Delivery delays, shorter-term contracts plague the vessel market

All signs point to a continued softness in the drilling rig market, at least for a little while. The decline in rig dayrates and overall contracting that has been plaguing the industry for the past several months is going to continue well into the next year. Most are even speculating that the first signs of daylight will not peek through the dense fog of low prices until at least the third quarter of 1999.

Softness will continue deep into 1999

Marshall DeLuca
Business Editor
All signs point to a continued softness in the drilling rig market, at least for a little while. The decline in rig dayrates and overall contracting that has been plaguing the industry for the past several months is going to continue well into the next year. Most are even speculating that the first signs of daylight will not peek through the dense fog of low prices until at least the third quarter of 1999.

Delivery delays

In 1999, the second wave of newbuild and upgraded rigs will enter the market. By 2000, almost all of the rigs in the building cycle of 1997 and 1998 orders are scheduled for delivery. However, several of the rigs slated for 1998 delivery have undergone major delays, and the delivery schedule has pushed them well into the 1999 delivery period. And it seems that delays will have the same impact on the "scheduled" 1999 crop. This will cause a snowball effect on all construction, resulting in final delivery of the 1997-1998 ordered fleet in 2001 or possibly 2002.

The industry is predicting around a 30% schedule overrun on the building cycle. This is going to have a major impact on the market. The cost of this overrun is going to be staggering. It has been estimated that this is going to cost over $2.5 billion to the contractors. Several of the new rigs under construction have already seen costs escalate well beyond original budget. This has resulted in several cancellations, and chances are that there will be more before the cycle is over.

Escaping contracts

These overruns have the potential to give operators a back door out of the long-term contracts entered into during the higher, stable, oil price era of 1996 and 1997. An operator could cancel the contract if delays exceed a certain point and contract for another rig at a dayrate well below what the original rig was contracted for. While it has not happened yet, there is a distinct possibility that it is on the horizon.

As a result of this problem, a new trend may emerge that may try to compensate for the cancellations. Contractors may begin to order new rigs speculatively. R&B Falcon, for example, recently ordered a new ultra-deepwater drillship on speculation, following the cancellation of two of its conversion projects, and is currently in negotiations with the operators of the cancelled rigs for the contract.

Whether the order was based on the cancellation or not has yet to be determined, but the drillship ordered is of the Conoco-R&B Falcon design similar to the recently delivered on-schedule and on-budget Deepwater Pathfinder.

Regardless of compensation orders, the current building cycle will be complete by the year 2002, with the exception of upgrades. New orders have begun tapering off and the low dayrate is not nearly close to the levels of justifying any newbuilds at this time. The current units on order should be able to compensate until things turn the corner.

Contracts

Contract terms for existing rigs are also going to be another influencing factor in the market. For the near future, it seems that securing a two-year contract will be next to impossible. Operators will want a quick exit if things get much worse. The contracts will, however, be provisioned with extension options in hopes of success.

This shorter-term contract will not only apply to jackups and the shallower-water semisubmersibles, but will expand to the low-end deepwater units as well. Although the deepwater will remain undeniably hot, deepwater rigs coming off contract in the coming months will start to feel the pinch.

The slowness will keep the fleet of stacked semisubmersibles where they are, as was seen earlier in the jackup market, but it may mean that some rigs will be working in shallower water. This trend has already being witnessed among contractors with speculative newbuilds such as Ocean Rig. Ocean Rig has begun marketing their ultra-deepwater Bingo rigs to shallower waters and shorter contract terms due to the depressed market.

Rig redistribution

Another trend emerging is the redistribution of the drilling rig fleet. Several of the rig contractors will soon be pulling rigs out of areas such as the Gulf of Mexico in search of higher dayrates and more secure contracts. One of the hottest areas will be Brazil.

Brazil, which for the most part has been dominated by Sedco Forex, is undergoing massive market and regulatory change. Those changes are being accompanied by the entry of new drilling contractors. Rates there are expected to be equal to if not higher than the Gulf of Mexico.

Brazil will be followed by West Africa and the Asia-Pacific region. West Africa has been accumulating discoveries at a record pace. More and more rigs will be needed to fully exploit new areas - especially in the deepwater. Licensing is also increasing in the region and rigs will be in demand to fulfill drilling programs.

Asia-Pacific, despite the troubled economy, is monopolizing a number of rigs and is continuing at a strong pace. According to the latest SCORE report, the region exhibited the least amount of change. Exploration activities are still mounting and more rigs are going to be called to service in the region.

Rig activity

• Jackups: Jackup drilling units have been hit hardest in the soft drilling. Operators started budget cuts at the shoreline and began steadily moving outward. But there may be a light at the end of the tunnel for the jackups, or at least a safe haven. With gas prices remaining at relatively steady levels, operators will continue gas drilling operations.

This will keep the jackups relatively busy in gas-prone regions such as on the shelf in the Gulf of Mexico. Subsalt drilling in the Gulf will also occupy many jackups. Subsalt discoveries such as Tanzanite and Hickory will help carve out another stable market for jackups.

• Semisubmersibles: Existing semisubmersibles in the mid-depth sector will see continued slack during the next few quarters. With shorter contract terms and lower dayrates, the market for these rigs is going to continue on a downward slope for a while.

The deepwater rigs coming off contract will remain fairly steady, but the contract terms will be shorter and contractors may have to relocate in search of higher dayrates. For the new crop of drilling units, things will be fine. The vast majority have secured contracts to last them at least two to three years. This, however, is contingent on the rigs being delivered on time and on budget.

Rigs that are being built on speculation are in trouble. Most of the spec rigs will not hit the market until 2000, so that should save them some time, but they will have quite a bit of trouble finding the kind of workable contract that existed when they were originally ordered.

• Drillships: Drillship contracting will also remain steady, because of the drillship's flexibility of working in almost any water depth. The new drillships also all have secured contracts for at least two to three years, so they will be spared the bulk of the crunch of the negative market. Once again, however, this is strictly contingent on delivery efficiency.

Third calendar quarter

Most drilling contractors are anticipating an upswing in the market in the third calendar quarter of next year. Whether the rig market will return to the levels seen in the past few years, much less exceed those levels, is doubtful. The third quarter will not be another boom. It will just be the result of the market fully adjusted to the lower oil prices. The rig market will be seeing some higher dayrates, but not enough to justify another wave of new construction.

With most of the new rigs entering service being secured under contracts, the supply increase will not have much negative impact on the market. The delivery of this wave of new rigs will be able to meet current supply until things do improve to justifiable building levels. But, at the current time, new orders will continue to taper off.

Existing rigs coming off contracts will feel most of the pain in the coming quarter. Contracts will continue on a downward spiral. However, by the third quarter, rates will be at sustainable levels and on their way back up as longer-term contracts ensue.

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