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Diamond Offshore Drilling Inc.

Q3 2009 Earnings Call

October 22, 2009 10:00 am ET

Executives

Les Van Dyke - Director of IR

Larry Dickerson - President and CEO

Gary Krenek - Senior VP and CFO

Bob Blair - Senior VP of Contracts and Marketing

Analysts

Dan Boyd - Goldman Sachs

Scott Burk - Oppenheimer

Ian Macpherson - Simmons & Company

Arun Jayaram - Credit Suisse

Judson Bailey - Jeffries & Company

Joe Hill - Tudor, Pickering

Rob Mackenzie - FBR Capital Markets

Geoff Kieburtz - Weeden

Pierre Conner - Capital One Southcoast

Operator

At this time I would like to welcome everyone to the Diamond Offshore Drilling third quarter 2009 results conference call. (Operator Instructions).

I would now like to turn the conference over to Mr. Les Van Dyke, Director of Investor Relations. Please go ahead sir.

Les Van Dyke

With me on the call today are Larry Dickerson, President and Chief Executive Officer, John Vecchio, Executive Vice President, Gary Krenek, Senior Vice President and Chief Financial Officer, and Bob Blair, Senior Vice President of Contracts and Marketing.

Before Larry begins his remarks, I should remind you that statements made during this conference call may constitute forward-looking statements, and are inherently subject to a variety of risks and uncertainties that could cause actual results to differ materially from those projected.

Forward-looking statements include but are not limited to discussions about future revenues and earnings, capital expenditures, industry conditions and competition, dates that drilling rigs will enter service as well as management’s plans and objectives for the future.

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

After we have discussed our results, we will have a question-and-answer session during which we ask that you please limit yourself to one question and one follow-up. So that we can open the floor to as many people as possible.

With that, I'll turn the meeting over to Larry.

Larry Dickerson

Thank you, Les and welcome everybody to our third quarter 2009 conference call. I think this quarter that just ended was a period of time where Diamond Offshore was able to execute against its strategy in a tremendous manner, obviously the first thing to talk about is within a space of 100 days we acquired both P2 and P3 rigs at auction. As everyone knows these are modern, newly constructed, well-designed, dynamically positioned drilling rigs capable of drilling in up to 10,000 feet of water. We renamed the rigs Ocean Courage and Ocean Valor. We have since contracted the Ocean Courage and we are working on contracting the Ocean Valor. I will return to that in a minute.

Our strategy has always been to take advantage of markets at points in time, when prices are advantageous. We think the prices that you compared that we paid for these rigs in the $400 million compared very well not only to peak pricing, but to what pricing maybe for an order at the shipyard today and of course we have immediate delivery and no shipyard risk.

We continued on our strategy of making sure that we are able to return parts of our earnings as a part of our strategy of maximizing shareholder value and this is done through the dividends, which we declared a combined regular and special dividend of $2.25 again this quarter.

We also used our very strong balance sheet to go to the debt markets. In May we borrowed $5 million tenure money in '05 and '07, '08 and we returned right at the end of the quarter. Gary Krenek will talk about how it's impacted in the balance sheet because we closed on the deal or made the offering on September 30th of $500 million 30 year notes at an outstanding interest rate of 5.7%.

So our strategy as we've looked at them on the acquisition of these rigs, have been to acquire, to buy, borrow and then contract. We put the Courage to bid and we're working on the Valor along those lines. And this methodology does not divert cash that we're continuing to pay on dividends.

And then most importantly we have to attend to our business and execute very well. We were pleased with our results in the quarter where expenses were flat quarter-over-quarter. They are down from where they were last year and in December the fourth quarter of 2008. And this is with actually more rigs being delivered and working during that time period, so that's a great achievement.

Our G&A is also in line. We were able to manage the amount of downtime that we occurred in our fleet very well, so we were pleased with the results that we had across the fleet.

