter levels. Other expense is anticipated to be approximately $37 million, comprised of $40 million of interest expense, partially offset by interest income.

Now let's move to the outlook for the full year 2013. Other revenues are estimated to increase on a percentage basis in the low 20% range year-over-year. ENSCO 8506 and ENSCO DS-6 have both recently commenced operations on multiyear contracts and will contribute to earnings in 2013. In addition, ENSCO DS-7 is scheduled to commence operations with Total in Angola in the fourth quarter. We expect floater segment utilization to be in the mid-80% range for 2013. This includes higher downtime estimates for new rigs coming out of the shipyard as they ramp up on their first drilling assignments, as well as planned shipyard stays.

Turning now to jackups. On average, 2013 reported utilization is expected to be in the mid-80% range. With respect to total contract drilling expense, we expect an increase of approximately 19% in 2013, primarily due to our growing active fleet, with operations expected to commence for 3 ultra-deepwater assets: ENSCO 8506, ENSCO DS-6 and ENSCO DS-7.

Also contributing to this year-over-year increase is a full year of operations for ENSCO 8505 and $63 million in warranty claims settlements during 2012, with no similar amounts contemplated in our 2013 outlook. Additionally, we anticipate an 8% increase in average unit labor rates for offshore employees to meet current market conditions. Please note that many of our long-term contracts include provisions that protect us from cost inflation, including labor.

If you look closely at our most recent Fleet Status Report, you'll notice several rigs receiving rate increases in the middle of their multiyear contracts directly related to these cost escalation provisions.

Depreciation is projected to increase approximately $60 million with the addition of the rigs I mentioned earlier. G&A expense is anticipated to be approximately $140 million, a significant decrease from last year and in line with our synergy targets. Interest expense is estimated to be $160 million net of approximately $65 million of interest that will be capitalized in 2013. We expect interest income for the year of $18 million due to interest earned on certain long-term contracts, reimbursement of mobilization and capital upgrade costs.

2013 capital spending, which is subject to change throughout the year, is forecasted to be $1.8 billion, which breaks out as follows: $1.2 billion in contractual commitments related to new rig construction, which includes the final milestone payments for ENSCO DS-7, ENSCO 120 and ENSCO 121; plus $350 million for rig enhancements; and $275 million for sustaining projects. And please note, approximately $80 million of the shipyard capital spending is reimbursed by our customers.

In terms of our financial position, we ended 2012 with $487 million of cash and $50 million of short-term investments, which were included in other assets. We had a 29% leverage ratio and $10 billion in contracted revenue backlog. During the first quarter, we added another $1 billion of revenue backlog, bringing the current total to $11 billion.

So in conclusion, we feel very good about the progress we made last year and remain optimistic for 2013. All 6 of our rigs under construction are on track and on budget for their delivery dates. Our growing fleet produced record revenues and earnings in 2012, and we expect rigs under construction will provide continued long-term growth for our company.

We have divested several older rigs and reinvested the proceeds back in our fleet as part of our continuous high-grading strategy. Integration of our operations in 2012, following our acquisition in 2011, has gone extraordinarily well, and we've exceeded our targeted synergies. We improved our leverage ratio to below 30% even as we increased our dividend by 7% and invested another $1.8 billion in our fleet last year. We plan to invest another $1.8 billion in our fleet this year and believe we have the flexibility to make further investments in our fleet while also returning additional capital to shareholders.

Now I'll turn the call back over.

Daniel W. Rabun

Thanks, Jay. Before we open it up for questions, I want to acknowledge our crews around the world and our onshore personnel, who once again exceeded our customers' expectations in 2012.

Yesterday, EnergyPoint issued their independent customer satisfaction ratings for the offshore drilling industry. And once again, Ensco was rated #1 by our customers. This recognition is very gratifying. We earned the #1 ranking in 10 of EnergyPoint's 16 individual categories, which reflects our commitment to safety, operational excellence and can-do attitude, all important core values of our company.

We have built an enduring trust with our customers, which is also evident in the sizable repeat business we continue to earn from customers who are happy with our people, our processes and our technology. We will continue to work hard in 2013 to maintain and build upon that trust.

