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Rowan Companies (NYSE:RDC)

Q3 2011 Earnings Call

November 01, 2011 11:00 am ET

Executives

Mark A. Keller - Executive Vice President of Business Development

Suzanne M. McLeod - Director of Investor Relations

Thomas P. Burke - Chief Operating Officer

William H. Wells - Chief Financial Officer, Senior Vice President and Treasurer

W. Matt Ralls - Chief Executive Officer, President, Director and Chairman of Executive Committee

Analysts

Matthew D. Conlan - Wells Fargo Securities, LLC, Research Division

Douglas L. Becker - BofA Merrill Lynch, Research Division

Collin Gerry - Raymond James & Associates, Inc., Research Division

Kurt Hallead - RBC Capital Markets, LLC, Research Division

Frank Harestad - Pareto Securities, Research Division

Michael W. Urban - Deutsche Bank AG, Research Division

David Wilson - Howard Weil Incorporated, Research Division

Robin E. Shoemaker - Citigroup Inc, Research Division

Judson E. Bailey - Jefferies & Company, Inc., Research Division

Operator

Greetings and welcome to the Rowan Companies Third Quarter 2011 Earnings Results Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Ms. Suzanne McLeod, Director of Investor Relations for Rowan Companies. Thank you, Ms. MacLeod, you may begin.

Suzanne M. McLeod

Thank you, Manny, and good morning. Welcome to Rowan's Third Quarter 2011 Earnings Conference Call. Joining me on the call this morning are Matt Ralls, President and Chief Executive Officer; Mark Keller, Executive Vice President, Business Development; and Bill Wells, Senior Vice President, Chief Financial Officer and Treasurer, who will have prepared comments. Also in the room to respond to questions are Tom Burke, Chief Operating Officer; and Kevin Bartol, Senior Vice President, Corporate Development.

Before Matt begins his remarks, I'd like to remind you that during the course of this conference call, certain forward-looking statements may be made within the meaning of the Private Securities Litigation Reform Act of 1995, including statements as to the expectations, beliefs and future financial performance of the company that are based on current expectations and are subject to certain risks, trends and uncertainties that could cause the results to differ materially from those projected by the company. With that, I'll turn the call over to Matt.

W. Matt Ralls

Okay, thanks, Suzanne. Having met or exceeded estimates for our drilling operations for the past 10 quarters, we are disappointed to report $0.25 of earnings for the third quarter or $0.14 below consensus estimates. The third quarter was an extremely active quarter for Rowan in terms of rig moves and upgrades with 9 rigs preparing to go to new contracts. For a number of reasons, including longer than expected shipyard stays and transit times and higher than expected repair and maintenance expense related to this group of rigs, our revenues were below expectations, while our expenses were higher than our prior guidance.

In total, shipyard and transit time increased from 461 days in the second quarter of this year to 619 days in the third quarter. As Bill will discuss in more detail in his comments, we believe that most of these factors are one-time in nature, though some will impact fourth quarter results as well when we are expecting 400 days of shipyard or transit time.

During the third quarter, we also had an unusual amount of operational downtime, increasing from 75 rig days in the second quarter to 136 rig days in the third quarter, with the greatest impact arising from the dispute with PEMEX regarding their downtime claim on the Gorilla IV related to a linking delay in pulling the bow leg and subsequent jetting system repairs. We don't agree that these activities constitute downtime under the terms of the contract, but we've elected not to accrue day rate for the contested operations until the disputes have been resolved. We also experienced downtime in the quarter due to problems with top drives, pipe racking systems and dropped objects on our Super Gorilla class rigs which are, of course, among our highest day rate rigs. On the positive side, we expect to have all 9 of the rigs I just referred to on contract by the end of this year, have 2/3 of our fleet on term contracts or with customers expected to keep them for additional work. This will leave us with an availability in 2012 on only a few of our high-spec jack-ups, and demand for those rigs continues to strengthen as Mark will discuss further in his comments.

In addition, we've had very encouraging feedback from potential customers for our 2 new drillships, which led us to seek and obtain board approval to exercise our option on a third drillship from Hyundai Heavy Industries. This rig is scheduled to be delivered in the third quarter of 2014 at a shipyard cost slightly below the price per rig we paid for the first 2. And finally, given our confidence in the outlook for high specification offshore drilling markets, our company's strong financial position and the weakness in financial markets in the third quarter, we obtained board approval to repurchase up to $100 million of Rowan shares. During the quarter, we acquired roughly $80 million of shares at an average price in the low $30s and our board has now authorized a further $50 million, leaving us with approximately $69 million available to purchase additional shares. Now with that, I will turn it over to Mark for comments on the markets.

Mark A. Keller

Thanks, Matt, and good morning, everyone. According to ODS-Petrodata, there are currently 485 jack-ups worldwide. Demand is 375 rigs with utilization at 77%, having steadily increased since January 2011. We are encouraged by the increasing utilization which will be further strengthened by anticipated upcoming demand. Recent tender activity is strong and we project international jack-up demand to be approximately 40 units, driven by increased activity in Southeast Asia and the Middle East as evidenced by our recent mobilizations. Since the last call, we've had 2 jack-ups enter the Southeast Asian market and added another rig to our presence in Saudi Arabia. Worldwide market utilization just reached 90%. From a historical perspective, we would expect a corresponding upward shift in day rates.

