Trends Driving Transocean’s Ultra-Deepwater Business

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Transocean (NYSE:RIG), the largest offshore drilling contractor, has traditionally counted on its fleet of ultra-deepwater rigs to drive earnings. However, the ultra-deepwater market has been facing a cyclical downturn of late, with the supply of rigs steadily outstripping demand, putting pressure on utilization levels and day rates. In this note, we take a look at how Transocean’s ultra-deepwater rigs have been performing of late and some of the factors that are likely to drive their performance in the near term.

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Recent Trends In Transocean’s Ultra-Deepwater Operating Metrics

Ultra-deepwater rigs are typically capable of drilling at water depths of over 7,500 feet.  Transocean has a fleet of about 29 ultra-deepwater rigs, which together account for about half of the company’s total revenues. These rigs have been important to the company from a margins standpoint, since they have the highest day rates and among the best utilization rates in the fleet. However, there has been some recent softness. During Q4 2013, the utilization rate of the company’s ultra-deepwater fleet stood at around 87%, down from around 94% a year ago, while day rates remained flat at around $500,000 [1] Utilization rates are a ratio of the number of rigs working on contract to the total number of rigs. Things are likely to remain challenging going forward as well, with day rates estimated to decline industry-wide. Additionally, Transocean is estimating that the number of out of service days for its ultra-deepwater rigs will stand at around 597 in FY 2014  and around 838 in FY 2015.

Demand Is Cooling As Oil Companies Focus On RoI

2013 turned out to be a lackluster year on the oil and gas discovery front, considering some large and expensive exploration failures. For this year, oil and gas companies are likely to spend less on seeking out new discoveries, instead focusing on improving the productivity of their existing wells in order to maximize their returns on invested capital. Oil companies have also been allocating more capital to areas such as shale, where the exploration related risk is lower and the time frame between investment (in identifying and developing a well) to cash flow generation (from production) is shorter when compared to offshore deepwater wells, where the risks and time delays are higher.

Coming to the supply side of things, the number of ultra-deepwater drilling units is expected to stay ahead of demand through much of 2014 and 2015. The number of ultra-deepwater rigs is expected to grow from around 120 in early 2013 to over 160 by the end of 2014, while demand (including existing contracts, options as well as possible contracts) is expected to be around 140 by the end of 2014. [2] In terms of spending, Credit Suisse estimated that rig rental capital expenditures by oil and gas companies will grow by about 5% over the next three years, which is well below the 14% to 18% growth rate that would be required to keep the global fleet of rigs contracted. Transocean could have some difficulty competing in an oversupplied market, since its fleet is much older (about nine years ) than competitors such as Sea Drill and Ensco (age of less than four years). It seems possible that some of the company’s rigs could be idled, as oil companies would likely choose to lease newer and more capable rigs in the oversupplied market. Even if the company’s older rigs do find takers, its pricing power in these contract negotiations will be weaker. On the other hand, if the rigs are idled or stacked, Transocean could face higher storage costs, potentially impacting margins.

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Notes:
  1. Transocean Ltd. Reports Fourth Quarter And Full Year 2013 Results, Transocean, February 2014 []
  2. Howard Weil Energy Conference Presentation, Transocean, March 2014 []