Now operator, please open it up for questions.

Question-and-Answer Session

Operator

[Operator Instructions] And our first question is from Dave Wilson of Howard Weil.

David Wilson - Howard Weil Incorporated, Research Division

Jay, with regard to the upcoming shipyard payments in 2013 for the DS-7 and a couple 120 Series jackups, do you intend to debt-finance those -- some of those payments?

James W. Swent

Yes, David, at this point, the expectation is that those payments will be made from current cash flow. And I guess to answer your question a little more deeply, we really don't have any intent at this point to increase our long-term debt during the year. In fact, we actually have some scheduled repayments that will cause that to go down, probably about $75 million over the course of the year.

David Wilson - Howard Weil Incorporated, Research Division

Okay. And along that line of thinking, how do you -- with debt levels, cash flows, pending shipyard payments and possibly increasing the dividend, how do you balance all those? Do you think investors would like a little more debt in return for dividends? Or how do you guys think about that?

James W. Swent

Well, I think, as we said on the last call, we're in the very enviable position of being in a position to return capital to shareholders and also grow the business. We've got -- as I said in my remarks, we're investing $1.2 billion this year in newbuild CapEx for growth for the future. So I think as we've always said, we're in a position to do both, and all options are always on the table.

David Wilson - Howard Weil Incorporated, Research Division

Okay, great. And then I guess switching over to Kevin. While the current day rate trends would suggest otherwise, I get a sense that there are some angst out there regarding the number of jackup deliveries over the next couple of years, which you guys will have a few. But in relation to your existing fleet, given the various characteristics, its age, size, water depths, capabilities, how do you do the influx of these newbuilds in relation to your existing fleet?

Kevin C. Robert

First of all, we don't have any angst over the coming deliveries. I think from the comments, we see more than enough demand to absorb 2013 supply. All of our rigs, if we had more jackups in the fleet, they would all be working. Everything that we have has multiple opportunities, so I think we see that as a robust market and room for more growth.

Operator

And our next question is from Doug Becker of Bank of America Merrill Lynch.

Douglas L. Becker - BofA Merrill Lynch, Research Division

Kevin, the rate on the 8501 extension, which is ever so slightly lower than the rate on the 8506. Globally, we're seeing some idle time on equipment that classifies the lower end of the ultra-deepwater spectrum. Your commentary is very positive. But are you seeing any signs of weakness in the lower end of the ultra-deepwater market?

Kevin C. Robert

First of all, the rate on that rig does not have a mobilization attached to it, so the rate is actually higher than it is on the 8506, if you recognize that rate had mobilization in it. Second, there are multiple opportunities for all of our rigs in the Gulf of Mexico. As I mentioned, we see that as one of the strongest growing markets. So at this moment, no, I don't see any weakness in that market.

Douglas L. Becker - BofA Merrill Lynch, Research Division

Okay, perfect. And then just some of the downtime, I guess, in the last Fleet Status is related to the bolt issue. Just can you quantify how much time is in the bolt issue? Is there any difficulty getting the equipment? Just how do you see that playing out?

John Mark Burns

Regarding -- this is Mark Burns. Regarding the bolt issue, obviously, as you know, GE Oil & Gas issued a safety notice requiring us to inspect certain connector bolts on the model H-4 connectors. We have completed this inspection, and we anticipate no further downtime related to this issue. And the downtime, which we did occur [ph as a result of this matter, was reflected in our February Fleet Status Report.

Douglas L. Becker - BofA Merrill Lynch, Research Division

Good. And then Jay, just a housekeeping item. You mentioned the 19% increase in the contract drilling costs. What base are you using for that? I just couldn't see if there was some warranty.

James W. Swent

It's the total from last year, so just take last year's number and it's 19% on top of that, Doug. But obviously, part of the reason for that increase is we did have some warranty settlements in 2012 that we obviously would not outlook for in 2013.

Douglas L. Becker - BofA Merrill Lynch, Research Division

So the $2.028 billion?

James W. Swent

Yes, right from the press release table, exactly.