I will now address our areas of operation. Let's begin with the U.S. Gulf of Mexico. Supply in the region is 78 jack-ups, while demand is 38 rigs for a total utilization of 49%. However, if you discount the 35 units that are cold stacked, market utilization is 88%. We currently have 6 active jack-ups working in the region, 4 of which are contracted to McMoRan. We value our long-standing relationship with this leader in deep-gas drilling and wish them success in their upcoming well test of Davy Jones 1. The EXL-IV was delivered in October and is contracted to drill 3 shakedown wells in the U.S. Gulf of Mexico for Apache. These wells do not require all of the operating capabilities of this rig and accordingly earn at a day rate below what we would be able to obtain for an HPHT drilling program. We are currently in discussions with customers internationally with term opportunities for the rig. The Gorilla IV is expected to complete its work for PEMEX next month and will likely reenter the U.S. Gulf of Mexico for a well to well operations following routine inspections. The Gorilla III is now working in Trinidad for Sinopec before its 1-year commitment to Niko/Bayfield. Also in country, the EXL-II continues successful operations on its 3-year contract with BP. We're seeing additional tendering in the region, and we are pleased with the increase in high-spec activity in Central America.

Now turning to the North Sea. Supply is 42 jack-ups, while demand is 39 rigs for a contracted utilization of 93%. Rowan currently has 6 jack-ups fully contracted in the region. Five of the units are drilling, and upon completion of upgrades and modifications, the Rowan Norway is expected to commence operations with Xcite in December 2011. We believe that recent significant discoveries by Statoil will change the operating landscape in terms of rig requirements for Norway, which should play favorably for Rowan's high-spec fleet in the future.

Moving on to the Middle East. Supply in this region is 119 jack-ups, while demand is currently at 100 rigs and contracted utilization is 84%. When the Rowan-Mississippi commences operations in December, Rowan will have 8 jack-ups operating for Saudi Aramco, approximately 1/3 of their jack-up fleet. In an ongoing effort to attain its production goals, Aramco has outstanding tenders for 5 to 10 jack-ups for both gas and extended reach oil drilling commencing in the first half of 2012. We are hopeful to secure additional contracts with Aramco and continue our successful drilling relationship.

I'd like to take a few moments to discuss Southeast Asia. We are pleased to have reentered one of the most active jack-up markets in the world. The J.P. Bussell commenced operations with Petronas Carigali Vietnam in late October at a day rate in the high 120s for a 240-day commitment. The Gorilla II will begin operations for Petronas Carigali in Malaysia this month at $118,000 a day for 1 year. As this market continues to shift towards high-spec equipment, we see many opportunities to strengthen our presence in Southeast Asia and look forward to developing new business relationships.

Before I conclude our market overview, I wanted to share our optimism with you regarding Rowan's entry into the deepwater arena. Since the last call, we have met with 16 of the top 18 ultra-deepwater operators globally and have received very positive feedback. Both IOCs and NOCs worldwide are impressed with the redundancies and efficiency that will be built into these rigs. They likewise appreciate the caliber and organization of the team we have in place and are pleased to see Rowan bring our long history of operational excellence to the deepwater market. Following introductory meetings, we have already received requests from 6 operators for follow-up sessions to expand our discussions on the technical merits of the design and the expected commercial terms. Recent ultra-deepwater fixtures suggest a favorable market environment as we've progress towards securing contracts for our drillships. We look forward to bringing you the news of our first ultra-deepwater commitment.

Thank you for your time this morning and I'll now turn the call over to Bill Wells.

William H. Wells

Thank you, Mark, and good morning, everyone. As a reminder, we are showing the after-tax results of land operations, related gain on sale and remaining assets and liabilities as discontinued operations in our financial statements. Our continuing operations consist solely of our offshore drilling operations and will receive the bulk of our commentary this morning.

Our third quarter 2011 offshore drilling revenues were $235 million, up by 5% over last quarter, but down by 2% from last year. The sequential increase reflects slightly higher average day rates between periods primarily as a result of the June startups of our first 2 N-Class rigs in the North Sea and the August startup of the Bob Palmer in the Middle East. The effects of these startups more than offset the impact of other rigs moving between markets or entering shipyards for modifications and upgrades. Third quarter revenues were 5% below our expectations as a result of unanticipated downtime on the Gorilla VII in the North Sea, a later than expected start for the Bob Palmer and the suspension of revenue recognition on the Gorilla IV in Mexico.

As of October 26, the date of our most recent fleet status update, our backlog of drilling commitments totaled approximately $2.4 billion. We estimate that 9% of that amount will be realized as revenue during the remainder of 2011, another 48% will occur in 2012, 20% will be realized in 2013 and the balance in 2014 or beyond. We expect a significant increase in revenues during the fourth quarter based on an anticipated 15% to 17% increase in operating days over the third quarter level. The startup of 8 rigs in 4 geographic regions during the fourth quarter should add $35 million of revenues during the period, and the impact from incremental activity related to our third quarter startups, including the Gorilla III in Trinidad and the Bob Palmer in Saudi Arabia, should exceed the effect of rigs rolling off contracts during the fourth quarter such as the Rowan-Paris in Qatar and the Gorilla IV in Mexico.

As previously reported, PEMEX has suggested that operations during the 6-week period we were working to free the bow leg on the Gorilla IV are not covered under the contract. They recently expanded this to include the subsequent period that the rig was performing repairs and waiting to move to their next location. We believe the contracted day rate should apply and intend to pursue collection. Although for accounting purposes, we have not recognized day rate revenue for the rig during the period from mid-August through late October.