I'll make some brief comments about the market before we turn over to questions and both I and Bob Blair will be available to answer some of your more detailed questions.

First, let me comment on the Valor. We have interest in the rig, but I am not going to comment specifically on any contract that we might make or what our marketing strategy is. We think that's best conducted between us and the customers and that we will continue to utilize our fleet status report and other such public mechanisms to make the announcements as to rates that we obtained for that rig. But we think if you look at the availability in the worldwide fleet and the capability of that rig, I think we're in a very good position to be able to put that rig to bid.

I think in general we’ve seen, although we haven't, we don't have any evidence yet on our fleet status report that there is increased interest in the U.S. Gulf of Mexico for jack-ups. It’s a minor part of our fleet. We only have two active rigs there, although the Ocean Columbia will be returning from Mexico, so we’ll be at three active rigs potentially in the Gulf of Mexico. But we're very pleased at the level of activity and inquiries we have for our rigs.

We also in the last quarter have taken some steps to move into other markets with rigs that were previously idle. The Ocean Guardian which was idle in the North Sea and our belief that operators would be allowed to pick up a rig and winter weather caused us to relocate the rig or will be relocating the rig to the Falkland Islands whereas in the southern hemisphere it will be relative summer and we’ll be able to drill down there.

And then we just recently announced that the Ocean Star will be leaving the U.S. Gulf of Mexico where it's been idled for sometime and a difficulty putting a moored rig to work during hurricane season has caused us to sign a one year contract with OGX which brings to four the number of rigs that we’ll have working for OGX down in Brazil. So that's pretty much what's happening in the market. I think in general the high oil price has helped and has some confidence going on as people look around to what they may want to contract.

Then finally the Ocean Valiant arrived for 16 days activity in the quarter in Angola, marks our return to West Africa, a market that we worked in over the years, but have been absence from for the last four or five years. Frankly we just haven't had enough equipment to move there, but again this was a rig that we have a two-year contract with Total in Angola, and we are very pleased to return to that market and to begin working for Total, as we have worked for over the years, but its again been a couple years since we had a rig work.

So that concludes my opening remarks and status of our fleet and market, and we will now take your questions.

I am sorry, Gary Krenek will make some comment on the accounting processes that are in place on some of the transactions and also provide some guidance as to where costs are headed.

Gary Krenek

As Larry commented our two most significant events for the quarter occurred right toward the end of the quarter and that was the acquisition of Ocean Valor and our issuance of $500 million of 30 year debt at a fixed interest rate of 5.7%.

To expand on that just a bit, the acquisition of the rig did occur in the third quarter and thus it reflected in our financial statements as so. The debt issuance however, while being priced and announced in September 30th, do not close until October 5th, and thus is considered a fourth quarter event for accounting purposes and is not included in our September 30th financial statements that we released with our press release today.

Our third quarter results are pretty clean with operating expenses coming within expectations and within the range that we gave at our last conference call. The most significant item that did vary from our prior guidance was our tax expense rate, which came in slightly lower at 23.4%, lower than the 25% to 27% range that we had previously expected.

Slower range was due to us being able to recognize some foreign tax credits that we had not been able to do previously due to accounting rules. We expect this to partially affect our fourth quarter rate also and expect the Q4 rate to be in the 24% to 25% range with next year's tax rate in 2010 coming in somewhere between 24% and 26%.

Looking forward to other fourth quarter items, we again expect to incur normal daily operating cost for our rigs as outlined in the rig status report that we filed earlier this morning. These normal daily operating costs will be inflated slightly as a large number of larger expense projects that were budgeted earlier in the year are now set to be completed in the fourth quarter adding approximately $10 million to our cost in the fourth quarter.

In addition, we'll spend some $8 million to $10 million to complete the survey with Ocean Guardian, which was begun in the third quarter and to do some repair work on the jack-up Ocean Columbia.

