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Executives

Lyle C. Whitmarsh - Chief Executive Officer

Lesley Bolster - Chief Financial Officer

Brent J. Conway - President

Lisa Ciulka - Vice President, Investor Relations

Analysts

Dana Benner - AltaCorp Capital

Scott Treadwell - TD Securities

Andrew Bradford - Raymond James

James Spicer - Wells Fargo

Jon Morrison - CIBC

Kevin Lo - First Energy

Trinidad Drilling Ltd. (OTCPK:TDGCF) Q2 2013 Earnings Conference Call August 8, 2013 11:00 AM ET

Operator

Good morning. My name is Christy and I will be your conference operator today. At this time, I would like to welcome everyone to Trinidad Drilling Limited First Quarter 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) I would now like to turn the call over to Lisa Ciulka, Vice President, Investor Relations. Please go ahead.

Lisa Ciulka

Thank you and thanks for joining us today. We will be discussing Trinidad Drilling Limited's second quarter and year-to-date 2013 financial and operating results which were released last night. A full copy of the MD&A and financial statements along with a presentation outlining the quarter highlights are available on our website at trinidaddrilling.com. Our full second quarter results are also available on sedar.com.

Please note that during the call we will be discussing forward-looking information relating to various areas of our business, including but not limited to, the completion of rig construction programs on a timely and economic basis; the assumption that Trinidad's customers will honor their take-or-pay contracts; the ability for Trinidad to attract and retain qualified crews to operate their rigs; assumptions respecting capital expenditure programs by oil and gas exploration and production companies and other expectations about future events or performance.

Such information and statements involve known and unknown risks, uncertainties and other factors that may cause actual results or events to differ materially from those anticipated in such forward-looking information or statements, and you are cautioned to not unduly rely on such forward-looking statements. For a copy of our full forward-looking disclaimer, please refer to the disclaimer included in last night's press release and our MD&A.

To discuss our results, our view on the drilling sector and Trinidad's opportunities going forward, are Lyle Whitmarsh, Chief Executive Officer; Brent Conway, President; and Lesley Bolster, Chief Financial Officer. I will now turn the call over to Lyle.

Lyle C. Whitmarsh

Thank you, Lisa. Good morning, everybody. Trinidad performed well in the second quarter despite wet weather in Canada and lower activity levels in the U.S. We maintained stable dayrates and continued to significantly exceed Canadian industry average utilization. We also reached the milestone in our debt reduction strategy by repaying our revolving credit facility to zero and moving closer to our long-term leverage targets.

In the second quarter, industry activity levels remained fairly stable in the U.S. compared to the first quarter and were lower in Canada as a result of the typical seasonality experienced at this time of the year. Compared to the same quarter last year, the U.S. activity levels were lower due to weaker industry conditions that have been present for the past few quarters while Canadian utilization was unchanged.

During the second quarter, Trinidad's revenues totaled $165 million, down 5% from the same quarter last year and 33% from the first quarter of 2013. Revenue decreased year-over-year as a result of the lower operating days in the U.S. and international operations, driven by lower industry demand. When compared to the previous quarter, revenue was lower largely due to the spring break-up in Canada which restricts drilling activity and leads to lower utilization levels. Dayrates remained relatively unchanged compared to both the same quarter last year and the first quarter of 2013 reflecting Trinidad's fleet of high-performance equipment that remains in demand and its high contract base.

Operating income net percentage or operating margin was 36% in the second quarter, down from 40% in the same quarter last year and 43% in the first quarter of 2013. Operating margin was lower in the current quarter because of repairs and maintenance cost that were delayed in the first quarter in our Canadian operations and incurred in the second quarter. In addition, lower activity levels year-over-year in our U.S. and international division led to lower revenue generation and reduced operating margin.

Adjusted EBITDA was $40 million in the quarter, down from $53 million in the second quarter last year and $85 million in the first quarter of 2013. Adjusted EBITDA was lower than the same quarter last year due to the lower contribution from the U.S. and international operations and higher G&A costs. G&A costs in the quarter included a bad debt expense and higher professional fees. Adjusted EBITDA lowered from the first quarter largely as a result of spring break-up in Canada and higher G&A costs.

The bad debt expense that we recorded in the quartet had an impact of approximately $900,000 on adjusted EBITDA. The charge is not reflective of the trend that we see developing in the industry and we do not expect to have similar expenses in the coming quarters. Year to date in 2013, our G&A costs excluding stock-based compensation expense have totaled $29 million, approximately $4 million above the same period last year. We estimate that for the full year, our G&A expenses excluding stock-based compensation will be approximately $55 million.

Net earnings were $0.3 million in the quarter, down from $13 million in the same quarter last year and $33 million in the first quarter of 2013. Net earnings were lower than last year as a result of lower adjusted EBITDA, higher stock-based compensation, higher depreciation costs, and a loss on the sale of property equipment partly offset by lower income taxes.

Now, let's turn more specifically to our Canadian operations. In the second quarter, dayrates increased by $168 per operating day compared to the same quarter last year and $110 per operating day compared to the first quarter. Dayrates increase in both cases is largely a result of the five new high performance rigs that have been added over the past year. These rigs generate higher dayrates and increase the division average dayrate.

Utilization levels in the second quarter were in line with the same quarter last year, despite wet weather that led to an extended spring break-up. Trinidad was also able to record 146 more operating days this quarter compared to the same time last year as the new rigs added to the fleet were largely able to drill throughout break-up. As well, we continued to demonstrate our ability to outperform the industry, recording activity levels 6 percentage points above the industry average in the quarter. As expected, activity levels were lower in the second quarter than the first quarter because of the spring break-up.

