AN INTERVIEW WITH JON COLE AND MARK MEY: Industry veterans putting ideas to work at Scorpion Offshore

April 1, 2007
EDITOR’S NOTE: Scorpion Offshore Ltd. is an offshore drilling contractor currently constructing 5 ultra-premium, deepwater jackups at the Keppel AmFELS shipyard in Brownsville, Texas.

EDITOR’S NOTE: Scorpion Offshore Ltd. is an offshore drilling contractor currently constructing 5 ultra-premium, deepwater jackups at the Keppel AmFELS shipyard in Brownsville, Texas. The first Scorpion rig is due to be delivered from the shipyard in May 2007. Successive units are scheduled to be delivered, on average, every 4-1/2 months after delivery of the previous rig. Therefore, Scorpion rigs will take delivery of 2 rigs in 2007 with 3 additional units being delivered in 2008. Scorpion is incorporated in Bermuda, headquartered in Houston, and publicly traded on the Oslo Stock Exchange under the ticker symbol SCORE. OGFJ spoke recently with the company’s president and CEO, Jon Cole; and senior vice president and CFO, Mark Mey.

OIL & GAS FINANCIAL JOURNAL: It’s rare to see an offshore drilling company start up these days, mainly because constructing new offshore rigs is a capital-intensive venture. How and why did Scorpion get started?

Mark Mey (left) is senior vice president and CFO of Scorpion Offshore. Jon Cole is the company’s president and CEO.
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SCORPION OFFSHORE: Scorpion was created to address an unmet need in the offshore drilling business - modern high capability jackups. Operators today are drilling deeper wells in deeper water in more remote locations. Rigs built during the early 1980s boom and before are simply not up to the task of efficiently drilling many of today’s more demanding wells.

Since the extraordinary supply expansion in the late ‘70s and early ‘80s, the global jackup fleet has steadily declined. Minimal new construction failed to offset attrition, retirements, and conversion to other uses. By the late 1990s the industry’s active jackup fleet had declined by about 25%. Today the average age of the jackup rig fleet exceeds 25 years, and even after the inclusion of the 78 jack-ups being delivered in 2005 to 2009, the fleet will still have an average age in excess of 25 years.

Relative to the current global jackup fleet, the 78 aforementioned newly-built jackups represent an increase of roughly 19%. Of this increase in supply, Scorpion is responsible for about 6% of this global jackup supply growth.

The concept of creating a new drilling company was conceived by offshore rig brokers and industry veterans Jonathan Fairbanks and Erland Bassoe, both principals in Bassoe Offshore AS. In April 2005, Bassoe secured 2 options for “kits,” which included the license to build the rig along with leg material, cranes, jack houses, and other equipment from LeTourneau.

With these options, Bassoe then approached Keppel AmFELS, which at the time did not have new construction underway. After negotiating fixed-price shipyard construction contracts with Keppel AmFELS, Bassoe raised the initial seed equity capital to fund the down payments. Thereafter, they established a management team who then raised an additional $170 million in equity and $445 million in debt financing in late 2005. These efforts culminated in the company’s stock being listed on the Oslo Stock Exchange in December 2005.

OGFJ: Can you provide some background on senior management and why they chose to join Scorpion at this time?

SCORPION:We are all veterans of the offshore drilling business and average 26 years in the offshore drilling sector and have worked for most of the major US drilling companies during our careers. Therefore, we have an abundance of ideas as to how to build an offshore drilling company. Scorpion provides an ideal opportunity to put those ideas into practice. The result can be seen in our innovative approach toward safety management, personnel recruitment, development and retention, client-management, as well as our approach to procurement and inventory management.

Furthermore, several members of our operations and engineering management team were involved with a previous start-up that built 4 new jackups and purchased a fifth unit in the late 1990s. This is an opportune time to fill a void in the industry and create a drilling company built to last through the cycles.

OGFJ: Can you elaborate on Scorpion’s funding sources?

SCORPION:The initial seed capital (approximately 1% of current equity market capitalization) was raised from friends and family of Scorpion’s founders. The next 2 rounds, representing an additional $23 million, were predominantly raised from 4 hedge funds, 2 in the US and 2 in London. Thereafter, in August 2005, as part of Scorpion’s IPO on the Oslo Stock Exchange’s OTC, we raised $111 million. Subsequently, we raised an additional $445 million in debt financing, including a $50 million revolving credit facility, and $120 million in additional equity. We are now fully funded for the first 4 rigs and have raised the necessary equity for the fifth rig. We anticipate completing the debt financing for the fifth rig by mid-April.

