Navigating recovery in the offshore drilling industry

Glenn Kangisser, partner at Haynes and Boone, Carl Minikes, vice president of sales at Spinergie, Mark Johnson, partner at Haynes and Boone, and Jean Cristofari, CEO & co-founder at Spinergie, explore how, in turbulent times, offshore drilling can work towards recovery.

Between 2008 and 2015, an unprecedented number of newbuild offshore drilling rigs were constructed and introduced to the market. However, the demand for offshore drilling rigs was already steadily decreasing due to technological developments and quicker returns yielded by investments in the tight oil market. 

A tight oil investment can generate cashflow for an operator within 30 days of the commencement of the well being drilled; an offshore deepwater project, however, may not generate any profit for the first three to five years following deployment. 

As a result, an oversupplied market, compounded with shrinking demand for offshore drilling services, has seen daily rates for offshore drilling rigs decrease significantly. In the ultra-deepwater drillship segment, the daily rates have decreased by approximately 70% since peaking between 2009 and 2013.

The way to price recovery

A reduction of the marketed fleet of drillships of four per year over the next five years will allow utilisation to reach an 80% threshold by the end of 2023. Historically, daily rates start increasing where marketed utilisation for floaters exceeds this threshold. However, without such reduction in the marketed fleet, the utilisation threshold required to achieve price recovery would not be reached until 2024-2026.

Based on the period spent to date in cold stack and having regards to upcoming SPS, it is possible to identify 20 drillships that are strong candidates for recycling or conversion over the next five years. The re-activation costs for drillships are dependent upon multiple factors, including the age of the unit, the period spent idle and without full maintenance crew, as well as the steps taken to preserve the unit during any idle period. 

By way of example, the cost of re-activating a modern high specification drillship could rapidly exceed $100m if the unit has been cold stacked for over five years without a robust preservation programme prior to putting the unit in cold stack, as well as the drillship not maintaining its class certificates.

The changing industry

Financial debt covenants tied to specific drilling units, and their associated long-term employment contracts at the time of raising capital, have meant that recycling has not been an appealing option for some owners. However, analysis suggests that there is increasing appetite (particularly when there are periods of higher steel prices) to dispose of surplus drilling units. 

This could be done by recycling the units in order to rationalise fleets, thus avoiding the ongoing expenditure of cold stacking and the requirement to incur substantial upgrade costs, on top of reactivation costs should the unit be used again.

The situation has shaken up the traditional model for the construction of drilling units, where the buyer pays the contract price in instalments. In the prolonged period of a depressed drilling market, this model has resulted in a number of shipyards left owning units at various stages of construction (and with depressed asset value). 

Buyers have either cancelled the construction contracts (and sought to be refunded for instalments already paid to the shipyard), or otherwise sought to avoid making any ongoing payments for the drilling unit under construction.

Confronted with such challenges, a number of shipyards have explored alternative models to either divest themselves of such distressed assets, or at least reduce their losses. Shipyards have begun offering new buyers attractive rates (and even substantial competitive loans) to allow a drilling unit to be completed and delivered by the shipyard to the new buyer. 

Other shipyards have seen the shipyard retain ownership of the drilling unit after its completion and departure from the shipyard and into bareboat charter of the unit to allow the shipyard to recover some of its losses through the receipt of hire.

Where the opportunity exists, a more radical and less destructive option is worth considering. Taking advantage of certain specialised characteristics of drilling units, it is possible to transform the units into platforms or vessels that can competitively service alternative and more attractive markets, providing new life to old units. 

Conversion projects become viable when new owners can exploit these specific characteristics at a second-hand purchase price, where the economic benefits of acquiring and converting the second-hand unit outweigh the potential risks such a conversion may entail.

Where are we and what happens next?

Affected by such distressed market conditions, offshore drilling contractors will have to continue their consolidation efforts. This should be done with a view to regain pricing power to better position the offshore drilling industry and enable new investments and newbuild projects to be a viable business case.

This requires aggressive and decisive measures, with contractors needing to take a combination of the steps mentioned before their cash reserves are exhausted.

In the ever-evolving energy transition landscape, technology will be instrumental in transforming the offshore drilling market. Those who are willing to affect fundamental and bold change in the way they conduct their business are more likely to emerge in a strong and sustainable position when the storm is finally over.