The Ocean Courage is moving to the Gulf of Mexico, as Larry said and the Valor will continue its commissioning work for the bulk of the fourth quarter and thus the cost associated with these rigs will either be deferred as in the case of the Courage or capitalized in the case of the Valor in accordance with GAAP.

However, both rigs will experience some costs that will be expensed during the fourth quarter and we expect those combined costs to total somewhere in the $6 million range. We will also record in the upcoming quarters from $7.5 million in amortized mobe and contract prep costs that have been previously deferred and we will also record approximately the same amount or slightly more a deferred mobilization revenue costs that were previously deferred.

Offsetting these costs will be a reduction in our daily operating expense of approximately $8 million, as we defer operating costs incurred during mobe and contract prep time for the Star and the Lexington related to term contracts in Brazil.

We’ll also save another approximately $7 million in Q4 as a result of our reducing costs on the Ocean Bounty which is currently stacked in Australia. Again if you do the math this should result in expected rig operating cost excluding reimbursable cost as always of 315 to 330 million for the fourth quarter of 2009.

Looking further down the P&L statement, we are revising our guidance for DD&A and interest expense as a result of acquisition of the Courage and our most recent debt issuance. Depreciation expense should run $89 to $91 million in the fourth quarter and interest expense should be approximately $21 million per quarter on an ongoing basis.

Our updated capital expenditure guidance for 2009 is for us to spend some $420 million for maintenance capital, additional spare parts and required upgrades needed to comply with international contracts that we’ve been awarded. This guidance is relatively consistent with what we’ve been saying in the past quarters.

In addition to this maintenance capital, we expect to spend some $980 million for the acquisition of Ocean Courage, the Ocean Valor and other major upgrades that were completed earlier this year primarily the completion of Ocean Monarch.

And finally as always I would refer you to our rig status report which can be found on our website for expected downtime for our rigs for the remainder of the year, contract durations, timing of contract rollovers and other pertinent information.

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

Larry Dickerson

Operator, I believe we're ready for Q&A session.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) Your first question is from Dan Boyd with Goldman Sachs.

Dan Boyd - Goldman Sachs

Quick question on what your outlook is in Australia. I know there are a number of L&G projects that have reached FID, and maybe that demand is out for some years, but you do have a couple of rigs there now, one of them currently idle. If we could look out two to five years what are your expectations for that market?

Larry Dickerson

I'll let Bob Blair comment on that. I guess the rig we have idle there, the Ocean Bounty is the rig that we took off of a contract and put the Ocean America on instead to provide some more capability in that market. The Bounty requires a substantial amount of shipyard work to refurbish the rig and we’ve pretty much elected at this time to defer that decision and to keep the Bounty in a cold stack mode for sometime. But Bob, any comments looking out.

Bob Blair

Well, the two floaters that we have in the area have contracts extending to 2011 or late 2010. We’ve already begun discussions with the current operators about ongoing work as well as the operator that who are moving the Ocean America to Australia. And all indications are that there continues to be interest in the drilling programs that these rigs are working on. We see it as a viable market going forward.

Dan Boyd - Goldman Sachs

Your comment on the Bounty actually brings me to my next question. I think that's a good point. There are a lot of jack-ups at the end, mid-water rigs out there that are idle currently. Can you talk about the market of some of those rigs need quite a bit of investment before they’d be brought back, and what level of demand or day rate do you think you would need to see to bring those rigs back. Can you talk generally about your fleet some of rigs that what type of investment they might require?

Larry Dickerson

Well, it all depends on what sort of market we'd want to put the Bounty back into service for, but we are $50 million to $100 million in cost to refurbish that rig is our estimate without any sort of substantial upgrade. At one point in time, we have done one of our Victory-class upgrade since that, where the rig is, but at the moment we’d much rather put our money into acquisitions similar to the Courage and Valor. It's the same thing on refurbishing the Bounty, that number it was at the high end $100 million dollars, I think is better spent at the acquisition prices that we're seeing right now on those two rigs.

