Transocean's CEO Presents at Sanford Bernstein's 29th Annual Strategic Decisions Conference (Transcript)

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Transocean Ltd. (NYSE:RIG) Sanford Bernstein’s 29th Annual Strategic Decisions Conference May 29, 2013 2:00 PM ET


Steven Newman - President & Chief Executive Officer


Scott Gruber - Sanford Bernstein

Scott Gruber

Good afternoon. I’m Scott Gruber, the oil services analyst here at Bernstein. I gives me great pleasure to introduce the speaker for our next session, Mr. Steven Newman, the President and CEO of Transocean.

Mr. Newman has really worked his way up through the company. He started at the organization back in 1994 in the Corporate Claiming department, and during his career at Transocean he has filled various senior management positions, including Chief Operating Officer and EVP of Performance and he has been CEO since early 2010.

Now as many of you know, Transocean has recently ended their successful defense of their capital allocation strategy against competing proposals put forth by the Icahn Group. With this battle now in the rear view mirror and after numerous discussions with investors across the globe, I’m very excited to hear about where Transocean goes next.

So please join me in welcoming Mr. Steve Newman. Thank you.

Steve Newman

Thanks for that introduction Scott. This room is a little bit cold. I’m sure you did that to remind me of my Swiss home.

Standard forward-looking disclaimer; our business does involve risks. Those risks are I think fully described in our quarterly and annual filings with the SEC. During the course of today’s conversation I will make certain statements that are not historical facts, statements about the level of activity in our business, outlook for oil price, the prospects for the company’s financial results. Should any of the risks that we talk about in our SEC filings actually materialize, our actual results could be different than our expectations.

A few comments today I’ll make. I’ll start with an overview of the company. Many of you are probably very familiar with the story, but I will touch on a couple of high points relative to the Transocean story and then touch on some of the things that Scott alluded to in his opening comments, the company’s plans for creating value across our operating strategy, our capital strategy and the asset strategy and then close out with some comments about the market.

In terms of the company, starting at sort of a high level overview of the company, we are the world’s largest offshore contract driller. We are active in most of the major markets around the world and typically because of the company’s size and geographic footprint, we generally have a leadership position in those markets around the world. We operate in most of the asset classes and the company’s relationships with the customer community really span the spectrum from small independent companies, to national oil companies, to the large IOC’s like Exxon Mobil, BP, Shell, Chevron, companies like that.

The company long ago recognized the strategic importance of first, deep water and then ultra deep water and also harsh environment, and as a result of that early recognition of those strategic opportunities, the company has a very strong leadership position in ultra deep water and harsh environment today.

The company also has as a result of its history, tremendous reputation for innovation and new technology development and great reputation for operational experience and a great reputation for technical expertise. When you put all that together, and that really sets the company apart in terms of organizational capability and its that organizational capability that our customers value, that creates interesting reinvestment opportunities for the company going forward.

I mentioned that we’re the largest contract driller. This chart puts that in pretty clear detail. You can see the company’s leadership position in ultra deep water. Today the company has six ultra deep-water drill ships under construction that we’ll continue to add to that leadership position. We got a bright position in mid water floaters and we’re competitive in terms of high-spec jack ups in that scenario, that in terms of the asset strategy, I’ll talk a little bit more about in a new moments.

You can also see the company’s exposure to an improving marketplace. When you get out to sort of 2015, on the ultra deep water side and on the high spec jack up side, you can see that more than 50% of our fleet is available for reprising and so as you look forward into an improving market place going forward and increasing levels of activity on the part of our customers in ultra deep water provinces around the world, this kind of operating leverage creates an interesting opportunity for the company to continue to improve the financial results going forward, and that comes on the foundation of a strong portfolio of contracts today.

The company’s gotten a little over $28 million in contracted revenue, extending well into the next decade. So that portfolio of contracts that the company has today provides an excellent foundation for continued growth and reinvestment and distribution of capital going forward.

You can see that today as a result of the company’s efforts over the last couple of years to continue to focus our fleet on high specification assets, you can see that today over half of our revenues come from our ultra deep water fleet, but we still do enjoy a significant contribution from the deep water floaters and the new water floaters as well.

