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Transocean Ltd. (NYSE:RIG)

Q4 2011 Earnings Call

February 27, 2012 10:00 am ET

Executives

Thad Vayda - VP, IR

Steven Newman - CEO

Greg Cauthen - EVP and CFO

Terry Bonno - SVP, Marketing

Analysts

Ian MacPherson - Simmons & Company

Doug Becker - Bank of America Merrill Lynch

Scott Gruber - Bernstein Asset Management

Matt Conlan - Wells Fargo

Kurt Hallead - RBC Capital Markets

Angie Sedita - UBS

Ole Slorer - Morgan Stanley

Operator

Good day and welcome to the Transocean fourth quarter 2011 earnings conference call. Today's conference is being recorded. At this time, for opening remarks and introductions, I'd like to turn the conference over to Thad Vayda.

Thad Vayda

Good morning and welcome to Transocean's fourth quarter and full year 2011 earnings conference call. A copy of the press release providing our financial results along with supporting statements and schedules is posted on the company's website at deepwater.com.

We've also posted a file containing three charts that may be referenced during this morning's call. That file can be found on the company's website by selecting Investor Relations, Quarterly Toolkit and then PowerPoint Charts. The charts include average contracted dayrate by rig type, out-of-service rig months and operating and maintenance cost trends. The Quarterly Toolkit also has four additional financial tables provided for your convenience covering revenue efficiency, other revenue detail, daily operating and maintenance costs by rig type and contract intangible revenues.

Joining me on this morning's call are Steven Newman, Chief Executive Officer; Greg Cauthen, Executive Vice President and Chief Financial Officer Ricardo; and Terry Bonno, Senior Vice President, Marketing.

Before I turn the call over to Steven, I'd like to point out that during the course of this call, participants may make certain forward-looking statements regarding various matters related to our business and company that are not historical facts, including but not limited to future financial performance, operating results, the prospects for the contract drilling business and the impact of the Macondo Well incident. Such statements are based upon the current expectations and certain assumptions of management and are therefore subject to certain risks and uncertainties.

As you know, it's inherently difficult to make projections or other forward-looking statements in a cyclical industry since the risks, assumptions and uncertainties involved in these forward-looking statements include the level of crude oil and natural gas prices, rig demand and operational and other risks, which are described in the company's most recent Form 10-K and other filings with the U.S. Securities & Exchange Commission.

Should one or more of these risks and uncertainties materialize or underlying assumptions prove incorrect, actual results may vary materially from those indicated. Transocean neither intends to nor assumes any obligation to update or revise these forward-looking statements in light of the development which differ from those anticipated.

Also note that we may use various numerical measures on the call today that may be considered non-GAAP financial measures under Reg G. As I indicated earlier, you will find the required supplemental financial disclosure for these measures, including the most directly comparable GAAP measure and an associated reconciliation on our website at deepwater.com under Investor Relations, Quarterly Toolkit and Non-GAAP Financial Measures and Reconciliations.

Finally, to give more people an opportunity to participate on this call, please limit your questions to one initial question and one follow-up.

Thank you very much and I'll now turn the call over to Steven Newman.

Steven Newman

Thanks, Thad, and thank you all for joining us today. A quick word regarding the rescheduling of our release and conference call. Based on the advice of counsel and in the context of the recent OPA and Clean Water Act ruling and the anticipated start of the trial today, we're elected to accelerate the disclosure of our fourth quarter and full year results by about a day. I apologize for any inconvenience this may have caused and appreciate your flexibility.

Before providing my overview of the quarter and outlook for 2012, I'd like to take a minute to reassure our shareholders, customers and employees that I am fully committed to addressing the issues that negatively affected the company's performance in 2011.

Throughout the organization, I have stressed the urgency of improving our operational performance both in shipyards and in the field and executing our asset strategy. We will continue to collaborate with our customers to deliver the right solutions, leveraging our resources and seasoned expertise.

This includes maximizing the uptime of our rigs, while achieving incident-free operations. Despite the challenges presented by the current operating environment, we will work hard to deliver the results that you expect.

I also officially welcome Greg Cauthen who accepted my invitation to temporarily return to Transocean and as CFO provide interim leadership of our finance function. The search for a permanent CFO is going well and we're fortunate to have a number of very highly qualified candidates under consideration.

Following my review of the quarter, Greg will give you the details of our fourth quarter performance and our guidance for 2012, followed by Terry who would give you color on the markets.

For the fourth quarter, we reported a net loss of $18.62 per diluted share. This net loss reflects the $5.2 billion impairment of our goodwill which we reported earlier this month and an estimated Macondo contingent loss of $1 billion. After consideration of these and the other items noted in our press release, adjusted earnings were $0.18 per share.

The fourth quarter also reflects an additional increase in our annual effective tax rate. This change in tax rate from the third quarter resulted in a $0.14 per share adverse effect on the fourth quarter's results. Greg will talk more about this in a moment.

I'm pleased that when compared to the third quarter, the fourth quarter's results reflected an increase in utilization and revenue efficiency, contributing to revenue approximately 8% higher. Revenue efficiency in the fourth quarter was 91.9%, an improvement over the 89.5% in the third quarter and generally in line with the second quarter's results of 92.1%.

During the fourth quarter, our ultra-deepwater floaters, which have the most significant impact on our overall performance, delivered revenue efficiency of 89.5%, their best of the year. I continue to believe that we are on the right track. However, I will remind you that while our revenue efficiency should gradually improve going forward through and technical and contractual efforts, the progress will not necessarily be linear.

