Drilling companies strategize to navigate a capricious marketplace

Drilling companies are strategizing to make the best of a bad situation.

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High commodities prices fail to ignite a boom

Judy Maksoud
International Editor

Drilling companies are strategizing to make the best of a bad situation. Commodities prices have been high for a sus-tained period of time. Gas has been over $5, hitting a phenomenal one-day high near $20 in late February. Before the war with Iraq, oil prices held at around $35/bbl. The upshot of this is that oil companies are seeing tremendous revenues. The problem is that, uncharacteristic-ally, oil companies are not investing the incoming cash into exploration drilling.

While oil companies play "wait and see," drilling companies have to make decisions. Regardless of the inclement business climate, drilling companies have to place assets profitably, judiciously invest money in upgrades and newbuilds, and support large numbers of personnel.

Although drillers have been dealt the same hand of cards, they are playing them differently.

Senior managers at three Houston-based drilling companies recently shared their views on the worldwide market, asset placement, and strategies for making their companies profitable in a time of instability.

Selling value

Rowan Companies' 2003 budget is comparable to last year's, according to Danny McNease, president and COO.

"We are in a continuous process of changing old equipment and replacing it with new equipment," he said. The company will spend about $50 million in upgrades in 2003 and an additional $200 million in newbuilds.

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The market is unquestionably a major factor in determining how capital is spent. In the case of Rowan's new Tarzan class rigs, gas demand has been a catalyst. In fact, strong gas prices were essential to Rowan's decision to build the new Tarzan rigs, according to Robert Palmer, Rowan's CEO. These newbuilds will target the deep gas on the shallow continental shelf in the Gulf of Mexico.

Finding a niche

While money goes into newbuilds that will expand Rowan's capabilities in the Gulf, the company continues to focus on a few core markets. According to Palmer, in the coming years, Rowan will serve the niche markets in the North Sea, Atlantic Canada, and the Gulf of Mexico.

"I think you could make a good case that those three markets have another 20 years of life. That doesn't mean that we'll turn a blind eye to other international markets if they develop. Right now we're very happy with where we are and the kinds of equipment we're building," Palmer said.

"Our niche market is high horse power and high pump capacity," explained McNease. That capability is used to drill the deeper wells around the world – off Trinidad, Eastern Canada, the North Sea, McNease said. "If our services are needed in an area where we do not already operate, we will go there. We will move our rigs to the places where our customers operate."

Though the North Atlantic has not yet fulfilled its promise, Palmer remains optimistic. "This year could be the turning point," Palmer said. EnCana, El Paso, Canadian Superior, and ExxonMobil are planning active programs over the next few years that Palmer believes could turn things around. And Rowan intends to be there when the tide turns.

"In Eastern Canada, it looks like things are going to get busier and busier," said McNease.

Rowan has viewed the GoM for a long time as a natural gas market, Palmer said.

"We think natural gas provides better profitable opportunities for our customers than does the oil market. All but two of our rigs are in the Gulf of Mexico. We keep between 10 and 12 of those rigs drilling deep Miocene wells. That's one of the reasons that our day rate structure has not suffered as much as those companies that have commodity rigs," he said.

Building on relationships

Rowan relies heavily on the relationships the company has built over the years. Alliances, particularly with independent oil companies, are the mainstay for the company. "At the end of the day, the companies we have strong business relationships with (El Paso, Anadarko, Newfield) have lower drilling costs and are more successful – and we are too," McNease said.

Rowan's emphasis, Palmer said, "has always been our people, our equipment, and our balance sheet." That corporate culture is not going to change any time soon. "When you have a strong team, you don't have to worry about the business climate."

Marketing premium assets

GlobalSantaFe's newbuild spending this year will be up nearly 20% over 2002. According to Jon Marshall, currently executive vice president and COO and slated to become president and CEO in May, "This increased cost is attributable solely to timing as we continue our $800-million newbuild program that includes two ultra-premium jackups and two ultra-deepwater semisubmersibles for development drilling."

The company does not expect to spend as much this year on upgrades.

"As long as the rigs are working and earning good returns, we don't typically take them out of service," Marshall said. "With that said, part of our culture is to maintain premium assets."

GSF uses a "rig enhancement task force" that makes recommendations for upgrades. Management refines those recommendations, and decisions are made based on securing a greater investment return than the weighted average cost of capital, Marshall explained.

Keeping busy

The challenge is to make sure the company's assets are working. GSF's fleet of 58 offshore drilling rigs is working all over the world, with 75% of the rigs in international waters. Rig diversity, market distribution, and premium assets are three keys to maintaining high fleet utilization, Marshall said. "One of the good things in having a worldwide exposure is the ability to move rigs expeditiously."

One critical issue to bear in mind is the quality of the fleet, Marshall said. "The international market tends to be dominated by very large independents and majors who want high-specification equipment, the kind of equipment GlobalSantaFe can provide."

