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SeaDrill (NYSE:SDRL) announced on June 4 that it is in advanced discussions regarding a five-year contract for the West Polaris drillship. The new contract will start immediately following the October 2012 end of the current contract and promises $1.16 billion in potential contract revenue. That would work out to a dayrate of approximately $635,600.

The West Polaris is a 2008-built drillship that is currently operating in Nigeria for Exxon Mobil (NYSE:XOM). The rig is capable of operating in up to 10,000 feet of water and is capable of drilling wells up to 35,000 feet deep. This makes the West Polaris one of the most competent ultra-deepwater rigs in SeaDrill's fleet, although all of the company's drillships under construction carry higher specifications.

SeaDrill stated in its first quarter press release that the market for ultra-deepwater drilling rigs is very tight and getting more so. This, in turn, is exerting upward pressures on dayrates for these rigs. According to the company,

"Tendering and contracting for ultra-deepwater units has grown at a strong pace during the first quarter of this year. Daily rates reached the $550,000 to $650,000 range depending on location and contract duration. The spike in daily rates has led to increased contract durations and more favorable commercial terms and conditions. This development is forcing oil companies that are planning their future drilling campaigns to excel their requests and tenders for available rig capacity. As a result, we are already engaged in discussions regarding our ultra-deepwater units available in 2014 and beyond.

We have seen a strong trend recently where oil companies deviate from their normal tender process and are taking a more direct approach towards the rig owners. This is a clear sign of the strength of the market and similarly reflecting that rig owners are not willing to tie up their rigs in lengthy tendering processes.

Newbuild ultra-deepwater rigs delivered from yards continue to be effectively absorbed into the market. As such, the number of competitive high specification ultra-deepwater floaters available in 2012 remains very limited. Given the observed development in demand we expect all newbuilds that have been ordered to be absorbed into the market with no adverse effects on utilization or dayrates. And as we have seen in earlier upcycles, oil companies will enter into contracts earlier and accept longer durations. Dayrates have now reached the levels we achieved in 2007. Compared to the market in 2007, we see a significant growth in the number of major and independent oil companies that are looking for new rig capacity. The driver is largely the change from exploration work to development drilling with significant focus on getting production on stream at the right time. With the tight supply-demand balance we now see in the ultra-deepwater market, it is clear that several oil companies who have not secured enough rig capacity will have to postpone their field developments. This could postpone some future production and might have consequences for the supply-demand balance."

This announcement serves to provide supporting evidence for this market outlook. As I stated earlier in this article, the discussions are for a five-year contract. This supports SeaDrill's statement about oil companies becoming more interested in longer duration contracts. These contracts offer benefits for the drilling company.

One benefit that long-term rig contracts offer is earnings visibility. During periods when the market favors short-term contracts, it is more difficult to predict how much money a rig or a fleet of rigs will earn. This is because the dayrate will change every time a contract period expires. That introduces uncertainty into revenues. For example, in the case of a one-year rig contract, a drilling company has no way to be certain how much that rig will earn after the contract expires. A company can use market analysis and similar techniques to estimate but it cannot be absolutely certain. In the case of a five-year contract, a drilling company can predict its revenues from the contracted rig much more accurately one, two, or five years out. This offers advantages in budgeting, for example. Longer-term contracts also reduce a driller's exposure to market cycles (in some cases).

The current contract for West Polaris is from November 2011 until October 2012. This is therefore a one-year contract. Since the new contract is a five-year contract, that provides some support for SeaDrill's statement about oil companies becoming more interested in longer duration contracts.

Perhaps even more telling is the dayrate that this contract is carrying. As I mentioned in the introduction, the contract is a five-year contract that carries potential revenue of $1.16 billion. That implies a dayrate of $635,600. The current contract with Exxon Mobil carries a dayrate of $617,000. Prior to ExxonMobil's one-year contract for the rig, West Polaris had a contractual dayrate of $562,000. This provides some evidence that ultra-deepwater dayrates are increasing. Overall, this is a very good trend for offshore drilling companies since higher rig dayrates equate to higher revenues and profits for these companies.

Source: SeaDrill's West Polaris Contract Provides Further Evidence For Strong Offshore Drilling Fundamentals