Turnkey management allows operators to manage drilling risk

Jerry Greenberg
Freelance writer
Houston

Turnkey drilling services offer a viable method for operators to better manage drilling risks and reduce costs. In the future, they may be able to utilize drilling management contractor services for complete field development programs.

The offshore turnkey drilling industry remained a high-margin, low-volume business until about 1993 when turnkey drillers began to realize bidding prices were not competitive with most operators' internal cost estimates.

Increasing market share could only be achieved by reducing margins to match the real competition, which is the operator's AFE (authority for expenditure). Since then, the number of offshore turnkey wells has increased almost every year (Fig. 1 [112,798 bytes]).

However, the future of the offshore drilling management services industry involves moving beyond merely providing a well or a completion for a fixed price. It means working with an operator and other service companies to provide a range of services for complete field development, from drilling and completion to facilities design, installation, and field management through depletion.

Drilling management

Oil and gas companies use drilling management contractors because there may be a shortage of internal drilling department staff resources and drilling rigs. In addition, cost management and schedule management concerns may provide incentives to contract out the work.

However, the primary reason why operators choose a turnkey manager is to mitigate risk.

Larry McRae, vice-president of operations for CXY Energy Inc., said "[turnkey management] keeps our costs fixed and the risk is basically passed on to someone who feels like they are good enough to handle the risks and make money. Most of the wells we consider drilling turnkey are those that we consider to be higher risk and have higher potential for drilling problems." The company says it obtains turnkey bids on 20% to 25% of the wells it drills.

Sonny Bryan, engineering manager for King Ranch Oil & Gas Inc., agrees. "We have partners in our wells [who] desire the same thing as King Ranch," that is, the need to manage risk. "We're willing to pay that small premium on some wells that may turn out to be large savings."

"We get a turnkey bid for every well we drill," Bryan adds. "If we get a turnkey bid lower than our AFE, we'll go with turnkey." King Ranch Energy drilled two offshore turnkey wells during the first half of this year, and plans three to five more turnkey wells in the second half."

"We use turnkey to mitigate risk, but it also depends on how much more it's going to cost," said Bob Waldrup, vice-president of operations with Newfield Exploration Co. "I've let them make $5,000 or $10,000 over my AFE on a $5 million well, but not when it gets to be a significant amount."

Newfield, which gets turnkey bids as well as day-rate bids with every well it intends to drill, drilled 8 turnkey wells in the Gulf of Mexico this year. The company is planning another 10 to 12 wells in the Gulf the remainder of this year but Waldrup doesn't know how many might be turnkey. "If they can beat my AFE by $1, they can have the well."

"We've drilled about 10 turnkey wells during the past 2 years," said David Sartain, drilling manager for Burlington Resources Inc. "But part of that was a function of rig availability."

That's because the two major turnkey contractors were chartering about 20 jack ups between them when the jack up market was tightening in 1997 and early 1998, assuring enough rigs to fulfill their turnkey contracts. "But now," Sartain says, "we can pick and choose what rigs we want. From what I've seen in the last few months, you can almost name your price."

"If the turnkey bid is similar to our estimate, or has a minor additional cost, we would take a turnkey bid to mitigate the risk," said Dalton Polasek, vice-president of Gulf Coast Engineering with Denver-based Basin Exploration Inc. "Prior to this, a lot of the factors involved in choosing turnkey had to do with rig availability."

Basin Exploration gets turnkey bids for about 90% of the wells it plans to drill. That figure takes into consideration the fact that Basin had to look to the turnkey contractors because of rig availability.

"At this point," Polasek said, "we'll look at turnkey, but it won't be as necessary now that rigs are so available. But the turnkey companies are changing with the rig situation. They're adapting their prices to the rig and boat situation. As long as they remain as competitive as they have been on some of our wells, we'll continue to look at the numbers."

"The only reason we use turnkey is to mitigate risk," said Emmett Wassell, vice-president of operations for Seneca Resources Corp. "Our AFE is normally going to be less than a turnkey bid, but with a turnkey there's no risk. There are going to be a few wells that you've drilled yourself and everything goes okay, and you save a little bit of money. But that one time where you get into a little bit of trouble, it can cost you enough to offset the additional cost of a turnkey."

