It Lost an Oil Rig, but Transocean May Easily Ride Out the Gulf Oil Spill

Last Updated May 13, 2010 9:19 AM EDT

Transocean (RIG), operator of the Deepwater Horizon rig that exploded and sank last month, looks to have adequate liability coverage. Looking ahead, however, a looming ecological disaster could threaten Gulf of Mexico rig operations, a significant revenue source for the company.

The cause of the April 20 disaster, in waters some 41 miles off the coast of Louisiana on BP's Macondo exploratory well, remains unclear. Nonetheless, with more than 5,000 barrels of crude still spilling into the Gulf each day, the blame game has begun:
  • Majority owner of the well, BP America (BP), said before a congressional hearing that as operator of the semisubmersible rig, Transocean (RIG) "had the responsibility for the safety." Investigators are suggesting a cascade of failures led to the explosion, fire, and subsequent sinking of the rig. Federal and BP engineers are seeking to determine why the blowout preventer (BOP), which sat atop the Deepwater Horizon well, failed to activate as designed when a sudden surge of gas into the wellbore hurdled toward the surface. The BOP is a series of large valves that shut -- a failsafe measure -- when pressures from the wellhead surge toward the surface. In testimony before a House sub-committee, Transocean has acknowledged making "extensive modifications to the BOP -- which BP will likely look to turn to its advantage.
  • Transocean, in turn, is pointing an accusatory finger toward Halliburton (HAL), questioning (a) the integrity of cement used by the oil service contractor to encase the undersea well's piping and (b) the decision to displace drilling mud within the well opening with seawater, which is much lighter than mud, before attempting to temporarily cap the pipe opening with a cement plug. The purpose of the mud is to weigh down any fluids or gas trying to push upward.
Federal investigators, in my my opinion, ought take a look in the mirror before assigning ultimate blame. Washington bureaucrats knew when the license was granted to BP and its partners that the Deepwater Horizon rig would be drlling at untested depths in the Gulf of Mexico -- a record depth of 35,050 feet, including more than 4,100 feet of water.

"It is impossible for a man to learn what he thinks he already knows," said the first century Greek philosopher Epictetus. Unfortunately, given the outsized egos of those in Washington, I don't expect much self-reflection coming from federal investigators. To the U.S. Interior Department's Minerals Management Service I say, "Shame on all of you too!"

Although the investigation into the accident is still in the early stages, standard industry practice is such that unless BP can prove gross negligence by Transocean and Haliburton, it and minority interest-holder Anadarko Petroleum (APO) bear ultimate liability for clean-up and recovery costs for the environmental damage resulting from the spill, not to mention likely punitive damage payments to all affected parties, such as fishery and tourism industries.

Transocean has contractual indemnification from BP that protects the rigger from subsurface risks associated with the loss of control of the well, such as blowout or cratering, the cost to regain control of -- or re-drill the well -- and associated external costs, such as environmental damages resulting from and assessed fom the spill, according to its regulatory filings with the SEC.

Transocean does carry $950 million of third-party liability coverage exclusive of the personal injury liability deductibles and third-party property liability deductibles, too.

Subsequent to the April 22 sinking of the Deepwater Horizon, underwriters declared the vessel a total loss and, as of May 5, 2010, issued $401 million as partial payment toward expected insurance proceeds totaling about $560 million (less a deductible ranging from $0.5 million to $1.5 million).

Unfortunately, the rig wasn't indemnified or insured against loss of revenue. Transocean estimates that cessation of the performance contract for the rig, which ran through September 2013, will result in lost revenue of $590 million (recorded backlog).

With respect to operating outlook, the Deepwater Horizon disaster couldn't have been more ill-timed. Save for deepwater floater prospects (water depth capabilities of 4,500-feet plus) in the Gulf of Mexico and other key markets (such as, West Coast of Africa, Brazil, and India), demand for shallow-water jackups is still on life-support: year-on-year utilization rates declined 36 points to 53 percent; average daily revenue at quarter-ended March 31 slipped 15 percent to $133,100 -- compared with an 8 percent increase in ultra-deepwater day rates to $486,000; and, as of April 13, 2010, 23 of its 66 jackups were still stacked onshore.

As of April 13, 2010, after adjusting for the loss of Deepwater Horizon, Transocean had 44 of its 48 current and future deepwater floaters contracted through the end of 2010, with 32, including all of its newbuilds, contracted beyond 2011. However, 14 of these deepwater and ultra-deepwater floaters were contracted for operations in the Gulf of Mexico. The longer it takes to cap the oil spill, the greater the likely public outcry for a moratorium -- or at least short-term delays targeting wells-in progress -- for offshore drilling activities in the Gulf. At least until new safety protocols are put in place.

A drilling slowdown in the Gulf and subsequent relocation of rigs to other active global markets could result in a worldwide supply glut, forcing day rates and utilizations downward. Transocean's balance sheet, however, is healthy enough to ride out any stormy interruption or temporary work stoppage in the Gulf of Mexico: liquidity includes cash on-hand of $1.6 billion, access to a $2 billion in revolver credit (no foreseeable loan covenant issues), additional cash from $1.1 billion available on a $1.5 billion commercial paper program, and trailing 12-month free cash flow of about $2.5 billion.

During 2010, expected capital expenditures are estimated to be approximately $1.4 billion -- actual level is dependent on contractual re-imbursements to be determined with customers. In other words, should drilling activity in the Gulf freeze-up, the company has the flexibility to redirect much of this capex toward debt-service reduction. At March 31, long-term debt was $11.9 billion, with no more than $2.4 billion scheduled to mature each year out to 2015.

As the world's largest offshore drilling contractor, short of being found grossly derelict in the contractual performance for Deepwater Horizon, there are many other harbors worldwide that Transocean can seek shelter in during the political maelstrom currently brewing in Washington DC.

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  • David Phillips

    David Phillips has more than 25 years' experience on Wall Street, first as a financial consultant and then as an equity analyst for several investment banking firms. He sifts through SEC filings for his blog The 10Q Detective, looking for financial statement soft spots, such as depreciation policies, warranty reserves and restructuring charges. He has been widely quoted in outlets such as BusinessWeek, The International Herald Tribune, Investor's Business Daily, Kiplinger's Personal Finance, and The Wall Street Journal.

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