Mark Tranfield, OCS Group
From 2008 to 2014, Chinese shipyards thought they had conquered the rig building industry by giving free finance with 5% down payment and nothing more to pay until delivery. At that time, it seemed too good to be true. Now there are countless rigs awaiting reactivation.
The attraction of this almost free financing seemed too good to miss and brought out companies that had little or no experience in rig construction and offered them the chance to make a quick buck. All these companies had to do was invest 5% of the cost of the rig and then turn it over before completion. It would be easy to sell the rig back into a market that seemed to have an inexhaustible demand at this time, or so it seemed. Furthermore, some of the new companies saw the chance to start up new rig contracting operations and to take advantage of the market conditions with cheap finance.
The rig market has always been cyclical in nature with boom and busts; however, previously the rig construction industry was required to follow normal finance management which included reasonable deposits and staged payments.
During the housing market crash from 2008 to 2012 in the US, the same principle of giving away upfront capital was applied to the customers, who wanted to purchase new homes with almost 100% finance opportunity. Unfortunately, it did not work as planned, and the housing market collapsed and went into a deep recession period.
So, what will happen now, and how are the Chinese yards going to sell the excess of rigs that former owners walked away from, leaving the shipyards in billions of dollars of debt?
Winners and Losers
Like all recessions, there are opportunities to take advantage of the situation; however, you really need to understand what you are getting into if you buy one of these rigs.
Many of the companies that jumped into this market had little or no experience in rig building. Plus, they were not investing in an operational asset. Their underlying intention was to turn over the product, at a premium of 10% or more making a quick $20 million. Their principle was to sign the contract and spend as little capital as possible during the building period without having a proper project team, which historically managed the documentation, construction, and commissioning ensuring a quality product upon completion. During the boom period, to decrease costs there was a shift of mindset and this sector has been severely affected with poor quality management and oversight as a reason of buying cheap substandard rigs – which will not to be sold easily.
The more established companies with project and operational experience played it differently. Most of these companies had good and experienced project teams in place. While this did not solve all the problems, it helped to catch much of the poor quality and ensured project control as much as the shipyards and contracts allowed. However, most of them still had extensive problems.
These rigs will generate more interest from potential buyers; however, they will still require major work to get them into operational condition. This group also is not a winner. It suffered from over exuberance, lack of financial management and risk assessment for any pending recession. However, they did end up with an asset that was possible to get into service, provided some preservation and maintenance, when the market recovered.
So, who are, or will be the winners?
It depends on your point of view. There will be opportunities when the market slowly starts to recover, and there will be winners and losers.
With the new jackup rigs costing from $180 to $220 million at the time of build, now these pre-built assets can be purchased from $80 to $90 million. This seems to offer some opportunity; however, there will be significant additional investment required to get these rigs into operational condition. Cost range will vary considerably for what preservation/maintenance, if any, from the time construction was completed. In addition, pending the expected drill location and purchasing company these assets may require upgrades or higher standards in order to be acceptable for the potential clients.
In saying this, the winners will be the companies that can forecast the market and prepare for the future. New rigs, or rigs that have not been in operation can be purchased and put back into operation from between 50 to 65% of their original costs. Most of the major equipment will require an overhaul and rectification of non-compliant items or poor practices prior to the rig being ready for operation.
Getting the rigs ready for operations and acceptable for clients include a time factor. Time expectancy will be around two to four-plus months for most of the rigs; two months for those rigs that have been maintained and four or more for those that have not.
The above factors may vary depending on the OEM availability for servicing equipment, modification if required, and deficiency if identified.
It is highly recommended to have any rig inspected before being purchased. This may sound obvious; however, some purchases take place with minimal due diligence/completed inspections. OCS Group has conducted many inspections of rigs and assisted/managed the reactivation. On inspections, the company has found deficiencies in the order of several hundreds to more than 1,000 items to be rectified. These inspections have been prior to oil companies’ acceptance of the rigs. The company has worked with both the rig owner for preparation plus contract, the oil company itself for acceptance, and classification societies.
Often, if an oil company wants to hire a rig, it will do an inspection before the hire. Once an oil company has made up the mind to accept or take a rig on contract, it will want the rig in operations with minimum delays. A reactivation may take more than four months, which may be too long for a company. In saying this, companies are now looking at longer lead-time planning (12-plus months) and preparation in many cases with some pre rig-selection being conducted now for 2020.
Companies that have rigs ready to go and operational will always have preference to win a contract for both known costs required and less problematic project delays. So, it will pay the drilling contractors to have selective rigs ready for service. In all cases, the oil companies will want reassurance that the rig is operational and will expect extensive testing/commissioning after inspections are completed. In addition to the rig acceptance, they will expect to have the crew competency assessments as many of the crew will be new hires due to previous layoffs.
Future of the Chinese shipyards
The clock is ticking for the Chinese shipyards; they have a short timeline to redeem themselves. They need to have a plan to have their rigs acceptable for the international market. These rigs should be ready to operate, inspected and tested, not only by themselves for lack of previous rig reputation, but also by an independent company to manage the process to restore some confidence.
If the shipyards do nothing, it can be expected that more of them will fall into bankruptcy in the near future, as they cannot sustain the loans and loses being experienced. There is little doubt that these yards are presently being bailed out by the government, but for how long can this support last with a crippled industry with little future, especially with the pressure on the Chinese economy?
In the coming years, it is quite likely that new rigs will be scrapped in China.
What the Chinese yards do now is up to them. However, they may find it difficult to recover from this downturn without solid investments and a strategic plan that will be only achievable with government or bank financing.
It should be noted that it does make sense for the banks or government to step in, even if they do require to invest an additional $20 to $30 million or more in each rig. If the rigs are ready for operation, they will probably sell for $110 to $120 million. They will not only get their investment back, but also potentially save an additional $80 million that may be lost if the rigs are scrapped. The important factor is that they need to be selective on the rigs to invest in. In addition, they may save several shipyards from the grave.
What are the risks with taking some of these rigs from China? Once the rigs start operations, they may start to have equipment failures and prolonged downtime. However, it can be minimized by establishing the proper reactivation plans that have cost control, good quality inspection, reactivation procedure, maintenance, and correct testing protocol.
Many of these rigs are approaching five years of age requiring re-certification and OEM maintenance recommendations with full equipment overhaul. Additional maintenance will be required to ensure that there will be minimal problems once in operation and issues to resolve as per quality building standards. The cost range could be expected between $10 million and $40 million. If modifications are required, the cost will be more.
In either case, it is the same as any downturn, only the brave or the smart will be the winners.
The future of the rig market
There will be another boom; however, moving forward it is expected there will be extreme caution from those who hold the money, as the wounds of the past five years have cut deep. There are definite signs of market recovery, and there will be a fair amount of work to reactivate stacked rigs in the near future. The year 2020 should see the return of normality to the market. This author believes it will be a good year with projects and rigs that are going back into operation. •