The chart on the right hand side shows the diversification across the customer community, and you can see that its either relatively evenly split between the IOC’s, the NOC’s and the independents and it’s the contribution that we see coming from the NOC’s that has changed most significantly over the last several years and that I would expect it to continue to change going forward.

The national oil companies are becoming increasingly active in their home countries and many of them are doing a very good job of becoming truly international players as well. So we would expect to see a continued contribution to our revenue stream from the nation oil companies going forward.

Just in terms of some of the uncertainty that surrounds the company, that we’re in three key issues, the Macondo litigation in the Gulf of Mexico, the project yield incident in Brazil and some tax litigation ongoing in Norway. So let me just say – give you a brief update on each one of those.

In the Macondo litigation, phase I of the trial, which was really designed to identify responsibility for the accident, to a portion of fault for the accident, Phase I finished in the middle of April.

During Phase I, there were no new facts that came out relative to Transocean, so our position is the same post Phase I as it was at the outset of Phase I of the trial. The judge has given the parties 60 days to submit proposed written finding and conclusions from Phase I of the trial and then 20 days or so beyond that to rebut each others proposed findings. So all those findings are due in the third week of June.

We remain open to continuing to pursue both avenues that we have been pursuing, pursing the litigation avenue if we have to and we remain confident in the company’s facts and circumstances and the story that we have been telling with respect to the litigation.

We remain open to a business settlement as well and I think that’s reflective of the company’s willingness to enter into the settlement that we struck with the department of justice, which we announced in the early days of January this year, where we accepted a $1.4 billion payment structured over the coming five years. We remain open to a reasonable business resolution. If we can’t we will continue to defend the company’s case in court.

In the project field incident the judge who is overseeing the criminal claims resulting from the project field incident has completely rejected all of the, has completely dismissed all of the criminal claims against Transocean and our employees. So we’ve been removed from the criminal litigation surrounding the project field incident.

We remain a named defendant in the two largest civil claims, but in that respect Chevron have taken the lead in negotiating with the authorities in Brazil, a comprehensive growth solution. We continue to support Chevron in that regard.

With respect to the Norwegian tax litigation, the civil court which heard the claims against the company regarding the tax residency status of one of our subsidiaries, found in the company’s favor, so they acknowledged that the positions we have taken under, Norwegian tax law, the returns we had filed, the disclosures we had associated with those filings were all correct.

Now the state has appealed that finding at the civil court. But we think that finding in the civil court is helpful in terms of – in the context of the criminal court. We continue to maintain that our returns are materially correct as filed and we will continue to defend ourselves against any allegations to the contract,

The criminal court has indicated that they intent to hear all five claims against the company before they render a ruling, so we don’t expect a ruling out of a criminal court in Norway until early 2014, that’s the earliest.

I think over the last several months, I think the company has done a good job in terms of reducing some of the uncertainties surrounding the company; the resolution of the DOJ claims against the company and Macondo, the dismissal of the criminal claims against the company and project, the finding on the part of the civil court in favor of the company in Norway.

Just in terms of strategic objectives, they remain as they have for the last year or two, focused really on improving the company’s operating results, recognizing that first and foremost we are an operating company.

Improving the company’s operating results, maintaining the financial flexibility and the strong balance sheet we need to compete in a cyclical and capital-intensive industry. Executing our asset strategy, which is really focused on improving the company’s exposure to high spec assets and reducing our exposure to low spec commodity class assets and resolving the uncertainty that remains, surrounding the company associated with Macondo, Frade and Norway; let me say a little bit about each one of these.

In terms of improving our operational results, we remain focused on delivering against the improvement opportunities that exist wit respect to top line revenues; improving revenue efficiency and improving the utilization of the fleet.

In terms of revenue efficiency, there are two fundamental areas we’re focused on. First, it is the technical challenges of operating our equipment and that’s really underpinned by a consistent approach to standardized maintenance, thorough inspections and rigorous per-deployment testing and as have rolled that program out across the fleet, the operating teams around the world have been really receptive, they’ve endorsed the model and I think they are doing a very effective job of implementing that model.