Operator

And next, we have a question from Jud Bailey of ISI Group.

Judson E. Bailey - ISI Group Inc., Research Division

Question on -- you mentioned in the press release the ability and flexibility as you continue to reinvest in your fleet and Ensco's historically done a very good job of that over the last decade plus. Can you just give us an update kind of where you're head is with the deepwater market still tight, jackup markets getting tighter? Any change in your thought process on looking at additional drillships or jackups or maybe even any semisubmersible designs that may be catching your attention?

Daniel W. Rabun

Well, I think, Jud, thanks for the question. As I always like to say, all options are on the table, and we're looking at all of those options at the moment. I don't think we're in a position to say much more than that just right now. As I said we've got $1.2 billion in CapEx for growth this year planned. I should remind everybody, there's a lot of leverage on those investments because the shipyards are giving us very attractive payment terms. So in this kind of environment, the returns on investment are pretty attractive and certainly exceed our hurdle rates and our cost of capital. So we'll continue to look at them.

Judson E. Bailey - ISI Group Inc., Research Division

Okay. And are the shipyards still offering pretty attractive terms? Is that -- has that waned any or is it still attractive enough that it has your attention, I guess?

Daniel W. Rabun

Yes, it's still pretty attractive, and it varies by shipyards in different geographies. But there are still pretty attractive terms out there, particularly for investment-grade buyers.

Judson E. Bailey - ISI Group Inc., Research Division

Okay. And my follow-up question, I guess, would be directed towards Kevin. Kevin, it looks like or it feels like the jackup market is probably growing tighter and seems actually a little stronger than the deepwater segment right now. And I wonder, number one, would you agree with that statement? And number two, I'm just curious of your thoughts behind what's been a quickly tightening market and what kind of lags the day -- or I'm sorry, the jackup market may have in 2013 and 2014?

Kevin C. Robert

Well, we definitely think the jackup market for 2013 is a strong market as we count available supply and visible demand. We see that as we sit right now this early in the year in balance, so that always bodes well going into the next year. Terms are increasing certainly in the Gulf of Mexico. It's a very tight supply; North Sea, tight supply. Asia Pacific, even with the newbuilds, there tends to be, right now, plenty of inquiry for all of the available rigs out there. So it's hard to find a weak spot right now. But at the same time, the jackup market every year has a lot of rigs rolling over on contract, so that whole market is visible about 12 months out. So it's hard to talk to that, Jud, more than just in 2013, very strong in '13.

Judson E. Bailey - ISI Group Inc., Research Division

Okay. And if I could just slip in one more and ask you about the DS-2, that rig comes up for renewal this year in Angola. You mentioned how strong that market is. Can you maybe give us some expectations on -- I assume Total will probably keep that rig. But anything, any color you can provide on that rig in that market and how we think about the rate for that one?

Patrick Carey Lowe

Jud, this is Carey. At this time, we really can't confirm to you what we're doing with it. But let's just say that the rig is very suited for Angola and we will let you know in the near term.

Operator

And the next question is from Robin Shoemaker of Citi.

Robin E. Shoemaker - Citigroup Inc, Research Division

And Kevin, I wanted to just pursue a little bit, the comments you made about Petrobras not needing any incremental rigs currently. But you seem to have successes as evidenced by your negotiations on the 6001 and 6002 in terms of renewing contracts on fleets that are there. There were some concerns probably totally unfounded a few months ago about an idea that Petrobras would replace older rigs in their fleet with newer rigs and so forth. Do you see any evidence of that? Or do you idea think that all the kind of incumbent rigs in Brazil will probably be renewed as their contracts expire?

Kevin C. Robert

Petrobras' strategy is very clear. It's not a big mystery. They've got an enormous workload in their existing basins, which they call post-salt. All the rigs that we have in that basin are very efficient and very productive for Petrobras. So that's why they want to keep those rigs. At the same time, there's an emerging business in Brazil that has enormous goals and needs a lot of rigs. That's the pre-salt. So as we see that pre-salt area develop and Petrobras, like any other company, has to balance their resources versus their needs, we think they want to not only keep, but continue to expand rigs in pre-salt. And as the rigs that they are building in the country, as it becomes clear when those rigs are available, I don't know if you can call it incremental capacity, but there's going to be rigs that need to go into the country to bridge the gap and expect the delivery of that fleet. So we see it as a strong market. There's discoveries announced every couple of months, and we don't see that stopping.

