Noble Corp. (NE) and Diamond Offshore (DO) discussed the current strength in the offshore drilling market as a part of their respect Q3 earnings conference calls. The transcripts for each of these calls can be found on Seeking Alpha using the links that are found at the conclusion of this article. Both companies see that the overall market is clearly in an upcycle and this has resulted in rising dayrates for rigs across the board. Rising dayrates are conducive to rising earnings in this industry, and this is something that any investor can appreciate.
The two companies base their conclusions about the overall market strength on the contracts and contract extensions that each has seen recently. Noble also discussed several factors related to the industry as a whole that leads it to the conclusion that dayrates will most likely continue to rise going forward. I will begin this analysis by discussing a few of the new contracts that each company has seen recently.
- Ocean Valiant, located in Africa, secured a contract extension that increased its dayrate from $300,000 to $500,000.
- Ocean Endeavor secured a new contract at a dayrate of approximately $521,000. This is a substantial increase from the rig's previous dayrate of just under $300,000.
- Ocean Lexington secured a new contract at a dayrate of $300,000. The rig was previously employed at $250,000.
- Ocean America secured a new contract at a dayrate of $475,000 per day. This is well above the previous dayrate of $405,000.
- Awarded contracts for 16 rigs over the trailing 90-day period.
- Awarded a contract in the Middle East for a JU3000-series rig of Noble's choosing at a dayrate of $290,000. This is an exceptionally high dayrate for a jack-up rig.
- Most of the new jack-up contracts are for periods of one year or longer. Noble states that this suggests concern about rising rates. Noble also notes that it has been many years since an operator in the Middle East, other than Aramco, has contracted a rig for a long period of time. Operators are doing it now. Oil companies, the companies that lease these offshore drilling rigs, thus clearly see the tight market environment and believe that dayrates will continue to rise.
Neither company has been encountering any difficulty in obtaining contracts for rigs which speaks well of the overall fundamental strength of this market. Diamond Offshore, as shown above, has seen dayrates increase in its new contracts when compared to the older ones. This also showcases the fundamental strength of the market. The primary reason for these rising dayrates is the very tight supply-demand balance, which will be illustrated and explained later in this article. To put it simply, there is currently a much greater demand for rigs among customers than can be satisfied with the existing supply of available rigs. This has caused oil and gas companies to bid higher for the rigs that are available in order to secure the rigs that they need for their exploration and development plans.
The ultra-deepwater sector is one that has been showing signs of strength for a while now. I wrote an article earlier this year discussing this strength and have followed up on that at a few other times throughout this past year. This strength is showing no signs of abating anytime soon. Noble speculated during its second quarter conference call that the worldwide ultra-deepwater rig fleet had approximately 168 rig months of availability in 2013 but suspected that this estimate was far too high. Since that time, eleven contract awards have been announced. These awards have brought the official availability down to 97 rig months, but Noble suspects that actual availability is less than half that number due to ongoing discussions with customers for the remaining capacity.
According to Noble, only four ultra-deepwater rigs are available worldwide in the first half of 2013. This is evidence of further tightening of supply in this sector over the past quarter. Furthermore, the company observes that the average contract duration for new ultra-deepwater contracts has increased to four years versus 2.25 years during the first half of this year. The average dayrates for these new contracts has also increased to $575,000 compared to $533,000 in the first six months of the year. As mentioned earlier, the longer contract lengths indicate that customers have concerns that dayrates for these rigs will continue to rise. Thus, the customer with a shorter-term contract is worried that the price for the rig will be higher when attempting to re-contract it out (assuming that the customer will need the rig for longer than the contract term). Therefore, these longer contracts can be viewed as a hedge against higher dayrates on the part of the oil company that is contracting the rig.
The company believes that dayrates could continue to march higher from here; Noble's management does not believe that we have seen the peak of this strong ultra-deepwater market. One reason for this is the aforementioned rig availability. Since March 2012, there has been little to no near-term rig availability in the market. The presence of this availability should command a premium dayrate for prompt delivery to the customer. This is also true in the first half of 2013, where only four rigs have availability. These four rigs should thus be able to command this premium. There are seven or eight rigs available in the second half of 2013, but these rigs have a total of 19 rig months between them which implies very tight availability. These rigs may also be able to command premium pricing.
Additionally, there are several leading indicators that point to a higher volume of ultra-deepwater drilling activity going forward and thus a higher demand for ultra-deepwater drilling rigs. Chief among these is a higher rate of discoveries. I discussed this in a previous article that was posted to this site. There have been more ultra-deepwater discoveries in 2012 than ever before. From January through September, there have been 38 ultra-deepwater discoveries compared to fifteen in the previous year. There were seventeen discoveries in the third quarter of 2012 alone! These discoveries were made in a total of twelve different countries. This illustrates that there is the potential for future worldwide growth in this sector. Many countries are also announcing new rounds of bidding on offshore licenses which could mean that 2013 could also prove to be a good year for discoveries. As oil companies discover more and more resources in the ultra-deepwater environment, rig demand will naturally increase as these companies seek to develop and exploit these resources.
Diamond Offshore, meanwhile, was somewhat less optimistic about ultra-deepwater dayrates going forward. The company stated in its third quarter call,
"With respect to ultra-deepwater pricing, recent fixtures in the market continue to demonstrate that rates for three year deals are hovering around the $600,000 per day mark, with West Africa fixtures typically higher by another $20,000 to $30,000 a day. With contracts with longer-term, up to five years potentially, rates have been settling in the high-500s where I would expect them to remain for the near future."
Diamond Offshore thus does not appear to agree with Noble that dayrates for ultra-deepwater rigs are likely to continue to climb from here. The company does, however, appear to agree that the current market is a fundamentally strong one. Diamond Offshore provides little reasoning for this opinion, however.
Noble also had some comments about the jack-up market that has seen considerable strengthening over the past nine months. Noble cited five areas where there exist opportunities for jack-up demand to grow. These areas include the Middle East, the North Sea, Australia, New Zealand, and Southeast Asia. The North Sea and the Middle East are by far the most important (fastest growing) markets for high-specification jack-ups, which are the most technically capable rigs with the greatest drilling depths. There is now a growing demand for standard jack-up rigs as well; fourteen of the sixteen new contracts that Noble was awarded recently were for standard jack-ups. Of these fourteen, the North Sea and West Africa were the most common job locations.
The strong market for standard jack-ups may experience a few challenges over the next 2.5 to three years in Noble's opinion. There are between 85 and 89 jack-up rigs under construction that will be delivered between now and the first half of 2015. A look at recent history would suggest that the market could absorb these rigs without being over-supplied. However, this would represent 20% growth over the next three years in the jack-up sector. Noble is not certain that the market can absorb this. What will most likely happen then is that the lowest-end jack-ups, the oldest and least capable ones, will be retired as these would be the ones most hurt by these new units entering the market.
The ultra-deepwater market does not appear to be facing these challenges. There are 34 ultra-deepwater rigs under construction that will be completed between now and 2016 that do not currently have contracts. Noble believes that sufficient demand exists among customers to absorb all of these units without causing the industry to be over-supplied.
Links to Conference Call Transcripts
- Diamond Offshore Q3 2012 Earnings Conference Call Transcript
- Noble Corp Q3 2012 Earnings Conference Call Transcript
Additional disclosure: I am long a few other companies in the offshore drilling industry, although I have no positions in either NE or DO.