Operating margin was 22% in our Canadian operations this quarter compared to 32% in the second quarter last year and 48% in the first quarter. Operating margin was lower in the current quarter because of repair and maintenance cost of about $2.5 million that were delayed from the first quarter and incurred in the second quarter. We are largely at this point caught up on these expenses.

During the quarter, we announced the sale of our coring rigs for $12 million in cash and have closed the transaction in the third quarter. This sale reflects our strategy to focus on deep modern contract drilling market where we have made a reputation as a high-performing driller. We find the returns are generally stronger in this part of the sector and also the opportunities for future growth in this segment of the market.

We are out of spring break-up now and activity levels have been increasing for the past few weeks. The slow start to summer meant that utilization levels were lower than expected for the first part of the third quarter, but activity has caught up to the 2012 levels and surpassed them now. The industry active rig count currently sits at approximately 341 rigs, 13% higher than this time last year. This equates to a utilization level of around 47% and Trinidad currently has about 55% of its fleet working today.

We expect that the demand will remain relatively firm for the remainder of 2013, and particularly for our large equipment. We are continuing to see strong demand for rigs to operate in the Montney and Duvernay and we are also seeing an increasing number of requests for deeper rigs with increased mud pumping capacity. Overall, we expect that utilization and margins for the full year in 2013 will be similar to what we saw last year. Dayrates remained stable for our high-end equipment. However, we may see some weakness in the mid-depth and shallow equipment over the summer months.

We recently announced a contract for a new build to drill in the Liard Basin, an area being developed to supply natural gas for the proposed LNG plant on the BC coast. This rig will be one of the largest, most technically advanced land rigs, operating in Canada once it is completed. We have signed a five-year take-or-pay contract with our customer for a minimum of 350 days per year. Our payback requirements have not changed for this new build and we expect to exceed our project return threshold and get our initial capital investment back in approximately four years. The size of the rig means there may be limited plays where we could put it to work across North America. However, the rig will be well-suited to several international locations giving us the opportunity to move it internationally if needed to maintain utilization.

A number of our customers are also active in the LNG development currently occurring in Canada. We've had several rigs working in such areas as the Duvernay and the Montney and expect that this activity will continue to drive strong demand for our high-performance equipment and may lead to additional new builds either later this year or in 2014. Trinidad currently has approximately 45% of its Canadian fleet under long-term take-or-pay contract which helps protect our revenue stream from some of the volatility present in the spot market.

Now, let's turn to our U.S. and international operations. Dayrates in our U.S. and international division have remained relatively unchanged for the past year. In the second quarter, they averaged $22,436 per operating day, down slightly from the first quarter this year. Trinidad, and in industry as a whole, productivity levels pulled back in the second half of 2012, however so far this year, Trinidad's utilization and the industry activity levels have stabilized. Our utilization averaged 73% in the quarter, up 1 percentage point from the previous quarter, as we saw a few incremental rigs go back to work.

We continue to see a strong demand for increased efficiency with customers requesting moving systems and high-pressure pumping systems. We are also seeing a growing interest in alternative fuel capabilities such as use of natural gas and bifuel, a mixture of natural gas and diesel, in place of the typical diesel fuelled rigs.

Operating margin in the U.S. and international division decreased in the quarter to 40% from 42% in the same quarter last year as we continued to maintain our fleet. The actual cost of this work was fairly unchanged from last year but as revenue levels came down at a higher rate, it had a negative impact on margins. Conversely, as an increase in revenue from the first quarter of 2013 and relatively stable repairs and maintenance cost led to improved margins in the second quarter compared to 38% in the first quarter.

We currently have approximately 80% of our U.S. fleet operating and expect it to remain at this level or slightly higher throughout the balance of the year. We expect the dayrates and margins will remain relatively stable for the remainder of 2013. While market conditions are competitive in the U.S., Trinidad's modern highly contracted fleet provides more stable activity and revenue generation than the industry as a whole. Our customers continue to be committed to our equipment and we currently have approximately 50% of our U.S. and international fleet under long-term take-or-pay contract.

Our Mexican operations performed well in the quarter contributing stable activity, revenue, and margins, and have been typical of these rates over the past few years. Unfortunately, the contract on the three rigs in Mexico expired at the end of the second quarter, and due to capital constraints at Pemex, our customer did not extend our contract. We believe that this reduction in activity by Pemex is temporary and anticipate the work could resume in Mexico in late 2013 or early 2014 with a possibility that additional equipment may also be required in the area. We expect that the rigs currently in Mexico will remain idle in the near term while we evaluate the available opportunities.

Moving on to our U.S. barge operations now, conditions in the barge market have remained strong. Dayrates in the second quarter were up US$1,971 per operating day from the same quarter last year and US$1,919 per operating day from the first quarter, reflecting the ongoing demand for high-quality equipment. Utilization in the quarter was also strong at 98% compared to 94% for the same quarter last year and 92% in the first quarter. We expect that both dayrates and utilization will remain firm in this division for the remainder of the year.

In the second quarter, we spent $15 million on capital expenditures, bringing our year-to-date total to $32 million. During the quarter, we continued work on that one remaining rig from our 2012 construction program and upgraded a number of existing rigs. The new rig was completed early in the third quarter and put into operation in the Duvernay Shale.

In conjunction with the new rig we recently announced for the Liard Basin, we increased our capital expenditure budget for the full year of 2013 to $140 million. This rig will be built at our in-house facility in Nisku, Alberta and we expect it to be delivered in the second half of 2014. As well as the cost incurred on this rig, we are planning on performing additional upgrades to existing rigs during the remainder of the year.

