Seadrill: 2 New Contracts Show Continued Strength In Offshore Drilling

| About: Seadrill Limited (SDRL)

Seadrill Ltd (SDRL), one of the world’s largest offshore drilling companies, recently announced that it has entered into two new drilling contracts for the use of vessels. One of the more appealing aspects of these contracts is that both are for the use of drilling rigs that have not yet left the shipyard. This shows the continued strength in demand for modern, relatively new offshore drilling rigs.

The first agreement was a five-year Memorandum of Understanding with an as-yet-unnamed major oil company for the use of the ultra-deepwater semi-submersible West Capricorn rig. The location of West Capricorn’s assignment was left rather vague; it was only described as “North America.” The amount of revenue that Seadrill stands to realize from this contract was disclosed, however. The potential contract value is $919 million, which includes a $30 million mobilization fee and will be paid out over the five-year contracted period. Thus, the annual revenue that West Capricorn will generate for Seadrill over the life of this contract is $177.8 million excluding the mobilization fee. This gives the rig an approximate dayrate of $487,000. This is completely in line with recent contracts for the use of similar rigs and continues to show pricing strength for premium offshore rigs. The fact that this major oil company was willing to enter into a five-year contract could indicate the belief that pricing in this segment of the market will either stay the same or strengthen further going forward. This is not necessarily the case, however. The long contract length should also provide Seadrill with some hedging against a price decline since the revenue from West Capricorn is fixed for the duration of the contract. Seadrill’s customer, whoever it may be, also received the option to extend the contract for another year. While no dayrate was given for West Capricorn during that sixth year, it would be fair to assume that it will be at the then-prevailing market price. Thus, this contract could offer up to six full years of revenue for Seadrill.

The second agreement was with Tullow Oil Ghana Ltd for the use of the ultra-deepwater semi-submersible West Leo rig. Tullow Oil Ghana Ltd is a subsidiary of London, U.K.-based Tullow Oil plc (OTCPK:TUWLF). West Leo’s assignment under this contract is for one year of operation off of the coast of Ghana, a nation in western Africa. The total amount of revenue that Seadrill will realize over the term of this contract is $204 million. This includes an $18 million mobilization fee and works out to a dayrate of approximately $509,600. This is well above the dayrate that Seadrill got for West Capricorn, which is a similar class of rig. This is also in line with the dayrates for other ultra-deepwater semi-submersibles in Seadrill’s fleet.

West Leo will be the first deepwater rig that Seadrill has contracted out to Tullow Oil. Seadrill Management’s CEO, Alf Thorkildsen, is optimistic on the potential for Seadrill to secure future contracts with Tullow. He had this to say in the press release (linked above):

We are very pleased to have secured our first deepwater contract with Tullow, a fast growing and dynamic independent oil and gas company. We believe Ghana, which is one of the most promising new deepwater frontiers, may offer significant opportunities for us going forward. We continue to strengthen our revenue backlog and have with this contract secured attractive employment for all our deep and ultra-deepwater units.

One appealing thing about both of these contracts is that both are for rigs that have not yet left the shipyard. West Capricorn and West Leo are both still under construction. West Capricorn is expected to leave Jurong Shipyard in December 2011. It will begin operations for the major oil company beginning in May 2012. West Leo, meanwhile, is expected to leave Jurong Shipyard in January 2012. It will begin its work for Tullow Oil Ghana in April 2012. The fact that Seadrill was able to contract these rigs out before they have even left the shipyard shows the continued strength in the demand for offshore drilling rigs. This also increases my confidence that Seadrill made the right decision when it continued to execute the fleet expansion program. The company has been spending a lot of money over the past few years to expand its fleet and if it is able to keep contracting out rigs that are still under construction at these prices, then this money is proving to be well spent.

These two contracts also increase Seadrill’s revenue backlog and earnings visibility. West Capricorn in particular will be generating for five and possibly up to six years. Thus, it will have a positive effect on Seadrill’s revenue and profits over both the short and intermediate term. West Leo will not have quite as positive an effect because the contract is only for one year - but it will still have an impact. Neither of these contracts will affect the 2011 results though as neither rig will begin operating until the second quarter of 2012.

Disclosure: I am long SDRL and I am planning to add to this position within the next 72 hours.