So, we're just deferring that. I don't know where everybody else is, but ideally the market will turn around and get good again and then you will be sitting there missing part of it, because you will be sitting in the shipyard. Ideally, you should have crystal ball and be able to predict and go into the shipyard in advance of that.

We would typically use this downtime to do that, but given that we have a substantial fleet of second and third generation rigs, we don't think at the moment we need to spend more money there. We're not giving up on the unit. We will refurbish it at some point in time, but as I said there just better place to put your money.

Dan Boyd - Goldman Sachs

How about on the jack-ups?

Larry Dickerson

Jack-up refurbishment, we have completed a rework of our jack-up fleet over the past five to six years of leg extensions and life extensions and a lot of these units have deterioration in their voyage spaces if they have operated in certain climates and we have attended to all that.

So, I don't know where everybody else is. Certainly we have seen on the mat rigs and we have stacked our three mat rigs, but we have seen those rigs the margins are so razor thin that they can't stand any several million dollar refurbishment that they start looking at, at the moment, they got to go back in to the shipyard, but that's about all the help I guess I can give you on other people's rigs.

Operator

Your next question is from the line of Scott Burk with Oppenheimer.

Scott Burk - Oppenheimer

I just had a couple questions. First the revenue is a bit higher than what we modeled for the quarter and just wanted to see what the main driver of that was. Was it mostly bonus revenues or how did you come out in terms of bonus revenues for the quarter?

Gary Krenek

That came out about even with previous quarters. We did recognize an additional $16 million worth of de-mobe revenue in the quarter for two of our rigs. That's revenues that we can't predict because we expect to get them at the end of contracts, but if we get a contract in the same location or same area we may not be able to collect that at that time. So, we had that, but as Larry said we also had very good utilization during the quarter.

Scott Burk - Oppenheimer

Okay.

Gary Krenek

That $16 million is the only thing unusual in the revenue numbers.

Scott Burk - Oppenheimer

Let's see, I wanted to ask also about the Ocean Star. Are you mobilizing that down to Brazil for the one year contract with OGX, as you previously mentioned, and just wondering is the market in Brazil, does it look that much more attractive than the Gulf of Mexico and did you want to mobilize rig down there permanently or is this just opportunistically for the one contract?

Larry Dickerson

Well, we got a one year contract and it was better than being stacked. We think that Star would have gone back to work, but by shrinking the amount of available rigs it improves our lives, we are now down to just one fourth generation rig in the Gulf of Mexico, the Ocean Victory which has some contract commitments going forward. But it also has some holes that we granted the operator where we would be responsible for gaining those customers. Rather than having to try to work two rigs it made for sense for us to take this job. There was some competition to get this job, so we bided aggressively to win it. And it improves our overall line here in the U.S. Gulf of Mexico.

Scott Burk - Oppenheimer

And actually I just wanted to have one follow up question on the Victory. You know the rate that you have there for the one well contract, low 150s, is that something you're willing to do just because it was such a short-window that you needed to fill or is that indicative of rates generally.

Larry Dickerson

No, that was a very specific gap we had in the program that we accepted when we took the contract with ATP. So there was an operator that was able to move the program forward and to accommodate him we proposed a discounted rate. It's not where rates are currently.

Operator

Your next question is from the line of Ian Macpherson with Simmons & Company.

Ian Macpherson - Simmons & Company

I didn't see it in the release and I might have missed it in the early commentary, any comments regarding the dividend this quarter?

Larry Dickerson

I just said it was a continuation of our strategy of returning value to shareholders. But it's still the same. We make no representation as to what it will be in the future and remind everybody that the board sets it at each individual time. But it is clearly when you look in the rearview mirror and the amount of money that we paid out, I think we're approaching $20 now since we began this aggressive dividend rate and that represents a huge return to shareholders. And if you factor that in along with our share price, then indeed I would say our performance, our total return performance to our shareholders is certainly in the top among drilling contractors.

