In the wake of the 2010 Macondo oil spill in the U.S. Gulf of Mexico, the market for deepwater rigs has bifurcated. Producers increasingly favor high-specification units that feature advanced equipment and are capable of drilling deep, complex wells. These newer models are outfitted with advanced blowout preventers (BOP), a key piece of equipment that’s designed to prevent spills when an operator loses control of a well.
The Deepwater Horizon’s BOP failed to perform that function, resulting in a major oil spill in the Gulf of Mexico. Many speculate that the BOP wasn’t strong enough to overcome the well pressure in that field.
In addition, younger rigs tend to experience less downtime — an issue that’s plagued the world’s largest offshore contract driller, Transocean (RIG). The company has incurred the expense and lost operating hours involved with upgrading its rigs to meet stricter safety standards. Rigs also must be re-certified before they’re allowed to work in the Gulf of Mexico and other markets, leading to further downtime. Producers often pay a discounted day-rate when a rig’s idle time exceeds a predetermined threshold. In other cases, the operator can cancel a signed contract if the rig is unavailable for excessive periods.
For example, Transocean’s 13-year old Deepwater Expedition ultra-deepwater drillship had its contract canceled in January 2012 because of the rig’s prolonged downtime. As a result, the firm lost out on a day rate of $630,000. With many of its rigs facing expensive upgrades, Transocean decided to suspend its dividend for the next year.
Ensco’s average ultra-deepwater rig is only two years old and its average deepwater unit is seven years old. By comparison, Transocean’s average ultra-deepwater vessels are seven years old, while its deepwater rigs sport a mean age of 15 years.
Ensco’s efforts to standardize its fleet also bode well for the company’s success. Several manufacturers produce deepwater and ultra-deepwater rigs, so the parts aren’t necessarily interchangeable between models. In addition, each manufacturer has different maintenance schedules for its rigs. By standardizing the types of rigs it owns, Ensco ensures that its employees can operate more efficiently. Downtime for maintenace is also easier to schedule.
When an ultra-deepwater rigs earns upward of $600,000 daily, a few days of additional downtime across a sizeable fleet can impact the bottom line significantly.
In Ensco’s case, the company has built a fleet focused on Ensco-8500 series of ultra-deepwater semisubmersibles and dynamically-positioned drillships built by Samsung Heavy Industries (Seoul: 010140, OTC: SMSHF).
Currently, the firm has five operating ENSCO-8500 rigs and a newly built unit that’s slated for delivery in the fourth quarter of 2012. Ensco recently confirmed that Anadarko Petroleum (APC) has secured this new rig under a 2.5 year contract for a daily rate of $530,000. This is the the third ENSCO-8500 rig that Anadarko Petroleum has booked, a sign of a satisfied customer.
Ensco owns six operating Samsung drillships and has an additional unit slated for delivery in the second half of 2013 that hasn’t been placed under contract.
Meanwhile, the most recent rig to arrive from the South Korean shipyard appears to be on track for a contract with an unnamed producer. Although Ensco hasn’t disclosed the terms of the deal, the operator will make some project-specific modifications that will keep the rig at the yard until the fourth quarter of 2012. Once released, the rig would work under a five-year contract worth more than $1 billion, implying a day-rate of almost $550,000.
Some investors might quibble that this rate is lower than recently announced fixtures that exceed $600,000 per day. However, shorter-term contracts have produced the highest day-rates. That this five-year contract involves only a slight discount to prevailing rates on two-year fixtures is impressive.
As I explained in previous article, the deepwater and ultra-deepwater markets are the strongest segments for contract drillers. Demand for these rigs will only increase.
Brazil plans to develop aggressively a number of massive deepwater oil and natural gas fields discovered in recent years. In 2012 Petrobras (PBR) aims to sink 65 exploratory wells in the deepwater, up from 47 in 2011.
Meanwhile, activity in the U.S. Gulf of Mexico continues to recover gradually from the Macondo oil spill and moratorium on deepwater drilling. Ensco’s recent experience in the region bodes well. Two of the firm’s 8500 series semisubmersibles will operate in the region and generate solid day-rates under recently signed contracts. That Anadarko Petroleum and other producers have committed to these deals suggests confidence in their inventories of drilling prospects.
Finally, Cobalt Energy (CIE) and a number of producers have announced a series of pre-salt discoveries in the deepwater offshore Angola in West Africa. The geology of these fields resembles Tupi and Brazil’s other giant fields, leading to speculation that the Angolan play could equal or surpass these plays. Producers with stakes in the region have made inquiries about booking deepwater rigs that will be available between late 2012 and mid-2013.
As deepwater drilling activity heats up, the incremental demand for rigs is pushing up day-rates on the few deepwater and ultra-deepwater rigs that are available for contracting in the near term. Contract drillers with significant available capacity over the next couple of years could secure fixtures that approach $700,000 per day.
A number of Ensco’s rigs will be available within the next two years. In addition to the newly built drillship that Samsung Heavy Industries will deliver in the second half of 2013, the Ensco-8502 semisubmersible’s contract in the Gulf of Mexico will expire in June 2013 and the Ensco-8500’s fixture will expire in August 2013. The day-rates earned by these rigs are well below prevailing rates, offering Ensco plenty of pricing upside.
In a conference call to discuss fourth-quarter earnings, Ensco’s management echoed the bullish outlooks of Pacific Drilling (PACD) and SeaDrill (SDRL), both of which have significant capacity available for contracting in the coming years.
The management team emphasized that all Ensco’s operating rigs are certified to work in the markets where they’re scheduled to operate, limiting downtime for upgrades and inspection. Nevertheless, some of the company’s newly built rigs have spent additional time at the shipyard to replace faulty or substandard equipment. Management also expressed confidence in the firm’s ability to limit these delays in the future.
Ensco also owns a fleet of older mid-water rigs, floating rigs that are capable of drilling in water less than 2,000 feet deep, and jack-up rigs capable of operating in depths of 400 feet to 500 feet. The mid-water market remains under pressure because of a lack of exploration and development opportunities at that depth.
Nevertheless, some encouraging trends have emerged in this segment. Mexico’s national oil company, PEMEX, has expressed interest in contracting additional mid-water rigs. At any rate, four of the Ensco’s six mid-water floaters operate under fixtures that won’t expire until 2013, so the company has limited near-term exposure to weak demand.
Day-rates for jack-up rigs haven’t strengthened to the same extent as in the deepwater market, but pricing trends have improved. Ensco has received inquiries for its premium jack-up rigs for North Sea work in 2013 and 2014–a sign that producers are planning a longer-term shallow-water drilling program. Ensco’s emphasis on high-specification jack-up rigs should provide more exposure to any upside.
Ensco currently pay a quarterly dividend of $0.375 per share, equivalent to a yield of about 2.7 percent. Given the company’s strong contract coverage and exposure to rising day-rates, the firm could have the scope to hike its dividend. However, the stock’s primary upside catalyst remains potential fixtures for the company’s rigs that are available in 2012-13