Gulf of Mexico action tightening worldwide offshore rig squeeze

Diamond M semis Ocean Quest in drydock, background, and Ocean Star, foreground, undergo deepwater upgrading by Texas Drydock Inc. at its Port Arthur, Tex., complex. Ocean Quest is shown with square blisters added to round leg columns. Also upgraded was Diamond M's Ocean Victory. All units had blisters and sponsons added, increasing their 1,500-ton variable deck loads to 5,000 tons, as well as increasing each unit's water depth capability. Photo by Christopher Studio Inc., courtesy of Texas Drydock Inc.

Robust oil and gas prices and the need to replace reserves are spurring offshore drilling activity worldwide, squeezing the mobile rig supply/demand balance and driving up costs.

Drilling action in the Gulf of Mexico is setting the pace for this trend, but the squeeze is being felt in the North Sea as well. A second part of this special report on the tightening worldwide squeeze on offshore rig supply, focusing on the North Sea, will be featured in the Dec. 2 news section of OGJ.

Strong demand and firm prices for natural gas in the U.S. are propelling jack up unit demand in shallow and moderate water depths. At the same time, the lure of big oil reserves and improved oil prices-sweetened by incentive royalty relief-are key forces behind demand for units to work in deep and ultradeep waters.

With the clock ticking on many primary-term leases, operators pressing exploration and development programs in the most prolific U.S. offshore operating theater are finding that there aren't enough rigs available for wells they plan to drill in 1997 and beyond. That is forcing exploration, production, and drilling staffs to stay flexible and move quickly to meet new offshore market dynamics.

Drilling contractors, meanwhile, are scurrying to meet operator demand. But providing specific types of mobile units to meet the current surge is not an easy proposition in a thriving market.

"The business is certainly as good as we've seen it in the last 10-15 years," said one offshore drilling contractor.

Now, because of improved prices and a reasonable expectation of near-term price stability, contractors are reinvesting more capital in their rig fleets, but principally for upgrades and conversions.

For the most part, economic hurdles required to build new premium jack up and semisubmersible units can't be met, due to the higher commensurate costs of construction and operation in an economically healthier U.S. E&D sector.

But there is a subtle upside to the Gulf of Mexico's rig market tightness: Novel methods of construction, operation, and financing are emerging that hold the long-term potential for increased efficiencies and technological advances from new, enhanced-design, jack ups and drillships.

As 1996 draws to a close, the question for Gulf of Mexico operators and contractors alike centers on how to keep up-not with low prices but with a frenetic pace of activity that they haven't had to contend with since the start of areawide leasing early in the 1980s.

Market dynamics

There is plenty of cash flow and impetus to drill and produce from Gulf of Mexico leases, with U.S. gas prices recently topping $3/Mcf and oil prices oscillating around $23-24/bbl.

Oil and gas price improvement aside, passage of the Deep Water Royalty Relief Act was a major incentive for operators to ramp up their drilling programs in 1996 (OGJ, Apr. 8, p. 30).

"You have a good, strong demand in all areas of the gulf, all water depths, and even more toward Texas now," said Gary L. Kott, president and chief operating officer of Global Marine Drilling Co.

According to James K. Dodson Co., a Grapevine, Tex., Gulf of Mexico consulting firm whose data base uses Minerals Management Service statistics, there have been 43 drilling permits issued for the year through October on leases in waters deeper than 3,000 ft. Of the total, 26 permits involved leases that have had a well drilled on each or a well was in process of being drilled.

By comparison, 22 wells were permitted in 1995 and 11 wells were permitted in 1994 in waters deeper than 3,000 ft; five in 1993; two in 1992; 13 in 1991; and 10 in 1990, according to Dodson data.

Pres. James K. Dodson said, "We were advising our clients 2 years ago to get their semisubmersibles under contract."

Dodson predicted that drilling activity in gulf waters deeper than 1,500 ft could increase appreciably, to about 100 wells in 1997 from a predicted yearend level of 45-50 wells in 1996. Forty-two wells had been drilled as of Nov. 8, Dodson data indicated.

