Drilling asset valuations

Regardless of capacity, it is important that all parties involved understand the role of asset condition assessments as part of a thorough valuation. While projections for market rate and utilization are material elements of modeling the financial performance of an asset, relatively little attention is typically given to uptime performance projections as a component of financial performance.

We frequently hear from clients that their valuation framework will include an assumption for uptime - commonly pegged to a contractually mandated performance metric - with a single probabilistic control for variance. As players seek optimization in nearly every corner, it is important to consider the emphasis placed on condition assessment as an element of asset valuations.

To characterize the current approach to asset valuation as non-technical is reasonable given the relative lack of technical input into what is otherwise a financial exercise. The question becomes then how it can be that the technical complexities and condition of sophisticated offshore hardware become so subordinate in an evaluation of performance? Aren't the technical condition and capability of the asset material to the asset's operational and therefore financial performance?

The answer is of course yes. Why then don't technical condition and capability of an asset play a larger role in the process of modeling the future financial performance of the asset? The answer here is not quite as straightforward.

Quantification of failure rates for both individual critical and expensive components is an approach we often hear mentioned but seldom see executed in any comprehensive scale. When we look across the landscape of OEMS, contractors, and operators, we see a patchwork of approaches to capturing, curating, and leveraging this information. There is relatively little consistency when considering the context for how universal failure rate data sets would be used. It goes without saying that access to this information is severely limited as well. Some parties, sometimes, under some circumstances may share some of this data with some people or organizations; typically for very narrowly defined purposes.

While many organizations are increasing their emphasis on data, it will take time for large multi-national organizations to settle on and implement a standard approach and to build the operational histories necessary to validate the information. In the meantime, aggregation of failure data remains very much a manual, time consuming, and expensive process with limited value on a stand-alone basis to the analysis of asset reliability.

The integration of qualitative assessments into an analysis of asset reliability involves a comprehensive evaluation of uptime critical systems and components for condition, historical performance, maintenance quality, and assessment of redundancy. Third-party experts specializing in the type or class of asset at issue in the due diligence process are dispatched to the asset to conduct a physical survey and observe the condition and circumstances for each critical system and its components.

The workscopes associated with these surveys can typically be modified to accommodate particular areas of focus associated with the valuation and due diligence process. An example of where this may typically be done is in an instance where the asset itself may be of very sound technical condition and design but nevertheless have a history of uptime performance below an established benchmark for similarly situated units.

In this case, the scope of the qualitative assessment can be expanded to evaluate the personnel and operational systems and practices associated with the asset as well. Both are critical yet difficult to quantify elements of uptime reliability and optimization. While integrating a qualitative assessment into a financial performance model does present some fundamental methodological challenges (see 'haircuts'), the reliance on and acceptance of qualitative factors as an element of risk assessment is routinely managed in many corners of the financial world.

As the industry sees the maturity of data as a tool for performance assessment, it will become increasingly effective as a means for refining reliability forecasts thus improving the overall accuracy of valuation projections. It will allow for the comprehensive statistical analysis of failure and replacement data to assess and optimize everything from downtime to preventative maintenance and spare part management ultimately allowing for total investment optimization.

For the time being however, technical, commercial, legal, and cultural complications render quantitative failure data an approach with limited ability to increase the fidelity of the valuation process. And while qualitative assessments can reliably provide a comprehensive, custom approach to asset performance assessment, they carry with them the challenge of interpretation and inclusion into quantitative models.

It quickly becomes easy to understand how the underlying components of a comprehensive reliability assessment may be set aside during the valuation process. Clearly variables such as depreciated replacement cost and expected life of the asset would also impact to what extent underlying asset condition is further assessed.

These issues notwithstanding, the risks associated with failing to sufficiently consider the technical condition of critical systems can add up - and quickly. Even at current spread rates, a single foreseeable issue with an operation critical system can result in material losses to both the operators and drilling contractor. Taking a comprehensive approach to condition assessment that calls on physical inspection of the asset in tandem with assessment of the personnel operating the asset and the processes that steer those operations provides the clearest possible view of the likely uptime efficiency of the asset.

While data sets associated with the current quantitative modeling of failure rates often have incomplete or inconsistent histories and definitions, the experts involved in physical condition assessment of offshore drilling assets typically have significant experience on the hardware they are assessing and frequently includes contributions to either the design of the components themselves, or participation in the construction and commissioning of the asset. The importance of this last point cannot be overstated as it is during the initial build-out that many offshore units first begin to present unique technical challenges that may require experts familiar with the original issue later on in the asset's operational life.

ABOUT THE AUTHOR

Clinton Abbate ([email protected]) is a senior analyst with Lloyd's Register's Drilling Group. His main responsibilities include strategic initiatives and commercial economics. He is based in Houston.