I'm also extremely pleased with the results delivered by the two harsh-environment semi-submersibles we acquired from Aker Drilling, which achieved a combined 98.9% revenue efficiency in the fourth quarter.

I want to make a couple of comments on the recent decision taken by the Board, the not recommended dividend at the upcoming annual general meeting. In arriving at this decision, the Board considered a number of factors, including the outlook for our business and the context of the existing operating environment for the industry and Transocean specifically, our financial flexibility and the strength of our balance sheet and opportunities to reinvest in our fleet.

I think it's important to point out that our capital deployment philosophy is unchanged. We intend to ensure the financial flexibility and strong balance sheet we need to pursue our objective, which includes remaining and investment grade issuer. So we invest in our business and value-creating opportunities, and return excess cash to our shareholders. Our Board will continuously evaluate our business in the context of this capital deployment philosophy.

We are addressing the challenges we experienced in 2011 through our operational and project excellence initiative. Our emphasis on operational excellence includes thorough equipment inspection, enhanced maintenance and rigorous pre-deployment testing, and we're making progress with these efforts. In conjunction with our operational initiative, our focus on project excellence includes closer cooperation with our vendors, to improve capacity planning, quality control and more timely delivery.

We have also taken steps to remove the BOP recertification process from the critical path to redelivery of rigs from the shipyard. This should overtime significantly reduce project risk. Supporting both operational and project excellence efforts, we are rolling out a new maintenance, sales and upgrade program that is more compatible with the new rules for testing and certification and has a particular focus on rigs with complex, multiplex or MUX BOP control system.

In addition, we've planned to better manage project execution risk through our five-year cycle recertification plan based on a unit exchange approach versus a traditional inspect and repair philosophy. This approach will apply to all control systems during both operations and shipyard projects. Regarding our people and training solutions, we have established several subsea initiative including a subsea center of excellence and swat teams in our major operational locations, staffed with some of the best engineers in the industry, providing technical support.

2011 also had a share of encouraging progress in our asset strategy with the acquisition of Arker Drilling and the delivery of the newbuild jackup Transocean Honor from the shipyard, plus the divestiture of several of our low-spec jackups. We are committed to executing this asset strategy, increasing our exposure to high-specification assets and reducing our exposure to low-spec commodity class asset. With an improving second-hand market for drilling rigs, we will continue to pursue single asset divestitures, sales of asset packages or other large scale transaction.

During 2011, the company continued to lead in ultra-deepwater with the Dhirubhai Deepwater KG2 setting a new world record for drilling a well with the deepest water depth by an offshore drilling rig. I also want to thank the Transocean crews around the world for achieving substantial progress in 2011 towards our vision of incident-free operation. As Terry will tell you, the markets are improving across the globe and Transocean is extremely well-positioned to benefit from this improving environment.

Regarding the ongoing litigation related to the Macondo well incident. We are pleased with several recent important rulings. First, the court ruled that BP was not an additional insured party with respect to environmental damages under our excess liability policy. Second, the court ruled that BP generally owes us contractual indemnity for compensatory damages associated with the spill.

The third one, which we received last week, rules that we will not be liable for other damages for the subsurface release of hydrocarbon and that we are not liable for Clean Water Act fines and penalties. But we are still interested in finding an acceptable resolution that allows us to put all of the remaining uncertainty behind us. We are well prepared to argue the merits of our case that the trial which is current scheduled to begin next week.

Regarding the incident in Brazil, I was pleased to see Chevron accept responsibility for the incident and their complementary commentary regarding the performance of the Transocean equipment and crew. We believe that the potential claims being reported in Brazil are without merit and we will rigorously defend our position.

Let me conclude by reminding you that Transocean has always been a world-class organization with world-class people and assets, and we take pride in our ability to perceiver in a tough environment. While we recognize we have a long way to go, I believe we have taken important steps to return to best-in-class operating performance. We are intensely focused in all segments of our organization on getting our rigs back to work and taking full advantage of continued strong marketing conditions. In doing so, we believe we are well-positioned to deliver in 2012 and beyond.

With that, I will turn the call over to Greg, to take you through the numbers.

Greg Cauthen

Thank you, Steven, and good morning, everyone. As Steven just mentioned, we recorded a net loss of approximately $6.12 billion or $18.62 per diluted share for the fourth quarter 2011. Excluding, approximately $6.2 billion in certain net unfavorable items, our diluted earnings were $0.18 per share. This compares with similarly adjusted earnings of $0.03 per diluted share in the third quarter.

Net unfavorable items included an estimated non-cash charge of $5.2 billion for goodwill impairment, related to our contract drilling reporting unit. Under U.S. GAAP, we test for goodwill impairment annually on October 1. After failing the first step of the test in the fourth quarter, we had to do a detailed analysis to estimate the value of our goodwill.

This required us to determine and estimate at the market valuation of our contract drilling business and consequently an estimate of the implied value of goodwill. The estimated impairment was determined by comparing the estimated implied value to the existing book value of goodwill.

It is important to note that the estimated goodwill impairment is based solely on conditions on October 1 and includes the same market factors that also impacted our share price in the fourth quarter. Our estimate is subject to adjustments and will be finalized on the first quarter of 2012.

Net unfavorable items also included an estimated loss contingency of $1.0 billion related to the Macondo Well incident that we believe is probable. The loss contingency amount is our current estimate under FAS 5 of U.S. GAAP of the low-end of the range of reasonably possible losses. As new developments occur or new information comes known, the amount of estimated loss could change and the change could be significant.

