SeaDrill Stands To Benefit From Offshore Rig Shortage

Sep.10.12 | About: Seadrill Limited (SDRL)

In its second quarter 2012 report, SeaDrill (NYSE:SDRL) provided its industry outlook for the offshore drilling industry as a whole. The company also provided an expanded outlook in its conference call. Overall, it is a very good time to be in the offshore drilling industry. The company notes that demand is continuing to outstrip supply as it has in past quarters. Additionally, some of the company's smaller and less established rivals are experiencing difficulty in getting the needed financing to carry out their respective newbuild programs. This presents some opportunities for larger, more established, and well-financed firms such as SeaDrill to secure additional newbuilds to drive growth.

SeaDrill states that the market for ultra-deepwater floaters has tightened even further since the first quarter. At this point, there are no remaining floater rigs available in 2012. The company estimates that less than five floater rigs are available in 2012 and these are likely to be contracted out shortly. Thus, for all practical purposes, there are no more floater rigs available until 2014. Oil companies are now being forced to lengthen their planning horizons due to the supply shortage. As a result, these companies are now in discussions to secure rigs that will not become available until 2014. Thus, offshore drilling contractors are in a position to secure their revenues for several years with large oil firms that are more than capable of paying. This is quite an enviable position to be in.

SeaDrill itself is quite well-positioned to take advantage of this trend. The company has eight ultra-deepwater floater rigs under construction. Three of these will be completed in 2013 and only one of them (the West Telus) is not contracted out at this time but it looks likely that SeaDrill will announce a contract for this rig shortly. The company has another three rigs that will be completed in 2014. None of these are currently under contract. The company's statement that "discussions are already underway for drilling rigs available in 2014 and beyond" would seem to indicate that contract announcements may begin coming for these rigs as well. SeaDrill stated in its earnings conference call that it has already gotten several requests for these units. The company will thus be likely to be able to contract these out at very good dayrates.

SeaDrill also notes that there are positive trends in the market for jack-up rigs as well. I first noted these trends in an earlier article entitled, "A Bullish Case for Ensco." In short, the market for premium jack-up rigs has been tightening due to interest from customers and this has been driving an increase in dayrates and contract lengths. This tightening supply is immediately apart in the utilization rates for different types of jack-up rigs. SeaDrill notes that the utilization rate of premium jack-up rigs (defined as jack-ups capable of operating in more than 350 feet of water) has been over 90% since March 2011 and has increased in every quarter since then. This has resulted in a decreasing number of these rigs that are available in the short-term. Thus, supply has decreased at the same time that areas such as the Middle East and Southeast Asia have been displaying strong demand for these rigs. This has the natural effect of pushing up dayrates.

The aging of the worldwide jack-up fleet could also act as a supply constraint. Over the past two years, a high number of older jack-up rigs were retired from service. However, the average age of the fleet remains in excess of twenty years. At the same time, SeaDrill notes, customers have been showing a marked preference for newer rigs due to their higher performance and better safety equipment. There are 26 jack-ups due to be delivered in 2012. This is relatively in line with the average annual jack-up deliveries since 2008 and the expectation is that these new rigs will be used as replacements for older rigs which will then be retired. Therefore, these new rigs will do little to alleviate the tight supply-demand balance. The bigger question is what impact the 45 jack-up rigs scheduled for delivery in 2013 will have upon this balance. SeaDrill itself remains cautiously optimistic about the impact of these rigs. Current development plans in the Middle East will require at least an additional 20 rigs in that area over the next few years (on long-term contracts). Additionally, West African development plans will also require additional rigs in that area. West Africa has seen its supply of these rigs tighten over the past year. The hope is that these development plans combined with the refresh of the worldwide fleet will be enough to absorb this large delivery volume. Only 17 jack-up rigs have been ordered so far in 2012, a number that is below the average. While there could certainly be more jack-up orders in 2012, the numbers seem to point towards fewer deliveries than average in 2014. This will further limit the impact of the large amount of capacity coming online in 2013.

SeaDrill noted in its second quarter earnings presentation that there is a growing bifurcation between premium jack-up rigs and commodity jack-ups. While both types of jack-up rigs have been seeing rising utilization rates, there is not the same extremely tight supply for commodity jack-ups as exists for premium jack-ups. This is largely due to customers showing a marked preference for the premium rigs. The current utilization rate for commodity jack-ups is just under 80%. As a result, there are more rigs available to customers that want them and so there is not the same upward pressure on dayrates for these rigs as for the premium jack-ups. However, these rigs have still been seeing steadily rising dayrates since January 2011.

Click to enlargeSource: SeaDrill Ltd.

SeaDrill is also the world's largest contractor of tender rigs. As such, the company also provided an outlook for this segment of its fleet. SeaDrill controls 54% of the tender rig market and so strong tender rig fundamentals stand to greatly benefit SeaDrill. The tender rig market is indeed benefiting from many of the same trends that are benefiting other types of offshore rigs.

SeaDrill made this statement about the market for tender rigs during its earnings call:

"We continue to see strong interest from oil companies for the tender rig concept. This interest along with excellent performance from our existing fleet continues to translate into new contracts and extensions of existing contracts, at higher daily rates and longer contract durations. We intend to meet the needs of our customers in this segment by continuing our organic growth strategy of both tender rigs and semi-tenders to meet future demand developments, along with an ongoing high grading and rationalizing of our existing fleet."

Historically, the primary market for tender rigs was Southeast Asia. Recently however, there has been increasing demand from West Africa for these rigs. Just recently, SeaDrill announced that it had secured a contract extension for the semi-tender rig West Setia in Angola at a dayrate of $223,000 per day. The rig previously earned a lower dayrate of $167,000. The new and improved dayrate took effect in August. Additionally, SeaDrill also recently secured a dayrate of $235,000 for the West Esperanza in the West African nation of Equatorial Guinea. This was the first contract for this newbuild. Both of these contracts provide support for SeaDrill's statement that dayrates are rising. Ultimately, this will mean higher revenues and, most likely, profits for the owners of tender rigs.

SeaDrill's tender rig average contract duration also provides support for the company's statement that contract lengths are getting longer. At the end of last quarter, the average contract duration of SeaDrill's tender rig fleet stood at 25 months. Today, that number stands at 29 months. This increase provides some indication that supply of rigs is so tight rig now that oil companies are attempting to lock up this equipment for longer periods of time so that they will have it for their development plans. Additionally, this improves the earnings visibility of offshore drilling companies, such as SeaDrill, and ensures revenues and profits for the short- to medium-term (barring a Macondo-like incident or similar such event).

Disclosure: I am long SDRL. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.