Survival mode

Leslie Cook, of Wood Mackenzie, examines falling dayrates in the floating rigs sector, and the view out to 2020.

Graph sources: Wood Mackenzie

As the cyclical downturn in the deepwater market continues to drag out, drilling contractors are settling into a new way of life. The standard mode of survival rests in the ability to leverage debt, sustain costs, maintain revenue efficiency, and preserve idle relationships with customers and crews.

Contracted floating rig counts have reduced by nearly 30% over the past year and by 50% since the peak in 2014. Over 80 floating rigs have been idled since 2016 and utilization is heading towards 50%. Deepwater ports are filling up around the world as half of the existing fleet is now idle. Roughly three-fourths of older generation rigs are now idle or rolling off contract in 2017, many of which will be permanently retired. Among 3rd-5th generation rigs, hot supply consists of approximately 35 moored units and 10 dynamic positioned rigs.

The pressure to keep 6th and 7th generation rigs in operation is of growing concern among drilling contractors with high exposure to the ultra deepwater market. These newer generation rigs took a hard hit in 2016 as operators terminated several contracts early in effort to get out from under high dayrates. Term contracts signed at legacy high dayrates back in the peak years of 2011-2012 are now rolling off contract. In 2017, over 60% of the rigs rolling off contract are among this high-specification fleet and leading edge rates for new rigs have plummeted from mid-US$500’s to low-$200’s causing serious cash flow concerns for firms in the drilling supply chain.

Long-term stacking of rigs causes disruption throughout the supply chain which inevitably will impact operators when the market begins to climb back up. Based on current industry estimates, global oil prices are predicted to stay at or below $60/bbl for the next few years, which will keep many of the deepwater rigs idle through 2019. With very little precedence to go by, the true cost of reactivation is still unclear. Publically disclosed estimates of $25-$35 million for reactivation of a 6th generation drillship only covers capex estimates, which are incurred by the drilling contractor and do not reflect the true overall picture of putting a rig back to work. There are 100 newer generation rigs in hot mode today (fully crewed and operable), but only 20% of the units have firm contracts into 2020. Despite efforts to keep rigs as warm as possible, long-term idle time will likely result in fewer economical choices for operators in 2020 versus what is available today.

Keeping a rig hot is not an easy task under current market conditions. With limited opportunities for new fixtures, there is heavy emphasis to maintain revenue efficiency (measure of how much a rig earns while under contract). Every drilling contractor in the deepwater space must maintain strict financial and operational discipline in order to keep contracted rigs under full rate at the lowest possible cost without compromising safety. So far drillers appear to be up to the task as the major contractors are maintaining revenue efficiencies above 95% with razor thin margins and no major safety incidents. Over the past two years, as dayrates have continued to free fall, drilling contractors have successfully reduced daily operating costs by upwards of 30% by reducing onshore logistics, manpower, and wages.

Currently, there are 147 floating rigs under contract of which roughly 80% are working. Among the working fleet, 45% are operating in Brazil and US Gulf of Mexico. Total well demand in 2017 is forecast to drop another 10% with declines expected in both exploration and development programs. As a result, rig demand is expected to be somewhere around 110 units average for the year, so we expect to see a continuation of rigs going idle at the end of their contracts, and contractors will fight to get one well at a time in an effort to keep rigs hot. Long-term fundamentals favor a return to deepwater activity, but the climb up is poised to be even more challenging than the fall.

Leslie Cook is a principal analyst in the Upstream Supply Chain Group at Wood Mackenzie. She is recognized for her sector expertise in the supply and demand dynamics of the offshore drilling market.