The remaining net unfavorable items are as follows. $30 million of charges related to our acquisition of Aker Drilling, specifically $70 million of charges in G&A and a $13 million loss on Aker securities held prior to the closing of acquisition.

$0.6 million in income from discontinued operations primarily related to the gain on the sale of Challenger Minerals (North Sea) Limited, $18 million of favorable discrete tax items and finally $11 million from a gain on the sale of the GSF Adriatic XI as we continue to execute dispositions in line with our assets strategy.

The company's overall operational performance excluding the net favorable items that I have already described improved sequentially in the fourth quarter primarily related to reduction in shipyard at a service time which favorable impacted revenue. The quarter also benefited from the inclusion of Aker Drilling as well as improvements in the revenue efficiency and utilization. Fourth quarter also included reduced shipyard expenses with most of this savings related to a reduction in well controlled equipment certification cost.

Revenue for the quarter increased by $180 million to approximately $2.4 billion. The Aker acquisition increased revenue by $100 million. Overall fleet utilization continued to improve to 61% for the fourth quarter versus 58% in the third quarter. Improved utilization increased revenue by $71 million related primarily to reductions in shipyard time versus the third quarter. Revenue also increased by $17 million as revenue efficiency improved to 91.9% compared to 89.5% in the previous quarter.

Operating maintenance expenses excluding the net unfavorable items already mentioned increased by $25 million compared to the third quarter. The acquisition of Aker Drilling increased cost by $44 million. Cost also increased by $26 million or $0.03 per share due to the termination of Deepwater Expedition contract related both to an accrual for certain disputed items as well as the immediate expensing of certain items which would have been recognized over the remaining contract period.

These costs increases related to Aker Drilling in the Deepwater Expedition were partially offset by net $40 million of others favorable items with the most significant being at $25 million net reduction in well controlled system certification and shipyard related cost.

Excluding the net unfavorable items described above fourth quarter operating income was $394 million increased by 47% compared to the third quarter and essentially represents a return to the level of operating income in first and second quarters of the year.

The increase in interest expense, net of amount capitalized in the quarter to $178 million was primarily related to the debt assumed in the acquisition of Aker Drilling as well as the new senior notes issued during the quarter.

The increase in interest income to $17 million from $7 million in the third quarter was primarily due to the Aker restricted cash helped to support the export financed debt assumed in the Aker transaction. Although not considered as the fees under U.S. GAAP this restricted cash arrangement essentially economically defuses the $889 million of export financed debt. The Aker restricted cash is included in other current assets and other assets on the balance sheet.

The effective tax rate of negative 2.2% in the fourth quarter decreased from 212.8% in the third quarter primarily due to the impact of the goodwill impairment and the loss contingency.

The full year annual effective tax rate for 2011 which excludes the $18 million of various favorable discrete items was 41.3 % for the quarter compared to 34.1% for the third quarter. The increase in the full year annual effective tax rate is primarily due to lower level of full year profitability that was expected in the third quarter as our marginal tax rate is significantly lower than our annual effective tax rate.

Importantly, the fourth quarter income tax expense includes a true-up of $46 million or $0.14 per diluted share related to applying the increase in the full-year annual effective tax rate to the first three quarters of the year. Net cash flow generated from operations amounted to $563 million in the quarter. An improvement of $71 million compared to the third quarter and is largely attributable to better operating results.

Capital expenditures totaled $350 million, up from a $137 million in the third quarter due to the timing of shipyard milestone payments associated with our newbuild construction program. Proceeds from asset sales were $96 million. In addition, we closed the acquisition of Aker Drilling, for a cost net of cash required of $1.05 billion. And we paid the third installment of our 2011 dividend for $255 million.

As Steven has indicated, the company remains committed to remaining in investment grade issuer. Further to that commitment, we issued $2.5 billion in senior notes at $1.2 billion in equity during the fourth quarter. The proceeds were used to repay the Series B convertible notes and to replenish cash used to finance Aker. The net result of the above was an increase in cash on hand of $4 billion from $3.3 billion at the end of the third quarter.

Turning to 2012, I'd like to now update our full year 2012 guidance. As reported on our latest fleet status report and subsequent update, we expect fewer out-of-service days related to shipyards in 2012. We also expect a more favorable mix of shipyard comprising fewer high-value generating ultra-deepwater and deepwater rigs. As a result, we expect lower revenue losses in 2012 from shipyards as compared to 2011. We cancelled the reduction in planned shipyards, the change in mix of rigs and the various operational initiatives, Steven, has highlighted, we expect a lower risk of shipyard overrun. We are encouraged that the Millennium and the Grand Bank shipyards, the first two shipyard projects executed with our new processes have been completed to plan.

With that, we've remained cautious. We know that even prior to Macondo it is not uncommon for unplanned or exceptional major shipyard to increase our annual loss revenue due to out-of-service period by 15% in excess of plan. And for 2012, we estimate this would be about $75 million in additional loss revenue. We are not able to predict exceptional shipyards and they are not included in our fleet status report and update.

As Steven discussed, we expect our revenue efficiency to gradually improve over time, however, this improvement will not be linear. Based upon recent experience, we currently expect average revenue efficiency during 2012 to be similar to that experienced in the fourth quarter of 2011.

We expect a gradual improvement, but it is possible it may take several years to achieve our historical level of performance, as we continue effort both technical and contractual to accomplish this goal. The actual revenue efficiency will vary from quarter-to-quarter as was the case even prior to Macondo.

We expect other revenues to be between $625 million and $650 million for the full year 2012. Recall that other revenues generate fairly low margins, generally in the mid-to-high single digit range.

