Diamond Offshore - Marc Edwards, CEO, 2016 West Coast Energy Conference On June 21, 2016 - Personal Transcript

| About: Diamond Offshore (DO)

Summary

Marc Edwards, CEO, spoke at the 2016 West Coast Energy Conference On June 21, 2016.

Marc Edwards announced a significant loss in revenue for 2Q'16 due to safety recall and BOP problem on the four UDW "Black" drillships.

It is about approximately 80-day of zero revenue or about $35 million.

Marc Edwards also explained the floating factory concept.

The transcript will start without the actual required announcement (from safe harbor) from 0 to 0:40.

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Image: the Ocean Great white.

Jud from Well Fargo:

So, first thing, I want to ask you about, Marc, is kind talk high-level, big-picture in your view, we talked about a little bit this morning on an offshore drilling panel. I would like to get your thoughts on where things stand... How you see supply & demand, and your views for the next one or two years, I guess, how the market comes back in balance?

Marc Edwards, Diamond Offshore CEO:

Sure, the way we are looking at oil prices is really, it's an output of the supply & demand stack, that we are facing as we move into the next five or ten years, so to speak.

And if you look at the supply/demand perspectives, specifically, around how demand is still growing, you know, we've have had the demand revision already in 2015 going upwards just over a million BOPD and then you look at the decline curve that we are experiencing.

And many people or many commentators in our space have differing views, but it is anything from 3.8% per year through to maybe 5% or 6% and over the next ten years it is not impossible to come to the conclusion that we might see liquid production in a "do nothing scenario" drops from let say 95.5 MBOPD today to around 71 MBOPD.

And then you stack that up against demand growth, let's be conservative, just less 1 MBOPD, then look at 10 years or so, there is a definite shortfall in supply, even if you put in, say around, 6 MBOPD above yet to be delivered from a net (?) perspective.

And then, you have got yet to close the gap, where the gap get closed. Whether it is OPEC or whether it is tight oil, no matter you stack it up there is still room for deepwater in the years to come, and that could be growth, as much as 5 maybe 6 MBOPD that need to be found and delivered over and above where we sit today.

So whether you listen to commentators such as (?) we know he is on the board of Slumberger no Aramco today, right now, he publicly said recently that we are heading towards a price spike, and whether you go to some analyst houses or some of the research analysts out there, again we start to see a more bullish perspective starting to materialize. As it relates to oil prices they are definitely going.

We have seen a bottom, I think many people will agree with that, oil prices nearly doubled since the beginning of the year, so there is still uncertainty as to what the trajectory is. But I think the general consensus is that the price is moving in the right direction, then you have to ask the question. Ok, what do we need for deepwater to come back into play in terms of the price?

And there is no real single answer to that, it depends, really is the answer. If you take a look at what BP is doing, I think that is the one is taking generally as an example .

BP today will make better shareholder's return with an oil price at $60 that they would have done two years ago at $100. The same can be said for Pelegrino in Brazil or Johan Kasberg with Statoil, we have seen deepwater costs materially move down, as the oil prices move back up.

Jud Wells Fargo:

How do you think the Industry needs to continue to move forward to keep deepwater competitive with its share under low cost resources. How do you see the deepwater costs curve continuing to come down and your views on how the rigs can perhaps play a role in that.

Marc Edwards:

Yes, that's a very good question, of course, our clients have capital resource allocation as we all do. And if you look at what many of our clients have experienced in the last five to ten years, they did struggle to meet the cost of capital hurdle, and, at the end of the day, deepwater is competing against light tight oil or unconventional work.

And If you look at the two together, I think from a cost prospective, they will actually end up being very similar from a costful? failure? I think the issue we have seen in the market, today, is the unconventional business or light tight oil business is, of course, very transactional, so what you see is the cost advantages materializing much faster than they do in the deepwater, which has a longer time horizon, it is more contractual and therefore the cost savings take longer to materialize. So where the unconventional space has seen its costs dropped to the levels we have seen today, I think that's it.

You know, I came from unconventional for my whole life, and as it relates to efficiency games, then I think we've seen for the most part that play out and for the deepwater space, we haven't seen yet the end of the cost saving, it is still going through the pipeline, and materializing as we go forward when it relates to costs, flow lines?... As well, of course, to the drillship itself, as we see the rates come down.