Although we trade on the Oslo Stock Exchange, 62% of our shareholders are non-Norwegian, with the majority being based in either London or the US. In addition, our commercial bankers are all European.

OGFJ: Can you tell us more about the jackup rigs and where they are being built?

SCORPION:We are currently building 5 ultra-premium LeTourneau Super 116 jackups at the Keppel AmFELS shipyard in Brownsville, Texas. Keppel FELS, AmFELS’ parent company, is the world’s largest builder of offshore drilling rigs. Keppel FELS purchased the AmFELS shipyard in 1990. Since opening in 1972, the AmFELS yard has completed over 40 major construction and/or conversion projects including delivery of 33 new jackups. At present, there are 7 rigs being constructed in the shipyard - 6 LeTourneau Super 116 units and 1 KFELS Mod V B Class jackup. Scorpion’s first rig, the Offshore Courageous will be the next LeTourneau Super 116 to be delivered by AmFELS in this building cycle.

The Offshore Courageous is the first of 5 ultra-premium LeTourneau Super 116 Jackups being constructed at the Keppel AmFELS shipyard in Brownsville, Texas.
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OGFJ: Tell me a little about the design and specifications for the rigs. What will be the advantages of your new rigs over similar jackups operating today?

SCORPION:We are really competing with two distinct classes of jackups: rigs built since 1990, and the units built during or before the early 1980s. The vast majority of jackups currently under construction have similar equipment and capabilities. We chose the LeTourneau Super 116 over competing designs due to its ease of construction; ease of operation, and its more reliable and rugged legs and jacking system. The LeTourneau 116 has been tested through operations in most of the offshore E&P provinces worldwide, and there have been more LeTourneau 116 design jackups built than any other deepwater jackup.

We believe that the choice and layout of equipment on our rigs will make them more efficient than both new and old jackups. Scorpion’s rigs will incorporate numerous productivity-enhancing features using state-of-the art equipment that will make their capabilities superior to those of most existing jackup drilling rigs. Examples of these improvements include:

  • Larger and more powerful mud pumps, which will deliver improved hydraulic horsepower (up to twice the horsepower of the typical premium jackup rig - 6,600 hp vs. 3,200 hp);
  • A higher-strength cantilever, which will permit the drilling package to extend up to 70 feet beyond the hull versus the 40 feet for typical cantilevered jackups;
  • A casing running tool;
  • An optimized rig-floor design and carefully selected equipment, which will facilitate “off-line” stand building activities and enhanced safety and operational performance and reliability; and
  • A dual-mud system, which will simultaneously accommodate drilling mud and completion fluids.

Our rigs are capable of operating in essentially all worldwide markets except for “harsh environment” drilling areas such as the central North Sea, Norway, and Eastern Canada.

In sum, we believe the proven LeTourneau Super 116 design along with Scorpion’s improvements and the accompanying enhanced equipment package selected by Scorpion and provided by National Oilwell Varco and LEWCO will provide Scorpion and its clients with an excellent platform for completing high-pressure wells and horizontal and extended-reach drilling projects.

Scorpion expects that our choice of rig design and equipment will deliver exceptional safety and drilling performance to our clients - especially when compared to the majority of the world’s existing jackups and many of the new jackups currently under construction.

OGFJ: You say the rigs are “state of the art” with a number of drilling productivity enhancements, but you still consider them a cost-effective solution for your customers. Can you explain?

SCORPION: Given the operating experience of our management team, our approach to new technology is consistent with our operating philosophy - deliver safe, cost effective drilling performance. We have, therefore, not installed some new equipment or technology simply because it is available, but rather we selected equipment only if it promotes safe and efficient drilling operations.

As mentioned earlier, many of the members of our management team have been involved in previous drilling companies that built new drilling rigs. It has been our collective experience that some new technology does not necessarily increase productivity and does not always enhance safety performance.

