MORE MODU ATTRITION KEY TO BETTER RIGS AND CONTRACTOR PROFITS

Gary L. Kott Global Marine Drilling Co. Houston For the offshore drilling industry to remain profitable, the attrition rate of aging mobile offshore drilling units (MODUS) needs to increase. These aging rigs should be removed and possibly replaced with new or upgraded rigs so contractors can deliver more reliable equipment and service to the operators. Unfortunately, only moderate attrition of the worldwide fleet appears likely.

Sept. 13, 1993

8 min read

Gary L. Kott
Global Marine Drilling Co.
Houston

For the offshore drilling industry to remain profitable, the attrition rate of aging mobile offshore drilling units (MODUS) needs to increase. These aging rigs should be removed and possibly replaced with new or upgraded rigs so contractors can deliver more reliable equipment and service to the operators. Unfortunately, only moderate attrition of the worldwide fleet appears likely.

If the drilling industry waits solely on the slow increase in demand to increase day rates, a possible shortfall in quality equipment could occur in the late 1990s. Despite the limited working life remaining in the existing aging fleet, few contractors have plans to build new rigs because virtually no capital is available for investment in construction. Most contractors have been limited to upgrading rigs to increase profits slightly through improved efficiency.

An increase in rig day rates is necessary to increase cash flow to levels that can support new rig construction. The long-term challenge for the contract drilling industry is to develop enough cash flow to allow for rig fleet replacement during the late 1990s and early 2000s.

A supply and demand balance in the offshore rig market will allow drilling contractors to invest in the better iron, training, communications systems, safety equipment, zero-discharge equipment, computer inventory systems, preventive maintenance programs, drilling information systems, and rig efficiency programs the operator must have to remain competitive.

To realize the profit potential of a healthy offshore drilling market, drilling contractors must avoid the temptation to dump barely able rigs on an already overcrowded market just to turn a quick profit. These older rigs may not have the experienced crews, safety and environmental protection, and efficiency upgrades operators need.

RIG ATTRITION

The 11 largest offshore drilling contractors worldwide have a total of 106 rigs built prior to 1980; another 126 pre-1980 vintage offshore rigs are owned by the various other offshore contractors. The year 1980 is used for comparison because that was the last time supply and demand were in balance, and the drilling market was healthy.

The drilling contractor with the largest number of rigs today has 37, 26 of which were built before 1980. Global Marine g Co. has 23 rigs in its fleet, but only 1 of the rigs was built prior to 1980. Global Marine has removed 17 rigs during the past 16 years. The attrition strategy is difficult, but the end result is a fleet of modem, safe, efficient rigs. The other large contractors have fleets with between 31% and 58% of pre-1980 vintage rigs.

Many of the old rigs are being replaced or removed from the fleet because of age, but the attrition is not fast enough to balance supply and demand immediately. Based on a 20-year rig life expectancy, the average life remaining in the fleets of the major drilling contractors ranges from a low of 4.4 years to a high of just over 9 years. Of the major drilling contractors, most fleets have an average of 5.5-8 years of service life remaining.

Given the short life expectancy of available rigs, the drilling contractors with the fewest rigs, especially if the rigs are older, will feel the effects of rig attrition the most. As the market becomes more reasonably balanced, the higher class (newer) of iron will be utilized first; the lesser quality, or older, rigs will be stacked.

Which drilling contractors will be most affected by a return to a balanced market? A review of the major gas contractors' total rig years in inventory is necessary to estimate the working life remaining. Only three of the leading drilling contractors have more than 200 rig years in inventory. The other major contractors have between 46 and 161 rig years remaining in their fleets.

MODU SUPPLY

How do these numbers relate to the supply and demand outlook? Overall, 582 mobile offshore drilling units (MODUS) are currently available for hire, but only 474 are 'Ln demand (Fig. 1). At the end of July, the remaining 108 rigs were idle with little long-term prospect of finding work. This situation is an improvement of the utilization rate 8 years ago when only 339 of the 694 available rigs were in demand, creating a surplus of 355 MODUs.

Only 72% of second generation semisubmersibles and drillships are utilized currently, whereas 87% of the third and fourth-generation semisubmersibles are working (Fig. 2). The premium, large cantilever jack ups are working at a 90% utilization rate today, but the slot and smaller jack ups are working at only a 79% utilization rate (Fig. 3).