These upgrades are in response to a growing number of requests we are receiving from customers for increased efficiency and automation. These upgrades are typically done in conjunction with increased contract terms and higher dayrates. The type of work we will be doing includes, adding top drives, moving systems, increasing mud pump capacity, and the size of BOPs, and adding bifuel kits. As I mentioned earlier, there is some potential for new additional build contracts. However, these will most likely be for 2014 delivery with most if not all the cost spent next year.

We are also seeing a growing interest for equipment in several international locations. We have evaluated a number of different international locations over the years, but given the added risk, we have not been able to find the contract terms that meet our hurdle rates. These conditions appear to be improving with international customers understanding the importance of high-performance equipment and becoming more willing to agree to competitive terms. We have not signed any international contract at this point. However, we continue to carefully review these opportunities.

Overall, we have remained committed to maintaining conservative capital structure and expect to be very selective in those growth opportunities as we choose to pursue. At the end of the quarter, our total debt-to-EBITDA was 1.8 times, continuing to move closer to our long-term leverage target of approximately 1.5 times. In addition, we completely repaid our revolving credit facility during the quarter. We expect to be able to fund our increased capital budget in 2013 with free cash flow. However, we do anticipate that we will continue to utilize our credit facility in the normal course of business.

Part of our strategy is to maintain contract base that protects a portion of our revenue stream from the cycles in the industry. This strategy allows us to participate in the upside of the market when pricing increases while eliminating the impact of the down-cycle. We currently have approximately 50% of our total fleet under long-term take-or-pay contract with an average term of approximately 1.5 years remaining. To-date in 2013, we have seen conditions that are weaker than this time last year but they still remain steady. We are seeing some early indications from improved activity in 2014 and expect that the growing demand for high-performance equipment will continue to provide demand for our largely high-spec fleet.

Our recent announcement for a new rig to be built for the LNG development in Canada demonstrates that our existing customer base and reputation as a deep technical driller positions us well to participate in the LNG focused growth we anticipate continuing in 2013 and beyond. Our modern high-tech equipment, solid contract base, and growing financing flexibility will continue to drive more stable activity and EBITDA levels than the industry as a whole. Looking further out, Trinidad's growing free cash flow position and lower leverage will allow us to take advantage of expansion opportunities, both within North America and internationally.

Before I conclude, I would like to take a moment to thank the people at Trinidad Drilling who have worked so hard to help achieve our goals this quarter and for the past several years. We continue to strive for new goals and reach new milestones and make Trinidad a stronger and more profitable company and that positions us well for the future. Together, I believe that we have prepared Trinidad well for the coming years and I am confident that Trinidad will perform strongly through the future challenges and opportunities we encounter. Thank you for listening. I would now like to pass the call back to the operator and take any questions that may be on the line.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Dana Benner from AltaCorp Capital. Your line is open.

Dana Benner - AltaCorp Capital

I wanted to – I may have missed it, I know you gave some U.S. margin commentary and I understand the reason for the lower Canadian margins, but given your commentary that maybe a little bit slower start in Canada in Q3 but now we're back about the year ago levels, do you think there is a reasonable probability that we could see Canadian margins up at year ago levels on average for Q3 and maybe even Q4 overall?

Lyle C. Whitmarsh

Yes, I believe that we are fairly comfortable in moving towards that. We are seeing just recently some added interest in broad-based rigs. So I would think that would be a fair comment that we would be returning to more normalized rates at that point. I think that we're just starting to see it but I think the activity looks like it could be heading that way for sure in Q4.

Lesley Bolster

And if you remember, Dana, last year Q3 and Q4 activity levels really dropped off, and we are not seeing that same trend this year.

Dana Benner - AltaCorp Capital

That's great. Secondly, as it relates to Mexico, a note in your comments, maybe by the end of this year or early 2014 could see some things come back online, perhaps even expanded programs, is there any way to assess the probability of that happening, is this it might happen or are you feeling pretty good about it?

Lyle C. Whitmarsh

I think we're pretty comfortable. We just really are in the process of marketing. As we got notice from our customer there, we couldn't really react until we got the official word, and now we're out marketing. There has been some awarding of contracts down there. So we're pretty comfortable that there is going to be ability to execute and stay in Mexico. Barring that, we would certainly start to look at other opportunities, whether they would be in the U.S. or back to Canada, but right now I'm pretty comfortable with just what we are seeing.

We have spent a lot of time down in Mexico, we're well connected there. So we are seeing some positive signs throughout some of the more specific areas. We are evaluating the new leadership within the country which is nicely getting settled, and there is some definitely positive signs that we are seeing. So I have to say we're fairly comfortable but I still believe it will be towards the tail end of this year or into early 2014, but I'm pretty comfortable that we will be able to restart the rigs, and potentially if some of the tenders become more realized in these certain areas that we still believe there is potential for incremental rigs into that area.

Dana Benner - AltaCorp Capital

Right, that's great. Third question relates to your dividends. You've been very, very disciplined in your management of the balance sheet about a number of years here, within very closed-eye shot of your ultimate target, gives you the ability to look at projects like the Liard rig, et cetera, but I know you've held off looking at the dividend for a while. At what point does that maybe come into sharper focus and allow you to make a move there?

Brent J. Conway

The dividend, we look at it every quarter, I think it's just something right now that when we look at the landscape of what the demand is in both Canada and the U.S. and potentially on the international side, we may be able to put most if not all of our capital to work at return rates that make a lot of sense for our shareholders. So I think that's something we'll continue to look at. If that changes, then obviously it becomes more to the forefront, but right now it looks like we're going to be able to put pretty much all of our free cash flow back into the business at rates that are very attractive. So, that's really been the focus of the free cash flow as we continue to work towards our debt target. So that's really the way we look at it on a quarterly basis with our Board.