The market in the Gulf of Mexico remains fairly soft, but Marshall is optimistic about the future. "All of the factors that have in the past created a turnaround in activity exist today, but we have not seen that turnaround yet. I think these same circumstances will inexorably produce that turnaround, and I think our impatience perhaps makes the delay more disconcerting. One element that we're currently lacking that we've had in all the prior cycles is the full support of the capital markets. But that too will eventually return."

Building identity

"If we were looking at the world as we wanted it to be, we would see commodity prices low enough to stimulate consumer demand, but high enough for the producers to be profitable," Marshall said. Of course, that could only exist in very short bursts. "The rig business is a commodity business, and as in every commodity business, you are compelled to differentiate your product from everyone else's."

Marshall believes GSF does that by providing premium operating capability, an example of which is the new Constellation I jackup, the most efficient jackup built by the company.

Another way GSF plans to distinguish itself is in providing turnkey drilling and well engineering service. "There is a market for turnkey drilling, but we don't have the universal market for turnkey services that we have for rigs," Marshall said.

Over time he sees oil companies becoming less able to provide that expertise internally as a consequence of multiple layoffs, dependence on an aging population of consultants, and of not training their own employees to fill this need.

"One of the ultimate differentiators will be the ability to use the iron more efficiently, and that is what the incorporation of a well engineering service will enable over time," Marshall said.

Manning the rigs

Recruiting and retaining qualified personnel is another critical part of GSF's long-term plan.

GSF has taken a unique approach to recruitment. "We went to the US military," Marshall said. GSF targets people who self-actualize physically, understand discipline, are highly motivated, and understand teamwork. By doing so, "GlobalSantaFe is getting an entirely different cut of individual." He cautioned that the impact of this hiring program may not be seen for several years, or until the new crew members grow into rig supervisory positions.

Placing assets

Pride International is positioned for a successful year, according to Paul Bragg, CEO.

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"Last year, Pride looked at 2003 as the year the company would have its fleet, with the exception of the US Gulf of Mexico, nearly fully deployed. Opportunities during the year led to capital spending that allowed Pride to move idle assets into new markets. Spending decisions and decisions to enter into contracts of longer duration were made on the basis of an observation 18 months prior that the market was going to be difficult for a lot of different asset classes," Bragg said.

One of Pride's initiatives has been securing long-term contracts for assets around the world. "We re-contracted many of the rigs that had short contract periods on a long-term basis. We now have the entire 11 deepwater units repositioned and contracted with a backlog. Those units will be fully employed this year," Bragg said

A large portion of Pride's jackup fleet has been upgraded and redeployed. "We have approximately two years of backlog on all of the international units now," Bragg said. That leaves the jackup fleet at 16 in the US GoM. Pride will look for opportunities to re-deploy several units from the US GoM to other markets in 2003.

Bragg believes that the start of a rebound is likely in the GoM, but a complete recovery is further down the road.

"I think it will take maybe nine months to ramp up to something that results in better returns," Bragg said. "Today we're looking at above $5 gas prices, and we see the reserve base depleting at 6% a year. That number is probably going to turn into 8% a year and 10% a year decline if we continue to put off drilling. So the macro-economic review says that the return for drilling for gas in the GoM is going to be very good."

Some units are working in the Mexican sector of the GoM. Pride has nine jackups, one semi, and two platform rigs in the Mexican GoM, with an average contract length of three years.

The move is in keeping with Pride's overall business plan. "We've contracted a much larger portion of our fleet on a long-term basis than our peers, and the timing has really been a benefit to us and will continue to be this year," Bragg said. "We have contracted about $450 million worth of backlog with Pemex alone."

He believes working globally with specific concentrations of assets gives Pride a competitive edge.

"We have eight offshore rigs in Angola, for example. Clearly we have a sort of dominant position in that market. Those units are in position where they'll have work opportunities for many years to come," he said.

Looking ahead

Bragg sees a positive future for Pride, partly because of the company's business plan. "The thing that Pride has done differently from other drilling companies is to focus on building backlog where our capital is invested. Our big-ticket assets are fully employed, and we have good visibility on the cash flow and earnings coming from those. What I see over the next few quarters is our results increasing as we are fully deployed with those units. Many of our peers are going to face the problem of renewing at lower rates and having some idle time on similar units."

"One other distinguishing thing about Pride is our commitment to developing technology, particularly for deepwater. We've undertaken five deepwater development projects with BP and ExxonMobil. We are building the drilling units to go on Spars and TLPs. We have probably the largest engineering group amongst our peers today," Bragg said.

Pride has also entered into operating agreements for the drilling operations on the deepwater platforms it is constructing. "We see that as a big part of the market. Possibly 50% of deepwater developments will be done from dry tree completions with fixed platforms. We're prepared to play in both environments, not only with the fleet that we own and move around the world, but also with working directly with the operators on their massive capital projects," Bragg said.

Pride has two semisubmersibles under construction. They will be completed this year and will likely be contracted in 2004.

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