Our third quarter drilling expenses of $130 million were 21% above last year and 24% above last quarter, primarily due to rig fleet additions between periods. Operating costs were also 10% above our previous guidance for the third quarter as we spent more to supply rigs that we're preparing for or just beginning new overseas assignments and incur higher than expected maintenance cost during extended shipyard stays. Almost 30% of our available rig days during the third quarter were consumed by shipyard, transit and idle time, and we took advantage of these periods to perform needed rig maintenance, the extent of which was underestimated in our previous forecast.

For the fourth quarter, we expect drilling expenses in the range of $150 million to $155 million or up by 16% to 19% over the third quarter level, as the incremental impact from rig startups and increases in personnel-related costs should exceed the effects of rigs rolling off contracts. Shipyard transit and idle time is expected to comprise approximately 18% of available rig days during the fourth quarter, which is higher than normal, but down from the third quarter level. Our full year 2011 estimate of drilling expenses is now approximately $495 million to $500 million, up by 5% to 6% from our previous estimate, due largely to the factors mentioned previously.

Our third quarter depreciation expense totaled $50 million, which exceeded our previous estimate, and was up by 43% over last year and by 23% over last quarter, primarily due to the rig fleet additions and upgrades. Our latest estimate for 2011 depreciation is approximately $183 million for the year, including $54 million in the fourth quarter. Our third quarter SG&A expenses totaled $23 million, up by 10% over last year, by 4% over last quarter, and above our previous guidance, primarily due to incremental severance costs. Our latest estimate for 2011 SG&A cost is approximately $87 million for the year, including $22 million in the fourth quarter.

Interest expense, net of interest capitalized, was $4.2 million during the third quarter, lower than our previous estimate as a result of increased capitalized interest associated with the newbuild projects. We estimate fourth quarter 2011 interest expense will be approximately $18 million, about 3/4 of which should be capitalized. Our expected full year 2011 effective tax rate on continuing operations is a credit of approximately 1%, down from the 4% expense previously forecast as a result of the outbounding of 1 additional rig during the third quarter and reduced contributions expected over the remainder of this year from our remaining U.S. owned or operated rigs. The cumulative impact of reducing the full year rate was reported in the current period resulting in a credit of 14% during the third quarter.

Our after-tax income from discontinued manufacturing and land drilling operations totaled $162 million in the third quarter, most of which resulted from a $215 million pretax gain on the sale of our land division, offset by $60 million of total income taxes. We expect no further results of discontinued operations. Property and equipment additions totaled $238 million in the third quarter and were split almost evenly between newbuild projects and those related to our existing fleet, including contractual modifications.

At September 30, we had approximately $1.3 billion of remaining capital expenditures under our newbuild program, with $151 million required in the fourth quarter of 2011, and most of the remainder in 2013 and 2014. The downpayment on the third drillship will increase 2011 capital expenditures by approximately $112 million. We currently estimate as much as another $176 million of capital expenditures over the remainder of 2011, including $97 million of substantially reimbursed contractual modifications, $30 million toward planned life enhancement projects, $35 million for existing fleet maintenance and upgrades, and $14 million for area, equipment spares, drill pipe and needed improvements to our shore bases.

That concludes our prepared remarks. With Manny's assistance, we'll now open it up for questions.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question is from the line of Matt Conlan from Wells Fargo Securities.

Matthew D. Conlan - Wells Fargo Securities, LLC, Research Division

We have been discussing for quite some time the Southeast Asian market progressing towards using more and more high-spec jack-ups. When do you think these tenders are finally going to be resulting in some contracts?

Mark A. Keller

Matt, we currently have several active tenders in the region right now. We are very close on a couple, but we continue to see Petronas and other operators, BP, TOTAL, and other operators shift toward a higher spec, a higher level of rigs, including high-spec rigs. As you've heard us say before, even in Indonesia, we're seeing BP and TOTAL go to a higher spec of jack-up in their tender requirements. So I think in the next few months, you'll see some contracts awarded there.

W. Matt Ralls

And of course, we're just moving 2 in now.

Mark A. Keller

That's right.

Matthew D. Conlan - Wells Fargo Securities, LLC, Research Division

And for the EXL IV, it sounds like you're leaning more towards moving that rig internationally. Is that a fair takeaway?

Mark A. Keller

Yes, Matt. It is. We talked to McMoRan and to Chevron here in the U.S. Gulf, but we have it actively marketed in several different areas of the world, and our current position, the contracts that we took on the rig, the shakedown wells, were to walk the rig to international contracts.

Matthew D. Conlan - Wells Fargo Securities, LLC, Research Division

Okay. So we should anticipate some mobilization time in the first half of next year?

Mark A. Keller

Yes.

Operator

Our next question is from the line of Collin Gerry with Raymond James.

Collin Gerry - Raymond James & Associates, Inc., Research Division

So Bill, I want to follow-up on the cost side. I think, as you pointed out this past quarter, it was a little bit higher than I think maybe we were thinking going into the quarter and I think the same can maybe be said about your Q4, at least relative to my expectations. So my question is, is kind of, if I look at 2012, it seems like a lot of the moving parts should be ironed out in terms of upgrades, kind of the mobilization tapers down a little bit, shipyard time. Can we start talking about what the more normalized kind of cost level on a quarterly basis with all the rigs delivered? I mean, is it going to be in that $150 million range or is it closer to the $130 million that you did this past quarter?

William H. Wells

I think it's probably a little too early on that, Collin.

Collin Gerry - Raymond James & Associates, Inc., Research Division

Fair enough.