Dana Benner - AltaCorp Capital

Right, just one final question, from what we can gather, it looks like there's only been two formally tendered rigs awarded in the basin to yourselves and AKITA, maybe walk us through why you think you were one of only two players that actually win one of the formally tendered ultra-deep rigs, what did the client see in you, I know you have been a deep driller but maybe more color around that award would be helpful?

Lyle C. Whitmarsh

Yes, I think that when we look at it, it was a very extensive process and very technically challenging for I think everybody involved. I think when they looked at it, they looked at a lot of different boxes that required check marks from. I think where we really started to differentiate was our history, our in-house manufacturing was a very critical part of it, our track history on execution and delivery, on timing, and our safety record, and I think when we added up the entire package and our ability as a company over since 2005 entrant to key areas of development and show of outstanding performance and reduction in overall costs in areas that are continuing to tough I think are very difficult to operate in, and lowering that cost, I think really started to help us move towards the front. And then I think as they really started to look again back to some of our safety and overall package that we presented with internal manufacturing and basically our focus on this type of market well ahead of the peer group, I think we were awarded it based on that and I think we'll continue to see more of that evolve as the requests come in.

Dana Benner - AltaCorp Capital

That's great. I'll turn it back. Thank you.

Operator

Our next question comes from the line of Scott Treadwell from TD Securities. Your line is open.

Scott Treadwell - TD Securities

I guess maybe just on the comments you've made around the new build, I guess your thoughts on the temperature of the producers, you've got at least at the moment three rigs arrival in Mexico, there is some very deep very good rigs in the U.S., is there a potential for you to sort of short-circuit the build cycle by moving some of these rigs or it is customer desire for what kind of custom new build with the new car smell trump the sort of delivery timeline concerns that might be out there?

Lyle C. Whitmarsh

Yes, I think that's a great question. When we look at it, certainly the specification on the currently awarded contracts on the LNG up in Liard were certainly of a spec that were very higher to use any of the existing assets. There it was fairly formalized on that style. Even retrofitting or upgrading at that point was fairly tough I think for all involved including most of the guys that were involved on the [short lift] (ph). As we move through into some more of this development dependent on the Duvernay and different areas that we are discussing, there will might be some of that possibility but I still – I think that we are going to find a nice balance between depending on some of the existing rigs and I think that's why you're seeing us upgrade or increase our capital spending a little bit as we move through 2013 and into 2014 with these upgrades to some of the existing rigs for exactly the reasons you are describing.

Where we are starting to see the real big change is, the demand on the specification of the rigs that potentially were only six years old, for example a rig built six years ago, the demand and the specification of the rig has changed quite a bit. It's been is very steep learning curve for the industry, and I think companies are really focused on what sort of upgrades we can do to that rig to make it more competitive in today's market to eliminate, maybe not eliminate but to be more competitive against the new build to ensure that we are not – I think at Trinidad we are very careful not to displace ourselves with the new rig, and we've talked about that in previous quarters, where we don't like to build a new rig to park an idle rig that's six years old. So we are very, I think all customers in the industry, but definitely Trinidad is very focused on that, to not deploy a new rig in order to have one of our existing rigs parked, if that makes some color for you.

Scott Treadwell - TD Securities

That's great. There's obviously been a lot of talk about Liard and a fair bit of focus on the Montney, certainly with Progress. Horn River feels like it's kind of been forgotten to some degree. Do you have any visibility on sort of next year, whether it is new builds or just recycling of drilling activity, maybe some increases, what's your sort of thoughts on the temperature there?

Brent J. Conway

Specifically to the Horn you're asking or just?

Scott Treadwell - TD Securities

Yes, just sort of Horn River specifically.

Brent J. Conway

We have been active in Horn River last several years. I think it really depends on where gas pricing goes and kind of where the clients want to spend their money, but we have been active there, we have been active in Duvernay, we have been active in the Montney, and it's not really, this is not new business for us, it's just really kind of an extension and more highlight on what's happening there. So, I think eventually with others there are going to be more rigs that are going to be added there as well but it's really going to come down just to economics right now. It looks like we'll have some assets running in there but it really depends on where the clients want to focus their drilling program. There seems to be right now more focus on certainly on the Duvernay, the Montney, and probably the Liard Basin, and maybe to Horn but it's really totally driven by economics and where they want to spend their money.

Scott Treadwell - TD Securities

Okay. My sort of last question I guess about Canada is, just over the last 12 hours, you've seen a couple of producers announce increases to their drilling plans without sort of corresponding increases to overall CapEx. Obviously if you do the math, drilling efficiency and costs seem to be kind of carrying a day. Is that the sort of steam and feedback you're getting from your customers generally that could lead to, as you said, maybe some further increase in the back half of the year without CapEx dollars moving up?

Lyle C. Whitmarsh

Yes, I think that's the kind of trend we are seeing and I think that they are looking for them this year. I think the efficiency is not only I think one comportment to what we are starting to see in the trend, but we are also starting to see just the wellbore dynamics change a lot which is of course driving a little bit different than the efficiency but that's been driving change on what the spec of the rig is required to drill these sort of wells. For example, we are taking some of the rigs on the heavy double or ultra heavy double into ranges of the 5,000 metres type styled well. So I think at Liard, it's spot on. I think it's twofold. One is the efficiency gains, but then there is another side of this whole component that's starting to play in into what we are seeing, which is, there is just a stronger or more demand on what the rig equipment must be in order to be efficient.

