I will be giving a brief introduction to Ocean Rig (ORIG) and the segment of the oil industry it specializes in. The reason for doing this is that it is important to understand the different market and business dynamics at play with different investments in the oil market. I will then provide a link at the end of this blog to the official article that is published on Seeking Alpha.
The oil industry is vast with many different areas to invest in. The oil industry can be broken into the following segments: upstream, downstream, midstream, and service and supply companies. Upstream consists of exploration, development and production of crude oil or natural gas. Many of you are familiar with my work on Energy XXI (EXXI), a small independent E&P company focused in the upstream portion of the industry. For those who are not, you can read my article here I will be discussing a brief preview of theinternational offshore drilling contractor industry dynamics that provide oilfield services for deepwater offshore oil and gas exploration.
It’s important to realize that EXXI and ORIG are in two different areas of the market. One is an E&P company involved in the upstream business (EXXI), while the other is an offshore drilling contractor involved in providing oilfield services via their rigs (drillships and semi-submersibles). Also, EXXI is involved in the exploration and production in the shallow waters of the Gulf of Mexico. In contrast, ORIG contracts rigs to E&P companies interested in exploration and production in the offshore deepwater business. ORIG’s customers are actually E&P companies that are interested in exploring for oil in deepwaters. See below for a picture of their current customers for which they provide their state of the art modern day fleet of rigs consisting of drillships and semi-submersibles.
Source: ORIG Investor Presentation (page 7)
Please see page 66 below regarding how deepwater differs from shallow water on a CAPEX basis:
Source: Green Light Capital (page 66)
The reason to understand this key distinction is that ORIG’s ability to receive contracts in the future will be dependent upon a greater appreciation in the price of oil. Otherwise there is little incentive for companies to increase their CAPEX budgets for deepwater oil exploration.
I will be giving an overview of the offshore drilling industry so people can have an understanding of this area. Offshore drilling rigs consist of different offshore drilling units such as the semi-submersible platform, jack up rig, oil platform, submersible drilling rig and drillships. ORIG specializes in the ultra-deepwater and harsh-enviroment segment of the offshore drilling industry and provides a modern fleet, all built after 2011 of 11 drillships (3 of which are under construction) and 2 semi-sumersible which can withstand very harsh environments. The 2 semi-submersible rigs were built in 2001 and 2002. Please see an incredible video on the Eirik Raude below.
I will be sharing some of Link77’s (from Grey School) in depth understanding of the offshore drilling industry. The offshore drilling industry contracts that make up ORIG’s primary business model consist of contracts that are anywhere from 12 months to five years. Both sides in one of these agreements need to hedge in some way. Indebted drillers need to get their equipment working (stock price, income numbers, employee retention, not to mention the astronomical cost to stack or stand-by a rig). E&P’s want the lowest dayrate and the least amount of carrying time charged back to them (it’s common in the industry for customers to pay a reduced dayrate while a rig is in for inspection, moving to location, etc.). In today’s low oil price environment, many of those costs can be negotiated down, or even out completely, because drillers are so desperate to have rigs working under contract.
The situation that will manifest as oil climbs, is that more contracts will be tendered, and offshore drillers such as ORIG will be pushing hard to get this premium iron working. They will push so hard that the dayrates quoted will equal those of lesser rigs. Anyone involved in awarding contracts will chose the higher spec rig, as that will hedge them against rising oil prices and, more importantly, their own eventual drilling budget increase.
So lower class/depth rating, older rigs are not even going to be in consideration, hence the popularity of companies scrapping rigs that were still making them good money only a few months ago. The standby, upkeep, and certification renewals on rigs are extremely high cost. Regulations have increased over the years and it is prohibitive to hold a rig through a survey without some contract income to offset the high costs of getting the rig up to all codes (remember, these are oceangoing vessels not just drilling rigs). Drillers used to get the E&P to help upgrade their rigs as well. When demand was high, a rig rated for 4,000 ft. could be upgraded to 6,000 ft. with the operator footing the bill because they would not want to wait for a deeper water capable rig to come available.
Simply put, E&Ps are looking to get the best rig for the lowest rate with longest term while demand is low. ORIG possesses a competitive advantage having a majority of their fleet comprised of modern day drillships as a drillships ability to save time moving (mobility) between oilfields worldwide is far faster than semi-submersible drilling units. In fact, it takes 20 days (drillship) vs. 70 days (semi-submersible) to move from the Gulf of Mexico to the Offshore Angola. The drillships also command a much higher day rate for their contracts. Reference
A breakdown of ORIG’s modern day Ultra-deepwater premium assets.