Seadrill's West Tellus Contract Continues To Show Industry Strength

| About: Seadrill Limited (SDRL)

On Friday, July 19, Seadrill (NYSE:SDRL) announced that it has secured a contract for the West Tellus, an ultra-deepwater drillship currently under construction at the Samsung Heavy Industries shipyard in South Korea. The contract is for a period of 180 days and carries a total revenue potential of $150 million, making it one of the more interesting contracts that I have seen in the ultra-deepwater sector lately. The contract also underscores the ongoing demand-driven strength in the sector that I have written about several times over the past year.

The West Tellus is a 2013-built drillship that is capable of drilling wells up to 37,000 feet deep in up to 12,000 feet of water. Seadrill has several rigs that are capable of drilling deeper wells, but the West Tellus is still one of the more capable ones in the company's fleet, as can be expected from a brand new rig.

(Click to enlarge)

Design photo of West Tellus
Source: Seadrill, Ltd.

Under the terms of the contract, the rig will be operating in China immediately following the completion of its construction. After performing its work in China, the rig will then be moved to the West African nation of Liberia to complete the contract. This will position the rig well to be able to secure another contract in West Africa after this short one ends. West Africa is one of the most rapidly growing ultra-deepwater markets in the world and it commands some of the highest dayrates that have been achieved by other companies in the current market. For example, Pacific Drilling (NYSE:PACD) was awarded a contract in West Africa by Chevron at a rate of $680,000 per day for the Pacific Khamsin. Ocean Rig has also received a contract in the region at a rate of more than $650,000 per day.

Seadrill's contract may be larger than these two. As previously mentioned, the contract for West Tellus has total potential revenue of $150 million and lasts for a period of 180 days. That works out to approximately $833,000 per day. However, not all of that is dayrate. Seadrill states this itself in its announcement (linked above):

"The agreement is for a period of 180 days with revenue potential of approximately US$150 million inclusive of bonus potential and mobilization."

Note that the company specifically states that the calculated rate of $833,000 per day includes both the mobilization fee and the potential for bonuses. The mobilization fee is simply a reimbursement of the expenses that Seadrill will incur by moving the rig to its assignment location (or locations, in this case) on behalf of the customer. Therefore, it does not truly represent new money for Seadrill even though it is amortized over the full term of the contract. The performance bonus mentioned in the announcement is intended as a way for Seadrill to share in the revenues earned from a successful well. It does therefore represent new money to the firm but is not guaranteed. Thus, it would be most helpful from an analytical perspective to know the dayrate, mobilization fee, and potential performance bonus to determine the impact to cash flow caused by this new contract. However, it is likely that West Tellus will have a dayrate in excess of $600,000 considering recent ultra-deepwater contracts signed by Seadrill and others, some of which are listed above. Pacific Drilling shows the dayrates for several recently awarded ultra-deepwater contracts in a presentation on April 10:

(Click to enlarge)

As the chart shows, dayrates for ultra-deepwater rigs have risen steadily over the past two years. This is due to the demand for such rigs relative to supply. To put it simply, there are not enough ultra-deepwater rigs available to meet the demand that oil and gas companies have for such rigs. This also strengthens the conviction that the dayrate on the West Tellus is likely above $600,000.

A dayrate of $600,000 would be very profitable for Seadrill. In its presentation at the Howard Weil 41st Energy Conference, the company included this chart that shows the economics of operating the three types of rigs that the company previously had in its fleet:

(Click to enlarge)

Source: Seadrill

As an ultra-deepwater drillship, West Tellus would be considered a UDW Floater in the chart above. Therefore, the figures provided apply to it. However, Seadrill has used this same chart in presentations dating back over a year. Both dayrates and operational expenses are higher now than they were when the company constructed the chart. Seadrill's ultra-deepwater specialist peer, Pacfic Drilling, states in more recent presentations that it costs approximately $180,000 per day to operate an ultra-deepwater rig. At that rate, it would cost Seadrill $32,400,000 to operate the rig for 180 days with the remaining contract revenue being profit for Seadrill (net of the mobilization fee).

Unfortunately, Seadrill will not be able to generate the maximum theoretical profit that the contract will allow. This is because it is unlikely that the rig will achieve 100% uptime. Offshore rigs are sophisticated pieces of equipment that require periodic downtime to perform maintenance and repairs. Additionally, the term of this contract will be the first six months of the rig's operational life, a period of time in which the rig tends to have lower reliability and experiences more downtime than after the period has passed. As I have discussed in many previous articles, offshore rigs do not generate revenue during periods of downtime. Therefore, it is highly unlikely that the rig will generate its theoretical maximum revenue from this contract.

The contract will still prove to be quite profitable for Seadrill however, due in large part to the low cost of operating the rig compared to the dayrate. If we assume that the rig will achieve 90% of its maximum potential contract revenue, then that would be $135 million compared to $32.4 million of operating expenses. If we assume that the rig has an actual dayrate of $600,000 (which is probably too low of an estimate) then it will still generate $97.2 million in revenue at 90% utilization compared to $32.4 million in operating expenses.

Disclosure: I am long SDRL, PACD. 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.

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