William H. Wells

We're going through the budgeting process right now, and it's also affected with what Mark was just talking about in terms of the EXL-IV potentially going to an international market, also the Douglas. So I'd rather not comment beyond the fourth quarter at this point.

Collin Gerry - Raymond James & Associates, Inc., Research Division

Okay. Well, switching gears more to the, maybe the marketing side, Mark, you mentioned 90% marketing utilization on the jack-up market globally. Are you surprised we haven't seen day rates? I mean, they're certainly trending in the right direction, but are you surprised that maybe the pace of day rate improvement, would you forecast that maybe your competitors get a little bit more aggressive or yourselves that we should see a little bit more price escalation over the next, call it, 6 months?

Mark A. Keller

Collin, I think we're already seeing that on tenders that are being awarded. I'd certainly like to see it escalate faster. But there's a lot of rigs that have rolled off contract and rigs going back to work. But once the market supply of jack-ups gets above 85%, as I mentioned in my statement -- in my prepared remarks, historically, you see day rates begin to move. And I think we're getting there. I think we're seeing it in different markets that we're operating in today, and on different tenders that we're submitting. So I think you'll see some improvement next year in day rates.

Operator

Our next question is from the line of Robin Shoemaker with Citigroup.

Robin E. Shoemaker - Citigroup Inc, Research Division

Say, Matt, I just wanted to ask -- you cited in some of your comments the Super Gorilla operating issues and that I think it was more than the Gorilla VII, but could you just expound on that just a little bit? And is it just purely limited to the third quarter?

W. Matt Ralls

Well, the reason I mentioned that -- Tom Burke is here and he can also add his comments. But let me start by saying that I mentioned those because they are some of our highest day rate rigs and we have had some recent downtime in the third quarter related to those -- for the items that I mentioned. Downtime is almost always episodic in our business. I mean, we've had a pretty good record going, but the third quarter was just a period where we had talked top drive issues, some pipe racking, even some BOP issues. And it was on those rigs with high day rates, so it had a significant impact. It's not a situation where we view this as a chronic problem. These are things that crop up and get you in this business every once in a while. We don't make excuses for it, but we certainly shoot for and expect a much lower level of downtime than we had in the quarter.

Robin E. Shoemaker - Citigroup Inc, Research Division

Okay. And similarly, on this dispute with PEMEX that you have, is that also -- do you find the downtime or unplanned or just broadly speaking, downtime on rigs where you expect to be reimbursed that this is also a broader issue, getting reimbursed from customers? Or is it really, in this PEMEX case, just specifically a one-time kind of issue?

W. Matt Ralls

Pretty much a one-time issue. I mean, it's the first time in my, what now, 14-year career in this business that I've seen us had this kind of problem getting off location. It's happened back in, further back in Rowan history, but we actually had to bring out a special piece of dredging equipment and it went on for a long time. It's a highly unusual to go this length of time, but we were on location for 2 years and so we got free on the stern legs without any problem, but the bow leg just wouldn't budge. And so we believe contractually there is no basis for considering this downtime and we're always on day rate when we're pulling legs. So yes, it's a very much a one-time incident.

Robin E. Shoemaker - Citigroup Inc, Research Division

Okay. And one other issue going back to the cost for the quarter, are shipyard costs themselves escalating? I know you have some additional shipyard days that weren't anticipated, but just wondering if you could comment on shipyard costs, generic kind of inflation or escalation or is it that at all an issue for you guys?

Thomas P. Burke

Robin, this is Tom. I wouldn't say so. No, we haven't seen any significant escalation in shipyard cost.

W. Matt Ralls

Yes, and if you look on the newbuild side, actually, the shipyards are being very aggressive, they're -- which is part of the reason that we elected to go forward with this when they agreed to drop the price further. But -- so, no, we don't see a lot of pricing leverage on the part of the shipyards.

Robin E. Shoemaker - Citigroup Inc, Research Division

And that includes repair, maintenance, upgrades, that kind of thing as well?

W. Matt Ralls

Yes. I'd say our current experience with them is they're busy, but not to the point where it's moving cost substantively.

Operator

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

Ian Macpherson

Matt or Mark, I wanted to ask, first, what your outlook is for maintaining or possibly expanding the relationship with McMoRan next year? Specifically, when do you think that we convert the verbals for the Joe Douglas and the Ralph Coffman to firm contract extensions? And do we think that the EXL-I will similarly be extended next year with McMoRan as well?

Mark A. Keller

Ian, this is Mark. To answer your question, a lot obviously is going to depend on how rapidly our relationship expands with McMoRan. It will be based on the results of this well test at Davy Jones 1. We have been told by McMoRan that they will extend the EXL-I. They have multiple wells in the process to be permitted. They're all ultra-deep gas wells that are 30,000-foot plus type wells that we're drilling currently. We would very much like to expand our relationship with McMoRan, as far as the Joe Douglas is concerned and our relationship with McMoRan. We have the ability or the opportunity to tender the rigs internationally, which we have done. And we have tendered the Joe Douglas internationally as long as we communicate that and clear that with Mr. Moffett, with Jim Bob, and we have done that. So we're looking at it both ways. We have tendered the Joe Douglas to international markets, and we are also keen to stay with him if that's what presents itself. But I just wanted to let you know that we are exploring 2 different avenues there. And that's always been... Ian, that's always been the case with our fleet with McMoRan.

