Companies in the offshore Drilling industry generate income by providing contract drilling services to E&P companies primarily to drill wells for exploration, development and production of hydrocarbons offshore (in the sea).
This is a cyclical industry, as it benefited from the interest of Oil & Gas companies in increasing its production. It usually happens when commodity prices are high which relies on the economic cycle (primarily).
Producing oil onshore is generally cheaper than producing it offshore. However, as Tier-1 onshore fields are depleting in several areas in the world, the offshore industry is gaining attraction. Huge discoveries in the last years plus the improvement of technology are making the business cases more appealing
Background of the Offshore Drilling Industry
At the beginning of the last decade, oil prices were about $100 per barrel. It entailed high utilisation and rates for the offshore industry. As a consequence, a wave of new rigs came into the market.
After the 2014-2015 decline in oil prices, energy companies dramatically reduced their budget for offshore exploration and development. It collapsed the rates and utilisation of the rigs. There was a huge oversupply of rigs, so rates and utilisation were depressed during the 2015-2018 period.
In 2018-2019 the perspectives of the industry started to improve, but with the Covid-19 arrival, demand for offshore rigs plummeted again and send the majority of the companies in the sector to bankruptcy.
A lot of old rigs were sent to scrap or used in other industries (offshore wind for example), diminishing the supply of rigs.
In 2022, after several years of pain, the horizon has improved considerably thanks to the lack of investment and the worries about energy supply due to geopolitical tensions.
Structure of the Offshore Drilling Industry
The industry is composed of three different type of rigs, each with different characteristics: Jackups, Semisumersibles and Drillships
Jackups
Jackup drilling units are designed to drill in shallow water. Normally in a range from less than 100 feet to as deep as approximately 500 feet of water.
A jack-up drilling unit has a floating hull equipped with three or four legs, which are lowered to the seabed at the drilling location.
Jackup rigs can be used in open water exploration locations, as well as over fixed, bottom-supported platforms.
Jackup rigs are predominantly deployed in the Middle East, South East Asia, North West Europe, and North America.
Semi-submersibles
Semi-Submersibles along with Drillships are referred to as floaters. They operate in waters deep ranging from 300 to 12000 feet.
They are categorised in terms of water depth:
- Mid-water range of 300 feet to 4,000 feet
- Deepwater range of 4,000 feet to 7,500 feet
- Ultra- deepwater range of 7,500 feet to 12,000 feet
As well as by their generation, or date of construction
Due to their stability characteristics, semi-submersibles are the most commonly used floating rig type used in harsh environments.
Semi-submersibles are most prevalent in South East Asia, Latin America and the Norwegian part of the North Sea. Due to the good motion characteristics of semi-submersibles, these units are the only floating rig type that practically can operate in harsh environment regions, including the Norwegian part of the North Sea
Drillships
A drillship is a type of floating drilling unit that is based on the ship-based hull of the vessel and equipped with modern drilling equipment that gives it the capability of easily transitioning from various worldwide locations and carrying high capacities of equipment while being able to drill ultra-deepwater oil and gas wells in up to 12,000 feet of water.
Drillships can stay directly over the drilling location without anchors on open seas using a dynamic positioning system (“DPS”).
Drillships are, however, less stable than semi-submersibles, which makes them less suitable for harsh environment areas and therefore are usually operated in benign water regions such as offshore South America, West Africa, and the US Gulf of Mexico. These three regions are commonly and jointly referred to as the “Golden Triangle” and have represented key markets for deepwater drillships over the last decade.
The different environments in the Offshore Drilling Industry
In the same way that offshore drillers are divided by water depth, there are also differences in the environment of operation. We distinguish between benign and harsh environments. Jackups and floaters can operate in a neighbouring water depth depending on if they are more adapted to one of these environments.
Harsh environments: pronounced wind, heavy waves and currents and in many cases operating in low service temperatures. Examples of this are North West Europe and Eastern Canada.
Benign environments are by contrast areas where severe weather is rare. Examples are Brazil, West Africa, the Persian Gulf, South East Asia and much of Australia.
Furthermore, there are other “intermediate” areas such as the US Gulf of Mexico, the Indian Ocean, and Western Pacific Rim, and much of Asia.
Jackup rigs and floaters typically form separate segments as they are used for drilling programmes at different water depths. However, there are cases, in particular when there is overcapacity across all market segments, that rigs may ‘trade down’ and operate in areas for which they are over-specified.
Offshore drillers’ activity status
There are three main states for the rigs: active, warm stacked or cold stacked (apart from building, in the yard for repairs,..)
Active
Active rigs are rigs subject to the contract (drilling, waiting on location, in transit, or a mobilisation/demobilisation status) and this is the only state in which a rig is generating revenue.
Warm Stacked
It is when the rig is idle, but the crew is still in the rig ready for starting a contract soon. The cost is more elevated than in the case of Cold stacked.