Robin E. Shoemaker - Citigroup Inc, Research Division

So no incremental -- you're saying no incremental rigs probably this year but very likely in the next few years, if those Brazilian-built rigs experience some delay?

Daniel W. Rabun

Actually, we expect to see Petrobras try to move within this year to extend and keep the rigs they have in the current fleet. If you want call that incremental, you can. It's going to keep those rigs in Brazil. They're there now, which, in effect, is incremental capacity. We expect that's going on. In terms of the rig count, when you look at them increasing that rig count, that's what I mean by maybe in the next 12 to 18 month, we don't see that going.

Robin E. Shoemaker - Citigroup Inc, Research Division

Okay. And then, Kevin, just one other thing on the -- the recent -- there's a new kind of, I guess, new/old competitor in the market now with this spin-off from Transocean and I'm sure that a lot of jackup tenders you're competing there. Is there any change in behavior that you've noticed with respect to those rigs and how they're marketed or what, if anything at all, has changed?

Kevin C. Robert

We really don't see that competition that much from that particular company. Our competition right now is trying to select who we want to work for, and our existing clients want to keep the rigs they have. So like I said in my comments, our biggest angst right now is we wish we had more jackups to spread around. At the same time, you're going to continue to have new companies and old companies in that market add and delete rigs. So I think it's an ever-changing, very dynamic market where your competitors are as much getting the right rig in the right places than they are other companies. So I don't think it's a real factor for us right now.

Operator

And the next question is from Rob MacKenzie of FBR Capital Markets.

Robert MacKenzie - FBR Capital Markets & Co., Research Division

Dan, I wanted to see if you could give us some more color on how you're thinking about returning more capital to shareholders, specifically the dividend? The last time you raised it, you talked a lot -- very similar to the way you are now. Can you give us more color on when and if we might see another dividend hike?

Daniel W. Rabun

So you weren't satisfied with Jay's answer? So I really don't have an awful lot to add other than what Jay has already commented on. As you know, we have the luxury of being able to do both, so we continue to evaluate that. And that's really about all I can say.

Robert MacKenzie - FBR Capital Markets & Co., Research Division

Okay, fair enough. Elsewhere, in the jackup rig market, do you view the Gulf of Mexico rates here as sustainable? It would seem so, given both the Mexican demand and the U.S. Gulf side. The high rates we've seen, is that more one-off? Or are we going to see more rates like that coming forward?

Daniel W. Rabun

I think that market has been somewhat for the last few years has been supply constrained. So while you have high commodity prices, specifically the oil prices that we're drilling in the Gulf of Mexico, I think you will see -- continue to have a healthy market because I don't see incremental rigs coming in the market. But I think it will continue to be fairly robust.

Robert MacKenzie - FBR Capital Markets & Co., Research Division

Right. And you answered my question earlier on Brazil.

Daniel W. Rabun

And Kevin alluded to the -- there is substantial incremental demand in Mexico this year, so that will continue to put pressure on the supply equation in the U.S. Gulf of Mexico, so it's potentially good.

Robert MacKenzie - FBR Capital Markets & Co., Research Division

And thus resulted in reactivation, perhaps. Right?

Daniel W. Rabun

I don't think there's a lot to reactivate though.

Operator

And next, we have a question from Ian Macpherson of Simmons & Company.

Ian Macpherson - Simmons & Company International, Research Division

I thought it was interesting that a couple of your recent deepwater contracts for the 5006, as well as the DS-7, have this day rate structure that almost looks like a contango curve. Is that a coincidence? Or is that some reflection on a new trend with regard to customers' expectations for the day rate structure going forward? And could you provide any color on what the peak day rates look like on those contracts towards the back end?