Ian Macpherson

Got it. And then, Mark, I think you mentioned Aramco has tenders for 5 to 10 more rigs. Do you see most of that as -- I know they've renewed most of their existing fleet over the past several quarters, so I guess that, do you see that mainly as incremental activity in the first half of next year?

Mark A. Keller

I do, Ian. They currently have 24 rigs under contract and there's only 2 of them that will roll off contract in 2012. As you said, they've renewed the rigs that they want to keep. I do think that, as I mentioned in my remarks, a lot of those are gas rigs which are certainly incremental. But the extended reach oil rigs, they -- the CapEx's are so high that I believe most of those will be incremental also. And it's hard to say whether there'll be 5 to 10 rigs. As you know, from the past and seeing how Rowan and other contractors have contracted there, they're subject to pick up 1 to 4 rigs off 1 tender. But that's kind of the indications we're seeing right now is 5 to 10 rigs. Then, if I could move back some because they've been a little late. It's taking longer to award those contracts.

[p: id="51304144" name="Ian MacPherson" />

Okay. And then can I squeeze in one more on Mexico. Some of your peers have talked about the fact that the rate ceilings are likely to die off simply because not many contractors are bidding compliantly against those rate ceilings. Are you seeing the same? And if so, therefore are you seeing day rate upside of Mexico and what does that hold for the Gorilla IV as you think about keeping it or taking it out of Mexico next quarter?

W. Matt Ralls

Ian, we have made several proposals to PEMEX regarding the Gorilla IV. Currently, our plans are to demote the rig to the U.S. Gulf of Mexico. We're in discussions with an operator here for a good contract that's above what we're currently operating at in Mexico. And we also have a lot of interest in the international market currently, that could possibly be a follow-up for the Gorilla IV when it completes the contract in the U.S. Gulf. But we have made numerous attempts to try to get a day rate satisfactory to PEMEX, and so far, we have not gotten through that day rate ceiling.

Operator

Our next question is from the line of Dave Wilson with Howard Weil.

David Wilson - Howard Weil Incorporated, Research Division

Just a quick question, as you mentioned, this quarter was hit by some rig moves and upgrades. Looking forward to this upcoming quarter, and perhaps into next year and the rigs that become available. Do you think there'll be ample opportunity for the respective -- for these rigs to get contracts in their respective regions for follow-on work or do you foresee that some of these rigs will definitely have to be relocated for any incremental work? In other words, can we see another quarter adversely affected by significant rig moves or upgrades?

W. Matt Ralls

Dave, I would say that beyond the ones that we've talked about, as I mentioned in my comments, I mean, we'll have 2/3 of our fleet either on term contracts or with customers that we think will keep them and that leaves just really less than a handful of rigs that we think will be subject to rig moves. And we are bidding some equipment that's either being delivered or in the Gulf, in the international markets like Mark was talking about. We bid those with -- to be paid for our mobilization expense. So we can still see some impact going forward, but it's going to be substantially diminished as we work through these issues here in the third and fourth quarter, just because everything will be kind of in place for a while.

David Wilson - Howard Weil Incorporated, Research Division

And then kind of as a follow-on, Mark, and we've talked broadly speaking about the EXL-IV, international. But I was wondering if you can get a little more specific as far as regions and perhaps timing. And I won't even go to the day rate, but any way, on the region and timing if you can give any more color on that?

Mark A. Keller

Dave, we've got it marketed in multiple regions. It's been marketed in the Middle East and in Southeast Asia. I would say that we're probably looking at, end of first quarter to second quarter start, if we are successful on those contracts.

Operator

Our next question is from the line of Doug Becker with Bank of America Merrill Lynch.

Douglas L. Becker - BofA Merrill Lynch, Research Division

Matt, just hoping to get a little more color on the decision to exercise the newbuild option. It sounds like the reduced cost was certainly an important factor of that decision.

W. Matt Ralls

Well, Doug, it was a facilitating factor, let me put it that way. We would not have viewed the decision as favorably -- I'm not saying we wouldn't have done it, but it was an important consideration that we get the price back in the range of -- or in this case, slightly below what we paid for the first 2. Our main motivation, really, is the response we're getting from the operator group. Mark touched on it in his comments, but just a very strong response to what we're building here. I mean, the redundancies and efficiency, as he commented on, truly make these industry-leading ultra-deepwater assets. We're getting a very strong response to the operations team and construction team that we've put together here. So it's -- we just feel very good about adding this caliber of rig to the Rowan fleet as our entry into ultra-deepwater. We think it's -- the record for the predecessor equipment in this line has been extremely good in terms of start-up and operations. We just feel very good about this particular design and feel like it's the right time to make this move.

Douglas L. Becker - BofA Merrill Lynch, Research Division

And I guess, day rates inching up doesn't hurt either?

W. Matt Ralls

That helps a lot, yes.

Douglas L. Becker - BofA Merrill Lynch, Research Division

Mark, on the Joe Douglas, is the base case here that it starts working with McMoRan, does some shakedown wells at a similar rate to the EXL-IV and then we'll see what happens to that?

Mark A. Keller

It's possible that you will see a shakedown well. One of the contracts, the international contracts operators that we're in discussions with, would require a 30 to 60 day shakedown well. So I would think it would be a little north of what you're seeing on the EXL-IV, but you never know. I mean it's just what's available and what's permitted given the current situation in the Gulf. But I do think you'll see some type of shakedown well even if the rig goes to work for McMoRan.

Douglas L. Becker - BofA Merrill Lynch, Research Division

Okay. And is there any update to the timing of a potential decision about the day rate penalty in the Mississippi?