So we have more to give in deepwater and I think the only thing you have to remember when it comes down to comparing unconventional with Deepwater is the life cycle of the project. Now, in Deepwater, I think many people realise that from a project return perspective deepwater, even today, can give better returns to shareholders than the unconventional projects.

So the real issue we've got is the timing of the cash flow so when our clients have a problem with the cash will, it is easier to invest in the onshore unconventional, because it becomes cash flow much sooner than deepwater. But if you look at it from a project perspective the return in deepwater can actually outstrip unconventional and in a lot of cases they do.

So, as the old prices come back up and once they have the opportunity to fix their cash wheeles, I think you will see more and more projects be brought back up of the horizon, becoming sanctioned and that process will accelarate in due course of time as the oil prices recover.

Jud Wells Fargo:

Ok, One thing I think is interesting is Diamond is positioning itself, I think a bit differently from some of your competitors and how you see the drilling rig evolving the kind of around efficiency and other metrics. Could you maybe first talk about your strategy about the floating factory and pressure by the hour, and your kind of vision for the Diamond fleet moving forward.

Marc Edwards:

Yes, sure, so once again this is referring to my whole life before I came to deepwater drilling I was playing a significant role in developing an unconventional story, with around the efficiency game. And this is something that goes back six, seven years, actually longer than that, let me put first the strategy in place to drive efficiencies, because even back in those days we did not realize that we could make unconventional successful in a sub $2 gas environment, and we did, through the efficiency game and innovation and technology. I think the same could be applied to deepwater.

And when I came into this space what concerned me the most was low hanging fruits around non productive time, and that is the drilling time actually on location, not actually drilling for whatever reasons.

If you do a deep dive into the wise and ? force, the liability of the subsea stack is an issue, and if you listen to the voice of the clients, its uniform, we have to fix the liability of the subsea stack. And, again in my old life, I had manufacturing, I had known R&D basis... But in offshore drilling, as a offshore drilling Co., you do not do your own manufacturing, you don't do your own R&D.

So how can you incentivize .. to build about a system? So that I considered low hanging fruits. So, I do relate to our new drillships the four black drillships that we have in our fleet, we all brand new, recently delivered, and they are stack on the same OEN and that OEN is a part of a large conglomer? that provides aviation turbines through equipment in power station and compression stations.

If you take a lead out of these industries and you apply to our industry, it is not difficult to see that going to a model that is based upon availibility, that would drive themselves to design for liability, and enhance their products, because frankly you know with the direct sale without even a warranty and then off you guys go. In couple months expected not work and dam? collapse.

So we spoke to this particular area, offer to bring in from the other part of the conglomer? the same ideas, and for the first time in the industry we've got to the stage whereby, when the subsea stack goes down it is not only the officer drilling that is feeling the pain but also the operator as well, the client and now for the first time it is the orien? as well because we sold back to them, and now we are renting from them do it and when the stack goes down they do not get paid, so the question comes, now, do I have your attention? Yes we did and the clients love it without exception absolutly without exception that makes sense to them I do not see ...Jud can I ask you a question?

Jud Wells Fargo:

Of course, yes.

Marc Edwards:

What car do you drive?

Jud Wells Fargo:

A Jeep Grand Cherokee

Marc Edwards:

Did you buy new?

Jud Wells Fargo:

Yes,

Marc Edwards:

Where did you get the serviced

Jud Wells Fargo:

With Jeep

Marck Edwards:

It is not rocket science, except subsea stack is much more complicated and its success, when it needs to work is absolutely critical. So, then we have it OEN, have a seat at the table when things go wrong from a financial perspective is for us the right way to go.

Let me say a couple other things around it, when you have when we went down this path we were listening to the voice of the customers in the industry. We wanted to provide leadership to the industry around driving the efficiency gains, to drive costs down in deepwater drilling and originally I thought we would have had first competitive advantage.

I am looking for a competitive differentiation that gives a competitive advantage that is sustainable, this what I thought would be the first advantage and I saw others copied it quite quickly. What happened is once we got the deal agreed with OEN, where we are, Moody's downgraded all of us to high-yield. So the cost party was changed, I don't think the deal would have been done with the downgrade to high-yield, before we got the deal signed, it would not have happened.

So the door is now closed you know we are still investment grade with S&P company, but with Moody's we are a BA2, which is still two notches above the next best drilling company.