So it's a double-edged sword but I think a lot of the rigs that we are currently seeing and I think we are starting to see a lot of that 1,000 horsepower styled assets fairly committed for to the next year for sure. So we are starting to see that, and as that demand starts to get more and more as we are seeing it, of course that drives pricing, it drives demand, and also it starts to drive the lower spec rigs that quite don't meet say the specification. Now our customers, if they continue to build, we could see ourselves as we enter into 2014 in a situation where again there is less capital spend but more of your lower spec rigs starting to fire back up just on pure demand, because a lot of the 1,000 horsepower rigs would appear to me, throughout the industry, but for sure Trinidad is pretty much committed at this point.

Scott Treadwell - TD Securities

Okay, great. My last question is based on Mexico, you mentioned the possibility of incremental equipment there. Just given the political risk and the ups and downs you see there and I would assume not the demand for the super high-spec rigs that you might see in some of the plays in North America, just the buying versus moving versus building argument sort of shift to where the best use of capital might be a new build or an upgrade in North America, and a sort of secondary use might be looking for rigs that sort of arbitrage into Mexico or some other solution?

Lyle C. Whitmarsh

Great question. They have raised their standard in Mexico for sure, their spec is certainly increased from our first deployment, but I do believe there is still some the style of wellbores we're drilling, the expectations and the spec, definitely allow us to have some mobilization of existing rigs versus the new rigs. Although I want to be clear that the specifications are definitely increasing and I still believe that there would be some opportunities to shift the existing assets in there with limited capital changes, but they have definitely been or the bench rigs tend to be much more higher-spec than we have seen in the past.

Scott Treadwell - TD Securities

Great, that's great color guys. Thanks very much. I'll turn it back.

Operator

Your next question comes from the line of Andrew Bradford from Raymond James. Your line is open.

Andrew Bradford - Raymond James

What are you doing to a six year old rig, following up on previous question here, what are you doing to a six year old rig to make it more marketable today?

Brent J. Conway

It depends on where we are going or what we've been asked to do with it. A lot of times it's moving systems, it's bifuel, it's increased mud pumping capacity, those are the types of things that – markets have moved a lot even in the last five years. It used to be that a 1,600 horsepower pump was totally acceptable and norm and now it's 1,800 and going larger, and the circulating system at 5,000 psi moving to 7,000 psi or 7,500 psi, BOPs, there are a number of things. And then obviously the moving systems, the ability to walk the rig, pretty much everything we've built has the ability to have that built on it. So it does allow us to leverage off that and in most cases get a contract extension and enhancement and get better returns. So that's really what we're really focused on, Andrew.

Andrew Bradford - Raymond James

Okay. Just is there a specific region or play in Canada where moving systems are more important than other places?

Brent J. Conway

I don't know where they are looking at pad drilling, obviously for Liard they are certainly looking at it, Montney, Duvernay. Usually the typical pattern is, you get in there with the high spec rig you think people want to drill that field with, we have rig pad drilling capability, we'll go in and we'll drill some wells that will make sure that they've got things working right, and then they'll come back and they'll start doing their pad drilling with a moving system. So it's still early days for some of the plays but that's typically the pattern we have seen in a lot of the other plays across North America, both Canada and the U.S.

Andrew Bradford - Raymond James

Just Progress would be the most active operator in the Montney region right now, I think they have something like 22 rigs running, as I counted you have seven rigs with them. Would any of those rigs have moving systems?

Lyle C. Whitmarsh

Yes, Andrew, but I think there's three or four that have a lot of them. Some of that – what really drives some of this is regulatory approvals. Progress included has to apply for a number obviously per well location, some of that can get a little bit regulatory in nature as they step back a tone from regulatory bodies. But there we do have some, and probably it would be safe to say, as they develop that field, then we start to more develop the pad drilling up there, but I believe that's definitely a trend that we'll be seeing.

And some of the existing rigs that we have in there that are not built for purpose or new build that we've had there or more existing rigs throughout the fleet, and so will be taken away I guess slowly and methodically, upgrading and getting them ready for where we see that trend. But definitely in areas like that I believe as regulatory approvals come down the lane and the environmental savings and the efficiency that they will continue to see that grow, and probably I think long-term, we are expecting the amount of wells per pad to increase, and the ability that we really need on the moving systems as the ability to not just move anymore in a direct straight line.

A lot of the advancements we're seeing is the ability to move on a well pad horizontally and move over. And sometimes depending on the geology of the well, of the pad, we might not necessarily drill in order and sequence, sometimes we're moving very, from one corner to the exact far corner. So that's where we have really seen the upgrades, and not only the move or scalability of the rig, but technically to be able to move from any given well on the pad at any given time.

Andrew Bradford - Raymond James

Okay, thank you very much. You just got a rig working, a new rig out in the Duvernay, and I know you have mentioned this before but can you remind me what the specs are on that rig?

Brent J. Conway

It's 1,500 horsepower AC.

Andrew Bradford - Raymond James

Say again, sir.

Brent J. Conway

It's a 1,500 horsepower AC new rig that we just built there.

Andrew Bradford - Raymond James

Okay, thanks. And then in your preamble, while you mentioned that you might – maybe I didn't hear you correctly, but I think you said something about that you might see some weakness in the mid and shallow range rigs in the third quarter and perhaps the fourth, did I catch that right?

Lyle C. Whitmarsh

Yes and no. We are still seeing that as the ultra-deep doubles are still fairly strong, heavy double is okay, and then after we get under that, we still see some fairly strong competition for rigs and securing work there. We think that can continue, although we are starting just recently, Andrew, to see some more positive as we move into again fourth quarter and into Q1 of 2014, we are seeing some, but just early signs of it, but I still believe that them are the areas that we are continuing to see the biggest pressure within Canada for sure.