Mark A. Keller

The rig will arrive -- it's estimated to arrive sometime between the 1st and the 15th of December. We, Tom Burke and I, have a trip planned to Saudi Arabia to meet with Aramco and to discuss that, both on the Bob Palmer and on the Mississippi.

Douglas L. Becker - BofA Merrill Lynch, Research Division

Okay. And you said something on around the 15th?

Mark A. Keller

The rig should arrive there, our meeting with them is around the 10th.

Douglas L. Becker - BofA Merrill Lynch, Research Division

Okay. And maybe one -- a quick one for Tom, just what type of opportunities for additional cost reductions do you see? I think Rowan's done a very good job over the last year or so in terms of removing some of the costs, but what do you see going forward? Are there additional opportunities, and maybe a rough magnitude of those opportunities?

Thomas P. Burke

I couldn't comment on the magnitude at this point, but we do have a much improved supply chain group in place which has been in place for about a year, and which is really focusing on understanding our costs and categorizing our inventory. So we've got a lot of different initiatives going on.

W. Matt Ralls

Yes. And just to elaborate on that some -- I mean one of the impacts we were fairly certain in the quarter was the fact that we did have quite a bit of buying on the part of these rigs that are moving to international markets. And we think there is still room to improve our efficiency in terms of what we buy and when we need it, by having better information about the inventory that's on the rigs. And that's the major push that's under way by the supply chain group right now. So we'll see cost savings, I'm quite confident going forward in our R&M expense on those -- across the fleet as we manage our inventory better. I'm not suggesting that's a major impact on our cost structure, but it will be a cost reduction going forward. And as always, we're very focused on our international labor make up and how we get national labor on the rigs as opposed to expat labor. And we've gotten a lot of those benefits out and some of it's being slightly offset by some wage pressure in the U.K. and Middle East, a slight wage pressure. But we still think there's a little bit of room in that area as well.

Operator

Our next question is from the line of Kurt Hallead from RBC Capital Markets.

Kurt Hallead - RBC Capital Markets, LLC, Research Division

I just wanted to follow-up initially, Bill, you provided some revenue numbers on a sequential basis going out into the fourth quarter and I was just wondering if they were all-inclusive. So to recap, you mentioned something about incremental $35 million of revenue and then some other things kind of offsetting each other to effectively have net no change. Is that -- the $35 million the expectation of what the total incremental revenue would be for the fourth quarter? Or was that some partial component of what incremental revenue may be for the fourth quarter?

William H. Wells

It's more of a partial component, Kurt. The $35 million is related to the 8 rigs that are starting up. We do see incremental revenue related to the rigs that's started in the third quarter. For example, the Palmer and the Gorilla III, relative to rigs rolling off contract. But we didn't quantify that number, but it should be a positive.

Kurt Hallead - RBC Capital Markets, LLC, Research Division

Okay. Well, will it, in an attempt to quantify, would it be as much as that $35 million or not quite?

William H. Wells

No, no. It's nowhere near that number.

Kurt Hallead - RBC Capital Markets, LLC, Research Division

Okay. All right. That's fair enough. And then, I think, Mark, you referenced actually before, Bill, before I hop on the financial element, I know you guys said you are still kind of working through your 2012 budgets, you have no specific commentary on that for now and that's fair. However, if I were to ask you from an operating drilling expense standpoint, assuming no additional rig restarts or otherwise, what's kind of a base level labor cost increases that you might be looking at going forward? I'm sure you got some general handle on that, at the moment.

Thomas P. Burke

So looking at, obviously, dependent by area and as we move rigs out of the Gulf to other regions, like Matt mentioned, the labor cost as a percentage of revenue will often go down. In some of the areas we're looking at, we're pushing in some pay rises around 6%.

William H. Wells

It's probably a good average impact for the company.

Kurt Hallead - RBC Capital Markets, LLC, Research Division

Okay. Fair enough. And then on the market, I think Mark, you referenced 40 rigs of incremental jack-up demand. I'm assuming you were kind of playing that out over the course of the next 12 months or so. Is that a fair assessment?

Mark A. Keller

Yes it is, Kurt. It's just tenders and inquiries that we have in-house right now or that we responded to, and that's the total number of rigs, not tenders. And it's what we see going forward over the next 12 months or even less. If they all come to fruition. But we responded to a lot of inquiries and tenders internationally.

Kurt Hallead - RBC Capital Markets, LLC, Research Division

Okay. And then in that context, so those 40 rigs of incremental demand, how would you characterize the mix between high-spec versus standard.

Mark A. Keller

I would say that probably 60% of them are high-spec and the rest would be a lower spec rig, could be 1.5 million rig or something like that. But 50% to 60% of them are high-spec.

Kurt Hallead - RBC Capital Markets, LLC, Research Division

Okay. And then the experience over the course of the past 12-month period in terms of those tenders turning into reality for the rigs, has that been pretty close to 100%?

Mark A. Keller

Kurt, I think it's been probably somewhere in the, some of them get deferred. I would use somewhere around 80% to 85%.

Kurt Hallead - RBC Capital Markets, LLC, Research Division

Okay. And then on -- just kind of a follow-up on that incremental demand. So you mentioned the rigs specifically that Saudi's are looking for. You referenced some incremental expectation of incremental demand out of Statoil based on these discoveries. So 5 to 10 for Saudi, how would you breakout the remainder?