So we are differentiated from a credit perspective, but we are high-yield, I do not think this deal would have been done or can be done, now, so the door is closed. It gives us a competitive advantage for our black ships in the subsea sector, that has the most excess capacity. So our black ships have been elevated to the top of the list of desiribility, because I mention to you that our clients, without any exception, think this is a good deal.

We went live with two of our black ships, on the 31st of March, and two weeks later we have non-plan stack pulls. So within two weeks we were feeling the pain. But let me tell you that what was painful for us was not painful and it is painful for my clients, but at least, I sit on the table with you talking about to enhance liability, upgrading the equipment and design for liability perspective, and so we are all working together with the same goal.

You know I mention it today, anyway, when you wait for a double deck bus in London, you are supposed to wait 15 minutes, sometimes you are standing there for an hour, all of a sudden, four buses come along together that supposed to come every 15 minutes.

We actually had four un-plan stack pull, on my bop this quarter. When I have a non-plan stack pull, I go to zero revenue, and I think in some of my earlier commentary around what the stack pull actually means, its 14 to 21 days that multiply by four in 0 revenue, it is natural for me, yes it is.

Is it material for my clients? Absolutely. Because, never mind the day rate they don't have to pay me, they still have the spread costs, they got the deferred oil, so they are losing a $600K/day to $800K/day.

I am not getting paid my revenue, but now I need to un-plan stack pulls, and we feel the financial pain, as well, and it is unique to the industry, we are the first to do this, but now the door is closed to everybody else.

So you could argue, Ok, let me ask you the question... You are going to say it is related to switching to this new deal, for un-plan stack pulls. Actually, it's not, because one of them was an assembly issue when the BOP was delivered, from the original manufacturer, and the other three are related to a safety recall.

So otherwise it is like Jeep comes to you and say hey pull up recall this is serious and so it is nothing due with the maintenance, people maintain it and actually people have overlap for the first six months from our people and GE people. We got three GE people on the rig, but it is a safety recall, now it would have happened whether control by the hour or not.

But for the first time when we got notice we had to do an un-plan stack pull, GE was all over it, from day one, and had people on the rig so when the stack gets to surface they have already pre-planning the logistics, the backup support from the design team etc. Etc.

It has not happened before you know the actual safety recall related to the bolts on the cutter on the shear end block, in other words, it is the bolts that hold the cutter in place, they were failing prematurely, so the issue of safety recall for this particular type of BOPs.

They did not immediately say you've got to pull them, they left ourselves and our clients to decide. Let me tell you this is high-risk stuff, this is a risk to my shareholders and my client shareholders then when the recall came down we sit down and we had a conversation. What do we do with the pole, even so we have financial consequences. Now, it could be much more material than the revenue I lost this quarter, so we pull them.

Now I think in the past the ... would have come to us with a bag of bolts and say try these, but now they are not, they try to design the bolts out of the cutter block interface, now would that happen before I do not know.

This is one example of where the timeframe is taking the industry because downtime in any industry is problematic, and I think the other thing that kind of frustrating me, a little bit, when I came to deepwater drilling.

Can you name an other industry where they provide two of something because one unit is so unreliable? Did Jeep tried to sell you two Jeep grand Cherokees, because the first one would not work, no they did not, why Boing is not trying to sell United, two dreamliners when they need one because the first one is so unreliable.

I cannot even imagine another industry who does it, but we allowed ourselves in deepwater because frankly we had great returns but really great returns, hopefully we can get back one day... and bring change as it relates to efficiency games in our industry I think we did or I did when I was in unconventional.

So that is one example of how we kind of differentiating Diamond offshore in a space that... I am looking here for Black ships, these are bought out of the catalog, they are very similar to my competitors if not exactly the same, except the pain is different. So it is a very commoditized business. So how do you differentiate yourself in commoditized the business. We do stuff like this, price control by the hour.

You know the other day we have made an announcement on Helico buoyancy riser and Diamond is not really well known for making an announcement on technology gain, that can take out 20% of the time and possibly more of the time it takes to run a riser...

So we do not make buoyancy risers, we are not a manufacturing company so we went into the manufacturer of the buoyancy riser, and we said we are working on this idea and it seems to work, we license it to you, you can sell it to whomever you want, we take 5% royalty, but the first two orders we are giving them to you, we will put it first in our black ships, it reduces the time it takes to a riser or incremental steps in driving efficiency game, there would be of benefit to my clients...

