Cost of Offshore Drilling Rising as Fast as Oil Prices

Last Updated May 8, 2008 3:35 PM EDT

Offshore Drilling RigA supply shortage for classes of offshore rigs capable of drilling in up to 10,000 feet of water means that the daily rate that operators pay to rent a high-end, deep-water drilling rig is now $500,000 to $550,000. That's up from a day rate of $450,000 to $500,000 a year ago-and more than double the price per day on the spot market just three years ago, according to ODS-Petrodata Consulting & Research.

ExxonMobilOil, PetroChina, and other oil exploration companies should expect the extended up-cycle in day rates to rent these rigs to continue unabated. Declining yields from mature, onshore energy fields coupled with increasing natural gas and oil prices is driving the demand for global drilling activity in deep-water provinces, pushing fleet utilization rates for high-end rig counts close to 100 percent, too.

Record oil prices are lifting corporate profits to dizzying heights throughout the energy industry, with energy giants ExxonMobil, Royal Dutch Shell, and BP posting record first-quarter 2008 earnings of $10.9 billion, $7.8 billion, and $6.6 billion, respectively, up Y/Y 17 percent, 12 percent, and 48 percent, respectively.

Oil and natural gas prices, combined with full capacity world wide in the offshore rig market -- and competition for these fleets -- is hurting the back side of international oil companies, with drilling and production costs more than doubling in recent years. My own review shows that exploration and production costs in the first-quarter Y/Y at ExxonMobil, Royal Dutch Shell, and BP, rose 30 percent to $5.8 billion, 39 percent to 7.4 billion, and 59 percent to $10.0 billion, respectively.

In the aggregate, the top five drilling companies (Transocean, Diamond Offshore Drilling, Noble, SeaDrill, and Ensco International) operate about 95 deepwater rigs -- some out-of-service for repairs -- are making for an increasingly tough exploration environment, according to ODS-Petrodata. Expect full capacity -- and competition for deepwater fleets -- to hurt the backside of international oil companies through at least 2010.

On recent first-quarter conference calls, Noble and Transocean reported that all new deepwater floaters are now 100 percent committed through the end of 2009 and 2011, respectively. Transocean Inc., the world's largest offshore drilling contractor, reported: "We continue to see substantial incremental demand for appraisal and subsequent development in traditional deepwater provinces like Brazil, Gulf of Mexico and West Africa." The company noted that it was recently rewarded a contract for one well in West Africa at $630,000 a day (with a start date estimated to be Q4:2009).

Expect $600,000 day rates to become more common. Last month, Brazilian Petrobras awarded Norway's SeaDrill with contracts for three deepwater rigs worth up to $4.1 billion, with day rates in excess of $600,000.

In addition, while 60 or so new rigs are coming out of driller's shipyards between now and the end of 20011, few of these floaters are targeted for deepwater sites. For example, Transocean has eight 6th-generation deepwater rigs (12,000 - 15,000 foot water depth capability) under construction; yet, the deepwater driller is struggling to meet $34.2 billion in revenue backlog, with management saying on its conference call that some of these new contract have push-out clauses now extending to 2015.

Drilling in unconventional places, such as India, and promising new finds, such as the Tupi projects, located in waters between 6,500 and 10,000 feet in depth offshore of Rio de Janeiro, are compounding supply shortages, too.

Gregory L. Cauthen, chief financial officer of Transocean, foresees a supply shortage in this segment lasting through at least 2010.

The Tupi field is also geologically complex. The test wells that have been dug in this field are more than 20,000 feet long and are directional (non-vertical) wells. And producers had to drill through a mile-long layer of salt to access the reservoir. Salt layers are notoriously difficult to drill.

Is an era of $700,000 day rates lurking just under the surface?

  • 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.