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  • Roger S. Conrad

Offshore Contract Drillers: Lessons from the Tanker Industry

By Elliott H. Gue on Sep. 12, 2014

However, readers should remember that the tanker market easily absorbed newly built vessels between 2002 and 2008, keeping charter rates at historically elevated levels. The tanker industry’s problems started when an influx of new ships arrived at a time when demand slackened temporarily.

A similar scenario has started to unfold in the market for deepwater drilling rigs.

This year, major oil and gas producers—BP (NYSE: BP), Petrobras (NYSE: PBR), ExxonMobil Corp (NYSE: XOM) and Royal Dutch Shell (NYSE: RDS A, RDS B)—reduced their spending on exploratory activity in deepwater regions.

These cutbacks stemmed from investors’ disappointment that the major integrated oil companies’ massive capital expenditures hadn’t translated into meaningful distribution growth. (We discussed this trend at length in the Feb. 13, 2014, issue of Energy & Income AdvisorKnowing the Drill.)

The cost of finding and developing new deepwater reserves has climbed considerably, thanks to the soaring cost of engaging the drilling rigs that handle these projects.

Paal Kibsgaard, CEO of Schlumberger (NYSE: SLB), addressed this challenge during the oil-field services giant’s first-quarter earnings call:

Analyst: Thanks. Good Morning. Paal, so at a recent industry gathering, you offered some interesting commentary about industry challenges and you reference the fact that E&P CAPEX [exploration and production capital spending] over the past 10 years had grown by 400 percent whereas oil production was up by only 15 percent. And you mentioned the fact that in the E&P value chain, the oil companies were the ultimate integrators of all the technical work associated with finding hydrocarbons and the collective oil services community was accountable for not delivering on required performance progress.

And you also mentioned that the required improvement was not going to come from yet another round of procurement-driven price reductions across the E&P value chain. So, along those lines, as the industry is in an introspective mood where the IOCs [integrated oil companies] and NOCs [national oil companies] in terms of getting their deepwater costs in alignment, apart from the infrastructure shift from infrastructure to well CAPEX, what structural reforms are your clients contemplating, implementing and the discussions you’re having with your clients along those lines?

Paal Kibsgaard: Well, I think if you’re looking at the short-term actions they’re taking today, they’re looking at bringing the deepwater rig rates down. I mean, if you look at what’s happened on deepwater day rates over the past three years, four years, five years, they have increased significantly, and they have been completely disconnected from the other deepwater oilfield services, right?

So today, the rig rental makes up around 50 percent of the deepwater well costs. So our customers have really been looking for the opportunity to get the rig rental rates down. And the opportunity is here in the form of the high number of new arrivals, old expiring contract expiring, and a significant activity reduction in Brazil. So, I think this is the opportunity in the short-term they’re trying to get some relief on cost.

Now, my comments in terms of a procurement-driven exercise across the industry is more focused in on we need to basically drive up the technical performance as an industry, whether that is process efficiency or reliability of the projects that we execute.

So, what some of our customers are doing is they are approaching us a lot more than in the past in terms of doing fully integrated projects, where we are a lot more engaged in the upfront planning and design of the work and where we have more performance-based contracts in terms of how we execute the work as well.

So, these are some of the short-term actions that they’re taking. And I think beyond that, I think the service industry needs to take responsibility in terms of finding ways of transforming themselves to drive both their internal efficiencies and their technical performance versus the customers. That is how we can create more value and support our customers.

According to Kibsgaard, the expenses associated with engaging a suitable rig now account for more than half the cost of sinking a deepwater well.

By tapping the breaks on their finding and development programs, major producers can take advantage of the influx of newly built deepwater vessels to push for some relief on day-rates.

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    • Elliott H. Gue

      Founder and Chief Analyst: Capitalist Times and Energy & Income Advisor

    • Roger S. Conrad

      Founder and Chief Analyst: Capitalist Times and Energy & Income Advisor