Andrew Bradford - Raymond James

Okay, so it's not that you are seeing more weakness, it's just the continuation of what we've been experiencing?

Lyle C. Whitmarsh

Yes, that's a great point.

Andrew Bradford - Raymond James

Okay. And just, sorry I don't mean to hog the topic here, but I'm curious about how the economics of these bifuel kits work, because in most cases I think your fuel contracts or your contracts are with fuel on the outside of the contract, so how do you get a return on the bifuel kit?

Lyle C. Whitmarsh

Generally with an increase to cover the capital cost of it, so we'll increase the – try to get that we took either all upfront or over a term which pays back over time based on the savings that the operator receives from whatever efficiencies in costs they've been facing.

Andrew Bradford - Raymond James

Okay.

Lyle C. Whitmarsh

Yes, for us it's a capital cost allocation obviously. Then for the customer, the operator, their real savings obviously is in the – still today one of the most expensive cost to run the drilling rig is the generating of power, and if they could reduce that cost substantially, then obviously their efficiency reduces obviously their day-to-day well cost, and for us – plus not only that, obviously it's much more environmentally friendly in many ways and helps on obviously the supply and demand of gas. So for them I think it's a win on many fronts, and for us we believe in doing all that as we are very focused on the efficiencies but also on the environment as well, Andrew. So it's kind of a win-win for everybody.

Andrew Bradford - Raymond James

Okay that's good, thank you. And then last question I promise is, you've been talking for a while about looking at new international markets. Do you have rigs in your North American fleet that are the right architecture that you could simply do some upgrading and put them to work in some of these different areas, or are we talking about new builds entirely?

Brent J. Conway

Let me get the combination, Andrew, we do have some rigs that – depends on where it is going, but we have some rigs that could go as they are, and then in other areas we would have to do some upgrades, and then in other cases we are talking about new builds. Mexico is a classic example where there is a significant portion of the existing fleet that we work in Mexico but there's also – Pemex has come out and before kind of they put the brakes on it, they may have some what people are calling super tenders for new rigs, 1,500 and 2,000 horsepower ACs, that they were trying to bring in the country on longer-term contracts. So that's the direction they are going but really it's country specific.

So there are some rigs that we could definitely move and not have to spend a lot of capital at all, some we would have to upgrade, and then in some cases it would be looking at new builds, and that's really where we're chasing the economics that we need to justify that. Maybe it is getting a lot closer, like Lyle said, it's starting to, they are starting to look at high spec, they are starting to think that they need to pay for it, and so we continually negotiate, have been over the last several months, and it is certainly getting closer to what makes sense for us.

Andrew Bradford - Raymond James

I appreciate the color. Thank you very much guys.

Operator

The next question comes from the line of James Spicer from Wells Fargo. Your line is open.

James Spicer - Wells Fargo

Looking at the CapEx budget increase here, it looks like it's up about $60 million to $65 million from what you had previously guided. Just wondered if you could provide us a little bit more breakdown as to how much of that is related to the new rig you're building versus upgrades to the existing rigs, et cetera?

Lesley Bolster

James, we haven't given the specific cost of the new rig just for competitive reasons, but to kind of give you something, if you look at the rigs that we have been building over the past few years, those typical rigs are 1,500 horsepower rigs that go into the Duvernay or the Eagle Ford, and those rigs typically cost around $20 million. This rig is significantly bigger, it's a 3,000 horsepower rig and it's got a lot bigger equipment on it, it's got a bigger BOP, bigger top drives, pumps, and all those kinds of things. So that kind of gives you a scale of what the cost might be for that rig. Basically it's double the size of the 1,500 horsepower rigs. And then we'll probably spend about 60% of the cost of that rig this year and the rest of that will be spent in 2014. And then the remainder of the additional capital we announced was upgrades.

James Spicer - Wells Fargo

Okay, that's helpful. And then secondly, can you tell us how much EBITDA rigs in Mexico generated during the quarter?

Lesley Bolster

Those rigs, we don't give specific amount because we include that within our U.S. and international division, but those rigs typically generate a similar revenue and margin to the U.S. division.

James Spicer - Wells Fargo

Okay. That's it for me. Thank you.

Operator

Our next question comes from the line of Jon Morrison from CIBC. Your line is open.

Jon Morrison - CIBC

Sorry if I missed this in your preamble but what was the absolute amount of abnormal R&M spending in Canada in the quarter?

Lesley Bolster

$2.5 million.

Jon Morrison - CIBC

$2.5 million, okay. Any update on plans for the seven remaining shallow rigs that were part of your former specialty drilling divisions that remained post the sale of your coring assets?

Lyle C. Whitmarsh

Yes, I think we'll continue to operate it, and we are seeing part of the trend I guess we are seeing for that division, or was the fact that the request on equipment up there needed for recovery of tar sands area in Fort McMurray continued to look for more of a complete drilling package. So we were fairly confident we'll be continuing to supply them rigs up into that area for the winter months for sure and for sure into Q1. So we're pretty comfortable about the majority of that rigs that worked last year out of that seven units. We'll return back out there late Q4 and operate through into Q1 working in that area. So, we're very comfortable with those rigs going back to work.

Jon Morrison - CIBC

So it's safe to think of them as largely just coring rigs on a go forward basis?