Ian Macpherson - Simmons & Company

So your dividend isn’t announced in the earnings release, but it's the same announcement for this quarter as it has been?

Gary Krenek

We put out a separate press release with that.

Larry Dickerson

It is a combined $2.

Ian Macpherson - Simmons & Company

On the Ocean Star, does that contract have full mobe, de-mobe on top of the day rate that you talked about?

Larry Dickerson

The rig will not be earning a rate under mobilization. But, all the transportation cost is being paid for by the operator.

Ian Macpherson - Simmons & Company

Okay. So you have essentially, you have a cost, you have to carry your OpEx from the rig yourself, but they pay for tow.

Larry Dickerson

That's correct. And the course of the mobilization period will be minimal because the rig will be under a dry transport.

Ian Macpherson - Simmons & Company

Last question the Nomad, what are the prospects for that rig gaining employment or, being cold stacked next year do you think?

Larry Dickerson

At this point in time we feel like there will be an active market after the winter months in the North Sea. But we don't anticipate a lot of work until the spring season.

Operator

Your next question is from the line of Arun Jayaram with Credit Suisse

Arun Jayaram - Credit Suisse

Larry, I just wanted to get some insight. Obviously, you have purchased two rigs in terms of how you're going to crew those, and just a thought on what you're seeing in the labor markets as you attempt to crew those two units?

Larry Dickerson

We handled that fairly well. We had, when we bought the P2, there were some crews that had been employed by the previous rig owner that were made available to us and we hired quite a number of those, so I would say maybe half the people came from there. We did not have as many on the P3 that were in that category, but all the rigs that have been mobilizing out of the Gulf of Mexico, enabled us to have a pretty solid base of folks to staff up and recruit to those positions.

Arun Jayaram - Credit Suisse

Any sense, Gary, if what the operating costs we should be using for those two units, when they're working?

Gary Krenek

Well, I believe for the Courage, we're reporting in the mid-120s and of course for the Valor, it will depend, where it goes to work. If you assume them in the Gulf of Mexico like Courage, 125 and then escalated up or down accordingly, wherever in the world it goes.

Arun Jayaram - Credit Suisse

Obviously oil prices have improved, have you seen any change in terms of enquiry levels et, cetera, regarding the second and third generation, older semi market and what are your thoughts in terms of the unit that you come up, next year. Do you think you will be able to maintain utilization on most of those units or what's your thought as you look out to 2010?

Larry Dickerson

One, oil prices have helped clearly and it's not people don't adjust their activity levels on a one-day spike or anything, but the sustained move up from the lows have certainly helped. I think, and, Bob can fill in some color here, but I think the second and third generation market is going to be highly dependent upon what applications it's in and what individual market it's in and our expectation, I believe is that we will be able to work substantial numbers of units, but we are still be exposed to things like seasonal activity, downturns in the North Sea and we may have another rig or two that we come up, where we say we don't want to spend the money in this particular market if it requires a lot of CapEx.

Bob Blair

Of course and adding to what Larry said, the word we are getting from operators is, they're going through their current planning cycles. If they see the oil price giving them the confidence to be able to plan their activity level and their activity level we believe is going to be higher than in the last year.

Our second and third generation fleet is in a pretty good position now just having a lot of backlog through next year and into 2011 and beyond, so we're not as exposed as many of the contractors, but we will see some seasonal problems like in the North Sea in the wintertime and hurricane season in the Gulf of Mexico.

Arun Jayaram - Credit Suisse

Okay, but at this point the only rig that has been somewhat stacked has been the Bounty is that correct, there are no other plans at this point?

Larry Dickerson

That's correct.

Arun Jayaram - Credit Suisse

Okay. Last question, Larry, obviously you've been successful on the deepwater front. In terms of acquisitions, are you seeing an opportunity with the P3 rig or elsewhere in the general jack-up market?