"What appeared to be the case in 1997 is that the turnkey drillers had tied up rigs at lower rates that were very competitive for long-term contracts," said Gary Christman, Worldwide Well Engineering Manager for Pennzoil Exploration & Production Co.

"As a result, they could offer us a total turnkey cost using those lower rates. It gave them an advantage over our internal costs because we would have to pick up a marginal rig on the market and would have had to pay more for it.

"But now some of that advantage has eroded," said Christman. "The turnkey drillers are going to have to show us a better price by internal performance rather than by the fact that they had rigs with lower rates than ours."

Pennzoil doesn't get turnkey bids on every well it drills, but Christman says they are getting management pressure to do that. "We're in a very marginal market right now," Christman said. "It's purely cost management."

Presently, says Christman, the company generally looks at the possibility of turnkey for the extremely complex wells, wildcats, and subsalt wells. The bottom line here is to mitigate risk. But Pennzoil also considers turnkey for its simple wells.

"The turnkey operators have the rigs already up and running," Christman said. "There's no geological uncertainty, no field uncertainty. The only uncertainty is mechanical uncertainty."

Christman says it's sometimes quicker and cheaper for a turnkey operator to drill because the turnkey operator has the equipment, people, and services that they are used to working with. In some cases, if an operator were to drill the well, particularly if it must contract a rig and then install the necessary services on the rig, it could take more time and money than using a turnkey contractor ( Fig. 2 [89,608 bytes]).

"With a new rig, new services, and a new drilling team, we're on the number one well of a learning curve," Christman said. "But a turnkey contractor may be on the twentieth well of the learning curve with a particular rig with the same crew and services. It's just more efficient."

Early Days

In the 1980s, there were as many as eight or more companies offering offshore turnkey drilling services, a few of which were divisions of drilling contractors who were in the turnkey business primarily to keep their rigs working during lean times.

These companies were not in the business for the long haul, and as soon as day rates began to increase in the 1990s, they exited the turnkey drilling business and went back to contract drilling.

Rowan Cos., through its Rowan Petroleum Inc. subsidiary, began drilling offshore turnkey wells in 1992 when the rig market was very soft. Its purpose was mainly to keep its own rigs working. The company drilled 68 offshore turnkey wells in 4 years.

But as the offshore rig market began to tighten in 1996, Rowan quickly exited the business. After drilling only two wells in 1996, the company drilled only one turnkey well in 1997.

That well encountered severe downhole problems and never reached its geological objective. The well directly resulted in Rowan's first-quarter 1997 earnings being reduced by about $20 million and marked the end of the company's venture into the turnkey business.

Diamond Offshore began drilling turnkey wells in 1993 through its Diamond Offshore Turnkey Service (DOTS) division. Like Rowan, Diamond Offshore drilled wells on turnkey to keep its own rigs working in a soft market.

DOTS drilled 28 offshore turnkey wells in the 4 years it was in the business, drilling its last turnkey well in 1996 when the offshore rig market began to strengthen.

One company that was active in the offshore turnkey business for 10 years, but drilled only 25 wells, was Offshore Turnkey Ventures (OTV), a partnership between Transocean Offshore and Petroleum Engineers International. That partnership came to an end in 1997 because of differences in operating philosophies and an unsteady level of success.

However, Transocean continued turnkey operations on its own in the Gulf of Mexico and internationally until late 1997 when it announced that it would concentrate on international opportunities exclusively.

Transocean's reasons for exiting the U.S. turnkey market were threefold, and best sum up the challenges of the offshore turnkey business. First, the U.S. market is more competitive than international markets.

Second, because of the competition, U.S. margins are at or under 10%. Finally, U.S. drilling programs are typically tendered one well at a time, so a turnkey driller is not able to obtain a multiple well program. A consecutive drilling program improves performance because geologic and logistical knowledge increases.

Transocean encountered problems with a well in a turnkey package from Pemex (Petroleos Mexicanos) offshore Mexico. "The second well encountered geological problems," said Jeff Chastain, director of investor relations for Transocean Offshore. "That well was terminated before the target depth was reached. The first well was successful and the third well is drilling ahead without difficulty."

The Mexican turnkey wells may be Transocean's last, domestically and internationally. "The day rate end of the business is so strong that it is probably best to focus on that part of the business as opposed to turnkey," Chastain said. "But that doesn't mean we wouldn't drill turnkey again."

