OVERSEAS EXPANSION REQUIRES CAREFUL ANALYSIS FOR CONTRACTORS

C.Russell Luigs
Global Marine Inc.
Houston

For many operators, the lure of better prospects overseas often balances the political and economic risk of conducting business in foreign, and sometimes volatile, nations.

With new destinations successfully charted, the offshore drilling contractor, like the rest of the energy industry, will regretfully continue leaving the U. S.

The pace of international growth may likely spur a slight comeback for the beleaguered offshore drilling industry.

However, the possibilities for a secure and plentiful U.S. energy supply may hang in limbo indefinitely, or at least until the U.S. adopts an energy policy with an appropriate balance between environmental concerns and access to domestic energy resources.

For the most part, the oil industry's exodus from the U.S. and the corresponding overseas expansion in the past 5 years have gone unnoticed by the national media and certainly by the U.S. government. The oil industry has set its course abroad so firmly that there now seems little near-term hope of it turning back to the U.S.

In the past decade, 380,000 domestic jobs have been lost in the oil industry and another 350,000 jobs are at stake. For an offshore drilling contractor, the implications of the exodus from domestic waters are far reaching, especially in light of the poor economics that contractors have faced in recent years.

Since 1988, the demand for rigs in the Gulf of Mexico has declined by 80 rigs. Fig. 1 shows the decline in rig demand for all of the U.S. offshore areas. Meanwhile, virtually every overseas market has steadily increased (Fig. 2). While "politically correct" ideology in this country helped shut down almost all of the U.S. exploration frontiers, other countries' governments made attractive offers backed by responsible and reasonable safety and environmental regulations.

Aware of the economic and political benefits of producing oil and gas to offset unsettling shifts in world trade and military power, every coastal nation worldwide now encourages offshore drilling. The U.S. is the only exception (Fig. 3).

Because drilling contractors work in a service industry, they must respond to factors beyond their control, anticipate problems and changes, and be prepared to alter course when the unpredictable happens. In the simplest terms, drilling contractors must follow the customers. Before drilling contractors follow the operators overseas, however, they should assess the strengths and weaknesses of their businesses.

Relocating overseas with equipment designed for the Gulf of Mexico is as likely to be successful as an offshore driller pleading his case in a California senator's office. To operate overseas today, drilling contractors need estab lished marketing contacts, legal staff, engineers, recruiters, training specialists, logistics teams, and ancillary support services for every major drilling region in the world. Few contractors have invested the time and money necessary to build an organization that can respond to the demands of today's operator, who has become leaner and far more inclined to take advantage of international opportunities.

As the domestic offshore market has shrivelled in recent months, much has been discussed about "taking on the international market"-a concept so vague that it simply has little meaning. Contractors must address dozens of international markets, each so different that little of what is known about one can easily be transferred to the next.

One country may favor joint ventures, yet another may lean toward indigenous contractors. One country may expect bribery as an accepted business custom, yet another may give stiff penalties. On the same continent, two countries can vary greatly. One country may make it nearly impossible to be paid within a reasonable time frame, whereas another may pose no special fiscal challenges.

A drilling contractor needs to look no farther than Louisiana and California to be reminded of how political climates within one country can differ enormously. Certainly, a business plan formulated for the "international market" is a broad strategy that invites the risk of failure of the business.

NORTH SEA

Two trends now developing in the U.K. sector of the North Sea are likely to require increased staff support, even for contractors already established in overseas markets. First, the increasing safety and environmental regulations raise new demands on contractors. Second, operators have begun to expect higher levels of engineering support as rising costs squeeze their margins.

For example, new safety regulations resulting from the Piper Alpha accident are under development. These regulations include an entirely new system for measuring safety performance, one which largely abandons lost time accidents as a measure of performance. These new guidelines will apply equally to operators and contractors. Under the guidelines, every injury, no matter how slight, and every near miss must be thoroughly investigated.

Safety must be integral to every activity onboard the rig, and compliance with the safety rules must be substantiated through auditable feedback loops. The cost in manpower and communications required to comply with these trend-setting regulations have become a necessary part of business for every contractor wishing to participate in the U.K. North Sea market.

A decade of rising costs and unpredictable oil prices has taken its toll on operators-with a predictable effect on drillers. As affiliates of oil companies in various regions of the world compete for exploration dollars from their parent companies, each is challenged to reduce costs. The result has been a 10-year squeeze on service contractors, who have been forced to reduce their own costs by cutting back on anything not immediately essential to today's business.

The end result has been that the operators have deprived themselves of a valuable resource-the drilling contractors' experience, expertise, and proficiency.

Sensing this loss, a number of leading operators have turned back to the contractor for some of the assistance that had been eliminated by budget cuts. Drillers are being asked to provide more than the "low-ball" bid that had become routine for many.

As often as not, today's U.K. tender includes a request for integrated drilling services, where the driller's participation in the planning and the management of drilling programs are the norm rather than the exception. The drilling contractor who lacks the technology and financial resources to respond to the maturing demands of the industry will find itself increasingly excluded from qualified-bidders lists.

Perhaps the real significance of the integrated drilling services approach is the shift in economies of scale. Certainly the smaller drilling contractors will find it hard, if not impossible, to provide the full range of services required to satisfy operator demands and maintain any margin of profit.

The increasing requirement for engineering support and safety staff may well signal the beginning of the long anticipated consolidation in offshore drilling.

