Pacific Drilling's Latest Contract Shows Company's Growth Prospects

| About: Pacific Drilling (PACD)
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Pacific Drilling (NYSE:PACD) announced on June 22, 2012 that it has contracted out the ultra-deepwater drillship Pacific Sharav to Chevron (NYSE:CVX) for a five-year period. The maximum contract revenue, including mobilization and client requested modifications, is $1,076 million. This works out to approximately $589,600 per day but it is important to note that this calculated day rate includes the mobilization fee and other costs. This makes it appear higher than it actually is. The actual contracted dayrate is $555,000 according to Pacific Drilling's updated fleet status report.

The Pacific Sharav is one of the most advanced drillships in existence today. The rig is capable of operating in up to 12,000 feet of water with a maximum drilling depth of up to 40,000 feet. It is also one of only a handful of rigs in existence that are capable of dual-gradient drilling. Dual-gradient drilling is a technology championed by Chevron that provides a safer and more efficient method for drilling wells, according to the U.S. Bureau of Ocean Energy Management, Regulation, and Enforcement. I discussed the potential of dual-gradient drilling in a previous article on Pacific Drilling.

This new contract has the highest dayrate and total contractual revenue that Pacific Drilling has ever received.

Source: Pacific Drilling S.A.

This provides evidence that Pacific Drilling is taking advantage of the strength in the market for offshore drilling rigs and is consequently pushing for higher dayrates. It will also cause Pacific Drilling's earnings to increase significantly once the rig begins its work for Chevron. The fact that this dayrate is the highest that Pacific Drilling has received also lends support to my convictions that the current upcycle in the offshore drilling market is likely to benefit those rig owners with modern, ultra-deepwater offshore rigs if not other players in the industry.

One of the more interesting factors about this contract is the start date and term. The Pacific Sharav is still under construction and is expected to leave the shipyard and be delivered during the fourth quarter of 2013. The contract itself is slated to begin in the second quarter of 2014. Offshore drilling giants SeaDrill (NYSE:SDRL) and Transocean (NYSE:RIG) have both stated that the demand for ultra-deepwater rigs is greatly in excess of supply. This is causing oil companies to move now to secure the rigs that they need for their respective offshore projects.

This contract's dates serve as supporting evidence for the accuracy of those statements. In effect, Chevron is so concerned about future rig availability that it has elected to contract out a rig that will be under construction until the end of next year. Furthermore, it also stands to reason that Chevron expects the price of rigs to be higher in the future. If the company expects rig availability to be a concern then that would be the logical conclusion. This is a very good thing for offshore drilling companies. After all, when demand is much higher than supply then it is a sellers' market in which prices and profits of those sellers should rise.

This latest contract carries the highest contractual dayrate and highest average daily revenue that Pacific Drilling has ever gotten. Even so, however, it is still lower than recently announced contracts that some competitors have gotten. For example, SeaDrill landed a contract back in May for an average daily revenue of approximately $668,000 and is in advanced discussions for another rig that would also have an average daily contract revenue of more than $600,000.

Contract dayrates do depend on a few factors, especially location and contract duration. The contract for the Pacific Sharav is a five-year contract in the Gulf of Mexico. The Gulf of Mexico is typically cheaper than some other areas such as West Africa or Brazil. Given the location of the assignment and the duration of it, Pacific Drilling certainly got a fairly good dayrate with this contract. I would, though, like to see the company push to get a contract or two with a dayrate in the $600,000 range.

Overall, this contract will prove to be accretive to Pacific Drilling's bottom line beginning in the middle of 2014. Thus, this is not something that will likely have an impact on this quarter's or next quarter's results. However, this does provide more certainty and visibility with regards to the company's future earnings growth. This also serves to show how strong the fundamentals are for rig owners, especially ones operating in the ultra-deepwater space.

Disclosure: I am long SDRL.