Poised to recover

What if actions by individual companies in this industry led to a trend that, in turn, actually accomplished what the companies set out to do originally?

What if actions by individual companies in this industry led to a trend that, in turn, actually accomplished what the companies set out to do originally? Sounds far fetched? In most cases it is, or rather has been, but occasionally things just seem to fall into place.

Case in point: Consolidation among the drilling contractors and supply boat companies. Consider the drillers first; last to see the benefits of an up-tick, and first to suffer when prices begin to fall. This sector was due some relief, and it appears to have come from within. As the analysts at Raymond James recently pointed out, it may be possible to teach an old dog a new trick. In this case, the trick is price stability.

In the past it was just too tempting for the majority of smaller drilling contractors to fold on price when faced with the prospect of stacking rigs. A major part of the problem was too many similar-class rigs chasing too few drilling dollars. Operators, in the Gulf of Mexico, had so many choices they naturally went with the low-price supplier.

What's changed? Well, for one thing, there no longer are as many rigs working in the Gulf. Many of them have moved to markets overseas, and the rigs that have come into the Gulf are designed to operate in deepwater where demand is more in line with supply. In addition, consolidation in this sector has reduced the number of players. With fewer companies controlling a larger portion of the market, there is less risk of one breaking rank on price.

This is an about face from the last downturn in activity when price was all but ignored in favor of market share. The strategy seems to be paying off. Utilization, according to GlobalSantaFe's Summary of Current Offshore Rig Economics, is hovering around 60% for all Gulf of Mexico rigs. The last time the utilization was at this level was in 1999. The interesting distinction is that in 1999 the dayrates were much lower. SCORE currently reports dayrates at 31% of replacement cost for the rigs. With the utilization numbers basically the same in 1999, this percentage of replacement cost was 20%.

As if an improvement in the economics of the drillers wasn't enough good news for the industry, Raymond James goes on to report that even the supply boat business is hanging tough. As with the more common rig classes, supply boats often find themselves competing strictly on price. Added to that was a building boom that left too many vessels chasing too few jobs. Now these new builds have circulated through the market. Again looking at this downturn compared to the last, Raymond James found the supply boats are fairing much better.

The recent drop in utilization was pegged at 60%, down from a peak of 85%, meaning 60% of the rigs are working. Looking back, Raymond James found a similar drop between 1998 and 1999. Comparing the two, researchers found during that downturn prices dropped 70%, from about $7,000/day to only $2,000/day. Compare this to current data and the results are comforting. During this decline, though the utilization dropped a similar amount, the day rates only suffered a 25% decline, falling from $8,000 to $6,000.

Now, no one is going to be excited by falling dayrates, but if there has to be a down market, and it appears that despite everyone's wishes downturns are with us to stay, it is preferable to see less violent swings in pricing.

The question still remains whether this was just a less severe downturn, or whether decisions made by the contractors had a positive affect. It is always dangerous to draw causal relationships of this sort. Too many factors feed into the pricing and utilization. While it is a relief that these rates hold strong, assuming they will do so next time around might be foolhardy.

It's admirable that the contractors are working to address the pricing volatility, but until the industry moves through at least one more of these cycles, it is impossible to say if the stability is a result of any specific action, such as consolidation, or a by product of other factors. The building boom that preceded the last downturn for example, could easily have accounted for the more dramatic price drop.

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