Larry Dickerson

Well, we said on the Valor, which was the

Arun Jayaram - Credit Suisse

The third rig that that group had, I'm sorry.

Larry Dickerson

The P3 has not been auctioned yet, so we can't really comment on that until the rig comes into the market. P1 has been put to bed, the P2 is still open and I would certainly expect the P2 to be put to bed before the P3, if and when it comes out, because I'm not sure when the final delivery date is on the P3.

Then you said something on the jack-up market, I guess as I indicated our fleet status report doesn't reflect it, but there has been increased interest we found in the US Gulf of Mexico for our limited jack-up fleet there. Other than that, we were new to jack-up this bareboat chartered in Croatia on a six-month contract.

Arun Jayaram - Credit Suisse

Larry, I was just talking about the acquisition market for jack-ups, I apologize.

Larry Dickerson

I think there's too much difference right now in the bid as to have any of the new jack-ups trade.

Arun Jayaram - Credit Suisse

I got you. That's helpful, thanks guys.

Operator

Your next question is from the line of Judson Bailey with Jeffries & Company.

Judson Bailey - Jeffries & Company

Thank you, good morning. Follow-up question on the Ocean Star, and Larry, I apologize if you covered this in your comments but looks like the rate is going to be 340, but you're also lowering the rate on the Quest while it's down there from 420 to 340. I guess that effectively nets to a 260-type number.

My question is, when we think about the Victory, which is up or going to have some availability in 2010, do we think about that as the potential market rate for that rig in the Gulf or something above 300 for next year?

Larry Dickerson

The Gulf of Mexico is a separate market and it's a short-term market, whereas you're talking about a one-year market in Brazil, which is some term in today's market, so I think they're very different and you got different numbers of supplies and demands that would impact the Gulf of Mexico, so I can't really tell you where the rates would be.

As Bob indicated sometimes if we wanted to take a fill-in job for a couple months if we needed, we will be prepared if necessary to discount that, but I think we have certainly had some talks of shorter term jobs in the 300s.

Judson Bailey - Jeffries & Company

Okay. That's helpful, and then another question on the PetroRig III, I don't know if you can really comment on this or not, but that rig has a contract with Pemex. Our understanding is the rig is going to be late from the yard. Can you comment on the potential for Pemex to cancel that contract if that rig is delivered late and how would that play into the thinking on making a bid on that rig?

Larry Dickerson

Well, I'll make a general comment on Mexico, but I'm not going to share for obvious reasons what our thinking would be on whether or not we've already got all the rigs we need or whether or not we would bid on III. In fact, the actual bid protocols haven't been released, so that could impact it greatly.

In Mexico, our understanding is that that Pemex contract has a delivery date that the P3 can not make and that Mexico has some pretty firm bid laws that they would have to follow and there can always be exceptions, but our understanding is it would likely follow that it would be canceled and that under the public laws of Mexico would have to re-tender.

Operator

Your next question is from the line of Joe Hill with Tudor, Pickering.

Joe Hill - Tudor, Pickering

Larry, you touched on something a little earlier I just wanted to follow-up on it. What do you think it would cost you to build today the P1 and P2 fully outfitted?

Larry Dickerson

Well, our bid price were 460 and 490 for the two rigs and then our additional outfitting costs for things like crew training and then just the time it takes to get familiarity and missing spares, because the rigs generally were under spared, range about $60 million. So, that puts you in all in cost of say on the Valor of 550 and 520 on the other one.

Joe Hill - Tudor, Pickering

What do you think?

Bob Blair

I believe there is a rate out there right now for one of our competitors for a similar rig at 750. I don't know how much of the 750 includes the additional cost, but I bet it doesn't include all of it. So, that effective rate probably for that rig I’d guess might be 780 and I’d think John, from our discussions that between the equipment suppliers and the shipyard there may be a $100 million dollars.

Gary Krenek

In around that range.

