Smaller Offshore Drillers Find a Niche
Chris is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Typically, a company would have to own quite a few assets to have a billion dollars worth. In the offshore drilling sector, a new drilling asset costs between $200 million (Jack-up rig) to over $600 million (Ultra Deepwater (UDW) drillship). A company could own just a pair of Jack-up rigs and a UDW drillship, or a couple of UDW drilling assets, and have over a billion dollars in assets. This article focuses on three smaller companies, each with less than 10 drilling assets, working to carve themselves a niche in the offshore drilling sector.
The first company is Ocean Rig UDW Inc (NASDAQ: ORIG), owner of six operating assets (two UDW drilling rigs, four UDW drillships) and three newbuilds (all UDW drillships). Ocean Rig UDW Inc. (or Ocean Rig going forward) is currently a subsidiary of dry bulk shipping company DryShips Inc. (NASDAQ: DRYS). The history of Ocean Rig is important because it might help explain why the company is valued the way it is today. The company was established in 1996 as Ocean Rig ASA, and for the first 10-11 years focused on acquiring & operating two UDW submersible rigs, Leiv Eiriksen and Eirik Raude. Dryships Inc. initially acquired a minority stake in Ocean Rig ASA, but in 2008 acquired the rest of the entity. After the Ocean Rig ASA acquistion, Dryships Inc CEO George Economou ordered a pair of new UDW drillships for the company, and another pair for a private entity he operated.
These events occurred just before a major downturn hit the shipping industry, in particular, the dry bulk shipping sector. Dryships Inc. took many steps to survive, including multiple stock offerings that severely diluted the company shares, including one offering that folded all the UDW assets into Dryships Inc. All told there was probably at least a 600% increase in shares between late 2008 and early 2011. Ocean Rig got listed, in Norway first, and then obtained a US listing in October 2011. Things had been rough for the company in early 2011, but a major event in May 2011 changed the company's outlook significantly. The company secured a $1.1 billion contract with Petrobras involving two newbuild drillships. That opened the door to financing, refinancing, and an additional vessel order.
Ocean Rig announced Q2 results on 8/16. The company indicated it had signed letters of intent (LOI) with three oil majors involving three UDW drillships, deals worth $2.2 billion. This significantly improves the company's backlog, taking the backlog from $2.6 billion to $4.8 billion. The company is also finalizing the remaining $1.35 billion financing for all three of its UDW newbuilds. I think financing is one of the major issues that tripped up Dryships Inc in the past. So the fact that the company is behaving responsibly with regards to Ocean Rig is a positive. In some ways they have to do so. Dryship Inc. still own about 65% of Ocean Rig's shares, and it represents a cash-cow to them.
The second offshore drilling company is Pacific Drilling S.A (NYSE: PACD), a Luxembourg based company with a management team experienced with offshore drilling. The company owns and operates four UDW drillships and has ordered three additional UDW drillships. Pacific Drilling took delivery of its first owned drillship in August 2011. Prior to this, Ocean Rig claimed it was the only pure-play UDW drilling company, and the claim had some merit. Now, both companies share the claim.
Pacific Drilling's operating fleet has contract coverage for all four operating drillships that cover the remainder of 2012, and all of 2013. If extension options are exercised on a couple of vessels, all of 2014 would also be covered. Just recently, one of its newbuilds was awarded a five-year contract with Chevron (NYSE: CVX) commencing in Q2 2014. More details on the fleet status can be found here.
Pacific Drilling still needs about $1.6 billion to cover the newbuild capex, over half of it due in Q3 2013-and-beyond. However, two drillships delivered within the last six months, so both are just beginning to ramp up operations and deliver to the top and bottom lines. In addition, the latest contract award, worth a little over $1 billion over five years, bodes well for the company. These items should help in financing negotiations. The company has a niche in utilizing dual-gradient drilling. The company utilizes this process for, at least, its two contracts with Chevron.
Unlike the two previously mentioned drilling companies, the third company is not a pure-play UDW drilling company. Actually, it doesn't even have a formal listing on a major US Exchange yet. But a US listing is supposed to be in the works. About 18 months ago, Seadrill (NYSE: SDRL) segregated some of its assets into a subsidiary, North Atlantic Drilling Limited (NADL). Seadrill then completed an equity carve-out, keeping a 77% interest and selling the rest of NADL to Norwegian investors. Currently, NADL's shares trade on the over-the-counter market as NATDF.
Initially, the assets were 2 + 2 + 2, or:
2 UDW assets (1 UDW drillship, 1 UDW driling rig)
2 mid-water floaters (max. water depth of 2,000 feet)
2 Heavy Duty, Harsh Environment (HE) jack-up rigs
A few months later, NADL were awarded a contract by ConocoPhillips and placed an order for an additional Heavy Duty HE Jack-up rig. This newbuild will deliver in late 2013, and start operations in the first half of 2014. In March 2012, NADL completed a $300 million private placement, with half the shares allocated to Seadrill. Some of the proceeds from this offering were used to cover the initial payments on a new HE submersible UDW rig, with expected delivery in Q1 2015.
Not all of NADL's rigs are UDW drilling assets. However, all their drilling assets are specialized assets, able to handle harsh weather conditions. Norway, where five of NADL's six existing vessels operate, has much more stringent requirements for operators. HE Jack-up rigs are typically more advanced, and thus more expensive. For example, NADL's newbuild Jack-up rig, West Linus, costs $450 million. That is more than twice the price of an ordinary Jack-up rig. Of course, these premium Jack-up rigs also have higher contract day-rates. Like Pacific Drilling, all of NADL's operating vessels have contract coverage for the remainder of 2012, and all of 2013.
Unlike the other two companies, NADL, like parent Seadrill, does pay a dividend.
To summarize the three smaller offshore drilling companies:
1. Ocean Rig UDW, a UDW drilling pure-play with a majority owner who has completely trampled over shareholders
2. Pacific Drilling, a UDW drilling pure-play with experienced management and a new fleet
3. North Atlantic Drilling Limited, a mixed fleet to take advantage of a more complicated work environment
All three offshore drillers have contracts with oil majors, and the length of contracts suggest all three can compete with their larger counterparts.
I own shares of SDRL and COP. I hold no positions in ORIG, DRYS or PACD, at this time. The Motley Fool owns shares of Seadrill, Ltd. Motley Fool newsletter services recommend Chevron and Seadrill, Ltd.. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.