Offshore jackup drilling rig oversupply isn’t getting better. Why isn’t fleet rebalancing happening at a faster pace?
By David Carter Shinn (email@example.com); Nov. 23rd, 2016
Analyzing global jackup fleet utilization against the fleet’s age profile, it’s clear that 1) there are too many jackups in the market and 2) old assets need to be taken out of the fleet. Eventually fleet balance will return, but it’s not happening at a quick enough pace to prevent dayrates from continuing to decrease. The current situation also means that many newbuild jackups are either stacked already or destined to be stacked upon delivery. This situation has not occurred following previous newbuild cycles where new units have secured contracts before or very soon after delivery.
Jackup supply & demand
At current the oil price, there are 292 rigs on contract. Adding a 15% supply buffer (i.e., assuming a normalized utilization of 85%) gives an adjusted demand of 345 rigs. Current supply, not considering newbuilds, is 534 rigs representing an oversupply of 189 units.
Over the past few years, exploration and development drilling has decreased significantly, and cost cutting measures are still being implemented aggressively by oil companies. Aside from that, there are too many jackups in the market to balance with demand even after taking into account the ramping up of drilling programs as the oil price increases. Assuming that oil prices recover and jackup demand subsequently rises, our view is that medium to long term market balance will be achieved at around 420 jackups (360 units contracted plus a 15% supply buffer).
In addition to the current supply of 534 rigs, there are 107 units under construction, which, once delivered, will leave supply at 641 rigs, an excess of 221 units against our forecast level of market balance. Oversupply is clearly the primary factor in restricting market balance.
But what’s keeping supply at such high levels? Our view is that it is a combination of: 1) lingering demand for older rigs and 2) lack of motivation by rig owners to scrap older rigs which aren’t in demand.
(Some) old rigs are still in demand
Despite the low utilization rate in the jackup market, a significant proportion of working rigs are old. In fact, 47% of rigs built before 1990 are drilling, compared to 62% of rigs built after 1990. In addition, approximately 50 rigs under construction are essentially complete and not being delivered because their owners can’t find drilling contracts.
Markets such as the Middle East and India (which are currently the largest jackup markets) continue to contract old rigs. With less challenging wells and benign weather conditions, operators in these regions are more inclined to take older rigs rigs which are fit for purpose and can be contracted at lower rates. Markets like these create an opposing force to market rebalancing, and owners of rigs operating in these regions have little motivation to change the situation.
Furthermore, the Saudi Aramco and Rowan joint venture to own and operate jackups in Saudi Arabia, including the construction of up to 20 new rigs, will create further pressure on global jackup supply and demand.
There are 76 rigs built pre-1990 which are on contract (or have announced future contracts) at least until Q1 2018. Of these, 38 are in the Middle East and 19 are in India, and it can be assumed that almost all NOC-controlled rigs (e.g., in the Middle East) will continue to receive contract extensions in the medium term.
Owners aren’t motivated enough to scrap old rigs
There are 68 rigs built prior to 1990 which are cold stacked and would require costly upgrades to bring them back into drilling condition. Beyond these, there are another 126 pre-1990 rigs which are coming off contract during 2017.
Currently, owners of idle pre-1990 jackups – primarily in the US GoM and the Middle East – have delayed scrapping due to the relatively low cost of stacking vs. scrap value of the rigs. High transport costs, technical challenges, and the hope of future contracts also deter rig owners from dedicating time and resources to scrapping old rigs.
So how does rebalancing happen?
Eventually, en masse scrapping must take place. As the older working rigs approach or exceed 40 years of service, special survey and maintenance costs will become so high that some newer rigs will be able to compete with them even in a low dayrate environment. A smaller number of older rigs will also be taken out of the fleet for change of application (e.g., MOPUs and accommodation), although there is limited further scope for these types of sales, noting that multiple rigs have already been sold for these purposes.
But demand for older rigs will never evaporate completely. As such, attrition from the newbuild fleet will also be part of the rebalancing effort. We estimate that around 10 rigs of the 107 under construction may never be delivered. These rigs are either at very early stages of construction (and are currently “on hold”) and/or are under construction at shipyards which may not have the competence to build assets of a sufficient quality standard to allow them to be accepted by established drilling contractors and oil companies. Getting these rigs into the market may require major expenditures, and in a market with oversupply, there’s little financial incentive to purchase rigs with potential technical (and thus financial) risk.
To balance the fleet, improvement on the demand side is needed, but that’s not enough to offset the glut of rigs in the market. Resolution will only come when attrition increases to around 220 rigs. With older rigs still working and owners of old rigs not motivated to scrap, jackup market rebalancing will take several years to materialize.
In the meantime, dayrates – and utilization – will remain at low levels, but newer, higher quality assets will stay ahead of the recovery curve and be well placed for future demand, and we expect the larger international drilling contractors to continue to focus on fleet renewal once their balance sheets support such action.