The second element of improvement in terms of revenue efficiency is the close coordination that comes with the strong relationships we have with our customers.

Our customers recognize that this is an industrial issue; its not unique to Transocean and so there’s an interest on the part of the customer community to making sure that the commercial framework exists to support execution of a robust maintenance program and taking the time necessary to inspect equipment and testing equipment before it is deployed. And so we’ve succeeded in cooperating with our customers to ensure that the contractual framework supports what we’re trying to do in terms of our operating and technical approach.

I believe that the company’s historic levels of revenue efficiency in the mid-90’s are achievable, but as I have said every time I’ve talked about revenue efficiency, our progress is not necessarily going to be linear and we are still susceptible to temporary setbacks in there.

The second element of the improvement in revenues has to do with our management of out of service time. On occasion we have to take rigs out of service and take them into shipyards for periodic inspections associated with the classification societies we work with, ongoing significant, major maintenance programs and overhaul programs and the opportunity therefore is to make sure that those out of service periods are executed in a time efficient and cost effective manner.

So close collaboration with our partners, both the shipyard partners and the original equipment vendor partners to plan the work scope and then ensuring that everything is in place, from the resources and supplies and manpower necessary to execute the work scope in an efficient manner when it comes to time to take the rigs out of service.

And the biggest challenge there over the last couple of years has been the time necessary to disassemble, inspect, repair, reassemble and test BOP equipment, well control equipment. Just a function of the increasing demand on the pressure control OEM’s that existed post Macondo.

The OEM’s have done a great job in terms of responding to that challenge with increased investment in their businesses. We are doing the same thing with increased investment in our business, trying to transition from an inspect and repair approach to a unit exchange approach. So that would take the inspection repair, reassembly and testing of BOP equipment off the critical path. So we’ll take additional deliveries in 2013 and 2014 of capital spares equipment that will allow us to fully transition to that unit exchange program.

And then the third element of our continued improvement in operating results is a focus on our cost structure, in showing that our cost structure is competitive and efficient in terms of our business model. There is a gap between our margins today and our peer group margins and I think that gap is bridgeable through improvements in our revenue efficiency and improvements in our cost structure.

So we’ve announced the first element of improvements in our cost structure. We are going to take $300 million out of our shore based cost structure around the world. There will be additional steps beyond that in terms of taking direct costs out of our cost structure, direct costs that are spent on the rigs.

I think the results in 2012 demonstrate that we’ve made good progress. We are on the right track. In terms of revenue efficiency we improved performance in 2012 over 2011 by two percentage points. Just as a rough rule of thumb, each one-percentage point in our business is worth about $100 million. So we improved by two percentage points from ’11 to ’12.

We’ve got continued improvement opportunities going forward, but I think we’ll capture the remainder of where – the difference between where we are now and what I think is the long term run rate. We also improved in terms of utilization. We improved in 2011 versus 2012 by nine percentage points and that improvement in revenue efficiency and in utilization served to increase our operating earnings and our operating cash flow and at the same time we continued to add significant back log to the company’s contract portfolio in 2012. So I think this is a clear indication that the company is on the right track.

That’s the operating strategy part of the story. Now we talk about the capital structure strategy and as Scott alluded to this in hid opening comments, the company believes in a balanced approach to deploying capital and how we think about capital from our perspective.

We recognize that this is a cyclical industry and consequently in a cyclical industry financial flexibility has a competitive advantage. So we intend to remain an investment grade quality balance sheet. We also recognize that this is a capital intensive industry and as a drilling contractor the only way you can drive long term shareholder returns is to continue to invest in your fleet.

So financial flexibility and continuing investment, then the third key element of our balanced capital philosophy is it should be capital to our shareholders and it’s the combination of those three things, a strong balance sheet, continued investment in our fleet and the distribution of capital to our shareholders that we believe is the right approach to delivering shareholder value at our business.

