Shallow-Water Drilling Market Shows Signs of Life

ABOARD THE GLOMAR HIGH ISLAND IV, GULF OF MEXICO -- Slowly but surely, the Gulf of Mexico shallow-water drilling market is shaking itself back to life.

Much of the evidence so far is anecdotal. Chevron's (CHV) recent decision to make this rig, Global Marine's (GLM) Glomar High Island IV, its core drilling unit in the western gulf region, is one sign.

Glomar High Island IV
Chevron recently made this rig its main drilling unit in the Western gulf region.
Photo: Mavis Scanlon

"The intent is to keep us busy for the next year or so," says rig manager Sam Ricord, while leading a tour of the rig's engineering underbelly Monday. Chevron and Global will renegotiate terms each 90- to 120-day period, based on market conditions. Shallow-water, or jack-up, rigs typically are contracted on a well-to-well, or month-to-month basis, so the longer-term nature of this agreement is a good indication of an uptick in activity.

Other recent contracts underscore the optimism that's taken hold of the industry and its investors heading into the fourth quarter. Global also signed a 120-day contract for one of its larger jack-ups for approximately $30,000 per day, up from the high $20,000 range. Ensco (ESV) has signed new contracts in the $18,000 to $25,000 per day range for rigs that were working for $16,700 and $16,500 per day.

The increases are a welcome sign for companies like Global, Ensco and Rowan (RDC). And while these rate increases have yet to be reflected in analysts' earnings estimates, if they expand to the smaller classes of jack-up rigs in the gulf, then estimates will surely be tweaked north in coming months, possibly fueling further share-price gains.

The driller in his drillhouse
As driller, Henry Tangaere, a New Zealand native, runs operations on the rig floor.
Photo: Mavis Scanlon

Overall, there were 132 out of 186 rigs working in the Gulf of Mexico in early September, according to Offshore Data Services, a Houston publisher that tracks rig markets. That's well above the low hit earlier this year, when just 107 rigs were working.

But in order for rental rates to move up significantly, utilization for the entire gulf fleet needs to hit 80% or 85%, analysts say. Increases have already taken hold for certain classes of jack-ups, such as the large, premium-class rigs that can drill in water depths of 300 feet to 350 feet. That's hard evidence that improvements are on the horizon. A smaller pool of these rigs also has helped push rates up.

Of course, negative signs linger. International rig markets, especially West Africa and the North Sea, are still weak. Stateside, nearly two dozen idle rigs are lined up in a channel in Sabine Pass, Texas, waiting for work. And many smaller, older rigs, such as the bulk of the gulf jack-up fleets owned by R&B Falcon (FLC) and Marine Drilling (MRL), are seeing minimal or no gains yet.

Rigs lined up at Sabine Pass

Nearly two dozen rigs are stacked and idle at Sabine Pass, TX.

Photo: Mavis Scanlon

"Your smaller-type rigs are still working for between $15,000 and $17,000 per day," says Lewis Kreps, head of oil service research at Frost Securities in Dallas.

Another factor that may depress or curtail day-rate increases is the growing number of rigs expected in the gulf, Kreps says. Right now, Rowan and Global are in the process of returning two rigs each to the gulf. Diamond Offshore (DO) is also returning two rigs to service in the gulf.

As always, drilling contractors must play a game of rental-rate chicken with other drilling contractors, as well as with their customers. There's always the temptation to keep rates low to gain or keep market share.

And rates have a long way to go before they reach the dizzying heights of the 1996 to 1998 period. Rates "take about 12 months to climb, and about 12 minutes to fall," says Clay Brethour, who follows the drillers at Dain Rauscher Wessels in Dallas, paraphrasing an industry adage.

In the last upcycle, once utilization hit 85%, rates climbed an average of 3.7% per month, he says. So it could take 17 months to 18 months from April lows before utilization hits that level. In the early 1990s in the gulf, it took 20 months for utilization to climb to 85% from 35%, he explains, and when rates and utilization had crashed again by early 1995, it took about 14 months to support significant increases.

But for investors, the trend for now at least seems to be going in the right direction.

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