Lyle C. Whitmarsh

Yes, exactly. Predominantly the rigs we just concluded the sale on were much smaller rigs, they were a class probably below what we would call to think of style rig that we're currently deploying out there, and that was a fundamental driver of why we were looking at selling the lower, the smaller spec rigs. So we are seeing much more request from our customer base in that area for a much more full-fledged style drilling regulatory relief-wise, we are seeing much more request for full BOPs, and just an overall capacity they're looking, and quite honestly the skill set and the people that we can deploy on that rigs comes with a little bit more of a pure drilling background, which as you have seen, some of the larger customer base out there is demanding a much higher safety and performance record on a quarter basis. So in order to get that, these rigs should fit nicely into that, and the rigs that we just sold were starting to be an issue to try to meet that standard.

Jon Morrison - CIBC

Just to follow on Brent with a question about international, can you just give an update on kind of your growth initiatives in that market and whether the rebound or pending rebound in new build opportunities in Canada starts to tamper some of those expectations or aspirations over the coming period?

Lyle C. Whitmarsh

Yes, I think that we'll continue to search areas where the returns are first of all I guess associated with risk and then internal hurdle rates as our Board places a dimension into our best use to capital, but I also think that one of our focus point as a strategy over time is to focus on areas outside of the North American swing of commodity pricing. So we've been very aware of that and I think we will start to strategize over the next few quarters and into 2014 on what we can do to protect our shareholders a little bit more from the swing, from the commodity pricing, totally North American based.

And so I think that the opportunity is going to be evaluated on based on all the metrics mentioned but still on a much longer strategic initiative to try to also look outside of just the North American commodity pricing swing, and quite frankly take our high spec model that has been working since 2005 in the areas where we believe we can provide them efficiencies and secure long-term contracts for our shareholders as well. So, kind of a balanced fill by what I think a driver of strategic planning for managing commodity swings a little better than in just one specific area.

Jon Morrison - CIBC

Specific to Mexico, what gets you excited about that market and possibly deploying more rigs? I realize that there are some things that are soft, foreign direct investment changes that could be coming if the size of the prize is big, but if you look at your past history in the country, it's been okay but it's been choppy and up-and-down which is kind of back in now at the most recent slowdown, but other than being established in the country, what actually gets you excited about that market?

Brent J. Conway

I guess for us since the day we've been in there, we've been on nothing but dayrates and we've been on contract the whole time. So, while it has been choppy and up-and-down, for us really it's been a good EBITDA basin or a good EBITDA based business and we are getting good returns there. The thing that's changed, I think that a lot of people are getting excited about, is the fact that the Pemex is rethinking the way that they are doing things and going in there with a different approach. They have done some programs where they have gone ahead and drilled and they are allowing the multi-service providers, the Weatherford, the Halliburton, and the Schlumberger, to go in there and drill wells like they should have been drilled in the first place, and not so focused on, you'll get $1 million to drill a well and we don't really care what the production is, they are incentifying them to drill them properly because they get a share in the production. And when they had done that, it actually had some pretty good results.

And so that's the change I think that everybody is excited about, it still has to play out here over the next little while, and the size of the prize is huge in Puerto Rico specific to each contract, they know it's there, it's just they just weren't getting that out of the ground the proper way. And then if you look in the south around Villa Hermosa, there is certainly lots of areas there that looked like they are very promising too, and they do need to do something, the offshore stuff for them is usually a decline.

So them moving the right direction, Pemex is moving the right direction, they are a powerful client and they will do some things that make a lot of sense. Yes, they allow I would say the technical aspect of the wells to be drilled the proper way and not worried about – the only issue there is typically that you're dealing with a client that is also a government. So they aren't always necessarily motivated the same way a standard E&P would be, but certainly based on what we see right now and based on what they are saying and based on what others are being told, it looks like they're going to get busy and they're going to be going in there with a new approach, and if that's the case, then the economics will make more sense and that just means we're going to get busier.

So that's really what we are looking at. When we say we're going to be able to add more rigs, we do have a number of people we are talking to that have looked at this and are looking at kind of end of this year and into Q1 and saying that, we are going to need a number of rigs to drill these 300 well tenders or 500 well tenders, and so that's really what's driving our I guess optimism around what it could be kind of going into Q4, Q1.

Jon Morrison - CIBC

With the market kind of going that way, is there any appetite to shift towards any production sharing arrangements as compared to the dayrate if there's opportunity to grow under that type of a scenario with an IPM arrangement?

Brent J. Conway

They've done that with the IPM companies. When they approach us with that, it's typically we have no issue going on a dayrate with a performance kicker so that if we drill it quicker we get paid more, we've done that before, but we're not going to take the risk on commodity pricing and we're not going to take a risk on exploration risk. We've already got risk attached to our asset, the point of the asset and the return on the asset. So if that was an add-on after we get a return, yes, we would look at it, but sitting on generally, that conversation is we are not an E&P company and we don't have the expertise that we believe we would need to do that to make it so that we would actually be attending on that to get a return. We would much rather lock in our return in the business that we know well, and if that showed up as a performance kicker or some type of an add-on production, bolt-on, then we might say, yes that's fine, but we certainly want to get our required returns first.

Jon Morrison - CIBC

Last one for me, what's the absolute number of rigs that you guys feel comfortable delivering either from an operational or execution point of view or financial perspective in 2014? I realize the mix of the assets is a large component of that but assuming 1,500 horsepower triples for instance?

Brent J. Conway

I was going to say, it is totally mix and it is depending on where they are, like putting five or six rigs into a new area is certainly a lot harder than putting them in our own backyard, but we've always told the market that the sweet spot for us is kind of that 8 to 10, maybe 12 rigs, depending on size, depending on location, that's what our TDM in-house manufacturing group decides to do today. And to go beyond that would we have to have people and it will take us a while to ramp up to do that, and really at that number, kind of we'd still stay within cash flow but still within our manufacturing capability and that makes a lot of sense. I think we have to be, we have to see a lot of demand and we have to see a lot of opportunity to go beyond that, but obviously we'll see where the market takes us, but that's kind of where we're starting today.