Mark A. Keller

5 to 10 for Saudi today, as far Statoil goes, there is some incremental demand for what we see of, let's say, probably 6 rigs right now, 6 to 7 rigs.

Kurt Hallead - RBC Capital Markets, LLC, Research Division

Okay. And then the rest will be kind of scattered or they kind of concentrated maybe in the Far East or PEMEX or how would I think about that?

Mark A. Keller

They would be in the U.K. sector. They would be in Southeast Asia. Some of them in West Africa. There's a couple, there's some in the Med, they're HPHT requirements, but Aramco would take -- it's hard to guess with Aramco, but I could say it could be as many as 4 more of the higher spec. And then of the 1.5 million rigs, that could be 4 or 5.

Kurt Hallead - RBC Capital Markets, LLC, Research Division

Okay. And then with the crossing of this 90% threshold on utilization and the subsequent expectation that rates are going to move up or have started to move up already, on that context. I guess in that framework, how would you think about the stratification of the pricing dynamic or the pricing improvement dynamic between the high-spec fleet versus the standard fleet? In other words, do you expect to see more day rate improvement on high-spec rates given that they're in short apply? Or do you expect to see much greater improvement in the standard jack-up pricing because it's been so depressed?

Mark A. Keller

I think you would see a higher margin of improvement in the high-spec. And even if you come down into the 1.5 million pound hook load or greater, you'll see a greater percentage of increase there. As far as the premium or commodity type rigs, I think the commodity class rigs are going to improve a little bit, but not a lot because there's so many of them. And depending on how many come out of cold stacked, as the market improves, but with the premium rigs were seeing a modest increase, but nothing substantial.

Kurt Hallead - RBC Capital Markets, LLC, Research Division

And sort of to spread the wealth before I turn it over to Matt. The ultra-deepwater environment, you said you were very encouraged. Predicated on discussions that you're having with drilling and oil companies and hence your decision and the board's decision to move forward with the exercise of this third drillship. So how much -- over what time period do you think you might be able to say, hey, we've locked in contracts for these existing ultra-deepwater rigs? And then just one other follow-up to that would be, when should we expect you to put forth the fourth drillship?

W. Matt Ralls

First things first, I would say that it's really too early to be anything but a wild guess about when we might contract. We're still 8 months from striking steel. So I would say that we feel good about the prospects of getting 1 or maybe both of the first 2 contracted in 2012. But that doesn't have to happen. And right now, we just feel like it's going to be a good market and we've had -- actually a few different operators asked us if we would consider contracting both rigs to a company. And so we take that as a positive sign. So we're pretty optimistic about getting something in 2012. I think something before that is unlikely. But with regard to the fourth drillship, that option didn't cost us anything. We have not even really begun to think seriously about it at this stage. I think for us to go beyond 3 without very strong prospects for contracts for 1 of the first 3 would be pretty low probability.

Kurt Hallead - RBC Capital Markets, LLC, Research Division

Okay. And then you mentioned, so I guess buy versus build on ultra-deep water, it's still the economics are more favorable on the build front now, I guess?

W. Matt Ralls

Yes, we just haven't been able to close the bid-ask spread on the ultra-deepwater. Either that or we have seen some equipment where we might be able to make sense of the price, but there are some operational issues or equipment issues that push us toward something where we can more completely control the type of asset we end up with. I mean, there's a lot of this -- not sure it's well understood but I mean, there's a lot of ultra-deepwater equipment out there that can't actually drill in it's kind of stated capacity because of the riser or the tensioning. And so it's -- what we are bringing to the market, really, we'll have all the capabilities on that we're advertising, and we think that's going to make these rigs pretty easy to market compared to some of the other equipment that's been built or being built.

Operator

Our next question is from the line of Judd Bailey with Jefferies & Company.

Judson E. Bailey - Jefferies & Company, Inc., Research Division

Bill, I wanted to circle back on the operating cost, if I could, for the fourth quarter. Understanding it, you guys are in the planning process for 2012. I guess I'll ask another way, but when I look at the fourth quarter guidance, is there any way to give us some sense of what amount of that cost is somewhat transitory in nature from all the rig moves and upgrades and whatnot?

William H. Wells

No, there's really not, Judd. Not at this point. I mean, we think there is some amount in our forecast that's transitory, but just wouldn't be able to quantify it at this point.

W. Matt Ralls

And Judd, the issue really is, we've got a strong handle internally on what's changing during this quarter. What we don't know until we get the budgets finalized is, as one of the previous questions asked about it is, how much movement are we going to have early in the year, we have other rigs moving to other locations or other operational issues, downtime that -- even planned downtimes. So we're just reluctant to kind of make a comparison between fourth quarter to imply something for 2012 until we're further along -- until we are complete, I should say, in that process.

Judson E. Bailey - Jefferies & Company, Inc., Research Division

Yes, I'm not really asking. I'm not trying to pin you down for '12. I'm just trying to figure out when I look at the jump from second quarter to third quarter, and then third quarter to fourth quarter, I would assume a fair amount of that is not related to just increases in your underlying cost base. And so I'm just trying to figure out -- I understand you have the potential to mobilize and upgrade rigs in '12, but just trying to get a sense of what that kind of base operating cost number is given the big increases over the last 2 quarters.

William H. Wells

Yes, some of it is an increase in our underlying base cost. As we reported last quarter, we did have a rather sizable compensation increase for our field over the last half of this year. And then as Tom alluded to earlier, we made another small increase in a couple of areas for the fourth quarter. We are seeing wage pressures that have increased our underlying cost. But then on the maintenance side, it's really hard to tell at this point what's in the base and what should come out of it going forward.

