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Transocean (NYSE:RIG) has won a 10-year contract from Europe’s largest oil company, Royal Dutch Shell (NYSE:RDS.A), to provide 4 newbuild ultra-deepwater drillships. The contact is the largest ever signed by the Swiss-based drilling firm and is expected to add a revenue backlog of $7.6 billion, excluding mobilization charges. The first drillship is expected to be delivered in mid-2015. The company estimates that it will incur capital expenditure of about $3 billion towards the construction of the drillships, excluding capitalized interest.

The drillships will be dynamically positioned, capable of operating at water depths of up to 12,000 feet and drilling wells of up to 40,000 feet. The ships will feature Transocean’s dual drilling technology that allows two drilling operation to be conducted simultaneously, saving time and reducing the costs of deepwater drilling. The ships will be built by South Korea’s Daewoo Shipbuilding and Marine Engineering Co., Ltd. (OTC:DWOSF).

Growing Importance of Deepwater Exploration

Despite the increasing scrutiny and regulatory oversight following incidents such as the Mocondo well blowout in the Gulf of Mexico, deepwater oil exploration has seen a strong revival. As land based oil resources are getting depleted, oil companies are increasingly relying on offshore and more particularly in deepwater reserves to cater to the world’s growing energy needs.

Transocean has also been realigning its fleet to cater to the growing deepwater market. Last month, the company announced the sale of 38 shallow water rigs to Shelf Drilling Holdings Limited for $1.08 billion.

Impact Of Deepwater Focus on Transocean

Among the various offshore drilling practices, ultra-deepwater drilling is the most expensive and technically challenging method since it involves drilling at water depths of over 5,000 feet. It is also known to involve the highest levels of risk. However, ultra-deepwater drilling is attractive to contractors like Transocean since it offers better day rates and profit margins. Ultra-deepwater rigs such as drillships and semi-submersibles can fetch day rates nearing $600,000, compared to shallow water rigs such as jackups that earn average rates of less than $200,000 per day.

Factoring the total value and duration of the Shell deal, we estimate that the average day rates for the newbuild drillships will come to around $520,000 each. These rates are significantly higher than the average $295,000 in revenues per rig that the company earned in 2011. We believe that if the company continues the trend of strengthening its deepwater and ultra-deepwater assets , its average daily revenues per rig and the gross margins of its contract drilling business will be positively impacted going forward.

We have a price estimate of $57.32 for Transocean, with represents a 27% upside from its current market price.

Source: Shell's Record Deal With Transocean Shows Importance Of Ultra Deepwater