Just in terms of financial flexibility; we’ve recognized that this is a cyclical industry and consequently we want the kind of balance sheet that allows us to withstand the cycles and take advantage and be opportunistic in the context of those cycles.

You’ve seen us takes steps to mitigate some of that concern and cyclicality in our business. There are four rigs that are on 10-year contracts with Shell. 40 rig years of backlog is simply a way to build a strong foundation upon which you can continue to invest going forward. The DOJ settlement was an attempt to reduce some of the financial uncertainty in our business.

We expect to remain an investment grade quality balance sheet. We think that’s the right way to compete is a cyclical industry and the company has an excellent tract record of distributing capital to our shareholders.

So as we made the rounds in advance of the AGM defending our capital philosophy, we talked about the $2.24 a share of dividend that our shareholders approved at the AGM as a staring point for dividend that we think is capable of being sustained and grown over time. So again that $2.24 a share, it’s a critical component of the balanced approach to deploying capital, the distribution of capital to our shareholders and that is the right staring point for a sustainable and growing dividend going forward.

In terms of capital investment, as I said, as a drilling contractor the only way you can deliver long term shareholder return is to continue to invest in fleet. The assets that the company built 10 or 15 or 20 years ago, are not the same assets that the customers need today to improve their opportunities, to access significant accumulations of hydrocarbons. You’ve got to continually respond to not just the markets needs, but specific customers needs and the Shell opportunity is the perfect example of that.

We have a preference for not simply adding capacity to the market place and that’s what you would get if you went to the shipyard and you are willing to buy whatever the shipyard is selling, you get the 17th or 18th or 19th version of their model.

If you collaborate and partner closely with the customer community, you can actually deliver what the customers what, which is incremental capability. So we got to focus on capability as opposed to simply capacity and we prefer that that incremental capability be funded by the customers and so we have a preference for contract-backed new builds and we’ve got a very disciplined capital investment criteria that we apply to any opportunity to invest significant capital in our business.

Our asset strategy as I have mentioned is really focused on increasing the company’s exposure to high speck; differentiated assets, both high speck floaters and high spec jack ups and reducing the company’s exposure to low speck commodity class assets. And we’ll do that in terms of increasing our exposure. We’ll do that through either buying our building and in terms of reducing the companies exposure, we are happy to do that through any kind divesture transaction, be it an outright asset sales or some kind of capital market transaction like a spin of an IPO.

With the intent that over time the company’s fleet is comprised of high-speck Ultra deepwater floaters, Harsh Environment floaters, High-spec Jack ups and high quality Jack ups and floaters.

And so the four rig Shell package is a perfect example of this. Shell identified a need that wasn’t met in the market place. So they certainly surveyed the existing class of assets; they surveyed all of the assets that were under contraction in the ship years and concluded that they needed something new and different.

So they partnered with us to collaborate on the design that will have the state of the art capability in terms of the state-of-the-art quick load, 20,000 a feet side, capability in terms of pressure control, an industry leading environmental power plant.

So things that weren’t available in the market place today and again this is reflective of the company’s history and reputation in terms of bring incremental capabilities to the industry and our reputation for designing, building, commissioning and delivering assets on time and on budget. So the four Shell rigs will really be state of the art and industry leading in terms of their capabilities.

In addition to those four rigs, the company has three other rigs under construction in the yards. They had two ultra deepwater drill ships that will go to work in the first half of 2014 and one remaining jack up in Singapore that will be delivered and go to work in the second half of 2013, so a total of seven rigs under construction today.

That’s the increasing our exposure to the high spec assets. So the other side of that is decreasing our exposure to low spec commodity class assets.

Over the last couple of years the company has sold 57 drilling rigs, 38 shallow water jack ups in a package to shell drilling and 19 other rigs in single asset transactions. All of these are low spec commodity class rigs, mostly jack ups, there were a couple of floaters involved in that package, but it really does sever to concentrate the company’s fleet in more strategic areas that reduces the complexity of the fleet and the diversity of the fleet. It allows us to focus on things that I think we do particularly well, where we have significant competitive advantage.

