Forty-five years ago, oil and gas producers owned most mobile drilling rigs. After an oil price recession set in and two hurricanes blew through the Gulf of Mexico, producers decided rig ownership wasn't much fun. The rigs were sold to more entrepreneurial types.
From that time forward, squabbling over contract terms and rates became a routine practice, reaching a peak during the collapse of oil prices or following new rig construction. The fact that producers and contractors need one another has kept most disputes out of litigation.
The participants are not to blame. The failing is a system that has little flexibility in immunizing a fixed price (contract day rates) from a moving price (oil and gas). Stabilizing oil and gas prices would remove day rate contracting risk, but that doesn't seem possible. There are three ways to fix the process:
- Turnkey contracting: Turnkey drilling allows contractors to factor in risk by averaging cost overage and underage over a large group of wells, and setting well prices accordingly. Even so, turnkey drillers need help from contract drillers periodically to weather difficult well conditions or a shortage of rigs.
- Index day rates: Contract day rates can be indexed to the movement of oil and gas prices. Contractors compete with premiums charged to reflect average losses. The negative side to indexing is that producers would be encouraged to contract and drill during low price periods, a time when they should refrain from adding production to saturated markets.
- Hedge day-rate risk: Normally, hedging swaps floating prices for fixed prices. In this case, producers would be compensated in the event of changes in commodity prices. Drilling contractors would compete by offering competing risk indemnification rates.
A financial risk premium for the disparity between contract rates and oil and gas prices would have to be developed.
Hedging day-rate risk has never been tried. Indexing day rates was attempted early in the history of rig contracting. Turnkey contracts are common in some areas today, but show no sign of replacing day-rate-time contracts. Often, well complexity forces turnkey contractors to bid unattractive rates, or the dearth of qualified rigs encourages producers to sign long-term agreements.
Should we leave the present day-rate-time market untouched, and tolerate the inefficiencies inherent in cycles of rig construction, employment, and consolidation?
Or can we improve predictability? If options to turnkeying don't collectively make a market of sufficient size, then turnkeying will remain the only option. But, the industry should examine the other options.
The bundling of services has created a wonderfully competitive product. Multiple in-house services are rolled into one market identity. An unusual risk emerges, however, as the size of the bundled operation grows. When large multi-service contracts end and others do not materialize, a prime contractor or supplier must unbundle the services and bid them out independently, or the next contract must be obtained at break-even, or the contractor has to pack up and get out.
This last option is real trouble. Not only is the cost of de-mobilization high, but invariably employees and infrastructure must be turned loose, effectively collapsing capability vital to continuing business in that region. Too often, it is a winner-take-all situation that is initially rewarding, but counter-productive later. Should we re-think how the services are bundled? Here are two suggestions:
- Service contractors should develop options to unbundle services and bid them out separately. To manage this effectively, however, contractors need to avoid merging or dissolving long-standing name-brands and capabilities.
- Producers need to look at the entire picture. The savings inherent in bundled services could reverse quickly if expansion creates an equipment shortage or contract renewal comes up after competitors have dismantled operations and departed.
Without flexibility, service providers and producers alike have plenty to lose over the long term, especially in more remote theaters.
CORRECTION: Our apologies to Schlumberger for improper editorial treatment of a Dowell product (Clear-Frac) in a June article (page 66). Critique of the product should have come from users. As the article was structured, Schlumberger Dowell did not have an opportunity to answer comments. After investigation, we (the editors) have not heard anything negative about this product and believe it achieves what tests of the product demonstrate. We regret raising concerns that have not been demonstrated in fact.