That's how you differentiate yourself in this space, now, I am in a position to do this because I have got a great backlog I have got from... Perspective my liquidity is sound and my four black ships and 6G assets are contracted through 2019 and beyond so I am not trying to sell assets to a highly distressed market which is the 6g drillships...

Jud Wells Fargo:

My next question would be, in a way, what differentiate yourself, is the balance sheet you are the strongest in the industry at this point we talked in the past about the 6G rigs new design, how do you think about capital allocation into distressed assets that are out there today with this new design rig that can you can walk it through your thought process, how you view capital deployment with several opportunities out there.

Marc Edwards:

Because we are in a unique position in deepwater drilling we can focus on some other things other than just debt covenants and contracting rigs that are not contracted in the 6G etc.

And if I come with the same philosophy that we bought the unconventional space is driving efficiencies, and an offshore driller doesn't buy an offshore un-contracted drill ship and what they have is a hole in the ground could be viewed from the manufacturing aspect around lean manufacturing principles and that it is exactly what we did in unconventional did to where we are today, great success story, if you think to apply the same philosophy to drill ships.

I am looking at the 6G drill ships and if you actually start with a white sheet of paper they will not look like that, what we have done is to take an onshore rig and put it on the ship. If you look at the lean manufacturing perspective you actually would not do that so we are looking at providing incremental gains we are moving the flat spots and drilling process through the manufacturing principles if you increamently add each other up it gives you an efficiency game over the best 6G drill ship, 15% to 25% depending on where you sit and it is important in this market that drives cost down in deep water?

Absolutely it does, but as interesting as it may sound, we are not married to that concept. Am I working on it, yes sir, are we close to finishing it, yes, about security technology for 18 months yes, but I am not married to the concept of building these drill ships. I am married to the concept of picking up distressed assets, to participate in an M&A... But I am willing to the effective use of capital moving forward and looking at those options. Capital allocation is the most important aspect of anybody in this space now looking forward, and if you get it right, it maximizes shareholder value.

So the principle of share allocation that drives shareholders' value, but I am not married, whether it's going to be this particular or this particularly of course capital allocation covers still shares buyback and distributions now we are in an unfortunate part of the cycle right now so it sits at the back in the queue.

But we do not have to declare today, we have time on our side, and I think as we said this morning deep water drilling has not hit the bottom, it is still in a downward trajectory around utilization. I think it is going to take another 6 to 12 months, maybe even longer, before you can start to pull and leave it. Because it is not just value and opportunity, it is not capitalization per say, it is not just the value you have to consider, it is the timing when you execute. It is not kicking the can down the road by any sense of imagination. It is supplied diligence in the process of capital allocation in the interest of the shareholders and if today is the right time or 6 months down the road, guess what, it is 6 months closer to recovery so things might make more sense, in that regard.

So we are creating strategic options for Diamond Offshore that no other OSD is considering. Because we have the balance sheet and liquidity profile that we have to include the floating factory. Remember, I have been consistently talking about lean manufacturing principles, now in turn we've had... Around the unconventional with the freak factory so it is no coincidence that we actually use the term floating factory to describe what the next generation of assets it should be and many of the clients love the concept... A lot of them are sharing with us how they like the efficiency game through a floating factory.

Are they in a position to order now? No, of course not, they have been burned so hard by the poor shareholder value that they have delivered the past five years, now, many of our clients have a very short term horizon, as it relates to financial perspective, so these drill ships, floating factory, is a three and a half -year build program so it is a 2020 delivery. It is extremely naive to expect our clients today, to say yes, we will have one of those today and this is what we pay in 2020.

I guess, the issue here really is around we have options, we are not declaring on any of them. We have got a new design that's ready, it is sitting in the paint tray. We might leave it there or we might not.

That is driven by the fact that capital allocation is shareholder return comes first. We do not know how far very good 6G distressed asset class we might drop in term of prices, so that where we are staying in term of differentiation, we try to stuff different in our space and our clients are very receptive to our ideas and thoughts we have proven already and ideas of thoughts it's out there today.

Jud Wells Fargo:

Just to confirm you want to move forward with a new conception of rig and you are talking to your customers and they are very receptive with the new design ... Would you move forward without a contract would you need a contract in order to order to the shipyard.

Marc Edwards:

I am not ready to declare on either building them or building them on spec without a contract.

I think if you wind the clock forward they will be some stickiness in the market as it relates to its recovering, but they might come a time with a lag for delivery you could envision, it is the right allocation but we are not in that place, right now, the 6G assets now are severely distressed.