Just in terms of a few comments about each one of the markets today. In terms of Ultra deep water, if you look at the 2012 exploration success, nearly 50% of the volumes that were discovered in 2012 were discovered in water depths in excess of 5,000 feet and that includes all of the volumes discovered both on land and off shore, nearly 50% were discovered in water depths exceeding 5,000 feet.

As I have said couple of times over the course of my comments, I think the company enjoys a very strong leadership position in ultra deep water, so we are well positioned to capitalize on that going forward. If you go out to 2015, more than half of our ultra deep-water fleet is available for reprising.

So when you see exploration results like this and you contemplate the kind of development opportunities in the portfolio of development projects that that creates, the company is extremely well positioned to benefit from that.

And the other element that I think is interesting in terms of the ultra deep-water market is a bit of a shift. An evolution in the thinking of our customer from sort of commodity ultra deep water floaters to more the spoke or project specific needs and again, reflective of Shells willingness to contract four sate of the art vessels with Transocean, built to a very exact in specifications. Customers are more and more interested in understanding differentiated capability to access the kinds of projects and reserves they are discovering.

In terms of the other markets, the company that participates in the deep-water market is benefiting from strength in the ultra deep-water market. Day rates in that market are 440 to 500 a day.

In the mid-water market, conditions in the North Sea and Norway are extremely tight to-date. Day-rates in the UK sector of the North Sea are in excess of $400,000 a day. So we are seeing sort of historical highs with respect to the day rates and term environment that’s available in the North Sea. Yet outside the North Sea things are a little bit less strong. There is some impact on the worldwide Ex-North Sea. A bit about our market is a result of the uncertainty that exists in Brazil with respect to Petrobras’s activity levels today.

In the high spec jack up market, very robust utilization and day-rate levels in that market today. That market has responded extremely well to the continued influx of new builds. Demand has increased enough to absorb all of the un-contracted new builds that have entered that market over the last couple of years.

So very strong ultra deep-water market benefits a strong deep-water market. Mid-water market in the North Sea and Norway is extremely tight today. Outside that market a little bit less. Certainly, a little bit of uncertainty introduced by what’s gong on at Brazil and in the jack up market, very solid performance in that market today.

Just to summarize the Transocean store, I think the company has an excellent approach to creating value for our customers and our shareholders and of course our employees. Really focused on improving our operating results, maintaining the financial flexibility necessary to compete in our business and to continue to invest in our fleet, while distributing capital to our shareholders, and the execution of our assets strategy designed to continue to position the company as a leader in high-spec drilling.

Very well positioned to capitalize on what is an improving market place. If you look out two or three or four years, the company has excellent operating leverage in improving the market place and a portfolio of contracts that give us a strong foundation for improved financial results going forward and the ability to continue to distribute capital to our shareholders.

With that I’m happy to take questions.

Question-and-Answer Session

Scott Gruber - Sanford Bernstein

Great, thank you Steven. There are question cards on the seats throughout the room. If you have a question, please fill that out. There will be at least one-person walking around collecting the Q cards.

I’m going to start it off with a question. In the weeks heading into your AGM, you had met with numerous discussions with investors on the transition strategy going forward. What are the key learning that you took away from those discussions?

Steven Newman

I would list them out like this. First of all, I think we benefit from dealing with a very, very willing formed shareholder base, and so as we would meet with the shareholders and talk about the company’s business, they were very well tuned to the uncertainties facing the company and as a result they recognized the need for a balanced approach to deploying capital.

As we would talk about the company’s philosophy regarding cyclicality and capita intensity and capital distributions, there was a recognition on the part of the shareholder community that that balanced approach is an important element to the company’s success going forward.

Scott Gruber - Sanford Bernstein

A question here on new building activity. I know we believe that even if the public drillers pulled back on ordering the floaters, the economics are sufficiently attractive to attract private investment, new entrance into the market. Can you comment on new entrance, particularly into the deep water?

Steven Newman

I think that’s always been an interesting element of this business. If you look at it from the outside and you can deliver a rig for somewhere between $700 million to $750 million all in, and the day rate environment is $550,000 to $600,000, that looks like a great business.

