Noble Drilling: A Case Study in the Pain a Drilling Ban in Gulf Waters May Cause

Last Updated Jul 9, 2010 7:00 AM EDT

Noble Drilling (NE) is one of the offshore drilling contractors with front row seats for Act II of the "drilling moratorium" drama playing in a federal appeals court today. Should the Obama administration win its bid to delay a recent ruling -- which overturned the deepwater drilling ban in Gulf waters -- the company (along with many of its peers) could find itself with rigs idled in the Gulf of Mexico, with limited options for favorable contract renewal terms.

The Interior Department has said it instituted a six-month halt on new permits for deepwater projects -- and suspended drilling on 33 exploratory wells -- to protect the Gulf of Mexico from another environmental disaster while it studied the risks of deepwater drilling, including cause(s) for the explosion onboard the Deepwater Horizon rig on April 20.

The government is asking the 5th Circuit panel for an order that would keep the moratorium in place while they appeal last month's ruling.

Average day rate prices across Noble's global rigs decreased 3.6 percent year-on-year to $187,214 for the first quarter of 2010, due to a 26 percent decline in average jack-up day rates (to $116,498). Jack-ups are drilling platforms "jacked up" above sea level using legs that can be lowered -- and anchored -- to the seabed, typically in shallow waters (depths no greater than 400-500 feet). With most of its worldwide fleet comprised of jack-up platforms (43 out of a total of 62 rigs), management had planned for stronger visibility from deepwater contracts to mitigate demand weakness for its shallow-water rigs.

Management detailed in its first-quarter 2010 regulatory filing how additional capacity entering the markets is hurting day rates:
Industry sources report that a total of 60 newbuild jackups and 72 deepwater newbuilds are planned or under construction with scheduled delivery dates from May 2010 and beyond. A significant number of these units, particularly among the jackup units, reportedly do not have a contractual commitment from a customer. The introduction of non-contracted rigs into the marketplace could have an adverse affect on the level of demand for our services or the dayrates we are able to achieve.
Rig capacity metrics also underscore the adverse impact from non-contracted supply entering the market:
  • jack-up utilization rates fell five-hundred basis points to 81 percent;
  • jack-up operating days (under contract) decreased three percent to 3,141 days; and,
  • operating rates for deepwater and ultra-deepwater vessels decreased 5.6 percent to 1,178 working days.
Noble had six rigs operating in U.S. Gulf waters, prior to the initial deepwater drilling ban. A win in the courts for the Obama administration -- i.e., a reinstated moratorium -- could have immediate negative financial implications for Noble, as approximately 30 percent of its approximately $7.5 billion in contracted drilling backlog comes from U.S. Gulf of Mexico operations. All customer contracts in Gulf waters have force majeure clauses, which are addendums excusing exploration customers from drilling agreements due to delays or defaults caused by events beyond their control. The drilling ban has prompted two customers to invoke force majeure terminations:
  • Anadarko Petroleum (APC) has asked a court to cancel its contract for an offshore rig leased from Noble, claiming the U.S. six-month ban on deepwater drilling triggered its force majeure provision. The Noble Amos Runner, a semi-submersible capable of drilling in water up to 8,000 feet deep, was contracted to Anadarko in the Gulf through March 2011, at an average day rate of $441,000 a day. Although Noble is disputing the notice of termination, the rig is currently idle (estimated lost revenue is $117 million).
  • Royal Dutch Shell (RDS) agreed last week to lift force majeure declarations -- but at a cost to Noble, specifically current contract resets. For example, the day rate for the Noble Jim Thompson is now $336,200, down from $505,000, according to company fleet status reports. Should drilling restrictions return, Noble agreed to accept significantly reduced suspension day rates from Shell, too, covering only its operating costs while the moratorium remains in place.
On June 27, Noble entered into a purchase agreement for privately-held offshore contractor Frontier Drilling. The acquisition will add six floating drilling units to the company's fleet and $2 billion (net) to contract revenue backlog -- most of it with Shell.

The agreement with Shell provides considerable future revenue visibility, including protections from the deepwater moratorium in both the short and longer-term (10- year contract deals, which provide for five-year fixed day rates, followed by five-year floating rates), according to credit analysts at Fitch Ratings.

This $2.16 billion acquisition isn't without near-term costs, however, as its debt ratio rises to 28 percent of total capitalization, up from a current 10 percent.

In addition, Noble is gambling that investing in a long-term relationship with Shell will help the drilling operator offset potentially more adverse revenue losses in Gulf waters (due to contract cancellations tied to drilling bans).

In the here and now, rental rates for deepwater rigs could drop by 20 percent in the next six months, as companies could be pressured into making more lower-priced deals because of global overcapacity and continued instability in U.S. Gulf waters.

A well-capitalized company like Noble - with the funds to diversify worldwide -- will weather the storm, though with shortfalls in coming quarterly earnings reports; but, for a smaller company with a highly levered balance sheet, such as Hercules Offshore (HERO) -- which owns the largest shallow-water jackup rig drilling fleet in the U.S. Gulf -- the revived push for a drilling ban could either sink company operations quicker than an approaching Category 5 hurricane -- or push the smaller drilling contractor into the arms of a suitor, such as Noble.

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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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