Most than the 4G so everyone said ... the 4G asset class is actually fixing itself, today, there is only 35 of them, and we have seen scrapping in the industry, up to 50 assets have left the market, and they are in the 3G and 4G space, not in the 5G or 6G space so the 4G is self correcting.

I have got seven 4G very very good assets, some of which are basically new... And they are totally different rigs, it is not stretching that far our imagination that to say every bolts have been replaced, steel has been replaced, the derrick, the accommodation etc. has been replaced electronics, the drill floor have been replaced, with new equipment, by the way they are bigger rigs that they were in 74-78 and are qualified as 74-78 rigs, which is baloney.

We are very comfortable with our fleet so my four 6G drillships are differentiated, sustainably differentiated, so they rose to the top of desirability and they got contract to 2019 and they will be hot when they will need to be re contracted. It is not like cold stacked rig clients want hot rigs you know there is a client in the North see that issue a tender for P&A and they have actually stated don't bring us a cold stacked rig, we will not consider a cold stacked rig. They want hot or recently warm stacked rigs so not only have I differentiated these assets, and driven to the top of the list of desirable rigs they will be hot when they will need to be re-contracted in 2019.

Then I have got very good 4G moored assets, an asset fixing itself, so when we talk about strategy these are the kind of things we are doing in Diamond offshore we are positioning ourselves as a broad fleet to ride the next wave when the time comes.

Oh, by the way we might be doing even more to bring technology to the table to help. We've got the designs we have done the heavy lifting just a case of do we want to push this button, but I keep back to the point that it is about capital allocation to add shareholders value.

Jud Wells Fargo:

Let me ask you of the way strategy, geographic perspective, what markets are you the most optimistic about over the near term or over the long term, is it the Gulf, is it Brazil, how do you think about these different markets.

Marc Edwards:

This is a good question, Brazil is not going away. I think, yes, it is problematic it is not going to reach the hay days of demand couple years ago, but with the reform they try to put in place by Petrobras it is going to give more opportunities ... To go down there, so you can't write off Brazil.

It is going to provide good rig demand in the deepwater space looking forward ... Base moving forward, we have a good relationship with Petrobras and it is up and down as much as anybody is facing the issue down there and we got to keep a close eye on the sanctity of our contract and I&C is going down there..

Again Gulf of Mexico is the most simple part of the World to do deepwater business because of the fiscal regime, the sanctity of the contracts etc etc. and I think if you move over the border we extend opportunity over to Mexico, geology doesn't stop with the line that delineate the Countries, it goes across the borders so I think Mexico is going to be an opportunity it might take a while to materialize and then you know West Africa I think we've got it more in terms of government looking at tax and fiscal incentives for that to pick up so do not write off Brazil and we love to do business in our backyard is one of the advantages of my fleet we've got Mexico which is the cheapest place to operate, because we haven't one in Angola, one in Egypt, one in Asia and one in Brazil

Jud Wells Fargo:

My last question going back to what you have said about the un-plan stack pulls, are the rigs are back to working yet or are you still experiencing downtime.

Marc Edwards:

No, there is still one that, you know, you have got to pick your point... oh yes the issue deal a lot, it was an immediate recall, we have to replace it today, it was less an issue of the discretion an issue of the discretion. We are always on the side of caution when it comes to safety, you know why. So when you get to a point in the drilling cycle that enables a smooth stack pull, we did it.

So three of the stack pulls have been completed and one is still in progress... Like I said, one stack pull is adding from 14 to 21 days and you can do the math around that. Unfortunately, it is an impact for us and it is an impact for our clients but at least it is aligned from a financial perspective to drive reliability to ... I do not think they were in the past frankly.

Question from audience... Ross.

Cannot hear.

Marc Edwards:

So the question was any comment around the main shareholders thinking?

I think it is better to ask them, they have been very successful in this space so Diamond Offshore provided huge returns over the last 8 years since we and when we had the special dividend in place our stock today is $24 we paid out in special dividends for the past four years $42 per share, this is a huge success and for a time it was one of the best assets in their portfolio.

If you do the supply, demand analysis, it is possible to say at some stage in the future we might be back there. So I can't necessarily speak for M. Tisch, you are going to have to ask him that question, but as of today they remain very supportive of what we are trying to do and how is positioning Diamond offshore in the market itself. .

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