We estimate operating maintenance cost for 2012 to be between $6.15 billion and $6.35 billion, reflecting higher utilization, a full year's activity for Aker Drilling, continued well equipment certification cost, and estimated $50 million of the Macondo expenses, net of estimated insurance recovery and general inflationary pressures. The midpoint and upper-end of this cost estimate range is lower than previously guided, as we have now completed our 2012 budget and implemented a variety of cost reduction efforts.

Our well control equipment certification costs are expected to be lower in 2012. We have completed certification of well control equipment on 29 over 63 active floaters, including 18 of 27 ultra-deepwater rigs and have eight planned in 2012.

As reported in our fleet status report and subsequent update our planned shipyards are more heavily weighted to the first half of 2012. Consequently, we expect operating and maintenance cost to be approximately $100 million higher in each of the first and second quarters than in the third and fourth quarters of 2012.

Finally, our operating and maintenance cost estimates assume the reactivation of the High Island IX. We expect depreciation expense for 2012 to be between $1.4 billion and $1.5 billion, reflecting the full year effect of the acquisition of Aker Drilling.

General and administrative costs for 2012 are expected to range between $270 million and $300 million. Interest expense net of interest income of roughly $50 million and capitalized interest of roughly $40 million is estimated to be between $610 million and $630 million with the increase versus 2011 primarily related to the debt assumed and the acquisition of Aker Drilling as well as the refinancing of the Series B Convertibles with the higher cost Senior Notes.

We currently expect the annual effective tax rate for 2012 to be between 25% and 30%. But this will depend on our overall level of profitability among various other factors.

Absent additional newbuild commitments, capital expenditures are expected to be between $1.2 billion or $1.3 billion in 2012. Of this, roughly $350 million is due to our existing newbuild programs, $250 million related to our well control equipment to support our operational and project excellence initiatives and the remainder relates to our planned shipyards and normal ongoing capital expenditures for our operating rigs and offshore basis.

As Steven indicated, our philosophy regarding capital deployment is unchanged, which is to maintain a strong flexible balance sheet and an investment grade rating on our debt, reinvest in the business through value-enhancing opportunities and return excess cash to shareholders. In support of maintaining a strong flexible balance sheet, the company has previously stated its long-term commitment to reduce debt to an amount between $7 billion and $9 billion, and we reaffirm that commitment.

For purposes of this target, debt does not include Aker export finance debt which is supported by a similar amount of restricted cash currently approximately $900 million.

To improve flexibility in order to better handle the various uncertainties the company faces, we have also decided to increase our targeted cash balance to between $3 billion and $4 billion, excluding the Aker restricted cash included in other assets. Even in the event uncertainty such as Macondo is resolved, we do not believe this is prudent to reduce our available cash to below $1.5 billion.

To support these targets, the Board has decided to focus our 2012 available cash and cash flow on retiring debt as it matures and on building fast liquidity. In addition to maturing debt, we plan to also retire early $300 billion to $500 billion of other debt.

Absent A asset sales, we expect our cash by the end of the year to be between $2.7 billion and $3 billion. Proceeds from the asset sale initiatives that Steven has discussed will allow us to build additional liquidity beyond this level.

And with that, I will hand it over to Terry to update you on the markets.

Terry Bonno

Thanks, Greg, and hello to everyone. Before we cover specific markets, I would like to make a few general comments.

From a marketing standpoint, 2011 was a very positive year for Transocean from many perspectives. We began the year with 35 stacked jackups, successfully returned seven to active service and sold six units. Consistent with our asset strategy, we added four premium jackups with combined day rates in term that are still leading edge for newbuilds even in today's improving market.

We acquired two harsh-environment semis from Aker Drilling that are delivering operational excellence to our customers. We added two ultra-deepwater drillships under construction in Korea that are being considered for several long-term opportunities.

We also executed a total of $6.7 billion of contract backlog during 2011. Since the last earnings call, we have executed $1.1 billion of contract backlog during a relatively quiet holiday season. Over 60% of the total contract backlog awarded since the last earnings call is related to our jackup fleet.

While the global economic uncertainty still lingers, our major customers' capital spending budget for 2012 pertains a year-on-year increase averaging around 12% to 15%. The availability of ultra-deepwater rigs for 2012 is very constrained and our customers are now shifting their focus to fulfilling their longer-term requirements for 2013 and beyond.

Tendering and contracting activity in the deepwater market was light for the fourth quarter; however, we expect some long-term fixtures to be announced shortly in Australia and in Brazil where Petrobras' current 1,200 meter and 1,500 meter tenders are ready to absorb additional units.

Midwater activity is holding firm and demand improved over the period especially in the U.K. and India. Apparent demand for harsh-environment semis in the U.K. and Norway exceeds available supply and we expect upward pressure on pricing in these markets.

Premium and standard jackups continue to enjoy an increasing utilization and day rates over the previous quarter and strong demand is leading to the reactivation of some of the world's idle standard jackups.

Demand continues to improve in Southeast Asia, India, West Africa, Saudi Arabia and Mexico, and we expect the newbuilds arriving in the market in '12 to be fully absorbed.

Let's now look at the various market segments beginning with ultra-deepwater. Limited availability in 2012 is pushing rates up quickly as evidenced by a few fixtures for short-term programs about $600,000 a day level. With the increase in demand in the Golden Triangle, which includes expected near-term demand resulting from significant discoveries in the Angolan presalt, Northern Brazil and East Africa in addition to the current outstanding tenders that remained unfulfilled, we're very optimistic that we will be able to extend contracts on our available fleet through 2012 and 2013. We are in advanced discussions on our units available in '12 and expect to conclude these discussions at attractive rates.

