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Transocean (RIG) is focusing on the ultra-deepwater drilling market and moving out of its non-core business. In doing so, its ultra-deepwater units will make up around 50% of its total rigs, increasing from this year's roughly 37%. The company's backlog in the ultra-deepwater offshore drilling market next year will be around $4.4 billion, around 54% of the company's total backlog . The deepwater drilling spend is expected to rise from $43 billion last year to $113 billion over a decade. This year, the number of deepwater oil and gas field discoveries will likely be 13. Volumes are one factor driving oil and gas operators towards deepwater, as the chart below shows.

(click to enlarge)

The greater depth of these discoveries will create the demand for high-specification ultra-deepwater rigs. Currently, Transocean has around seven ultra-deepwater rigs under construction. Next year, deepwater drilling will get a boost from the Gulf of Mexico offshore drilling market because of three ultra-deepwater field discoveries in the region by three oil companies -- Anadarko, Chevron (CVX), and Royal Dutch Shell (RDS.A) (RDS.B). In October, Transocean entered a five-year contract with Chevron on ultra-deepwater drilling rigs, and the contract is expected to commence in 2016. Further, the Bureau of Ocean Energy Management plans to auction three regions in the Gulf of Mexico next year. This will further increase ultra-deepwater drilling there. Transocean currently has around 13 ultra-deepwater rigs in the Gulf of Mexico.

Another region for deepwater exploration is West Africa, which will get a boost in offshore deepwater drilling. One reason that drilling will rise in West Africa is that Congo is going to auction around 10 oil blocks, both onshore and offshore, early next year. There may be oilfields in offshore Angola that contain oil deposits from 250 million barrels to around 1 billion barrels. These oil reserve prospects are likely to increase oil exploration in West Africa next year. Transocean has five ultra-deepwater rigs there now. Total (TOT) plans to drill around two pre-salt wells in offshore Angola. This increase in offshore exploration will create more demand for offshore rigs. This could be advantageous for Transocean, as the company has diverse customer bases operating in offshore West Africa. 41% of the company's customer base consists of integrated oil companies such as Exxon Mobil, Royal Dutch Shell, and Total; 31% are national oil companies such as Petrobras and NNPC; and 28% are independents.

The goal of financial flexibility

Transocean has formed a Master Limited Partnership, or MLP. It intends to add three to four rigs into the planned MLP structure initially, and will offer an Initial Public Offering, or IPO, of approximately 20% minority portion for $400 million to $500 million. During the IPO the MLP will be 100% equity funded. However, the initial rig purchases under the MLP will be 100% debt financed. The MLP will also consist of currently active floaters. Transocean plans to add one rig per year thereafter into the MLP's rig portfolio. The value of this MLP is mainly driven by assets, which have a long asset life combined with organic growth. This means that Transocean is likely to use assets of high specification with strong order backlogs. Since the company has more backlogs in ultra-deepwater drilling with high-specification drillships, it is more likely to add high-specification drillships into the MLP's asset base in the coming quarters. In addition to the access to equity markets, Transocean will benefit by taking debt as has been discussed. Also in the case of an MLP, a tax pass-through entity, cash flow is enhanced, reducing cost of capital for the company.

Transocean also plans to reduce the cost of operations for margin improvement by around $500 million through 2015. Around $225 million will be from cost controlling. The cost control will adhere to a proper maintenance schedule and reduce offshore head count. Blow Out Preventer, or BOP, downtime is around 50% of the total downtime this year. Transocean is partnering with Royal Dutch Shell to develop a new BOP that is fault resistant and fault tolerant. This new BOP will be used to retrofit all the subsea BOPs. Thus, the new BOP will reduce downtime for maintenance for the company and increase operational efficiency.

Bottom line

Transocean continues to strengthen its asset portfolio in the ultra-deepwater drilling segment with plans to have around 50% of its portfolio in ultra-deepwater rigs. The demand for ultra-deepwater rigs is expected to be stable over the long term, and Transocean's rigs will find markets for deployment. Moreover, the company is focusing on financial flexibility and shareholder value through creation of an MLP. This MLP will likely provide a source of funding for its operation and provide cash flow to the unit holders.

Source: Transocean: Going Ultra-Deep