In the wake of low crude oil prices and liquidity crunch in the market, rig owners will have to re-work their strategies to secure their business and tap opportunities arising out of the prevailing adverse conditions.
After a four year dream run, oil rig companies are waking up to the hard realities of a changed global economy. With oil prices down to a third from the 2008 peak of USD150 per barrel, rig owners face a challenging environment of declining exploration and production (E&P) spend, severely impacting rig demand and charter rates.
Global scenario: from boom to bust
Between 2003 and 2007, a continued positive demand supply phase firmed up oil prices and heightened exploration and drilling activities. Spurred by demand growth, the demand for the various classes of oil rigs – jack ups, semi submersibles and drill-ships grew, leading to an increase in rig deployment rate from 81% in 2003 to 96% in 2008 . To start with, this was a much needed phase coming after a 20-year period of low investments, when the world rig fleet actually contracted by 81 rigs.
However, with analysts predicting oil prices at USD200 levels, the market witnessed frenzied activity from 2007, on the newly built side. By mid-2007, the shipyards were full with orders, as besides actual rig operators, speculative asset investors also entered the fray blocking construction yard slots.
While day rates continued to grow to USD150,000 plus levels for a 300-350 feet jack-up (a 40-50% increase from historical levels), rig construction prices also saw a significant jump – USD130-140 mn to USD200-220 mn.
Aggressive financial investors and easy leverage encouraged players to rush for building new rigs. According to ODS-Petrodata, number of offshore rigs on order has increased from a modest 29 in April ’05 to 162 as of Feb. ’09. The year 2007-08 saw 53 new rigs being delivered ; a further 36 expected in CY 2009. Of the 29 newly built jack ups expected in 2009, nearly 76% do not have contracts .
The market however has since moved substantially, with oil prices bogged down at USD 50-60 range and global E&P investments expected to contract by 11% in 2009 from 2008 levels . Following on the heels of the crisis in the international financial markets, it has forced rig rethink strategies as players come to terms with a new world of oversupply, credit freeze and eroded valuations.
The analysis of data available for 14 contracts awarded to 300-350 feet jack ups between March to May ‘09 show that charter rates declined in 11 out of the 14 contracts, with an average decline of 35%. With approx 34 jack ups (in the 200-400 feet range) without contract, the rates are likely to face further pressure as players compete on pricing to stay afloat in the face of a liquidity constrained short-term.
Shipyards have been among the first to feel the effect as newly built rig prices are expected to come down in the near to short term. Significantly, yards may expect possible defaults on some of their scheduled deliveries. Rig replacement costs are likely to also correct with reduced capacity utilization and also decline in commodity prices.
India’s reaction to the global story
In the Indian context, the situation is not likely to be as grim, with players in this market being secure to the extent of having long-term contracts with ONGC. Currently, ONGC has 30 jack-up rigs in operation, which include eight of its own rigs. With the average age of ONGC’s own jack up fleet in excess of 25 years, it has successfully adopted the charter model to meet its exploration and drilling programmes.
Some Indian players are likely to undergo short term stress – highly leveraged balance sheets on the back of idle assets may force players to look at comprehensive restructuring and may be some divestments to regain viability. Indian players also have the unique advantage of a strong financial sector. Based on a sustainable business plan, lenders are likely to agree to restructure / refinance companies in the current circumstances.
Freeze on private equity cash coupled with severe liquidity constraints in the banking system may force rig owners to also consider sale of some of their assets which are without contract, in order to liquidate their debt obligations. For larger players, it may take the form of downsizing and asset correction, as they look to sell their older assets.
For Indian drillers, the situation may also be opportune for an expansion of their rig fleets at bargain prices. Credit constrained global players – owners and yards alike – may be forced to look at distressed sales.
Indian players can look at deployment of these assets with the Indian oil and gas majors like ONGC, Reliance, GSPC, Oil India, Cairn, British Gas etc. passing on benefits on lower charter rates in return for secure long term contracts.
It’ll be challenging for Indian players nevertheless for the next 12-24 months, as the economies and financial systems adjust to the new realities. However, it’s certain that strong domestic demand and relatively improved market conditions are likely to favour Indian rig owners in successfully navigating these choppy times, towards a secure future.
Views expressed are personal
The author is an Associate Director in Ernst & Young’s Transaction Advisory Services.
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