Exploratory drilling numbers also reflect the market tightness. Data supplied by MMS indicated that during Jan. 1-Nov. 15, 1996, there were 382 approved exploration plans on record vs. 325 for all of 1995 for all areas of the Gulf of Mexico.

Approved applications for permits to drill in the gulf totaled 919 through mid-November, 519 covering development and 400 covering exploration. For all of 1995, MMS reported 988 approved applications to drill-615 for development and 373 for exploration.

Another factor propelling demand for mobile drilling units-jack ups in particular-in the gulf is work outside the U.S. During the fourth quarter, two units departed the Gulf of Mexico for the Middle East, another went to Southeast Asia, and two were scheduled to move to Mexico before yearend.

"At the margin, in the whole supply...it doesn't seem like a lot," noted Global Marine's Kott. "But it is a tremendous amount of rigs, because it's the better rigs that are going foreign."

Lease term is another driver of activity. According to NatWest Securities Corp., almost 2,000 undrilled leases in water 1,000 ft and deeper in the Gulf of Mexico will expire by 2006. But, of even more significance, 55% of those leases will expire in the next 5 years.

NatWest said, "This equates to enough gulf deepwater leases to keep 33 semis or drillships fully utilized for 10 straight years (assuming an average of 60 days/well) vs. only 130 semis/drillships in the world currently capable of drilling in water depths of 1,000 ft or greater."

Utilization rates

"The offshore drilling business is experiencing fundamental change," said J. Michael Talbert, chairman and chief executive officer of Transocean Offshore Inc., Houston.

"Floating rigs are being utilized increasingly for longer-term development work, resulting in an expanded average contract duration per rig with some operator commitments extending to the end of this decade," Talbert added.

Day rates continue to climb as worldwide demand for both jack ups and semisubmersibles grows. The Gulf of Mexico utilization rate for semis is essentially at 100%, and worldwide jack up demand is approaching record utilization levels (OGJ, Sept. 23, p. 49). According to Offshore Data Services Inc., overall fleet utilization for contracted rigs in the gulf was above 92% as of mid-November.

All but a handful of the world's 143-unit semi fleet were under contract early in November.

Worldwide, according to Global Marine data, the total mobile unit supply has continued to decline, to 543 units, while demand continues to rise, to 477 units. But only seven rigs are capable of going to work today out of the total supply/demand gap of 66 units, according to Global Marine.

As of Oct. 31, Global Marine's Score (summary of current offshore rig economics) index worldwide totaled 60% for semisubmersibles and 57% for jack ups, and the Gulf of Mexico Score totaled 51% for all mobile drilling units (see related story, p. 26). The Score rose 1.1% worldwide for the month due to increases in day rates and construction costs, according to Global Marine.

Day rates for floating units have risen by more than 300% in recent years, and rates for second-generation, 1970s-era semisubmersible units are now surpassing estimated replacement value day rates.

Day rates continue to climb for premium 300-ft water depth cantilevered Gulf of Mexico jack ups, to the $40,000-45,000/day bid level in the fourth quarter, compared with levels of $20,000-22,000/day a year ago. And rates escalate appreciably for enhanced-design units and for international work in other hot areas of the world, such as West Africa, where rates are reaching or surpassing the $50,000-60,000/day level.

Gulf of Mexico rollover rates for premium 300-ft cantilevered units have been exceeding the $40,000/day level, while 250-ft, independent-leg, cantilevered units are seeing rates of more than $30,000/day.

The contractor scene

Drilling contractors maintain the current rig availability crunch is also being aggravated by industry's recent history, including the effects of depressed prices in the mid-to-late 1980s and again in the 1990s, as well as consolidation that shrunk their ranks and fleets significantly.

Many units that were stacked after 1986 never returned to service, and constrained rig reinvestment capital was earmarked for keeping units operationally fit, leaving few if any dollars for new construction.