While equipment such as pedestal-mounted iron roughnecks, rotating mouse-holes, and AC-driven top drives greatly enhance operational performance, other recent innovations such as vertical pipe rackers have not been shown to improve either operating performance or safety. It is with this perspective that we have carefully selected the new equipment to be installed onboard our rigs. With regard to new equipment, we made it a rule that equipment that had not been field tested previously would not have a place on our new rigs. This is why we believe our rigs will operate more efficiently and more safely than some of the other new jackups currently under construction, and that over the long-run, our rigs will be preferred by clients and employees.

OGFJ: The first jackup - Offshore Courageous - launched in November 2006. What is the fleet status of each of Scorpion’s rigs at this time?

SCORPION: As of March 21, 2007, all 5 rigs are on schedule and expected to be delivered on their respective contract delivery dates. The schedule for delivery from the shipyard of all Scorpion jackups is as follows:

  • May 2007 - Offshore Courageous;
  • October 2007 - Offshore Defender;
  • March 2008 - Offshore Resolute;
  • June 2008 - Offshore Vigilant; and
  • November 2008 - Offshore Intrepid.

We expect to have contracts in place for all of these rigs prior to delivery by the shipyard.

OGFJ: Where will the rigs operate - in the Gulf of Mexico?

SCORPION: We are currently marketing our rigs internationally. However, if the quality of the contracts available in the US GoM improves in the future, we will consider deploying one or more of our assets in this market.

The exodus of jackups from the Gulf of Mexico over the last 2 years has been widely reported. As you are well aware, not all jackups are created equal. The rigs that have mobilized out of the Gulf of Mexico are primarily independent leg cantilevered jackups - most of which are capable of drilling in water depths of greater than 300 feet. Therefore, when the Gulf of Mexico jackup market strengthens in the future, we expect that there will be a shortage of premium and ultra-premium rigs able to drill deeper wells - both in terms of water depth and well depth. Although we will initially work internationally, we will reconsider the US Gulf of Mexico in the longer term.

OGFJ: Are these new jackups less vulnerable to hurricane damage than other types of rigs? Please explain.

SCORPION: Outside of the drilling industry, there appear to be misconceptions regarding the cause of recent losses due to hurricanes. To our knowledge, almost all rig losses were due to either insufficient vertical clearance between the water and the drilling rig, or inadequate pre-load to meet a storm’s environmental loads. The latter factor refers to the depth that legs are driven into the ocean bottom prior to commencing drilling operations.

In order to address the problem, the drilling contractor needs to increase the vertical separation between the water and the bottom of the hull, otherwise known as air-gap and to ensure adequate pre-load to meet the 50- or 100-year return hurricane. Longer legs will allow Scorpion to increase pre-load, resulting in legs being driven deeper into the ocean bottom, and to increase the air-gap, thereby decreasing the odds of waves striking the drilling rig. The impact of greater air-gap and pre-load requirements is a reduced water depth rating. So in this sense, as a result of being new and having experienced no fatigue wear, and having longer leg lengths (477’ to 544’ depending on outfitting), the Scorpion rigs should be better suited to survive hurricanes than the older class of jackups.

OGFJ: As a relatively new company (founded in 2005) in an industry where there is supposedly a shortage of workers, how do you go about recruiting qualified employees at all levels - senior management, professional staff, and rig crews? That is, what do you offer to make your company attractive to prospective employees and how do you keep other companies from hiring them away?

SCORPION: We have been fortunate in the area of attracting skilled, qualified, and motivated candidates for employment both in the office and onboard the rigs. For example, we’ve had rig engineers on staff since summer 2006. We have gradually increased the number of people assigned to the rig according to our schedule. Currently, we have all senior, supervisory and technical positions filled for our first rig. We are actively filling positions for our second rig. In addition, we have recently commenced hiring for the third rig. The balance of the workforce required for the first rig will be hired locally.

For all of these positions, prospective employees contacted Scorpion in search of opportunities. Believe it or not, we recently had almost 3,000 inquiries in response to postings for mechanic and an electrician positions with our company.

We have found that our “hands-on” management style has appeal to many prospective employees - especially those who chose to leave large, established drilling companies for Scorpion. In addition, it has been our experience that people like to work with others they have worked with before. These relationships are often stronger than most other attempts to “bind” employees to the company. Travis Fitts, our VP HR and HS&E coined the phrase “it’s all about the people - always has been, always will be.” Everyone at our company believes this. It’s part of our corporate DNA.

