Offshore Drilling: Drillships Fundamentals March 2019 Edition

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Includes: CVX, DO, ESV, NE, PACD, PBR, RDC, RIG, SDLP, SDRL, VTGDF
by: Vladimir Zernov
Summary

In this article, I discuss the current fundamental situation in the drillship segment of the offshore drilling market.

Improvements continue: more rigs are working, dayrates are rising.

However, the pace of improvements is slow, which is understandable, since many rigs remain on the sidelines waiting for jobs.

I focus on the moving parts: newbuilds, which could soon come to the market, and cold-stacked rigs, which could leave it forever.

Three months ago, I wrote an article about the fundamental situation in the drillship segment of the offshore drilling market. Now that the earnings season is behind us, it’s high time to look at the current fundamentals and compare them to the situation in December 2018.

As always, I’m using the Bassoe Offshore database for this work. Fundamentals of the drillship market segment are relevant for investors and traders in companies that have drillships in their fleet: Transocean (RIG), Ensco (ESV), Rowan (RDC), Diamond Offshore (DO), Noble Corp. (NE), Seadrill (SDRL), Seadrill Partners (SDLP) and Pacific Drilling (PACD).

Currently, there are 128 drillships in the world: 63 are drilling, 29 are warm-stacked, 16 are cold-stacked and 20 are under construction. For comparison's sake, I’ll list the numbers from the previous article that was published on December 13, 2018. At that time, there were 129 drillships in existence: 57 were drilling, 34 were warm-stacked, 18 were cold-stacked and 20 were under construction.

As we can see, just one drillship left the fleet during these three months: PetroSaudi Saturn (1983). As the Bassoe database indicates, it was sold to scrap for $2.5 million at the end of 2018. Interestingly, one cold-stacked drillship made it back to the active fleet: Sagar Bhushan (1987). It’s an old drillship working in India. Despite the fact that one drillship came back to life from the cold-stacked state, utilization increased, as more rigs are now drilling and fewer rigs are warm-stacked.

This improvement led to a modest increase in dayrates, which are now $175,000, according to Bassoe estimates. As usual, real-life fixtures depend on the region, the duration of the contract and on the rig itself. Recent data points include Transocean’s long-term contracts with Petrobras (PBR) with dayrates of $195,000 and $215,000 - a disappointment given the region of work, the duration of contract and comparison with the recent fixture in the region - and short-term work for Vantage Drilling’s Tungsten Explorer (OTCPK:VTGDF) at an estimated dayrate of $160,000.

As time goes by, my concerns about the viability of cold-stacked drillships increase. Let’s look at the list:

Source: Bassoe Offshore

As Transocean reported in the last fleet status, Ocean Rig Paros will go to scrap, so soon another drillship will leave the scene. In my opinion, only 6 rigs out of the cold-stacked list have real chances to return to the fleet: Ensco’s DS-3 and DS-5, as well as Transocean’s Ocean Rig Apollo, Ocean Rig Mylos, Ocean Rig Olympia and Ocean Rig Athena. However, even these rigs are under question.

Transocean’s estimates of $25-35 million reactivation costs look like a complete dream and are not supported by peer views or by real-life data. In its recent presentation, Seadrill suggested that a cold-stacked unit needs $75 million to be ready for work, and that the dayrate required for such reactivation is $300,000.

In its last earnings call, Pacific Drilling stated that putting a rig from smart-stacked to hot-stacked state (the company’s own variations of a warm-stacked mode) will cost $10-20 million depending on the rig - taking a rig back to life from a cold-stacked state should be a much more costly exercise compared to returning it to the active fleet from a warm-stacked mode.

Real-life reactivations also don’t promise an easy road for those who decide to unstack floaters: Diamond Offshore’s reactivation of semi-sub Ocean Onyx will cost $110 million (with upgrades which are almost inevitable to position the rig in the market after years of stacking), while Transocean decided to scrap semi-sub Eirik Raude because the reactivation price tag went to the $100 million mark. Also, I’d note that Transocean has put itself into an uncomfortable financial position where it does not have the resources to reactivate cold-stacked rigs, as it needs to deal with material investments in newbuild rigs.

To sum it up, cold-stacked drillships are not coming back to the market anytime soon, if ever. This is a big concern for Transocean, a mild concern for Ensco and a good thing for the market in the long term.

Let’s now look at the newbuilds:

Source: Bassoe Offshore

Unlike cold-stacked rigs, newbuild drillships will come to the market en masse. Sete Brasil rigs Arpoador and Deepsea Guarapari have already received contracts from Petrobras and now wait for some player to take them and manage during the contract time.

One of Transocean’s newbuilds got a major contract with Chevron (CVX), and there is no doubt that the company will focus on getting work for the second one, as well as Ocean Rig’s newbuilds Crete and Santorini. Sonangol Libongos and Sonangol Quenguela found a place in the joint venture with Seadrill - it is possible that two Northern Drilling rigs will join them, especially in case Seadrill decides not to help out Seadrill Partners by employing West Polaris in the joint venture.

Ensco boosted its short-term liquidity with the Rowan merger, so we’ll likely see DS-13 and DS-14 in action relatively soon. At this point, only three Opus Offshore rigs which are specific (only 5000 ft. depth) and rigs that ended in the hands of yards - Cobalt Explorer (Northern Drilling had an option to buy it), KFELS Can Do DS, West Dorado, West Draco and Pacific Zonda (there’s an ongoing arbitration between the yard and Pacific Drilling) - are under question. The remaining 12 rigs will likely appear in the market in the next few years.

I expect that the situation with the working drillships will gradually improve and that dayrates will continue to incrementally rise, but in small iterations. There are many high-quality warm-stacked rigs, and many rigs that are currently drilling will need to get new contracts in 2019 to continue working.

The active fleet right now (drilling + warm-stacked + “hot” newbuilds) is 104 rigs, and 63 of them are drilling. Sure, some warm-stacked rigs and even newbuilds already have contracts, but we should also keep in mind that rigs that are currently drilling will also need to seek new contracts. Thus, it’s hard to expect a meteoric rise in dayrates unless we see a very big increase in awarded jobs.

A number of rigs will likely leave the market after they spend years without jobs. Of course, the rigs under the biggest risk are cold-stacked rigs. Also, lower-tier warm-stacked rigs are in danger. The biggest “rig survivability” risk is carried by Transocean, which has both cold-stacked drillships and lower-tier warm-stacked drillships. On the other side of the spectrum, Pacific Drilling has a decent fleet of 7 rigs that I believe will fully survive (although many of them are smart-stacked) due to both the rig quality and the company’s financial position after restructuring.

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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.

Additional disclosure: I may trade any of the above-mentioned stocks.