Offshore drilling rig empires emerging to take over the industry
We’ve commented on all the offshore rig deals that have happened this year, and there have been quite a few of them. Borr Drilling, Nothern Drilling, Shelf, Ensco, and most recently, Transocean have started acquiring offshore rigs at values which may never be seen again.
What do they know that nobody else does? If you’ve been following the market over the past few years, the answer should be nothing. Dayrates have fallen by at least 50% compared to their highs in 2013–2014. Values for modern (post 2007 built) rigs have declined to 50% or less of original construction cost.
The difference between the active players and those who remain idle is that the former believe in a material, sustained improvement in dayrates (and utilization) or simply have better access to capital compared to their debt-burdened peers.
Although one could argue that this year’s deals can be viewed as out of the money today, the conclusion is simple: if you think offshore rig dayrates are going to rise, then you should be buying new rigs.
The curvature of the offshore market recovery will make or break these deals
The idea is that you don’t have to believe that the market will return to its peak to make money off acquiring rigs these days. You just need dayrates to go up enough to support your investment.
The risk, of course, lies in the curve (timing and magnitude) that rig dayrates will follow. But this risk seems to be diminishing as signs of improvement in the rig market become clearer.
According to comments made by Borr Drilling last week, “since the start of the year, marketed utilization for Independent Cantilever (IC) jack-up rigs that are less than 10 years old has improved by 3 percentage points to 72% today. During the same period marketed utilization for IC jack-ups older than 10 years has decreased 4 percentage points to 66%.”
Borr’s statement reinforces the point that demand for new rigs is rising. It’s also consistent with our views on old rigs vs. new rigs where we estimate that up to 340 old rigs could be scrapped by 2020.
Current modern rig values at around 50% of original construction cost
Borr acquired the Hercules Super A class rigs at $65 million each, and the average price they paid for the newer Transocean jackups (not including those still under construction) can be estimated to be around $135 million. This compares to an average all-in construction cost of around $230 million.
Northern Drilling paid $365 for the Norway-compliant newbuild semisub, West Mira. In August, Transocean paid around $350 million for the four Songa Cat-D semisubs (also Norway-compliant) depending on how you value the rigs’ backlog. This compares to an average all-in construction cost of over $700 million.
While current average Rig Valuation Tool (RVT) values for 6th gen Norway-compliant semis are at $350 million, we already value the West Mira (including other “Premium” Norway-compliant semisubs) at $385–426 million and the four Songa rigs at $350 –389 million.
On the jackup side, our average RVT values match with these transactions, but we see values rising further for 400ft premium and harsh environment rigs through next year.
Forecasted dayrates enough to support investments at current rig values
Two highly simplified examples illustrate why rig acquisition deals are happening now.
Consider that a “premium” newbuild 6th gen harsh environment semisub cost around $700 million to build and can be purchased for around $400 millon today. With current dayrates of $225,000, a very basic measure of cash-on-cash investment payback comes in at 34.2 years based on newbuild cost and 19.6 years based current value. If dayrates rise to $350,000 within the next two years or so, payback reduces to 10.9 years and 6.2 years.
A similar scenario plays out for jackups, where a rig purchased at $120 million today can achieve a 6.6 year payback if dayrates rise to a conservative $125,000.
We don’t consider other variables like SPS costs, additional investments, and downtime between contracts as these are constants. Ceterus paribus, the numbers demonstrate that the magnitude of the investment advantage an owner gets by acquiring rigs at today’s values is significant. And that's why – if the market develops as they believe it will – new owners and established owners who are systematically adding first class assets to their fleets will dominate the industry.
Empire-building to continue
Empires are rarely built in a day, and the clock on this cycle's downturn in the rig market won't run forever.
If more rig acquisitions occur, rig values may rise ahead of the dayrate curve, so those who invest early will find themselves even stronger in the future. The risk of rig values falling further (for new rigs) seems outweighed by the likelihood that they'll rise as oil companies continue to prefer modern, efficient rigs and the pool of supply becomes smaller.
Look for more transactions as the shakeup in the offshore rig market continues.
Data: Bassoe Offshore, companies; Image attribution: main image by Gordon Ednie the Creative Commons 2.0 License; image has been cropped