Low oil prices crimp deepwater drilling

Feb. 15, 1999
Extended low oil prices are beginning to affect the one sector of the oil industry that had, until now, remained fairly robust: deepwater drilling. This is the conclusion of Duff & Phelps Credit Rating Co. (DCR), Chicago, which says that cuts in exploration and development budgets are beginning to result in the cancellation of some drilling contracts and delays for some deepwater projects. In addition, industry consolidation-particularly among major integrated oil companies and large

Extended low oil prices are beginning to affect the one sector of the oil industry that had, until now, remained fairly robust: deepwater drilling.

This is the conclusion of Duff & Phelps Credit Rating Co. (DCR), Chicago, which says that cuts in exploration and development budgets are beginning to result in the cancellation of some drilling contracts and delays for some deepwater projects.

In addition, industry consolidation-particularly among major integrated oil companies and large independents-is likely to depress demand for deepwater rigs.

"To date, the activity level associated with the deepwater drilling market has remained steady, as these projects tend to be long-term, high-yield plays that have traditionally been less sensitive to short-term market price fluctuations," said the rating firm. "However, due to the extent and duration of this current price environment, oil companies are beginning to implement strategies that may delay the development ofellipsedeepwater prospects."

Contributing factors

Since oil prices began declining late in 1997, oil companies have sought ways to reduce costs, conserve capital, improve productivity, and increase profitability. These efforts have resulted in a slowing of E&D activities, which has reduced demand for drilling services.

"Historically, the sectors first affected by pricing concerns were the land and shallow-water drilling markets, as these areas tend to be more commodity-like and have higher associated costs on a per-barrel basis," said DCR.

This trend has held true for the current low-price cycle, with day rates for shallow-water jack up rigs, for example, falling from about $75,000 at the beginning of 1998 to about $20,000 by yearend.

DCR says that the recent cancellation of some deepwater drilling contracts, although specific to the parties involved, may indicate that the effects of the current price environment are expanding (OGJ, Feb. 1, 1999, p. 30). And delays of deepwater developments could result in reduced utilization of deepwater, harsh-environment rigs.

"In addition to the anticipated reductions in exploration and development spending over the near term," said DCR, "the recent consolidation among large oil companies may also apply pressure to the operating rates for deepwater drilling vessels. Participants in this market tend to be the integrateds and/or large independent oil companies, due to the substantial capital costs and long development times associated with developing these fields. Therefore, a consolidation among the leading potential deepwater participants may (also) limit demand for these types of drilling rigs."

Cautious optimism

Despite these downward pressures, there is no need for deepwater drilling contractors to panic yet, says DCR. The firm does not, for example, anticipate widespread deepwater rig cancellations.

"The deepwater drilling sector has not experienced the speculative rig building that has been characteristic of other sectors-namely, the shallow-water jack up market," said the firm.

"Most current construction projects-either newbuilds or conversions-in the deepwater market have been undertaken only upon the signing of a drilling contract, which should help maintain a balance between supply and demand for this market."

Of course, that will only hold true if the recent spate of contract cancellations proves to be an anomaly.

"Additionally," said DCR, "the deepwater leaseholdings of oil companies are typically under defined terms and conditions, whereby the companies have a specific time in which to drill and develop their prospects. Therefore, while the oil companies may delay their exploration and development plans for the near term, they will ultimately have to drill or risk losing their ownership rights."

DCR warns, however, that the severity and length of the current low price climate will continue to affect all segments of the energy industry, including deepwater drilling.

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