Since 1986, the total mobile offshore fleet has declined to 548 total units from 687, and the ranks of contractors have dwindled, to 106 in 1996 from 143 in 1986.

There were 395 mobile offshore units with U.S. ownership in 1986 vs. 317 today, and the number of units available in U.S. markets in 1996 totaled 180 vs. 256 in 1986.

For drilling contractors, there are additional complications hindering upgrades, conversions, and new rig construction-all of which adds incremental cost. Included is the rising cost of steel, due to shortages, as well as delays in obtaining operator-provided equipment. Another problem is a lack of trained and experienced fabrication-construction personnel.

Two operators' strategies

Operators are pursuing differing strategies to compensate for rig market tightness in the Gulf of Mexico.

The strategy for the U.S. unit of British-Borneo Petroleum Syndicate plc was to quickly parlay considerable North Sea experience into an initial position in the Gulf of Mexico and expand its niche operating base.

British-Borneo started in the U.S. as a non-operator, opening a Houston office in 1989. By 1993, it became a deepwater player and caught on fast as to what was occurring in the offshore rig market. Early on, British-Borneo took strategic steps so development drilling would not be delayed for its Morpeth deepwater discovery, 75 miles off Louisiana in 1,500-1,700 ft of water on Ewing Bank Blocks 921, 964, and 965.

It had acquired a 100% working interest in the blocks from Shell Offshore Inc. (SOI) in December 1995. SOI previously drilled two wells on the prospect.

Exploration Vice-Pres. Steven P. Edrich said, "As soon as we started...it became clear that we had a development project. We were going to have to lock in a rig then, by January-February 1996; otherwise, come 1997, when we were ready to do development drilling, there wouldn't be a rig available to us."

British-Borneo put Diamond Offshore Drilling Inc.'s Ocean Endeavor under contract, initially on a one-well contract for 1996, "but we moved straight into negotiating a 1-year contract term, to suit the Morpeth development wells, with a 1-year option."

British-Borneo's appraisal on Block 965 flowed on test at a rate of 6.5 MMcfd of gas and 6,000 b/d of 32° gravity oil, and it disclosed that production would be done via subsea wells tied back to a SeaStar tension leg platform designed by Atlantia Corp., Houston (OGJ, Oct. 7, p. 46).

Edrich added, "It had become very apparent if you look at what was going on in the rig market that, to have any kind of control over our own destiny and to be able to both acquire exploratory prospects through lease sales or farm-ins and then drill them, appraise them, and develop them in an expeditious manner, one rig rated to 2,000 ft wasn't going to be enough."

British-Borneo subsequently put the Atwood Hunter, an Atwood Oceanics Inc. 2,000 ft water depth-rated semi, under contract for 2 years at an $88,400/day rate, beginning in summer 1997. It has an option for a third year at an undisclosed defined price and a fourth year option based on open market prices.

Hunter is being upgraded in a Singapore yard to enable it to drill in 3,500 ft of water.

Barrett Resources Corp., Denver, is ramping up a fairly new Gulf of Mexico exploration program in shallow waters. But unlike British-Borneo, it's betting it can find rigs to put on planned wells.

Barrett has a hefty 1997 drilling program budgeted at about $74 million, primarily for drilling and some 3D seismic. In the most recent federal offshore sale, Barrett was the sale's highest bidder on a single block and was apparently successful in bidding on 19 of 22 blocks, 15 of those 100% Barrett-owned.

"My guess is that we will drill, just from this latest Texas sale, somewhere between nine and 12 (as operator) of those wells next year," said Chief Executive Officer William J. Barrett. "Plus, if you're successful, then you're going to have development. We're trying to line up rigs based on that right now."

Barrett said finding rigs always tends to be a long-range proposition; however, at this point, he said the company is not seeking long-term contracts. Barrett believes the company will be successful in finding available rigs because of the anticipated activity level associated with its planned gulf drilling program.