Kevin C. Robert

Ian, any time we contract a rig or bid a rig, we want to protect our margin. There's lots of different ways you can do that. The simplest way is just to pass-through all documented costs. At times, clients don't want to have the structure that way, and they want us to take the -- a risk, if you want to look at it that way, of anticipating our cost. So that's how those particular contracts got developed. It was really in response to the client wanting a different formula. So you can kind of calculate the math out. And as we publish our Fleet Status Reports, we'll update the rates as those rates kick in.

Ian Macpherson - Simmons & Company International, Research Division

Okay. Kevin, also...

Kevin C. Robert

We're very pleased with the methodology.

Ian Macpherson - Simmons & Company International, Research Division

Okay, good. I was wondering if you could share also how -- when we see the day rates for DS-7, how we should think about how you're budgeting the different operating costs for that rig as opposed to the DS-5 or similar rig in the Gulf of Mexico? What is that differential between the daily OpEx?

James W. Swent

You're seeing a delta there, Ian of around $30,000 a day on cash operating cost.

Operator

And the next question is from Gregory Lewis of Credit Suisse.

Gregory Lewis - Crédit Suisse AG, Research Division

So it looks like you changed the way you reported and you merged the midwater fleet with the deepwater fleet. Is there any read-through into sort of how you're thinking about those second- and third-generation semis that are in Brazil just given that the combination of those 2 operating segments?

Daniel W. Rabun

Greg, what happened, quite frankly, is when we did the acquisition, we set up 3 business or 3 segments because it seem like kind of a logical thing to do. And over time, that's just not the way we've been running the business. We run the business -- go down to any business unit and look how we're structured. There's people running the jackup businesses. There's people running the floater business. There's nobody running the midwater business. So it's just not -- the way we were reporting was not really reflective of the way we were running the business, for one thing. And obviously, we just sold one rig and that sector is a pretty small number in comparison to the total of the floater business. It really just didn't seem like a good use of anybody's time to report on a very small segment going forward. I think, Kevin certainly could comment on our view of the future, but I think there's still lots of work to be done in that sector and reasonably bright future for a lot of those rigs. But as I say, it was just a very, very small piece of the business and not reflective of how we were running at.

Gregory Lewis - Crédit Suisse AG, Research Division

Okay, perfect. And just, Kevin, if you could -- you mentioned a couple of opportunities in Mexico potentially and also in Peru. If you could just provide us a little bit more color and maybe the potential timing of maybe when those opportunities could present themselves? I think that will be pretty helpful.

Kevin C. Robert

Well, we can't comment on the ongoing negotiations. But most of the opportunities that I commented on earlier are in the market now or will be in the market in the next few months.

Operator

And next, we have a question from Darren Gacicia of Guggenheim.

Darren Gacicia - Guggenheim Securities, LLC, Research Division

Wanted to ask one on the cost escalation comments earlier in the -- in your prepared statements. It would strike me that if you have kind of a nominal increase in cost of around 19% for the year but most of those are covered. If you kind of take out the growth for kind of additions to the fleet, if you -- and kind of factor in the cost escalation clauses that will sort of apply, what would you say the net kind of real increase in costs sort of after those cost escalations sort of take effect really are?

James W. Swent

Well, I think, Darren, what we said is it's up 19%, and that reflects some inflationary issues and it reflects just growth with the fleet or activity with the growth of the fleet. So we see labor as probably the major component of cost that is going up. And we've said on balance across all geographies, there is a fair amount of variability from geography to geography. But on balance, we see about an 8% increase in labor. And I think you can look at really most of the rest of the increase is really activity-driven.

Darren Gacicia - Guggenheim Securities, LLC, Research Division

Got you. So the fleet addition component, then you're talking about the nominal cost number. I'm just trying to figure out, of that 8%, is 75% of that covered by the cost escalation clauses through the contracts? Or am I thinking about that the wrong way?

Daniel W. Rabun

For our long-term contracts, Darren, yes. Those have -- those contracts have protection against cost escalation. So the best example of that is, if you go out to our Fleet Status Report that we just issued on Tuesday and you look at many of the day rate increases for some of the rigs, you'll see that those are actually rate increases in the middle of multiyear terms. So those increases are reflective of the protection of those contracts for cost escalation, labor being the single largest factor related to that.