Interest continues to build for the two DSME designed ultra-deepwater drillship under construction with our customers in the U.S., Gulf of Mexico, West Africa and Brazil. We've remain confident about the future of the ultra-deepwater market and our ability to capitalize on the many opportunities available in the marketplace.

Turning to the deepwater market, tendering and contracting activity was a bit lighter compared to the previous quarter with most activity occurring in Australia and Brazil. However, we see demand improving in this segment due to the continuing tightness in the ultra-deepwater market and we are offering our available units for multiple opportunities.

Petrobras is also expected to issue another tender for its deepwater needs in the near future. This opportunity coupled with open demand should tighten the deepwater market over the next few months. Indicative of this positive market sentiment, we have been able to execute an estimated eight-month contract for the Discoverer Seven Seas, a thousand-foot drillship at $445,000 a day with ENI in Indonesia.

In the midwater floater market, contracting activity in the North region and U.K. sectors of the North Sea continues to reduce available capacity through 2012 and 2013, and exert upper pressure on pricing. Little supply remains in the U.K. North Sea for 2012 commencement and with the influx of development programs. We expect to see increasing term that will further tighten supply in the U.K. With multiple operators trying to secure the same units, we believe that stacked units will return to the active fleet during the upcoming years.

Since our last call, we've been able to secure an additional 3.5 rig years in the midwater class with dayrates ranging from $260,000 to $280,000 a day. Based on our current discussions with multiple operators in Norway to U.K, West Africa and Southeast Asia, we will be able to secure further contracting opportunities through 2012 and 2013 at improving dayrates.

Moving to the jackup market, the tendering and contracting pace for premium and standard jackups continues to strengthen. Utilization in dayrates are on the rise is evident by the lower-specification jackups receiving rates around the $130,000 a day in West Africa.

In this improved market environment and since our last earnings call, we have been able to secure multiple contracts across our jackup fleet of approximately 16 rig years with dayrates ranging from $83,000 a day for lower-spec jackups to a $143,000 a day for the premium unit.

Most notably, we were able to execute a contract with Chevron in Angola for the delivery of a fourth newbuild jackup for a three-year term at a $149,100 per day. We are confident that the additional demand from our customers for premium extended jackups will lead to further contract extensions for our active fleet and provide opportunities to reactivate more of our stacked assets.

In conclusion, we are experiencing strong demand across all markets segments in all major oil and gas provinces and emerging markets which reinforces our view that utilization and day rates will continue to improve. The versatility and global footprints of our fleet positioned us to enhance our customer relationships by providing them with the optimal asset solutions for their future programs.

That concludes my overview on the market, so I'll turn it back to you, Steven.

Steven Newman

With that operator, we're ready to open it up for Q&A.

Question-and-Answer Session

Operator

(Operator Instructions) We'll take our first question from Ian MacPherson with Simmons & Company.

Ian MacPherson - Simmons & Company

It sounds like that the demand for the middles are certainly progressing very nicely but circling back to the cost guidance and I think you indicated, Greg, that we had cost assumed for the reactivation of the High Island IX. Should we prefer that there are not other reactivation costs in that guidance for floaters? And how is the outlook progressing for reactivation prospects in the conventional Deepwater fleet?

Greg Cauthen

All we have in the numbers are the reactivation cost for the High Island IX. So as other reactivations are planned during the year, if they are planned we'll include those in any future updated cost guidance. So right now it just includes the one jackup.

Steven Newman

And Terry's got comment on prospects for reactivations.

Tenny Bono

Ian, just to add a little bit more color, we are getting a lot of interest in the stacked fleet as you would guess. So while they're not in the cost guidance we do believe we'll have several opportunities over the next few quarters to be able to reactivate some of our Deepwater and also our continuing jackup fleet. And that would also include the midwaters. We have opportunity possibly for one in the near future.

Ian MacPherson - Simmons & Company

How would you characterize the lead times for your further reactivations if you were to get a contract for one today. Will it these be something you could rolled out in more two months or four, five months?

Greg Cauthen

It's going to be closer to latter, Ian, rather then the former. Generally the reactivation projects on the stocked floaters that we have are going to be relatively longer term in nature compared to some of the reactivations opportunities we have on some of our jackups. So think four to six months is a minimum.

Ian MacPherson - Simmons & Company

And then, Steven, if you don't mind just one more quick question. Any reassessment with your self on the board with regards to the assets strategy and the aversion to building spec rigs, sea drillers, as ordered two more this morning. And it seems plausible that we're going to have something of a replay of last year with your competitors going down that path. And I wonder if you're still comfortable with the strategy that's been emplaced of not doing that.

Steven Newman

I tend to revert back to the same things we've always talked about, Ian. We've recognized fundamentally we're in the supply demand business and a cyclical industry. And I think we're going to continue to hold to the principles and the philosophies that have stood this company very well over the course of the cycles we've been through.

Ian MacPherson - Simmons & Company

That sounds like middle change full stop?

Steven Newman

We remain averse to the idea of building on spec.

Operator

And we'll take our next question from Doug Becker with Bank of America Merrill Lynch.

Doug Becker - Bank of America Merrill Lynch

Just wanted to touch based on the Macondo loss contingencies, where are the assumptions associated with insurance there and could more or what could you apply to that potentially?

