Shallow-Water Success Should Aid Oil's Return From Recent Depths

A consensus is growing that total offshore rig utilization will move up over the next two quarters, pushing up prices for drillers.
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Signs of life are stirring in the Gulf of Mexico's shallow waters.

After deferring drilling plans for nearly 12 months, oil companies are signaling interest in drilling new wells in water depths under 350 feet. More than two-thirds of the Gulf's rig fleet drills in this shallow water. Bidding activity for rigs has risen in recent weeks, and more companies have filed drilling plans and well permits with the

Minerals Management Service

, which oversees all offshore drilling activity.

Drilling typically follows this high-cost paperwork phase two to three months later. That's good news for companies with jackup, or shallow-water, rigs, including

Rowan

(RDC)

,

Ensco

(ESV)

,

Global Marine

(GLM)

and

Marine Drilling

(MRL)

.

Much of the interest has come from independent oil companies, which typically react more quickly to fluctuations in commodity prices. Since early March, crude oil prices have surged to over $17 per barrel from near $12 in February. Natural gas, trading at $2.32 per thousand cubic feet, is up substantially from below $1.70 per thousand cubic feet in February, mainly thanks to supply concerns. In addition, a number of drilling leases expire over the next several weeks, so companies either have to drill or lose the lease.

"If the trend in the filing of plans and permits continues, we expect day rates for premium jackups to recover to $30,000 per day by 2000, nearly double their current day rate," writes analyst Bo McKenzie of

Jefferies

in a recent report. Since mid-March, the filing of drilling plans is up 59% over the December-January filing rate, McKenzie notes.

But the current level is still well below last year's figures, says Tom Marsh, an editor at

Offshore Data Services

, a Houston-based publisher that tracks rig markets. So don't expect any big jumps in rental rates in the very near future, he says.

"In the near term, we have this $17 to $18

per barrel oil, and that is a very good level," Marsh says. "If that can be sustained through the end of the year, then the

shallow-water rig count can go up and day rates will follow, but it's not going to happen overnight. Part of it is that we have so far to recover from."

Currently, there are almost 50 idle jackup rigs in the Gulf of Mexico out of about 125. Rental rates range from under $10,000 per day to over $30,000, Marsh says, but the average is in the midteens, right about the cash break-even point. The five working for more than $30,000 per day are performing only specialized drilling tasks, Marsh adds. A year ago, the average day rate for jackups in the Gulf was $45,778 according to Offshore Data. "Historically

day rates go down fast and move up slow," he adds. "You have 50 rigs to absorb before you see rates move up."

Underscoring the harsh conditions and idle time endured by offshore drillers over the past several months are first-quarter losses reported by Rowan and Marine Drilling.

Even so, a consensus is growing that total offshore rig utilization will move up over the next two quarters from its current level of about 60%. Heading into 2000, the Gulf's shallow-water rig market could be tighter, a precursor to higher rental rates.

The more technologically advanced jackups rigs, known as premium jackups, will be the first to benefit from higher oil prices and increased drilling, says Jim Day,

Noble Drilling's

(NE) - Get Report

chairman and chief executive. As the market tightens up, say at utilization rates of 80% to 90%, oil companies look to contract these more desirable rigs first, hoping to tie them up for longer periods of time. About 110 jackup rigs will have to find work to get to that level.

McKenzie at Jefferies recently revised his day-rate assumptions for all classes of Gulf jackups, but says the high-end rigs will command higher rental rates in coming months. He sees rigs capable of drilling in 350 feet of water moving to a day rate of $28,000 in 1999's fourth quarter, 48% higher than his previous assumption of $19,800. By comparison, he sees rental rates for rigs that are only capable of drilling in water less than 200 feet moving to $17,000 per day from his previous assumption of $14,300, a move of only 18%. There's more competition for work in water depths under 200 feet.

Anecdotal information gleaned from earnings conference calls in recent weeks backs up the increasingly renewed optimism on a slow-but-sure recovery for the drillers with shallow-water fleets. As Noble's Day says, right now all the news seems positive. While he hopes that the agreement between

OPEC

members and four other countries to keep over 2 million barrels of oil off the market will continue to bolster oil prices, for him "the verdict is still out" over the next two quarters. "The next 90 days will allow me to see which direction this market will go in."