Seadrill: Downtime Has Negative Earnings Impact, But Positive Revenue Developments Remain

| About: Seadrill Limited (SDRL)
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Seadrill (NYSE:SDRL) is now the latest offshore drilling company to be affected by maintenance issues with the blowout preventers on its ultra-deepwater drilling rigs. On Thursday, January 31, Seadrill announced that it expects downtime in the fourth quarter 2012 to be approximately 100 days due to "BOP issues" on several of its rigs. This represents a substantial increase from Seadrill's initial estimate of 41 rig days, which the company made as part of its third quarter earnings report. This increase in downtime will serve as a drag on the company's earnings and for this reason, I am tempering my expectations regarding Seadrill's fourth quarter results. The company is scheduled to release its preliminary fourth quarter and full year 2012 results on February 28th.

Virtually every offshore drilling company has been plagued with downtime due to BOP issues over the last several months. The BOP, or blowout preventer, is a large, specialized valve that is used to seal, control, and monitor the flow of an oil and gas well during drilling operations. The BOP was originally developed to help cope with the erratic pressures and uncontrolled flow that emanates from a well during drilling. The blowout preventer also prevents tubing, tools, and drilling fluid from being blown out of the wellbore when a catastrophic event occurs. That catastrophic event is known as a blowout, which is the uncontrolled release of crude oil and natural gas from the well. As such, the BOP is one of the most critical safety devices on an offshore rig. A failure of the blowout preventer on the Deepwater Horizon is considered to be one of the primary reasons for the disaster that followed. Since that time, offshore drilling rig owners have been obsessing about the safety of the blowout preventers on their respective rigs, and this has resulted in significant downtime while the equipment is inspected, maintained, and recertified.

Seadrill has one of the most modern offshore fleets in the world, and its rigs sport the latest safety devices. That had given the company relative insulation from the BOP-related downtime that has negatively impacted its peers such as Noble (NYSE:NE) and Transocean (NYSE:RIG). For example, Noble suffered 277 rig days of downtime in the fourth quarter. The company states that roughly 60% of that time, or 166 rig days, was due to these BOP issues. This is obviously more than what Seadrill expects to experience in the same quarter. Seadrill's worst quarter for downtime so far was the third quarter of 2012, in which the company experienced 90 days of downtime. Obviously, the fourth quarter will be even worse.

As I have discussed in previous articles, including the most recent one linked above, downtime is a drag on earnings. This is because the oil companies that contract out these rigs do not pay dayrate during periods when the rigs are not operating (for example, during downtime). Therefore, the more downtime a rig experiences, the less dayrate it collects. As dayrate is the primary source of income for contractors, it should be obvious why downtime is a drag on earnings.

Unfortunately, Seadrill did not disclose which of its rigs are affected by the reported downtime. This makes it difficult to determine the exact effect that this downtime will have on Seadrill's quarterly earnings results. The reason that we cannot determine the financial impact from this downtime is because all of the rigs in Seadrill's fleet have different dayrates. Therefore, if a rig with a high dayrate suffers downtime, it will have a larger negative impact than if a rig with a lower dayrate suffers downtime. Seadrill did, however, state that the rigs that are affected by this downtime are deepwater and ultra-deepwater units. These rigs are, as a group, the highest earning rigs in Seadrill's fleet. The large amount of downtime that these rigs experienced will thus have a noticeable negative impact on Seadrill's fourth quarter earnings.

This downtime will be partially offset by the West Capricorn rig performing its first full quarter of operation in the fourth quarter. West Capricorn is currently under contract to BP (NYSE:BP), and began its work in the Gulf of Mexico in July 2012. As the rig started its assignment after the third quarter started, there were a few days or a week or two when it was not operating and was not earning dayrate. The rig, meanwhile, was on assignment for the entire fourth quarter, and so was generating dayrate for the entire time (excluding any downtime). Given the rig's dayrate of $487,000, these extra few days on assignment could represent an extra few million dollars compared to what the rig earned in the third quarter.

Additionally, the West Triton rig will also partially offset the revenue decrease due to downtime. This jackup rig began its current contract in Saudi Arabia in August of 2012. The rig was, therefore, operating for only half or two-thirds of the third quarter at this dayrate, and was only generating this dayrate over the same timeframe. Thus, the fourth quarter will also be the first full quarter of operation for this rig at this dayrate. This will result in at least an extra month of revenue generation at the rig's dayrate of $145,000. An extra month would thus represent $4.35 million in revenue. However, the rig was previously contracted out at a dayrate of $119,500. The rig was earning this dayrate up until the point when its current contract started. Therefore, what we are actually looking at is an extra $25,500 per day for a period of one to two months. This works out to increased revenue of $765,000 to $1.5 million in the fourth quarter compared to the third.

The West Janus rig began its current assignment in Vietnam in July 2012. There was no previous contract. However, the increased revenue from this rig quarter over quarter is likely to be minimal because of its relatively low $118,500 dayrate and the fact that the rig was also operating for most of the third quarter. There are also a few other jackups that began operating or worked their current assignments for the first full quarter, and so will partially offset this downtime:

Seadrill also has one tender rig that will partially offset this downtime. In August 2012, the West Setia rig saw its dayrate increase by $60,000 to $223,000. The fourth quarter will thus be the first full quarter during which the rig will be receiving this higher dayrate, since it received its original lower one during the month of July in the third quarter. The extra month at this higher dayrate represents approximately $1.8 million in incremental revenue for Seadrill.

Overall, it is unlikely that any of these positive contract startups or dayrate increases will completely offset the negative impacts from the downtime. The rigs that are experiencing the BOP-related downtime are Seadrill's ultra-deepwater rigs. These rigs command dayrates that are a multiple of the dayrates that Seadrill generates, and therefore, any downtime has a much larger effect than downtime on, say, a tender rig. However, there are enough positive developments here to ensure that the quarter will not be horrible for Seadrill. We could see the fourth quarter look much the same as the third, at least from an operational perspective. However, we will not see the significant growth in profit that I predicted a few months ago.

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.