Greg Cauthen

As you can see more fully described in our 10-K there are no additional insurance accruals that have been applied to the $1 billion. We do have recorded about $374 million of assets related to insurance that those relate to previous losses that we've recorded related to Macondo. There is a little more than $600 million remaining in our insurance tower. But under the U.S. GAAP rules it's very complex to determine how much of that could be recorded against the contingent loss like we've recorded in the quarter. And so we're not able to determine the amount of any additional asset that we could record at the U.S. GAAP. But we would expect overtime to be some insurance recoveries.

Doug Becker - Bank of America Merrill Lynch

And then taking a look at the cost side, notice that the average out-of-service cost for the ultra-deepwater fleet jumped up pretty substantially in the course to almost $640,000 a day from $490,000 a day in the third quarter. The out-of-service days were relatively similar.

I understand that you're expecting less the ultra-deepwater fleet to be out-of-service in 2012. But is this indicative of the out-of-service time and cost, I guess, really that we should be expecting going forward or is there anything specific in the fourth quarter that might have accounted for that jump?

Greg Cauthen

The in-service daily operating cost is always a fairly volatile number, because that can be heavily impacted by some major maintenance projects that occur during the quarter. So we like to look at the trailing average for the average of the last fourth quarters. And looking at average of the last four quarters to what we expect the average to be next year for the fleet as a whole, we expect to see about a 6% increase in that average daily operating cost.

Now, that's not 6% from the fourth quarter and the first quarter, that's 6% average-over-average year-over-year, so that will trend in during the quarters. But again it is very volatile and so it can be impacted by major maintenance projects and other activities like that.

Doug Becker - Bank of America Merrill Lynch

And just to clarify, that was for the in-service cost, it's correct?

Greg Cauthen

That's right.

Doug Becker - Bank of America Merrill Lynch

Any commentary on the out-of-service costs, which seems to jump up in the fourth quarter?

Greg Cauthen

Sure, we expect our total out-of-service cost next year to drop by about $500 million versus this year with the significant decrease in out-of-service time as well as the decrease in the higher risk BOP recertification efforts. So in our cost guidance we would expect at the low-end of the range to see that $500 million cost reduction. Now that is the most volatile, so at the higher-end of the range, we won't necessarily see much of a decrease.

Operator

And we will take our next question from Scott Gruber with Bernstein Asset Management.

Scott Gruber - Bernstein Asset Management

Could you provide some color on what compelled the goodwill impairment? Did they reflect a change in assumptions or regarding reactivation potential or a return to peak jackup pricing? Just adding contrast to the strengthening of market fundamentals here.

Greg Cauthen

Yes. Unfortunately, the goodwill impairment under U.S. GAAP is very mechanical and we elected probably 12 years ago, when the new rules came into effect to evaluate our goodwill on October 1. And so on October 1 is when we have to evaluate all the various market conditions and all the uncertainties, including the Macondo well uncertainties, the operational uncertainties that we were experiencing in the fourth quarter.

So all of those went into our evaluation of the contract drilling business and really all the same factors that impacted our stock price in our market capitalization in the fourth quarter end up reflected in our valuation of the contract drilling business. So when we compare that, we go through an allocation process and come up with the implied value of goodwill that's really a point in time, I always view it as, if you look back at our market cap at the time and you compared to our net book value, you would see our market cap is way below our net book value.

Now, it's a much more complicated process than that simple calculation. But essentially, it's the same. It has nothing to do with our view of the future, of our fleet. It's really a varied mechanical valuation exercise.

Scott Gruber - Bernstein Asset Management

And then an unrelated follow-up, is the new BOP unit exchange strategy, is that going to require having some backup systems in place and ready for deployment?

Steven Newman

I'm not sure, why would call them backup systems, Scott, or just an inventory of capital spares right across our fleet. So really the exercise is one of identifying how many of this particular make and model we have, what the outlook is for the five yearly recertification process for those rigs carrying that particular make and model, and ensuring that the company has enough capital spares in inventory to be able to have a rotational program across that particular make and model.

Scott Gruber - Bernstein Asset Management

So it's going to be more parts in inventory rather than full systems?

Steven Newman

Correct.

Operator

And we'll take our next question from Matt Conlan with Wells Fargo.

Matt Conlan - Wells Fargo

I was hoping to get just a little more clarity on the $1 billion contingent liability that you recorded? Can you help us separate the company's total liabilities into a couple of buckets? One, what are the probable exposures that are attempted to be estimated by the $1 billion? And then what are the reasonably probable exposures that are above and beyond? What's left after the billion dollars that you've estimated so far?

Greg Cauthen

If you look at our balance sheet, if you look into our 10-K, we actually have $1.2 billion of liability recorded related to the Macondo well incident. The $200 million has built up really since the incident primarily related to the crew claims and other similar liabilities.

So the additional $1 billion we evaluated under FAS 5. And so FAS 5 requires us to evaluate all the facts and developments that occur during a period. And if we believe, we can determine a reasonably possible range of losses than we are required to approve the low-end of the range of those losses.

So that range of losses that make up the $1 billion, again isn't related to crew claims, it's related to all the other losses from litigation that could come at the Macondo well incident. And because that is active litigation we really can't go into to the details of the various components of those losses. But it's really everything else.

All the litigation losses, all the things are going to be covered by the trial that starts a weak from today, so all of those losses are included in setting that low-end of the range. Now, we will continuously evaluate developments as they occur. And if possible, future developments could cause us to adjust that evaluation as the low-end of the range.

Matt Conlan - Wells Fargo

And in addition to you not being able to record any insurance benefit against that billion, it also appears there has been no tax deduction. And I'm unsure, given your Swiss status. If it were $1 billion expenditure, would you be able to deduct that for tax purposes from U.S. operations?