In the late 1970s and early 1980s, the market was balanced and profitable, leading to a rig-building frenzy. In the industry downturn that followed, these rigs contributed to a tremendous oversupply, of MODUS. In 1980, optimistic drilling contractors had 239 new rigs on order. When these rigs entered the market and oil and gas prices slumped in the mid 1980s, day rates plummeted.

DAY PATES

In 1986, heavy weather cantilever jack ups in the North Sea, which cost nearly $100 million to build, commanded their lowest day rates ever, earning only $13,000/day (Fig. 4). These day rates were too low for many rigs to operate and did not provide income for upgrades and replacement costs. The economics were grim for the drilling contractors that had earned $65,000/day for the same equipment several years earlier. Not until 1990 did the North Sea day rates hit $65,000 again. But by early 1993, the day rates in the North Sea were back down to $30,000, hardly enough to justify new construction.

Recovery from the 1986 rig glut has been slow in West Africa as well (Fig. 5). In West Africa in 1981, typical 300-ft cantilever jack ups received $52,000/day. Prices bottomed out in 1986, with drilling contractors earning about $14,000/day for premium equipment. Today, rigs earn about $22,000/day, roughly 40% of the 1981 day rate.

The day rate drop is similar in the U.S. Gulf of Mexico (Fig. 6). Day rates for 300-ft cantilever jack ups fell from $48,000 in 1982 to only $9,000 in 1986. The rates have slowly climbed up to $24,000/day in 1991. In 1991, however, many operators headed for international waters. The Gulf of Mexico rates plunged back to $10,000/day.

Higher natural gas prices in the Gulf of Mexico have increased activity there, beckoning drilling contractors back to the U.S. where increasing demand and lower operating costs have made the region appealing again. Unfortunately, the short-term opportunity in the Gulf of Mexico is equally appealing for contractors that ignore historical trends and add old iron to an oversupplied market.

Supply virtually equalled demand through the early 1980s in the Gulf of Mexico (Fig. 7). By 1985, however, the gap between supply and demand in the Gulf of Mexico had widened to almost 200 idle rigs. In 1993, the supply and demand curves have become closer than any other time in the past decade. Virtually every capable rig is busy, albeit on shorter-term jobs.

Fig. 8 shows the rig supply and demand curves for the offshore regions excluding the Gulf of Mexico.

CONSOLIDATION

Despite recent poor economics for many contractors, the offshore drilling industry has undergone little consolidation of contractors. About 100 drilling contractors operate about 600 rigs worldwide, and the offshore drilling contractor with the largest share of market owns only 6% of the rigs available.

Although supply and demand are approaching a balance again, there is still too much fragmentation in the drilling business. Consolidation has not occurred for numerous reasons: Financial structures of the leading players vary widely, owner objectives are different, tax considerations make some mergers undesirable, and, of course, many drilling contractors have conflicting egos.

Instead of consolidation, offshore drilling contractors have opted to build alliances to produce strategic market shares. For example, Global Marine Drilling Co. and Transocean Drilling AS created a joint venture to take advantage of the marketing and operating strengths each company possessed in two important regions, the U.S. Gulf of Mexico and Norway. Two other leading drilling contractors swapped North Sea and Southeast Asia rigs as a strategic marketing alliance to position each company in those regions.

As supply and demand continue to come into balance, the market will become increasingly stratified by type of rig and geographic areas of experience. For example, several contractors have specialized in high quality 250300 ft cantilever jack ups, heavy weather jack ups, moderate weather semisubmersibles, or fourth-generation semisubmersibles.

Because fleet expansion is not imminent, contractors must develop innovative methods to serve the operator while returning to profitability. Incentive contracts have become more widespread and work well for both operator and drilling contractor when they share the benefits of improved drilling efficiency.

Other means of increasing profitability have been integrated drilling services and turnkey drilling. Several contractors have had success with turnkey offshore drilling in the Gulf of Mexico, and some contractors are now likely to pursue limited turnkey offshore drilling in some regions outside the Gulf of Mexico.

These revenue-producing strategies will help offshore drilling contractors return to profitability, but the economic conditions may be fragile. Variations in market conditions-a likelihood in the volatile drilling industry may not be weathered well by some contractors whose market strategies are too concentrated in one niche. Contractors that diversify as a safeguard may find themselves spread too thin to achieve any significant profit at all.