Lehman Bros.: Jack up day rates remain static in GOM

Sam Fletcher
Senior Writer

HOUSTON, Jan. 17 -- Despite the continued mobilization abroad of jack up rigs, day rates for those remaining units in the US Gulf of Mexico will stick at current lower levels vs. a recovery to the higher rental rates of early 2006, said Angeline M. Sedita with Lehman Bros. Inc., New York.

Lehman Bros. analysts blame the recent drop in US natural gas prices for declining demand for jack up rigs in the gulf. However, analysts in the Houston office of Raymond James & Associates Inc. reported Jan. 17, "Natural gas futures have risen slightly since the beginning of the year based on the cold weather sweeping across much of the US." The February natural gas contract increased by 3.7¢ to $6.64/MMbtu Jan. 16 on the New York Mercantile Exchange. On the US spot market, gas at Henry Hub, La., shot up by 77¢ to $6.77/MMbtu.

If natural gas prices were at prior levels of $7-9/MMbtu, the mobilization of jack ups out of the gulf would have resulted in a surge in day rates for those remaining. "But with natural gas price levels in the $6-7/Mcf range and general cautiousness by many of the very small E&P companies, coupled with smaller and smaller prospects in the shallowest of waters, we believe that rates are likely to stay at or around today's levels," said Sedita

As a result, Lehman Bros. said Jan. 16 it was reducing by 5-12% its estimates of earnings per share for the jack up rig drilling contractors followed by its investment analysts. "Companies are already down 10-20% from their December highs (and down 15-35% from early 2006). We believe that the stocks reflect much, but not all, of this anticipated near-term gas-related weakness," it reported.

However, Lehman analysts said, "Our long-term outlook remains unchanged, and we believe the broader energy cycle will continue, with a focus on the deepwater and international markets."

With lower rates expected for most jack ups except for high-specification rigs, Sedita said, "Even standard class 300-ft IC jack ups have experienced rate pressure, which we expect to continue." Still, she said, "We are not expecting day rates to go to new lows, but to stay at today's levels, which are 20-35% off their early 2006 highs."

Sedita noted, "Today's day rates are still over 300% higher than the trough day rates seen in 2002, and gross rig margins are still a very impressive 55-70% at today's day rates. Thus by any historical standard, jack up day rates in the gulf are well beyond any prior peak levels, but we simply don't see rates recovering to earlier year highs given today's gas prices."

She said, "All of the shallow-water drilling contractors are earning far more than they ever would have believed possible on these older, lower specification jack ups.... Further rig mobilizations will provide some help to the market, and we would anticipate 3-5 more rigs leaving the region."

Most offshore drilling contractors anticipated this decline in activity and have already reduced their jack up exposure in the gulf. "Many of the companies have aggressively mobilized jack ups abroad, thus the exposure of most of the contract drillers is far lower than it would have been only a year ago, with some companies having no exposure to the Gulf of Mexico or only a few remaining jack up rigs," Sedita said.

Meanwhile, the international jack up market and the deepwater markets remain robust. "Rig demand remains above rig supply, and recent contract signings have been at day rates, which are higher than our expectations," said Sedita. "We do have concerns about the international jack up market mid-to-late 2008, but view the market as tight in 2007."

The weakness in the US jack up market is not likely to spread to international markets, Sedita said. "Unlike prior cycles where US day rates have led the way, this cycle has instead been driven by the robust international markets as rigs moved abroad. Across the international markets, jack up utilization remains high, backlog intact, and rate roll-overs higher. Recent contract signings at a material rate increase in Mexico have also added to our confidence," she said. "However, ultimately we believe new jack up construction will saturate the international jack up market by mid-to-late 2008 and could pressure rates, but not yet."

Sedita reported "modest upside potential" for floater day rates. "Recent contract awards have been meaningfully higher than our estimates, and customer bidding activity on available rigs has been strong. Even speculative newbuilds from lesser-known drilling contractors are signing long-term contracts at peak day rates," she said. "Customer demand is driven by long-term drilling projects and oil price thresholds of $25-35/bbl. "Not only are the major oil companies active participants, but also the national oil companies and independents, which have both become a growing presence," she added.

Recent world-class discoveries, including Jack field in the US gulf, add confidence in the long-term attraction of deep waters, Sedita said. "Additionally, Mexico's Petroleos Mexicanos has also expressed a growing interest in the deepwater markets and could need as many as 7-9 deepwater rigs. New construction is entering the market in 2008-10; however, we believe demand will outpace supply additions and that the market will remain tight until 2010-11," said Sedita.

Contact Sam Fletcher at samf@ogjonline.com.

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