Greg Cauthen

No. We're currently assuming due to the possible nature of the various components of that that there would be little to no tax deduction for that provision.

Operator

And we'll take our next question from Kurt Hallead with RBC Capital Markets.

Kurt Hallead - RBC Capital Markets

I guess my initial question for you guys is, Steven, you guys talked about having three different buckets of assets in determining your disposition strategy. And I was wondering if you might be able to give us an update on first those buckets? Secondly, whether or not the cost estimates related to the buckets may have shifted? And then just the other component to that question as it relates to the buckets, is given the market dynamic here have some of the assets kind of shifted around a bit and are there as many assets for sale as you thought there may have been?

Steven Newman

Are you talking about our asset strategy or the reactivation candidates?

Kurt Hallead - RBC Capital Markets

I think I am talking, I am thinking about it all inclusive manner. And I know you have referenced that the ideal assets that you put in different buckets in the past. I think there are three different buckets, you put them into, I think there is some cost estimates related to that. And I am just wondering, if you can just give us an update on if anything has changed as a market dynamic causing you to pull some of those assets off the market. Would you please give us an update on that if you can, that'll be great?

Steven Newman

So as we think about the opportunities for reactivation, Kurt, I generally think about the stacked fleet in three different buckets. There is a group of assets that I think make relatively straight forward reactivation candidates, whether they are jackups or floaters, it's about a third of the fleet that I think can be reactivated in a relatively straight forward manner.

So if you're talking jackups, these were projects that probably are 60 to 90 to 120 days, and maybe $20 million for reactivation expenditure. On the floater side, as I mentioned earlier, it's going to be a little bit longer that maybe four to six months in terms of reactivations and the reactivation expenditures going to be in the range of $50 million.

There is another third at the other end of the spectrum that are not likely to work for us again, but still make attractive divestiture candidates. We've sold the couple of those in 2011. We'll continue to focus on divestiture opportunities in 2011. And then there is a third in the middle, they are reactivation candidates. And as Terry has explained, the market is getting better out there. Activities increasing, demand is increasing. Term and day rate is increasing. And all that provides economics that are more supportive of further reactivation possibilities.

Kurt Hallead - RBC Capital Markets

And in the context of the market improving, Terry, where would you characterize the current market dynamic when you think about it in pretty Macondo terms, would you equate it to 2006, 2007, 2005. What's your best approximation?

Tenny Bono

Well Kurt, you don't feel a whole lot like 2006 and 2007. If we just looking at the ultra-deep water activity, if you look at the what's evitable in the market and then what we know that is being considered and close to being contracted at 2012 and 2013 and we kind of get a number that looks around six-day rigs left in the ultra-deepwater space. And then if we look at the deepwater segment we put the same pencil there and that's assuming that, some of these rigs get rolled over with their existing customer. So we kind of get the same numbers, six to eight rigs in the deepwater space, that's you know, active fleet.

And we all know there is heck of a lot of demand out there. If we look at West Africa alone, I think that there is a recent study done and it said they need 20 more rigs in 2012. And that doesn't include the recent discovery for the Angolan pre-salt. So we're very optimistic about 2012 and 2013. And like I said, it does feel a whole lot like the scenario that we saw in 2006 and 2007.

Kurt Hallead - RBC Capital Markets

We mentioned on the jackup side, you think all the new builds will be absorbed in by 2013?

Tenny Bono

Well with the rigs that are coming to the market we can see that there is a lot of demand there that we believe that will be absorbed and especially when you have Saudi out there trying to actively fulfill their needs. And then you have Pemex. I know, they're going to get back up to 40 rigs. And ONGC has been very, very active. We see that the demand is very tight.

We're seeing an opportunity for our class-3 bucket low commodity spec jackups, the one in particular the High Island IX. It just received a three-year contract with Saudi. So the demand is certainly picking up and if you look at over the last 12 months the biggest increase in day rate has been the old standard jackup. So as the ultra-deep water increase over the same time period from day rate pricing to about 23% and the old jackups have increased around 30%. So it's very interesting and we believe that is going to continue.

Kurt Hallead - RBC Capital Markets

And one more if I may, Steven, I believe it was last fall, there is some questions about the new Brazilian rigs and I think there was some discussion as well that some of those new rigs may actually lined up in the hands of the traditional rig operators. Can you give us an update on what may be transpiring in Brazil? I know you may not want to go out and build the rig on spec, isn't dying one of these Brazilian rigs or getting an interest in one of these Brazilian rigs or getting an interest in one of these Brazilian rigs, essentially a way to get a contracted rig in hand and take down the upfront risk. Could you give us an update on that?

Greg Cauthen

Kurt, we remained interested in growing our business in Brazil and further developing our relationship with Petrobras. And so we continue to have conversations with our colleagues at Petrobras about exactly how to do that. We'd be interested in having discussions about helping them in terms of taking over the operator ship and buying it into the equity ownership of some of the rig they've already contracted that they are looking to place in the hands of experienced operators.

Kurt Hallead - RBC Capital Markets

And have those discussions been happening or are they yet to happen?

Greg Cauthen

I would say it's more of a continuous dialogue with Petrobras then an episodic or discreet dialogue.

Operator

And we will take our next question from Angie Sedita with UBS.

Angie Sedita - UBS

First, Steven, congratulations on the encouraging rulings on the court, so far, it's certainly good to see.

Steven Newman

I'll tell you, I think we have an excellent legal team. And they've done a superb job of arguing the merits of our case.