The challenge is, can you really deliver if you are completely new entrant into the industry, can you really deliver, get the rig delivered. Can you convince somebody to give you a contract for it? Can you assemble enough of an operating team to actually operate it, and we’ve seen companies do that. We compete with company’s today who didn’t exist five or six or seven yeas ago. So that’s always a risk.

Scott Gruber - Sanford Bernstein

What do you think the market is missing in the transition story that keeps the stock trading below asset value?

Steven Newman

I think it’s the three things that I have continued to talk to shareholders about over the last couple of years; its operating results. I think there is, there had been ligament questions of the part of the shareholder community regarding the company’s basic ability to operate.

There have been questions about the quality of the company’s fleet and I think we’ve taken significant steps to improve the quality of the fleet and there are further opportunities to do that going forward.

And I think there is – there has been significant headline risk around the company when you’re involved in incidents like Macondo, Frade and Norway. Now these are not your run on the mill oil field disputes, these are some world-class litigation and significant exposure.

And so there has been a sense of the part of the shareholder community that’s got some real issues to resolve and as I said, I think our 2012 results demonstrate progress in our operating strategy.

I think the steps we’ve taken to execute against our asset strategy are moving the company in the right direction towards being a re-focused high spec driller, with respect to some of the uncertainty facing the company, the challenges, the disadvantages that we are not in control and we are subject to the litigation process or the decisions of counter parties who have their own interests.

Scott Gruber - Sanford Bernstein

And at the present time, which investment is more attractive, buying assets given current ask prices or building assets backed by contracts?

Steven Newman

Well, the challenge with buying assets given current asking prices is that everybody has the same robust optimistic outlook, particularly for the kind of assets that we would be interested in buying. High spec floaters and high speck jack ups; everybody sees that as a strong market going forward and consequently the ask prices reflect that.

I think the economic around contract backed new builds today are very attractive and I think the opportunities the company has secured and the opportunities we continue to peruse have very good economics associated with it. So I don’t think its an either or, but if you ask me to prioritize them, I think in today’s environment contract backed new builds provide an attractive return.

Scott Gruber - Sanford Bernstein

What assets do you consider non-core today?

Steven Newman

I think the non-core assets in our fleet today are those assets that are 25 or 30 or 35 years old. So you think about the age of the asset, you think about the capability of the asset. So if it’s a bulk standard mid water floater, that isn’t really a differentiated asset in Transocean’s portfolio.

So assets like that, they are aging, they are limited in terms of capability, they don’t really provide a very attractive upgrade path at all. Those assets, if they are deployed in the North Sea, today they are earning very attractive returns, but they do have a finite life to them.

Scott Gruber - Sanford Bernstein

How has the project experience altered if any? You’re thinking of the relative attractiveness of operating in Brazil. If you could add some comments on industry cost in the region as well.

Steven Newman

I got that question a lot in the immediate aftermath of the incident and particularly as we were facing the injunction, the possibility of an injunction in Brazil that would have forced us to suspend operations on all of our fleet, and the question was, doesn’t that make you less interested in deploying assets to Brazil.

I can tell you, every market we operated in anywhere around the world has its issues. We have never had anybody taken hostage in Brazil and yet there are other places where we work in the world where that’s a legitimate concern. And so we look at this as a worldwide opportunity and we try and take a portfolio approach and we go where the customers want to go and we try and make sure that wherever we go with the customer community, we price our services so that we are in an attractive return.

The cost structure in Brazil over the last couple of years certainly has been affected by the increasing levels of activity in Brazil and the finite labor resource in Brazil, but we’ve seen that in other areas where we work around the world as well. So Brazil is not unique in that regard.

We are interested in increasing our levels of activity with Petrobras, we are interested in building on our presence in Brazil, and the fact that we had an incident like Frade on balance doesn’t really alter that sentiment at all.

Scott Gruber - Sanford Bernstein

A couple of questions on operating in the Gulf after Macondo. What have you learned and from an operating perspective, how do you think about managing liability going forward, changing contract terms, insurance, etc...

