As the “lower for longer” outlook keeps getting longer, some rig owners are setting the scene for a major restructuring in the offshore drilling industry.
Within a reasonable timeframe, rig dayrates, especially for deepwater drilling rigs, won’t increase from current cash break-even levels.
Rig asset values are at less than 50% of build cost for most rigs (midwater harsh environment semisubs are the only real exception). Owners such as Seadrill and Pacific Drilling have outstanding debt which exceeds asset values on many of their rigs. Nearly 150 rigs are under construction or under deferred delivery agreements which could extend for years.
Nevertheless, some rig owners have a future to look forward to. And some will find ways to exploit the current market to ensure they make money over time. As they position themselves, the face of the rig market will change dramatically.
The first half of 2017 has shown us that this change is well underway.
The shakeup has begun
During the first 18 months of the downturn, the market waited. Forecasts for a quicker recovery bought struggling rig owners time as banks, shipyards, and financiers remained flexible and hoped for the best. Outside investors shied away from the rig market as distressed assets still had limited attractiveness even at “ridiculous” values.
That all changed in early January when two experienced offshore rig investors reincarnated themselves as Borr Drilling and Northern Drilling. Borr has become a 17-rig company, and Northern Drilling owns one of the highest valued harsh environment semisubs in the market (West Mira) with an option for another one (Bollsta Dolphin).
At the same time, other companies have changed or disappeared completely.
Hercules Offshore, once a major jackup owner, exists no more. Paragon has entered Chapter 11 and is likely to emerge as a fraction of what it once was. Vantage Drilling and Ocean Rig have restructured themselves into efficient, lower-cost organizations. With its sale to Borr, Transocean has gone from being one of the largest owners in the fleet to a floater-focused owner with a new strategy.
And most recently, Ensco announced its plan to acquire Atwood to form the largest offshore drilling contractor in the world as the former was looking for high quality assets with backlog and limited debt.
But there’s so much more to go
Just as we’ve seen already, four main types of events will continue to dominate the offshore rig industry: large-scale consolidation between rig owners; single asset purchases; major restructurings; and rig scrapping (including newer rigs).
We see more M&A deals this year which would remove at least one more rig contractor from the field. Along with that, we see high quality, well-maintained single assets owned by smaller or regional owners being targeted as their owners will have difficulty competing in the lower-rate, higher efficiency environment.
Owners looking to grow with high quality, right priced assets
Whatever each company’s specific strategy is, the ones looking to grow are all focused around a small selection of the overall fleet. This selection is made up of newer active or recently active (and warm stacked) higher spec jackups, harsh environment semisubs, and an even smaller subset of non-cold stacked ultra deepwater drillships and benign environment semisubs. Values for these key assets will continue to rise as they pull further away from the rest of the fleet.
The “rest of the fleet” includes old rigs which will incur SPS and upgrade costs which could exceed asset values. Along with these, cold stacked non-harsh ultra deepwater floaters (new and old) with high reactivation costs and Chinese-built jackups built by non-established drilling companies will remain “2nd tier”, and some may never see a drilling contract again.
Right now, the market is still muddled, with a sprinkling of key assets among many players. As well-funded rig owners search for and acquire these key assets (either via M&A or single asset purchases), the sphere of owners will become more polarized than it is now: premium owners with optimized fleets of key assets vs. owners with primarily 2nd tier assets.
This polarization of rig owners will be essential in reducing competition and will contribute to the restoration of premium owners’ financial health.
Where will it all end up?
Within the next 12–24 months, we expect the offshore rig market to look strikingly different than it did one year ago. There will be fewer players and fewer viable rigs competing for a slowly increasing number of contracts.
When the transformation is complete – when the key players have optimized their fleets (and capital structures) and have less competition to fear – they’ll be able to demand dayrates at sustainable levels again.
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