Angie Sedita - UBS

It's nice to see the contracts honored. The first question I have is, as you just spoke briefly on the dividend. Could you give us some thoughts there as far as the importance of the dividend to Transocean going forward and what is the possibility or probability that that could be reinstated in 2013?

Steven Newman

Well, I'll tell you Angie, I think the company has a long history of being really disciplined about how we think about reinvestments. We have always set really high criteria for ourselves. And there are times when we take some criticism in the marketplace for holding to those criteria when we won't build on specs. So we've been disciplined about our reinvestment criteria. And I think we've been similarly disciplined about our historical approach to returning excess cash to our shareholders.

So that capital deployment philosophy hasn't change. We remained focused on a strong balance sheet and in investment grade quality debt, on identifying attractive opportunities to reinvest in our business and being disciplined about returning excess cash to our shareholders. And we will continue to engage our board in discussions in evaluations of our business in the context to that capital deployment philosophy.

Angie Sedita - UBS

And then you discussed in various forms a potential spin or sale of some of your older jackups. And I believe our bank may have been hire to run this process. Is this a possibility or an event that could potentially occur in 2013?

Steven Newman

Well, as I said in my commentary, Angie, we remain focused on executing our asset strategy. We want to increase our exposure to high-spec assets and reduce our exposure to low-spec commodity class assets. We've done a good job. In 2011, we generated more than $440 million in asset sales proceeds.

We continue to explore a variety of alternatives, including single asset transactions which are asset divestiture folks are getting really good at. We have had discussions over the last several months about packages of assets and we remain interested in a single large scale transaction if we can make it work.

Angie Sedita - UBS

Terry, given the fact that we're delivering 23 ultra-deepwater rigs in 2013 of which most are still uncontracted, but certainly some positive data points in West Africa and elsewhere, your thoughts on ability to absorb those rigs in 2013 and the day rate outlook at the same time in 2013 for the ultra-deepwater market.

Terry Bonno

Angie, I think that if we roll back to 2012 for a second, I think with the availability, and there is not a whole lot left, you're going to see some of these short-term fixtures continuing. I think they're going to be over $600,000 a day.

Now, we know that 2013 is an inflect, but we see opportunities that are already developing. We are having conversations certainly with the new news of the Angolan presalt. We're already getting discussions there. So it looks very promising. And if we are having discussions, I have to think that our competitors out there are also having discussions. So I think that's why you see a brilliant movement here and there that everyone is very optimistic about the 2012 and 2013.

So I think they're going to be absorbed, and I think we're going to have plenty of opportunities certainly to place the units and we're certainly hopeful that that belief is down into the deepwater segment also. So again, we're very optimistic and I'm very confident of our talented marketing teams in the field to get these things done quickly.

Operator

We'll take our last question from Ole Slorer with Morgan Stanley.

Ole Slorer - Morgan Stanley

Back to the midwater market again, that's clearly where you have the most open exposure over the next 12 months. And with vacancy that's really on the three ultra-deepwater rigs available over that period that you have won. So assuming that these rigs settle in the $600,000, where do you see that you have the biggest pricing power on your midwater fleet? Is it in benign environment because of the very strong demand and very high rates likely to see in the sixth generation segment, or is it more in the areas like the North Sea which are coming back again?

Terry Bonno

Just talking about the midwater fleet in the U.K., we are seeing strong demand and we have several opportunities to roll our fleet over here shortly. And we're very optimistic about those opportunities and we have multiple customers who are asking for the same units. So we are very optimistic about that.

We have six available in 2012 in our active fleet and we are in discussions on all of those rigs at the moment. And these are very positive advanced discussions. So we like what we see in the midwater opportunities for 2012.

Ole Slorer - Morgan Stanley

You highlighted 2006-2007 and I think we all remember very well what happened in the midwater segment during that period. It was probably the most dynamic segment. So how close do you think we can get to old highs or let's say how close can we get as a percentage of leading edge high-spec rig rates?

Terry Bonno

I think if you look at 2007 as a marker, you'd have to say that we're there. So if in 2007 we were approaching $550,000 a day, it's what we accomplished. And today, you're already seeing the fixtures $550,000 to $600,000 a day. So I would argue that we're there.

Now where we're lagging, as you pointed out, is as soon as we get a little bit more tightness in the ultra-deepwater segment, then we do believe the optionality exists for the standard deepwaters and the midwaters to improve. They're not there yet, but in the next couple of months, I think we're going to see significant improvement.

And again, I feel the same way about the premium jackups and the standard jackups.

Ole Slorer - Morgan Stanley

If I look at your efficiency, conventional wisdom, I'd suggest that older rigs have a lower uptime. But when we look at your fleet, your harsh environment there are some of the older rigs and your midwater floaters represent some of the older rigs. Both have utilization of 94% to 98%, which is very good compared to your ultra-deepwater and deepwater at say 88%, 89% utilization.

So can you talk a little bit about how come that older rigs have a better uptime than modern rigs?

Steven Newman

Ole, it just has to do with the complexity of the controls systems. The older rigs tend to work in shallower water depths and they tend to utilize simple hydraulic control systems for their BOPs. What that means, Ole, is there is just fewer components in the system that are susceptible to the stress of working in deeper waters, the rigor of repeated testing and the low tolerance for failure rates. It's just a question of the complexity of the control system.

Ole Slorer - Morgan Stanley

Does the process means that when the midwater market comes back again, the execution risk for you should be a little lower than in the deepwater?

Steven Newman

Broadly speaking, I think that's true.

Thad Vayda

All right. That concludes today's conference call. Thank you all very much for your participation. We'll be available offline if you have any additional questions.

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