OGFJ: Since your first rig isn’t scheduled for delivery until May, I would assume your balance sheet shows a lot of debt and no income. Is this correct?

SCORPION: As previously discussed, we have capitalized Scorpion with a combination of debt and equity. Once all of our rigs are delivered, our capital structure will be two-thirds debt, one-third equity. Given our expected dayrates, we anticipate reaching our targeted debt level of 30% of book capitalization by late 2009.

OGFJ: The worldwide market for jackup rigs is strong. What is your contracting strategy?

SCORPION: Given our capital structure, we are targeting multi-year contracts for our first rigs. Thereafter, with our later rig deliveries, we are able to accept shorter term contracts, taking advantage of spot market opportunities. Ideally, we will be able to place multiple rigs in a single geographical location, thereby optimizing regional economies of scale. Finally, once we have reached our targeted capital structure, we will endeavor to maintain a balanced portfolio approach to contracts, i.e. a blend of short, medium and long-term contracts.

OGFJ: Although senior management is based in Houston, Scorpion is registered in Bermuda. What advantages did you see in registering outside the US? Was Sarbanes-Oxley compliance a factor?

SCORPION: Scorpion is incorporated in Bermuda, managed out of Houston, and listed on the Oslo Stock Exchange. Bermuda allows us to optimize our tax structure given the geographical diversity of our business; Houston is where the majority of the global oil companies are headquartered, and Oslo is an efficient location to raise capital. The offshore drilling business is truly global, and we are structured to meet the challenges of a global industry.

Compliance with Sarbanes-Oxley was not a deciding factor; however, with all else being equal, we would not have listed in the US. The effort and cost of attaining and maintaining compliance with Sarbanes-Oxley for a small company is prohibitive. This factor, coupled with the better stock price valuations being achieved in Oslo, would have resulted in a US listing being a value-destroying proposition for our shareholders. Fortunately, the US Congress has recognized this issue and appears to be taking steps to address this competitive disadvantage for the US capital markets.

OGFJ: Why did you choose to list the company on the Oslo exchange? Any plans to list elsewhere?

SCORPION: Norway has a rich history of shipping and a capital market with a deep knowledge of investing in assets. This translates into a higher level of comfort with fluctuating asset values and hence a greater propensity to invest in such markets. Our immediate predecessors on the Oslo Stock Exchange, Sinvest ASA and Awilco ASA, created an expanded investor base as their bankers exposed their London and New York clients to these “hot” new drilling stocks. For example, of the 33 meetings Scorpion held during its initial road show, 30 of the investors were well versed in the offshore drilling sector and understood oil and gas market dynamics.

Over time, as stock market regulation and valuations evolve, Scorpion will consider listing on other stock exchanges with a goal of optimizing liquidity, costs, and valuations.

OGFJ: Scorpion has presented at a number of conferences, including the Howard Weil Energy Conference in New Orleans. What benefits do you get from participating in these events?

SCORPION: The competition for capital is global. Although we are traded on the Oslo Stock Exchange, approximately 30% of our shareholders reside in the US. It is, therefore, important for Scorpion to provide existing shareholders with as much company specific information as possible while also attracting new shareholders. It is also a good forum to dispel misinformation and promote Scorpion as an alternative to investing in the traditional US drillers.

OGFJ: What are the company’s primary goals for the next few years?

SCORPION: We are all very focused on delivering our first 5 rigs on time and on budget; operating them safely and efficiently; building a reputation as the drilling contractor of choice and generating a steady cashflow stream. This will allow us to recapitalize our balance sheet thereby reducing our cost of capital. Simultaneously, we will continue to pursue our growth initiatives, both organically and through consolidation.

OGFJ: Is there anything else you would like to say about the company that we haven’t covered?

SCORPION: Yes, we would like to thank OGFJ for proving this opportunity to address your readers. We are very proud of Scorpion’s efforts to date and look forward to many years of successful operations.

At Scorpion, we are committed to doing things right - whether it be in terms of safety, operational or financial performance or personnel development. In striving to achieve these goals, we are committed to living according to our core values, which are:

  • Relentless pursuit of performance excellence;
  • People are the foundation of our company;
  • Teamwork and personal accountability; and
  • Honor our commitments.

As values, they are not subject to future modification or suspension for any reason.

Thank you for taking the time to talk with us.