Jon Morrison - CIBC

Appreciate the color, that's all I had, I'll turn it back.

Operator

Our next question comes from the line of Kevin Lo from First Energy. Your line is open.

Kevin Lo - First Energy

As I read through the commentary in the beginning, through your debt repayment, deleveraging phase and you are into growth mode, so at this point would you see – what's the constraint today, is it just the contract doesn't meeting your threshold, is it capital, or is it just trying to figure out where to best allocate the capital [indiscernible] or could you kind of give us a sense of that?

Lyle C. Whitmarsh

I think of late kind of – it's a great question as well because I think lately we have seen a little bit of incremental assets hitting the market to take up some of the demand on request of the new builds throughout the industry, and that would be a little bit more based in the U.S. but also in Canada as well. So I think it's predominantly from an economic perspective on returns that seems to be – still as things slow and incremental rigs come on, obviously some of the incremental rigs will drive down returns for Trinidad. We have been very selective and also trying to stay focused on areas of long-term development, like the LNG has been a real focus of the Board and management at Trinidad.

So trying to find the balance between them on our return calculation but also trying to be specific on areas that we believe are longer-term fundamental areas that we can develop in trying to find that balance. And I think from that, Kevin, we've been just really focused on that and using that model as well internationally to evaluate different opportunities, and then again trying to find out balance on our free cash flow and which best area on the risk-reward perspective works. But I think predominantly what we have seen in the past little bit is just probably more on an economic return basis, has been one of our hurdles for sure.

And I think secondly some of the issues that are coming up just on the horizon that we are seeing, that we are managing as a company and as an industry, is the assignment of liabilities is becoming a big issue on what that might look like for a drilling contractor to sign some of these new build opportunities, and of course as you know, indemnification is tough for a big part of our business and we have to protect our shareholders and we're very cautious and very I guess focused on ensuring we don't add any incremental risk. Although the returns might be there, we still have to manage our indemnifications, and I think that's starting to be on the forefront of a lot of the contract negotiations and different acceptance at different companies and different Board levels will be coming out here in the next little bit.

So, I hope that gives you the kind of color on the two fronts that we are probably just making sure that we are protecting our shareholders on a return, but also from an indemnification perspective making sure that we are not adding any incremental risk to our shareholders, because ultimately if you get the rate of return you need but you've exposed yourself on an indemnification on a quasi-contract on risk, I don't know if you could justify the return for that incremental risk. So I hope that's helpful color.

Kevin Lo - First Energy

Yes, that's great. In terms of your rigs today, how many of the existing fleet do you think you can still upgrade based on what you see from customer demand?

Lyle C. Whitmarsh

I think ultimately we're still, as I mentioned before I think with Andrew when he asked the question on a six year old rig, it's kind of an interesting discussion we have around our operation and Board tables on that exact topic, when we are talking about six year old rigs that today when the market tightens up and gets continued to add incremental pressure on specifications and efficiencies, that number probably grows in this type of market to even further than Trinidad with a high concentration of spec rates and Tier 1 probably still grows to 30%, probably higher, maybe even as high as 50%, could receive some sort of upgrades, and as the market picks up, kind of the temperament is to be able to use a lower spec rig and probably set us back a little bit.

But I'm saying probably still as it's been today, it's between 30% and 50% of our fleet could see some sort of capital upgrade to improve the efficiencies and that could result in just pump upgrade and/or a combination of any of the things we mentioned earlier, but I still think there is a lot of room for improvement for upgrades on this equipment over time to secure incremental contracts or extend contracts, and I think as the new builds, if we continue to see pressure on the things as we mentioned on your first question, then I think you'll continue to see Trinidad and the industry focus on these other capital expenditures which helps drive maintaining or even increasing the EBITDA base within just smaller allocation of capital to the existing fleet.

Kevin Lo - First Energy

Okay, great. I know one of the things that you guys have been working on is cost and focus on margins, et cetera, I mean do you think there's any more margin and cost you can squeeze out of the business right now?

Lyle C. Whitmarsh

I think we are always looking and trying and looking at different, everything from crew structure to how we run our business. The industry as a whole now with the training costs and with safety and everything better, it continues to be fairly efficient, but we still look at it, but honestly over what we are currently seeing, we are preparing to see crew wages again, but really from a safety perspective and an overall maintenance perspective, these new big rigs continue to be very expensive to maintain and certify over the life or the three-year, five-year cycle. So I think we are fairly there but I think we keep looking for efficiencies and long-term ways to increase that, but right now I think it continues to be a struggle just on a training and safety perspective alone.

Kevin Lo - First Energy

Great. Last question, just can you kind of give us a sense of what the burn rate of Mexico is on a quarterly basis?

Lesley Bolster

Are you talking cost?

Kevin Lo - First Energy

Yes, yes sort of.

Lyle C. Whitmarsh

As of today, we have really skeletoned down that old division, so it will be non-impactful. We have a few audits going on, we have basically rocked the rigs, we have reallocated our crews to different divisions, and so we have very little to no impact on that as a burn rate for the next few quarters.

Kevin Lo - First Energy

Okay, great. Thanks. That's all for me.

Operator

I will now turn the conference back over to Ms. Ciulka for closing remarks.

Lisa Ciulka

Thanks operator and thank you for taking the time to stay on our call. We look forward to talking to you again soon.

Operator

Ladies and gentlemen, this does conclude today's conference call. Thank you for your participation. You may now disconnect.

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