Steven Newman

We haven’t really seen much of a change at all for the contract terms or insurance, with the loan exception that the insurance tower now carves out fines and penalties. So at the time of the accident the insurance tower the company had, fines and penalties were included in some of the policy language; today they are categorically excluded from policy language today.

With respect to contract terms and conditions, no real change. We continue to bargain for the same liability and indemnity language we had that was embedded in the deepwater rise in contract.

The regulatory environment has changed and I suspect will continue to change, but I had the opportunity yesterday to meet with the Director of Fuel of Safety and Environmental Enforcement and Director Watson is a very pragmatic guy. He comes from the coastguards, so he understands the challenge of operating marine assets and I think he’s trying to take that kind of a pragmatic approach to that continued rule marking that I expect we’ll see coming out of the SCE.

Scott Gruber - Sanford Bernstein

Could you provide some color on the additional cost savings beyond this first phase? What can you do off shore on the rigs to continue to streamline the cost?

Steven Newman

So as it relates to direct costs, and these are costs that we incur on the rigs. There’s two broad buckets to that. One is in-service, so while the rigs are operating on location, the other is out of service. And with respect to outer service, the biggest opportunity is to shorten the amount of out-of-service time.

The value of an incremental day in the yard is significant. If you consider the loss revenue, the operating costs on the rig, the shipyard services costs, the overhead associated with the project, if we can shorter every project by one day, that would start to contribute meaningfully to improving our margins.

So out-of-service cost is really driven by shorting the amount of time we spend in the yard and attacking the amount of overhead associated with the project. So all of the engineering services and project management costs that are associated with the project, that’s the out-of-service opportunity.

The in-service opportunity is really driven by two key categories of expenditure, personnel, so fewer heads on the rig, and maintenance. Those are the two biggest drives of in-service cost. So being smarter about how many heads are actually on the rig and being smarter about executing your maintenance program on an ongoing basis.

Scott Gruber - Sanford Bernstein

And a related follow-up, when could we expect transition to eliminate the operating margins difference as it appears.

Steven Newman

I think you’ll see that come about through the next two business planning cycles of Transocean. So we are about to embark on our 2014 budgeting cycle and we will see some amount of that margin differential addressed during our 2014 business planning cycle. We will communicate that to the market at the end of the ’13 and again on our fourth quarter call in February ‘14.

And then the second step will be the 2015 budget planning process, which will take place a year from now. We’ll communicate that at the end of ’14 and again in February ’15. So over the next year, for 18 months you should see us give you the milestones that we are going to measure ourselves by, the terms of the addressing the margin gap between us and our peers.

Scott Gruber - Sanford Bernstein

And regarding the dividend strategy, how do you think about answering the dividend down the road. Do you have a certain payout ratio in mind?

Steven Newman

It’s difficult to think about a payout ratio in the context of a cyclical industry. So the challenge for us is continuing to lay the groundwork in the near term for dividend growth and I think that’s driven by improvements in our revenue and reductions in our cost.

So near-term improvements in our EBITDA margin will drive near-term growth in the dividend. Longer-term growth in the dividend is a function of continued reinvestment in our fleet. The ability of the company to continue to identify opportunities to grow our high spec floaters, high spec jack up fleet going forward.

Scott Gruber - Sanford Bernstein

Here’s another tough one for a cyclical industry, but how do you think about normalized CapEx?

Steven Newman

Its tough to think about normalized CapEx in the context of cyclical. If you look at the company’s historical approach to new building, it has tended to come in ways. We built a number of rigs in the 1999, 2000, 2001 timeframe. We built a number of rigs in the 2005, 2006, 2007 timeframe. We’ve got seven rigs under construction today.

If you average that out, which is the, I think the only way you get to a normalized approach to capital. If you average that out, it tends to be one to two rigs a year and probably with the company’s objective of fleet renewable going forward, its probably going to be closer to that two rigs a year than the one rig a year. So that’s about rough order magnitude, about a $1.5 billion a year in terms of new build CapEx on an average ongoing basis.