Larry Dickerson

Yes.

Joe Hill - Tudor, Pickering

Okay. That's very helpful. Thank you.

Larry Dickerson

650 to 680 delivered three years from now.

Joe Hill - Tudor, Pickering

Okay and just a follow-up, you said that you thought maybe interest was picking up in the Gulf of Mexico jack-up market. Do you think that's more than just the post hurricane bounce and there are more legs to it than that?

Larry Dickerson

I can't tell you. I mean we're coming off such a low base.

Bob Blair

We are actually talking to operators now, talking about term work of six months to a year worth of work. So, the enthusiasm for activity is certainly been boosted over the last two or three weeks. Maybe they're in their planning stages, looking at better product pricing, but there is more enthusiasm.

Operator

Your next question is from the line of Rob Mackenzie with FBR Capital Markets.

Rob Mackenzie - FBR Capital Markets

Earlier today one of the service companies made a fairly achievable statement that they thought ExxonMobil was going to increase spending on EMP by 10% to 12% next year primarily outside North America. What are you seeing from your customers in terms of their plans to increase activity going into the coming year and which regions do you think that will be most beneficial for?

Larry Dickerson

I don't know. We do pick up some G2 from time to time on what total spending plans are, but we typically deal with individual markets and their needs. So, ExxonMobil maybe talking to a Gulf of Mexico guy and it's not as important for us to track total increases in their CapEx budget that you might find at one of the big integrated service providers. So, I'm not sure that we have any data. Bob, do you.

Bob Blair

Well, ExxonMobil in particular has a couple fairly major development projects they're kicking off next year, one in West Africa, and one over the Australia region. So, I think some of that expenditure maybe related to those projects.

Rob Mackenzie - FBR Capital Markets

We’ve also seen I guess in recent days several comments coming out of the Middle East jack-up market which I guess you guys don't participate in as much, but . But in West Africa there continues to be good news there. Do you see much incremental business coming up in West Africa that might be applicable for the mid-water or is that still just for the most part ultra-deep?

Bob Blair

Most of the stuff in West Africa is in the ultra-deep water depth. The mid-water I think is still somewhat oversupplied.

Larry Dickerson

And we have been in and out of West Africa with mid-water equipment and we never seemed to be able to develop an ongoing market where rigs can move from job-to-job and keep working. We keep being exposed with so much downtime in that market, so I think for the time being we're likely to just expose our deepwater equipment to that market.

Rob Mackenzie - FBR Capital Markets

Is the hope for the mid-water equipment primarily centered on the North Sea or are there other regions we should pay more focus to in this next sub-cycle?

Larry Dickerson

Well, I mean our fleet is dispersed. We have a good number of rigs in Brazil in the mid-water. So next sub-cycle I don't know what's going to happen, but that's certainly a big growth area. Then Asia-Pacific includes a big number of our rigs. And what we have now in the North Sea is just three rigs, one in Norway, two in UK, one going down to the Falklands which we presume will return, but there is nothing guaranteeing that we would do that. It's a long way from there back and we could just as easily move to a different market.

Rob Mackenzie - FBR Capital Markets

Seems like in the down cycle going into the up cycle people historically underestimate the earnings power of the mid-water floaters in the next up cycle and underestimate how fully utilized they will be. Do you think that's kind of a fair characterization of where you think the market is now and in terms of viewing the earnings prospects for mid-water fleet?

Larry Dickerson

It reminds me of the joke, which I won't tell here, but the punch line is "Stand back. I don't know how big this thing can get." You're absolutely right, in the up cycle the size and demand for second and third generation equipment, I think astounded everybody and we were able to get decent amounts of term. Cycles repeat themselves, but they do have enough variance in there that I would be hesitant to give you guidance that we can achieve those same rates in the next cycle. But certainly no one is building mid-water rigs any more and there is, there are lots of coast lines around the world that haven't been fully explored and we think that over time there will be lots of opportunities for these units to drill.