"From Global Marine Inc.'s perspective," said Jon Marshall, executive vice-president and COO of the company, "It doesn't matter whether rig markets are weak or strong, because we believe our drilling management services business should stand on its own. We expect drilling management services to make money in good markets and bad."

Cliffs Drilling has been in the turnkey business since 1983, drilling 74 turnkey wells from 1983 through the end of 1997. The company began focusing on its day rate business earlier this year but still drilled a couple of offshore turnkey wells in the Gulf of Mexico. Cliffs also has a turnkey contract to drill 60 wells onshore in Venezuela.

Other companies which have quit the offshore turnkey business include W&T Offshore, which drilled about a dozen turnkey wells in the Gulf of Mexico from 1994 to 1996, and Francis Brown/Reading & Bates, which drilled a couple dozen offshore turnkey wells during the same period.

Two major players

While there were about eight offshore turnkey drilling companies a few years ago, the offshore turnkey drilling industry has evolved and matured to the point where there are only two major players left in the market.

These are Global Marine's Applied Drilling Technology Inc. (ADTI) and Noble Drilling's subsidiary Triton USA. In 1997, these two companies drilled 128 of the 136 turnkey wells in the U.S. Gulf of Mexico.

ADTI drilled 101 offshore turnkey wells in the Gulf during 1997. That was more than any operator in the region (Fig. 3 [101,927 bytes]) and accounted for approximately 10% of all the wells drilled in the Gulf (Fig. 4 [101,351 bytes]). ADTI's 101 wells was also 75% of the turnkey wells drilled in the Gulf of Mexico.

With the overall downturn in the Gulf, the company is behind the pace to match those figures for 1998. ADTI drilled 44 wells during the first half of 1998, compared with 53 wells during the first half of 1997.

Slowed by the worldwide slump in drilling, Global Marine's drilling management services group posted mixed results for the 1998 second quarter. The domestic turnkey division had an $11 million profit, close to the 8% normal margin, but two problem wells offshore West Africa resulted in a loss of $7.5 million. Both of the problem wells were eventually completed but only after one was redrilled.

To assure that it could get the rigs it needed, ADTI contracted 10 jack ups from R&B Falcon and 5 jack ups from Marine Drilling in 1997 and 1998, all under long-term charter. When the jack up market was tight, the move proved to be a good decision.

Some operators and other drilling contractors, however, were critical of ADTI tying up so many rigs. At the time, Dave Herasimchuk, vice-president of market development for Global Marine, said, "Operators are angry at ADTI because they have to stand in line for rig time. What operators should be angry about are market conditions. There are just not enough rigs to go around. We took the risk of contracting long-term and we expect to get the reward."

Herasimchuk also said that many smaller operators might not have got the rig time they required if it were not for ADTI. "The rigs can't operate continuously on ADTI's own work, so, like a major operator, we're farming-out and farming-in rigs all the time."

But with the downturn in the Gulf of Mexico jack up market, many of those jack ups that ADTI has under long-term contract at previously favorable rates are now higher than present market rates.

"We've got to compete" with market rates, said Doug Vrooman, president of ADTI. But, he adds, "The day rates on most of our rigs recycle every 3 months so we can review the rates. The contracts are renegotiated. The rates can go down as well as up. Some of them have already come down."

"We will probably be toning down our 300-ft jack up market and looking for additional mat-supported cantilever jack ups," Vrooman added. "If you look at our history, only about 3% of our turnkey business involved the use of 300-ft jack ups.

ADTI is pursuing opportunities to expand its turnkey services in the Gulf of Mexico beyond merely drilling wells. "We're talking with operators now regarding turnkey field development in the Gulf of Mexico," Vrooman said. "We have not only drilled turnkey wells in the Gulf but also completed about a dozen of them. We are actively promoting that market as a natural progression from our drilling activity.

"A lot of small operators don't have the staffs to both drill and complete wells. We're providing those services and we'll also put in the platform and pipelines and get the field ready to produce. At the customer's preference, we'll do it turnkey or on a management basis."

Triton USA began drilling turnkey wells in 1983 and drilled a total of 248 domestic turnkey wells by the end of 1997. The company has drilled 14 turnkey wells in the U.S. Gulf of Mexico during the first half of this year, according to figures from Offshore Data Services Inc. in Houston.