Kevin C. Robert

But it's difficult to give you a really precise answer to the question. I think you're asking because each one of these contract is different, and the basis for doing the cost escalation calculation varies very significantly between contracts. So we don't get 100% in very many cases, and we don't get 0 in very many cases. But there's a wide range of what you actually do get.

Darren Gacicia - Guggenheim Securities, LLC, Research Division

Got you. I mean, I guess what I'm trying to point out is it seems like the market may be missing to some degree, with the thought that people have a feeling that day rates have started to cap, and then they're worried about what happens with cost on either end. And I think what may be amiss is that the nominal number for cost is going up. But once you kind of factor in the pass-through, the inflation is really not as extreme as everybody seems.

Kevin C. Robert

I think it's a fair comment, and we see it that way.

Darren Gacicia - Guggenheim Securities, LLC, Research Division

And if I could sneak one more in. If I look at your leverage ratio, as you kind of end this year and head into next and the newbuild sort of deliver and cash flows pick up, you start to delever from the business. I'm kind of going after the dividend question, but I'm trying to look at it just a little different way. Because if you're going to reinvest or if you're going to pay out, is there some logic around kind of your net debt level that we should be thinking about for modeling purposes, if nothing else, in terms of either spend or payout and just getting a little bit of logic more on those lines.

Daniel W. Rabun

At the moment, I guess, we had described it as we have a scheduled debt repayment that will happen over time. And our intention is, as debt comes due, we'll pay it out of existing cash flow. Obviously, as time -- several years goes by, we'll reassess that. I'm pretty happy with the debt ratio that we're getting to. We always want to get down a little bit below 30, and we're achieving that this year. But as I said in my earlier comments, we have no intention right now to increase long-term debt. And at the moment, what's going to happen in the next year or 2 is we're just going to be making scheduled repayments that are pretty small numbers really for the next 2 years.

Darren Gacicia - Guggenheim Securities, LLC, Research Division

And is there any thought here to maybe use premium equity that could be yield-related to finance growth? Or is that something that is a little out of the ballpark?

Daniel W. Rabun

I think right now, we've got enough options on the table, just using our existing capital structure that we feel like anything we want to do is well-covered within the existing capital structure of the business right now.

Operator

And the next question is from Andreas Stubsrud of Pareto.

Andreas Stubsrud - Pareto Securities AS, Research Division

I have a question to your prepared remarks regarding ENSCO 121. I think you mentioned it and the profitability of getting a contract in the North Sea. Can you just repeat it and maybe elaborate a little around the potential contracts for this rig that will be delivered this year?

Daniel W. Rabun

Yes, I don't think we gave a comment about ENSCO 121 and the contract potential. I think we always said is we feel very good about the market with respect to that rig. But that having been said, I guess, I'll let Kevin comment on the different opportunities in the North Sea because there are quite a few out there.

Kevin C. Robert

Yes, there's actually, Andreas, a fairly active market with that tightness in the North Sea jackup market. There's a number of tenders out that the 121, the 122 type of rigs are working against. So we're positive about that for now.

Andreas Stubsrud - Pareto Securities AS, Research Division

Okay, great. So my follow-up question is that you secured a very nice contract for the first one, ENSCO 120, in my view. You're looking for a better contract, is that how you view the market at the moment, that it's a slightly better market or more or less the same? Or do you expect a lower day rate or a duration for the 2 last rigs?

Kevin C. Robert

We always want to do better than we did the last time.

Andreas Stubsrud - Pareto Securities AS, Research Division

Of course, but what do you think? Like, are we not even better in a tighter market? It looks a little on a supply demand balance, that it looks like an even tighter market, especially for the supply side based on some jacking system issues for some of your competitors.

Kevin C. Robert

Yes, I'm not going to speculate on that question right now.

Daniel W. Rabun

We'll choose our adjectives wisely.

Sean P. O'Neill

That was our last question, and we greatly appreciated everybody's participation on our call today. We look forward to talking to you on the next call. Thanks again.

Operator

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.

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