Judson E. Bailey - Jefferies & Company, Inc., Research Division

Okay. All right. Well, my follow-up is, could you remind us, you got the Paris and the Row [ph], 2 of your conventional jack-ups in the Middle East. Those are idle now and I believe they're in the shipyard and you're contemplating some upgrades. Can you remind us, are you going to go through with those or are you waiting to see if the contract comes through or how should we think about those 2 rigs?

W. Matt Ralls

I'll take that one. Judd, yes, we're looking at one, or at those 2 rigs. Right now, we do not intend to go forward in the immediate future with upgrades on those. We're looking at our options to either find work that we can do the upgrades against which has got one set of issues with it. And then the other is the possibility of even selling some of those older 116-Cs. So we're still evaluating is probably the best way to put it.

Judson E. Bailey - Jefferies & Company, Inc., Research Division

Okay. So if they do have work going forward, they probably have to have the upgrades, is that a fair way to think about it?

W. Matt Ralls

Yes, they would. They would go through some shipyard time. Those rigs have not been in the shipyard for a long time. And like the other 3 that we -- or 4 that we've put through the yards over the last couple of years, they need some steel replacement and equipment upgrades. So for modeling purposes, I mean, you really can think of those 2 rigs as essentially cold stacked for 2012.

Judson E. Bailey - Jefferies & Company, Inc., Research Division

Okay. All right. That's good color. And my last question if I can slip one more in. Your option, you're granted another option at HHI for delivery in the first quarter of '15, which I guess is a little surprising, it's pretty far out. Is that a function of HHI had other options that are pending ahead of you or is that the earliest delivery that they can give you or they're just more noncommittal? Because I believe they only have 2 or 3 rigs being delivered in 2014. So I'm just trying to think about if there's a constraint there that you can't really, that we can't really see right now.

W. Matt Ralls

Well, I guess that probably the most concise way to put it is, that's the best delivery we could get for not paying anything.

Operator

Our next question is from the line of Mike Urban with Deutsche Bank.

Michael W. Urban - Deutsche Bank AG, Research Division

Most of my questions have been answered, but I did have a couple of follow-ups on the drillship. I'm assuming the option you just exercised, that rig will be outfitted similarly to the first 2 and initially outfitted to 12,000 feet?

W. Matt Ralls

Virtually identically.

Michael W. Urban - Deutsche Bank AG, Research Division

Okay. And just I guess a clarification on your thought process regarding exercising the most recent option for the potential fourth rig. You said you would be unlikely to do it without a contract? Is that a prerequisite? I mean, a contract on the -- 1 of the first 3. Is that something you would definitely need to see or you'd have to be pretty confident on getting a contract on 1 or multiple of those first 3 rigs?

W. Matt Ralls

Yes, Mike, I don't know if I can give you any more definition than what I said earlier, which is I think it would be a low probability that we would go forward unless we started to see some contracts on these first 3 rigs. And I don't know whether that's 1 really good contract or 2 good contracts. We just have to think about it between now and February. But it's -- I think having 3 spec newbuild drillships is -- we've bitten off plenty in doing that.

Operator

And your next question is from the line of Frank Harestad with Pareto Securities.

Frank Harestad - Pareto Securities, Research Division

Just a couple of questions. The first one is on the standard jack-ups. You already commented on that, that you're considering 2 different things there. But could you say something generally about the asset market for commission to jack-ups, how you see that, and how many buyers there are out there? And my second question relates to the drillship. The prices seems to be a little bit down on the third one, is that a reflection of global yard prices or is it cost savings because you are building 3 at the same yard?

W. Matt Ralls

I'll take the first question. In terms of the sales potential for older jack-ups, there are sale potentials, but they are -- it's a thin market and they tend to be -- the people that are talking to us, they're tied to specific tenders and specific opportunities either to work the regular combination unit. So there are opportunities, but they're sort of one-off type of opportunities.

Frank Harestad - Pareto Securities, Research Division

Okay. And on the newbuild prices, is newbuild prices coming down or is it just a reflection that you're building a third unit and save some costs?

Thomas P. Burke

It's a reflection on that we're building a third unit and saving some cost.

[p: id="37611040" name="Frank Harestad" />

Okay. So the price in shipyard prices is not lower than they were when you start from scratch?

Mark A. Keller

No. I think you might say that we were able to -- the shipyard likes us as a customer because they see us as a long-term customer with the potential to build more rigs, as opposed to a financially driven company that's being built for sale. And they like the team that we've got to build the rig because that team has already built rigs in the yard. So it really lines up well. We think we are able to get a good price for some of those things. And I can generally would say that the shipyard prices are maybe up slightly but not much. We do think that the drilling equipment prices are up slightly.

W. Matt Ralls

And we have -- to answer the earlier question that these rigs are equipped virtually identically and for almost every customer in the world, that's the case. There were some customer specific pieces of equipment on the first 2 that we didn't feel like we needed on the third one, like the crown-mounted compensator. So we made some adjustments there. The shipyard made some adjustments on the option price to bring it back down to closer to where the first 2 orders. So that's why we ended up being just a hair below the first 2.

Operator

We have no further questions at this time. I'd like to turn the floor back over to management for closing comments.

Suzanne M. McLeod

All right. Well, that concludes our third quarter earnings conference call. We'd like to thank everyone for joining us. Thank you.

Operator

Ladies and gentlemen, this concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.

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