Cold Stacked
It is when the company does not expect to obtain a contract for the rig soon. The cost in this state is low ($10-15k/d) but they will need time before starting the rig again (hire a new crew,…). The costs of reactivation are high. Consequently, if the rig is old, there is a potential business case for scrapping the rig instead market it again for work.
Why invest in Offshore Drillers?
There has been a historic underinvestment in the sector for the last decade. This sector is very capital intensive, and production falls sharply if the CAPEX is not enough. Moreover, due to geopolitical tensions and the war in Ukraine, governments are starting to worry about having enough energy. Both factors increase the need for new supply in the short term.
We also see that the peak fracking in the US is behind us. Consequently, once the Tier-1 fields are depleting, offshore fields are gaining attraction against other potential options onshore.
The rigs industry is driven by the supply-demand balance of rigs. We can differentiate between the jack-ups market and the floater’s markets as they are used for different areas. Both of them have common drivers that affect demand such as oil prices. However, some drivers affect only specific regions, impacting differently the jack-ups and the floaters markets.
On the supply side, there was a boom in the construction of rigs back in the early years of the past decade. Nevertheless, a significant percentage of rigs have been sent to scrap or use in the incipient industry of offshore wind. Obviously, the bigger the demand and the lower the supply, the higher the rates for offshore drillers. It depends on the region of the world, but there are some areas with a lot of activity as West Africa or Brazil. The market for jack-ups is lagging a bit with the floaters. Specifically, in drillships, these rates have been raising for the last year and it is expected to continue raising to $500-550k/d in 2023-2024
A brief comment about some of the main companies in the Offshore Drillers sector
Transocean
It has a fleet of almost 40 rigs, the vast majority of them are 7G drillships and Ultra-Deepwater drillships. Transocean has recently received the world’s first 8G drillship.
The main problem is the huge amount of debt. The majority of its peers applied for chapter 11 back in 2020 and Transocean did not do it. Consequently, the high-interest expenses are still making the free cash flow negative.
It is the most renowned company in the industry. However, we believe that it is not the most attractive option in the current situation.
Valaris
Valaris was the first one to apply for chapter 11 in 2020. As a consequence, it has net cash currently. Moreover, they changed the management team in 2021 just before being listed again in the stock market. Valaris has the biggest fleet (56), dominated by 7G drillships and Jackups premium. Valaris has a Joint Venture with Saudi Arabia (ARO) to drill for Aramco in the Middle East (fleet of jack-ups).
There are some rumours in the market about a potential M&A on the horizon with Seadrill. Otherwise, we believe that Valaris will start to distribute dividends in 2023-2024 if the cycle continues the current trend.
Maersk – Noble
The resulting entity will have 39 rigs (11 7G drillships, 7 JU HE, and 12 JU premiums among others). It is expected to achieve synergies of $125MM, Free Cash Flow estimation of around $600MM. The NewCo will have moderate leverage and there is room for a significant shareholder distribution.
Diamond Offshore
Diamond also went for chapter 11 in 2020. However, it still has some debt. Its fleet is composed of 4 7G and 8 SemiSub. It also has an agreement to manage two rigs and get paid for it. They are fixing some idle rigs they had and we expect
Borr Drilling
Full fleet of 23 jack-ups (premium) + 5 under construction for 2023. The current value of the fleet is in the range of $50-70MM each.
The debt is unsustainable ($1800MM with EBITDA expected for 23 around $140MM…). They have agreed to defer the debt and make instalments until 2025. However, we think that the situation is very delicate and the investment in Borr is quite speculative
Deep Value Driller
A special situation where some PE guys acquired a Drillship for $65MM in 2021. The rig is warm stacked and the management is assessing the different options they have to sell or sign a long-term contract for it. We believe that it is an interesting option to spend some time evaluating it.
Our thoughts about the Offshore Drillers industry
Overall, as rates are increasing, the EBITDA for 2023 will be substantially better than in 2022 for the majority of companies. At the moment, we do not have a position in any company as we believe that they are not as cheap as we would like. We consider that the market is kind of discounting the $500k rates (we take drillships as a reference) and there are some risks in assuming that.
We are taking a lot of time to analyse the offshore drilling industry and be ready in case we consider that there is an entry opportunity in the future. In the end, we understand this industry as a leveraged bet on the oil cycle lasting for some years.
Note:
This is an introduction to the Offshore Drilling industry. We went through the basics, the current situation, and the different types of units and gave some notions of the main companies in the industry.
If we see that there is enough interest, we will develop the complete document. Likewise, we have analysed two companies in detail (Valaris and Diamond Offshore). Based on the interest generated by the article, we will schedule one of them in the November publication calendar.
We usually publish analyses of companies and macroeconomic articles. Moreover, we recently launched a blog to talk about markets events on a daily basis
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