Rig market will weather the storm

Most operators have the financial resources to maintain their exploration and development programs, despite the drop in oil prices.

Thomas E. Marsh, ODS-Petrodata

It’s doom and gloom splashed all over the newspapers and the Web, and pounded out by radio and television pundits: the credit crunch, global recession leading to depression, falling oil prices, collapse of emerging economies, and so on.

Can the offshore rig market weather the storm? Most industry observers believe it can, but not without a few casualties.

The key industry driver remains global demand for oil and natural gas, and the prices they command. While the recent decline in oil prices has been characterized by some as a “collapse” and others as a “correction,” the fact is that at present, an oil price to the far north of $100 is not reasonable or sustainable, and “correction” probably is the better description. Many analysts believe that, as far as the offshore segment of the oil and gas industry is concerned, as long as oil prices remain above $50/barrel, most exploration and production projects will proceed as planned.

The casualties in the rig market will not be the established drilling contractors, but the recent startups that have ordered rigs - or announced their intent to order rigs - that they may not now be able to finance due to the credit crunch. Morgan Stanley analysts Ole Slorer and Igor Levi put it this way in a recent report: “We believe only a handful of the 30 or so deepwater rig construction projects currently planned by undercapitalized newcomers will be successful in obtaining financing...”

Slorer and Levi see this primarily as an issue for Brazil’s state oil company, Petrobras, rather than rig owners, since many of the rig construction projects now at risk are being undertaken by the “undercapitalized newcomers.” These companies stepped in for the Brazilian market to meet the state operator’s ambitious production targets. In fact, the Morgan Stanley pair see recent events in the credit markets as a positive development: They expect established rig owners to have more opportunities to push up rates for deepwater rigs in light of the supply situation being tighter than expected, and they believe those rig owners with the financial resources to do so will step in and take over many of the construction slots abandoned by financially strapped speculators. This should bring these new rigs into the fleet at market rates, rather than the “below market” level that Petrobras had negotiated with the startups.

Long-term demand for deepwater drilling units remains strong. According to data compiled by ODS-Petrodata, every deepwater rig that is in the fleet or likely to join the fleet over the next four years will work at or near maximum utilization for the foreseeable future, as long as global demand for oil continues to grow.

The situation in the jackup market is different. Global jackup demand is forecast to increase next year, according to ODS-Petrodata’s World Rig Forecast: Short Term Trends report. However, the positive outlook may have to be tempered somewhat in the first quarter of 2009 as the full effect of the recent fall in oil prices and the global financial crisis are better understood.

More than 80 new jackup rigs are under construction or on order at present, and more than 50 of these do not have firm contract commitments. A significant number of these new jackups will be delivered over the next two years. Barring any changes in expected delivery dates or order cancellations (and some are possible in the current economic climate), 39 jackups will be delivered in 2009 and another 24 will follow in 2010.

The effect on the jackup market of this influx of new rigs has been made less clear by recent events in the global economy. However, jackup fleet renewal is needed - over 320 of the 432 jackups in the fleet at present are 25 years old or older - but such a large increase in supply could lead to downward pressure on jackup rates in the short-term as rig owners compete aggressively for the available work.

However, Tom Kellock, head of ODS-Petrodata’s Consulting and Research team in Houston, believes it is still too early to assess the full effects of the recent drop in oil price, the “credit crunch” and the developing worldwide economic situation.

“While undoubtedly we will see some reduction in demand for offshore rigs in the immediate future, although this will largely be confined to the jackup market, the longer term impact could well be higher day rates, if many of the new rig projects are cancelled,” Kellock notes. “There is no question that the world will need every last drop of oil that can be found, and although oil demand growth will slow, and may even stop for a period, a far more important factor is the declining level of production from existing reserves. With estimates of worldwide oil production depletion ranging from 4.5% to more than 9% a year, simply maintaining current production levels will require full utilization of the offshore rig fleet. Any hiatus in activity today will mean a greater shortage of oil and gas tomorrow.”

Fortunately for the world as a whole, most operators have the financial resources to maintain their exploration and development programs, despite the drop in oil prices. Kellock says, “It is worth noting that only a little over a year ago a survey revealed that most operators were using an oil price of between $35/bbl and $50/bbl when evaluating their projects. In summary, we will see some short-term disruptions, but in my opinion the outlook for the offshore drilling industry really hasn’t changed at all over the past few months.”