SURVIVAL

The trends toward requiring a deeper and broader array of support services from contractors are likely to spread beyond the North Sea to other markets. New guidelines for survival will emerge:

Single market competitors will not survive.
The 10-year U.S. gas bubble may finally have popped. The drilling bust of 1991-1992 has come close to balancing gas supply and demand.
From January through August, offshore wellhead natural gas prices doubled from $0.90/Mcf to $1.78/Mcf, the highest August price since 1986. While this change gives reason for hope, it also carries a caveat. Drillers must avoid over-reliance on a domestic market that, based on recent events in the U.S., will be fraught with potential for drastic and unpredictable swings.
For example, in the 1960s Global Marine decided to build flexible mobile equipment, rather than rigs exclusively for offshore California, where its entire rig fleet was once deployed. This decision saved the company from potential extinction because the rigs were capable of moving to other markets.
Today's drilling contractor must understand its risks.
Contractors must spend large sums of money every year to gather market intelligence, understand political nuances, and forecast which market opportunities are likely to yield the greatest profit potential.
With emerging democracies in former communist and socialist states, a prolonged period of change is inevitable. Until issues such as property rights, taxation, and peaceful coexistence are adequately addressed, any business plan must contemplate political instability.
The ability to move equipment and services to other markets during political upheavals has become a crucial strength of successful oil service contractors. However, contractors must beware the mentality that spreads resources too thin across too many markets. Market presence must be diversified and yet sufficiently concentrated to make the best use of investments in technology and business relationships.
The volatility in the industry necessitates flexibility.
Some of the first offshore rigs were drillships whose mobility made it easy to take advantage of changing markets. When evolving technology made ships a special-purpose drilling vessel, they were replaced with independent leg cantilever jack ups and severe environment semisubmersibles capable of competing in a variety of regions.
The many domestic offshore contractors who own smaller jack ups with less than 250 ft water depth capability face an enormous challenge in competing overseas. Rigs with a similar disadvantage include the slot jack ups that cannot drill many development wells and the mat jack ups that cannot be used on an uneven seabed.
The U.S. may not remain the home to the industry.
As the industry shifts overseas, many U.S.-based contractors with established operations in other parts of the world are evaluating the cost-effectiveness of a headquarters outside the U.S.
The industry is not likely to scatter; rather, the growing importance of Europe and Africa makes the evolution of a new hub within the European Economic Community a strong possibility. The continued erosion of the domestic manufacturing base and domestic support services will lead to further erosion of U.S. payrolls as the oil industry continues to move to areas of the world where the welcome mat is out to providers of technology and risk capital.
Staffing will require tremendous investment.
No longer do the industry's basic skills reside primarily in Texas, Oklahoma, and Louisiana. For example, 8017, of Global Marine crews on overseas rigs are not Americans-a complete reversal of its employment pattern 10 years ago.
Given the high costs of moving American workers overseas and the cultural adaptability required, this trend is not likely to change. The challenge for the drilling contractor in international markets is to identify and recruit local management talent as well as skilled local labor. Beyond that, the contractor will have to provide more intensive training programs for crews, especially in developing countries. In Angola for example, war raged for almost 2 decades, and an entire generation has had little opportunity even to attend school.
Developing a work force in international markets will not be as easy as retraining young American hot-rod tinkerers to become diesel mechanics, a common practice in the past. However, as the application of drilling technology becomes more common in more areas of the world, the trained international labor pool continues to grow.
Cost-controls and effective management systems will become a priority.
A proven history of cost monitoring combined with in-depth market intelligence can mean the difference between the contractor losing a contract or wishing he had lost it. The potential to overestimate risk or underestimate cost on jobs overseas is great.
For example, on occasion Global Marine has bare-boat chartered rigs to competitors who had sharply contrasting evaluations of market conditions. Today, while Global Marine collects the contracted charter rate on those rigs, its lessees cope directly with the pressures of currency restrictions, one-customer markets, and closed borders.
Desperation tactics can be devastating.
Attempts to find alternate uses for drilling rigs have led to some very risky investments. Modifying a rig for early production, for example, requires investment dollars that are unlikely to be recouped within the term of the initial contract.
Finding ongoing work for these highly specialized rigs will be a serious Challenges In reality, rig conversion is less a new business opportunity than it is an alternative to scrapping. The owner of a sound rig will generally be better off bearing the costs required to hold and maintain equipment until an upturn in drilling produces better day rates.
A contractor must beware of big project sinkholes.
The up-front costs of moving overseas can be substantial and hard to estimate, and bids based on estimates made from behind a desk in Houston can devastate a company if they miss a few details.
For moving overseas, costs include $1-3 million for mobilization, as well as expenses for rig modifications, recertification, spare parts inventories, and additional equipment. More onboard equipment is generally required in international markets than in the Gulf of Mexico, where proximity to supply stores, rental services, casing crews, fishing services, mud suppliers, and other shore-based support is taken for granted.
Because low day rates do not provide tolerance for many mistakes, the drilling contractor must plan with extreme caution.
Information technology will not solve all logistical problems.
Satellite phones, facsimile machines, and data transmission have been a boon to contractors operating in remote locations. But inadequate port facilities, sluggish bureaucracies, and the occasional strike or riot still make supply chains maddeningly long.
A contractor must be on the right side of the fence.
As the know-how to operate offshore rigs spreads, indigenous contractors will appear frequently. These local contractors will have a competitive edge over outsiders, even if the quality of service is marginal.
Joining forces with them may be the only way to keep the playing field level in many markets. Obviously, such joint ventures will entail new risks.