The company also drilled two turnkey wells offshore Mexico, one of which encountered severe downhole problems. Several sections had to be redrilled. In all, the rig was on the first turnkey well for approximately 225 days and on day rate for more than 75 days while completing the well.

Triton has drilled turnkey wells offshore Australia, New Zealand, Mexico, Nigeria, Gabon, and in the North Sea. Net income generated by turnkey drilling services during the 1998 second quarter was approximately $1 million compared with a negative $441,000 for the 1998 first quarter.

Like ADTI, Triton contracted several jack ups under long-term charter in the Gulf of Mexico. "Idle rigs, well performance, and weaker day rates combined to slow turnkey drilling services earnings momentum," the company said.

"Our bid level for the year is higher than last year at this time," said Dave Mannon, vice-president at Triton. "But we're going into the summer months and they are traditionally slower activity levels. August is usually our slowest month. I think that we'll have a good late third quarter and fourth quarter because independents still have to drill. They can't sit on the sidelines very long because they'll basically deplete their companies."

Also, Mannon said, "When you see prices that have fallen 30%-40% for drilling rigs, and those costs are factored into the well costs, that means your total well costs have come down about 30%-40%. So instead of spending $4 million on a well, you're spending $2.7 million. I think you're going to see people entering the marketplace and with that I think our turnkey activity is going to increase."

"There are a lot of rigs coming up for renewal and I think they're going to have pressure on all of those contracts. I think you're going to see prices ratcheting down. That's why operators are taking a wait and see position to see where rates are going to end up.

"Our activity internationally has slowed," Mannon said. "We have had some activity in West Africa. Nigeria was in a state of flux for a number of months but it looks like some stability is returning. Operators are taking a wait and see approach there as well as the Gulf of Mexico."

With only two major turnkey operators remaining, there is concern that there may eventually be only one turnkey operator. "I think it's healthy that there is competition," Christman said. "But quite honestly, if one of them were to disappear, we're going to carry on doing what we're doing, and that is to compare the turnkey costs to what we can provide internally.

"So there still is actual competition because they're still competing against our AFE. Back in the days when you had ADTI, Triton, and a few others, they were bidding aggressively against each other. The turnkey contractors would get the work but they would invariably lose money. That's what caused the industry to contract to where it's at today."

The future

Only 18 years ago, the only activity that drilling management contractors performed was to drill a loggable hole for a fixed price. Today, turnkey contractors can deliver anything from drilling a simple well to drilling and completing a multi-well program.

The future may include full-field development on a turnkey basis under an alliance with other service companies, including drilling, completion, platform and pipeline installation, and field management.

The concept is similar to the integrated incentive drilling services being offered by Halliburton and Schlumberger, although they do not offer their services on a turnkey-type basis.

The future of turnkey drilling lies with the expansion of services offered by the contractor beyond merely drilling a well at a fixed price. For example, Global Marine Integrated Services - Europe (GMIS-E), Global Marine's North Sea drilling management services company, is providing a completely outsourced drilling department to one operator.

The company also drilled the development wells on Amerada Hess' North Sea Fife field under a turnkey contract. And the company is presently talking with another company to provide a complete field development project on a turnkey basis with two other service companies.

GMIS-E doesn't drill turnkey wells but works under what is called an integrated-services drilling contract, which is based on a bonus-type incentive contract. "The well price isn't fixed," said James McCallum, president of GMIS-E, "but we perform against an industry standard. If we outperform that, we earn an incentive payment."

GMIS-E was the first North Sea company to provide a completely outsourced drilling department, for BG. "We do BG's drilling engineering and drilling management," McCallum said. "Basically, they have a single drilling manager who quality assures the product. All of the resource base [needed] to support him, all of the drilling engineers, the offshore supervisors, all of the logistics are provided by us."

GMIS-E is presently talking with a North Sea operator regarding a complete field development model encompassing the entire supply chain. The operator had the necessary data for the field development but could not come up with a development solution, according to McCallum.

The operator approached GMIS-E for a possible solution. GMIS-E then offered a plan that would provide reservoir engineering, well construction, facilities design, and installation services, above and beyond conventional drilling services. "We've now done all of that," McCallum said.

GMIS-E has formed an alliance with Kvaerner and Duke Power to provide a development solution for the marginal North Sea field. "The North Sea is a maturing province," McCallum said, "and I see us playing a key role in developing business solutions for marginal and economically challenged fields."

The Author