Then there’s another $500 million or so that is just normal sustaining capital we spend on the existing fleet to keep it competitive. And then there’s another $0.5 million or so of capital we spend as a result of significant shipyard projects, major maintenance, client requested upgrades. You put all that together and you are in that range of $2.5 billion to $3 billion a year on average, recognizing that it doesn’t necessarily take place on average, but somewhere between $2.5 billion and $3 billion of capital going forward.

Scott Gruber - Sanford Bernstein

Regulators are currently debating new BOP operating standards and design standards. Can you comment on your expectations regarding these new standards, and the impact on legacy floaters in particular?

Steven Newman

Yes, that was in fact the reason for my meeting with Director Watson in Washington yesterday was all around BOP regulations. So in November of last year API issued standard 53, which is related to BOP equipment.

Just as an example, in the UK, the UK Health and Safety Executive has given the industry seven years to implement standard 53, and Director Watson and I talked a little bit about that yesterday. I don’t know what underpinned the UK HSE’s decision to allow seven years. That seems to me to be a reasonable approach to allowing for the required changes to the existing fleet, the ability of the pressure controlled OEMs to deliver equipment and the contractor community to take advantage of normal out-of-service periods to effect whatever changes need to take place.

I got the sense from the conversation yesterday with Director Watson that as I said he is a very pragmatic guy. He is in terms of the U.S. proposed rulemaking relative to BOP requirements, they are going to be very reflective of standard 53 and they are cognizant of the fact that it will take industry some amount of time to respond.

Scott Gruber - Sanford Bernstein

Do you anticipate significant investments to comply on the legacy BOPs.

Steven Newman

If you are dealing with a second-generation floater, that’s only got a four-ramp stack and has height limitations and weight limitations, you would be looking at some significant expenditure. Fortunately, for a whole host of reasons we are trying to reduce our exposure to that class of assets. So folks who operate that class of assets could be exposed going forward and it’s our objective to reduce that kind of exposure within Transocean’s fleet going forward.

Scott Gruber - Sanford Bernstein

Now Transocean has been and will remain an industry consolidator. How do you think about industry structure in five or 10 years time? Do you get some pressure from potential new entrants coming in given new build economics, where ultimately this industry tends to consolidate? So in five or 10 years time do you see this as a more competitive landscape or a smaller number of drillers, particularly in the deep water, probably challenges are greater.

Steven Newman

I think it depends of what happens with the cycles over the coming five or 10 years Scott. This industry does go through phases. In the early part of the prior decade we went through a consolidation phase, the later part of the prior decade we went through a fragmentation phase.

So there are a number of small industry participants out there today and if the industry went through any kind of a significant downturn, I think that would present the large participates in the industry with significant consolidation opportunities. So it just depends on how you think the cycle is going to play out. Down cycles tend to beat consolidation opportunities.

Scott Gruber - Sanford Bernstein

And how do you think about investment in the jack up business versus the deep-water?

Steven Newman

Well, as long as the returns are comparable, I mean deferent about commenting significant capital to an ultra-deep water floater versus a high spec jack up. We think both of those are attractive asset classes and provide the company with an opportunity to continue to differentiate ourselves. So as long as the economics are comparable, I think we are generally asset agnostic.

Scott Gruber - Sanford Bernstein

During your prepared remarks, you continued to sound bullish on the market place. We have heard of a few projects being differed in the Gulf and there’s potential new taxes hitting the Norwegian operators. Has that impacted the appetite from your customers to contract additional rigs?

Steven Newman

You hear a little bit of it in the commentary with the customers; you don’t really see it in their behavior yet. So I’m aware of block 32 in Angola being delayed; I’m aware of, I think its Exxon Mobil’s Hadrian project in the Gulf of Mexico being delayed.

Outside of a couple of instances like that, I haven’t seen any behavior in the customer community that would give you any cause for near term concern. Long term I think all of the customers we regularly interact with are bullish about the opportunity set offshore and their willingness to continue to commit capital to those opportunities.

Scott Gruber - Sanford Bernstein

Great. We are out of time. Thank you again Steven.

Steven Newman

Thanks Tom.

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