Operator

Next question is from the line of Geoff Kieburtz with Weeden.

Geoff Kieburtz - Weeden

I understand the limitations on what you can say about the Valor contracting process, but obviously you were persuaded that it was the right thing to do to honor the original contract with Petrobras on the Courage. Why does the logic change with the Valor?

Larry Dickerson

I'm going to stick by that. Petrobras is a great customer of ours and we will conduct our negotiations between us and them and reveal when we reach a deal. All I can say is we’ve had interest in the Valor from a number of places and customers around the world.

Geoff Kieburtz - Weeden

Was the interest any different from the interest you got for the Courage?

Larry Dickerson

We were pleased to put the Courage to work here in the Gulf of Mexico for Petrobras International. It provided us an opportunity to contract the rig very quickly, so that we could follow our strategy of buy, borrow and contract and be prepared to deal with the next rig down the pike, so I can't really other than that, make comparisons between the Courage and the Valor.

Geoff Kieburtz - Weeden

Okay. All right, but in terms there is not that much difference in the time between when you bought the Courage and when you bought the Valor. Has there been a noticeable shift that you can detect in the nature or the level of demand, because the rigs are essentially the same, right?

Larry Dickerson

I think I've answered that, so I'll invoke our rule on the one question, one follow-up. I'm not trying to dodge the question, but there is nothing new I can add to Courage, Valor and the contract status.

Geoff Kieburtz - Weeden

It was more about the market, whether there have been a change in the market over that relatively brief time that you could characterize?

Larry Dickerson

I would say demand is still very strong, ultra deepwater has been a consistent market and I don't see much difference.

Geoff Kieburtz - Weeden

Okay.

Larry Dickerson

Bob, that's the strongest part of the world right now and remains so.

Geoff Kieburtz - Weeden

Okay, and could I just ask a separate question about operating cost trends? As you look into 2010, are you thinking that there is on a per rig day basis any inflation, is there deflation? How are you thinking about that right now?

Gary Krenek

I would say it's more or less flat. I mean we are still giving pay rises to our employees, but we've seen some price decreases in some of the other source items. I always tell people talk to (inaudible) is probably your best fleet on where pricing is. We got time for one more question. Let's take that from someone else. Thank you.

Operator

Your next question is from the line of Pierre Conner with Capital One Southcoast.

Pierre Conner - Capital One Southcoast

I think most of this has been covered. I wanted to maybe get a market outlook or commentary about the floater markets in Mexico. You have got New Era and the Voyager and we have got the other issue hanging out with the Pemex jack-ups, but there have been some recent discoveries, what is the outlook for potential activity there?

Larry Dickerson

At this stage, I think it's very difficult to read what's happening in Mexico. This is the time of year that they put their plans together. They’ll make their announcement on bids that will be coming up for delivery, rig deliveries in 2010. They’ll be making those announcements typically in late November, early December.

As everybody knows the bids have been expected, recently have been delayed because of the trying to process and get the funding put together for the programs, so I'd tell that it's difficult to get a read on exactly what's happening in Mexico right now.

We do believe that they have had change of management, it's going to put more emphasis on getting production back up and that there will be drilling activities spud from Mexico. Exactly where it's going to be? We're all waiting to see.

Pierre Conner - Capital One Southcoast

Yes, all of us. Okay, so you might expect some inquiries on floater demand towards year end?

Larry Dickerson

Yes, we may make that announcement on the bids they plan on issuing for next year's rig requirements.

Pierre Conner - Capital One Southcoast

Great, okay. Thanks gentlemen.

Larry Dickerson

Thank you, everybody for joining us this quarter, and we'll look forward to talking to you next shortly in the beginning of 2010.

Operator

Thank you all for participating in today's conference call. You may now disconnect.

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Source: Diamond Offshore Drilling, Inc.Q3 2009 Earnings Call Transcript
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