With the onshore market seemingly recovering in a vacuum, deepwater drilling contractors continue to grapple with record low utilization rates and leading edge dayrates that now barely cover cash operating costs.
Among most offshore drilling analysts, demand concerns have long taken a backseat to the structural glut of rigs in the medium-term.
Even without a material commodity price rally, there seems to be a general acceptance that floating rig demand will eventually get sorted and climb again (albeit presumably to lower peaks than before).
The Noble Homer Ferrington was retired 4Q16 by Noble Corp. Photo credit: https://www.neweurope.eu/
Perhaps demand confidence comes from faith that E&P investment curtailment will eventually catch up to the field development project production wedge. Perhaps it’s falling offshore costs and re-engineering progress made by majors and NOCs that will drive rig counts up. Or maybe reserve depletion will spur renewed interest in drilling as replacement rates move into unsustainable territory. Looking ahead, we can all (or at least a quorum of us) agree that some combination of these factors will ultimately push floating rig demand higher again. It’s harder to gain comfort that rig supply will self-correct to intersect with future demand.
If rig demand were to begin its ascent today, it would be met with a glut of rigs that would render the impact on dayrates, and indeed contractor bottom lines, relatively impotent. If more rigs aren’t removed from supply before demand moves higher, drilling contractors are at risk of entering not only a price-less recovery, but a potentially profit-less one. A structural oversupply of rigs + contractors desperate for work is a deadly combo for rig owners. This is why offshore rig supply concerns most folks more than does rig demand.
Announced Deepwater Rig Retirements Have Disappointed
On the surface, the only way out of this supply problem seems to be contractors announcing rig retirements. So far, these announcements have been woefully short of levels needed to balance the market. And in fact, scrapping announcements have begun to slow in recent months as the obvious candidates have been mostly removed now.
I am currently tracking about 70 floating rig retirements since the downturn began and the pace of announcements has been slowing.
The lion’s share have been midwater rigs, older units at the low end of the capability spectrum.
We can count the ultra-deepwater rig retirements on both hands, and less than 10% of scrapped floaters were built since the late-1990s. The industry badly needs to scrap rigs at the higher end of the spectrum (modern deepwater rigs) in order to have a chance at finding balance in the future.
Looking just at deepwater and ultra-deepwater rigs, Transocean leads the pack having scrapped about a dozen, followed by Ensco with six and Noble with five.
Is “Stealth Scrapping” The Answer?
Instead of scrapping some rigs that may have little hope of working again, contractors are choosing to let rigs pile up in cold stack, apparently to preserve their optionality after working hard to reduce stacking costs to manageable levels throughout the downturn. Today, more than 70 floaters are cold stacked, including almost 30 drillships. Contractors have become expert rig stackers since 2014.
Cold-stacked floaters (credit instagram user @kimi1977)
While several offshore drillers acknowledged the disappointing pace of scrapping on recent calls, some, like ENSCO, are starting to talk about “silent attrition.” “Stealth scrapping” would be another good way to label it.
This is the idea that more rig retirement decisions are occurring behind closed doors now than are being publicly disclosed.
Speculation by analysts about cold rigs never returning to work is nothing new. What may be new now is that more contractors are making internal decisions that cold stacked Rig X or Rig Y won’t be returning to the field without announcing said decision to eventually put saw to hull. In some cases, contractors may be force ranking their cold stacked capacity into “likely to reactivate” and “unlikely to reactivate” buckets.
We believe some of the 6th gen floaters the industry so badly needs to scrap may be part of this decision making process. The longer these rigs sit in mothballs, the higher their reactivation cost goes, and at some point, the writing is on the wall and the rig will never work again at any foreseeable dayrate level.
Attrition is occurring silently instead of publicly now for three main reasons: i) there is little incentive for contractors to announce retirements, ii) announcing actually may incentivize their peers to scrap less, and iii) contractors need to keep the book value of the rigs in order to support debt levels. To elaborate a bit on point iii, Diamond Offshore’s CEO said this week:
What is probably holding up the scrapping of the sixth-generation DP asset class is the effect of any impairments that would come with those, with that scrapping and the resulting effect on the debt covenants that many of those companies are holding. Many of our peers simply just can’t afford to take the impairment on those rigs due to, as I mentioned, breaking their debt covenants. And as a result, they’re just sitting out there. I think, ultimately, however, if we truly take a look forward to this recovery, which will be somewhat drawn out, I think that many of those sixth-generation rigs that are cold-stacked today, that are of the early-generation, sixth-gen category will not see the light of day again simply because as each year passes, your activation cost come up too high. And therefore, they will effectively be de facto scrap… and will ultimately be scrapped.
It’s easy to guess at how many cold stacked rigs will never return. But the real question we should all be asking is: how many have already been stealth scrapped?
This story was adapted from this research update originally published by Infill Thinking on May 2, 2017
About the source of this post: Joseph Triepke created Infill Thinking in 2016 to deliver high-caliber oilfield research updates to O&G decision makers. No ads. No clutter. No noise. Just research on the trends that matter most delivered to subscriber inboxes. Use the coupon code DrillersDotCom when you sign up to get 15% off the subscription cost.
Hat tip to Infill Thinking subscriber Ron Davis for calling Diamond Offshore’s comment to our attention.
Good comments. Hard to argue with your thesis. One of the nightmare scenarios that haunts me is capitulation. I’m not sure it’s come and gone. Economic theory tells us we need this event to clear the market. A lot of folks think and hope that it came in Feb 2016. I have my doubts.
We should have had more driller bankruptcies. Most of the few that have occurred are the restructuring type where they re-enter the market with a lower cost structure. Not a likely scenario for a market turnaround.
IF this notion holds any water there is an ugly day still hanging out there where the ‘blood runs freely’ in the street. Until that day, I don’t see drillers as being investible. Meaning that their stock could go to zero.
Agreed on all fronts Dave. Excellent comment. There is a day of reckoning coming. Things will reset and get back to normal there after. Until then, the game of deadman’s poker continues – it does not benefit individuals to fold early in this game…
Joseph
Excellent analysis and rock-solid logic.
You supported your reasoning with facts and evidence that nobody can deny or refute. It is unpopular to have to admit that poor forecasts and over-zealous rig-building has put shipyards and drilling contractors into their current dire straits, but it did.
Now, everyone is trying to out-wait their competitors, hoping they will scrap their high-dollar white elephants so that they will be left keeping their own “prize” rigs intact. A high-stakes game of “chicken” is all this amounts to. By their own reluctance, they may be presiding over the demise of the offshore drilling industry.
Thanks for sharing this insight, Joseph.