Upgrades, conversions

Gulf Coast area rig upgrade and conversion work is brisk from South Texas to Mississippi, with units undergoing upgrades and conversions for Gulf of Mexico deepwater and ultradeepwater or worldwide service.

Most semi work involves upgrades or enhancements to hulls, mooring systems, deck loads, deck space, cranage, drilling systems, rotary systems, and riser-tensioners, while the majority of jack up work involves cantilever conversions and associated equipping.

Texas Drydock Inc. (TDI) owns a total of six yard/pier complexes covering about 185 acres at Port Arthur, Orange, and Sabine Pass, Tex., five of which currently have work under way.

The company started seeing an activity upswing developing in mid-1995 and acquired three more yards in the Port Arthur-Sabine Pass area. It acquired a dry dock at Port Arthur owned at one time by Bethlehem Steel, as well as a 17-acre site with 1,000 ft of steel bulkhead for dockside work and the Sabine Pass site.

"We decided we needed to be prepared," said TDI Pres. Don Covington, noting that TDI has been encouraged by the amount of acquisitions and growth taking place among major U.S. drilling contractors.

TDI recently finished upgrading the first of three Diamond Offshore Drilling Inc. semis that had been rated to work in 800 ft of water. The Ocean Quest, upgraded to work in 3,500 ft of water, was delivered in September, and the Ocean Star and Ocean Victory are being upgraded to work in 4,500 ft and 5,000 ft of water, respectively.

A 300-ft Levingston 111 jack up owned by Noble Drilling Corp. is being converted to cantilever service and will work for Petroleos Mexicanos when completed.

In addition to constructing eight Maracaibo cantilevered drill barges, TDI is moving toward new jack up and semi construction. Also, it has converted four drilling rigs to production service and is aggressively working to develop contracts in the floating production, storage, and offloading market.

Another busy yard is Ham Marine Inc., Pascagoula, Miss. Carl Crawford, executive vice-president, predicted upgrades and conversion activity will stay strong for 1-2 years at least. "Then I think new construction will fall in place after that," he said, because "there are only so many rigs you can upgrade."

Ham Marine is doing one Sedco-Forex Aker H-3 design semisubmersible upgrade. The unit is having additional lower-hull pontoons installed in a 6-month project, and then it will depart for work off Newfoundland. Two jack ups in the yard are cantilever conversions. Both will work in the Gulf of Mexico when completed.

Global, Noble plans

Global Marine has plans to convert its newly acquired Polycastle dynamically assisted accommodation unit at a cost of about $200 million.

The unit has been renamed the Glomar Celtic Sea and will be converted into a drilling rig capable of working in 5,000 ft of water.

Global Marine has a 3-year commitment from a major oil company for deepwater service in the Gulf of Mexico, once the rig is upgraded. Plans call for the unit to begin service as a drilling rig in third quarter 1997.

However, for drilling contractors wanting to build new units, the "problem is one of simple economics," said Global Marine's Kott. He said the "spread," or the day rate vs. the cost of construction, is not currently aiding the majority of contractors.

"Even though the rates are rising, particularly on the shelf, you're still probably $20,000-40,000/day away of having a new jack up built."

The average newbuild cost of a premium 300-350-ft water-depth jack up in the Super 300 Class, such as Global Marine's Glomar Baltic, is about $120 million in 1996 dollars, according to Kott.

Noble Drilling Inc., meanwhile, is considering converting its eight triangular-shaped cantilever submersibles into deepwater semisubmersible units, giving the units the ability to work in as much as 6,000 ft of water. But because of the high cost involved, with some estimates placed at $500-700 million, the company needs first to obtain long-term contracts to justify conversion from the three-column, Trans- world design to a new design known as the Economic Value Advantage 4000.

New construction

In a surprisingly bullish $380 million move, Rowan Cos. Inc. unveiled plans to build two additional enhanced-design Gorilla units, the VI and VII, on the heels of the Rowan Gorilla V, now under construction at Rowan's LeTourneau yard at Vicksburg, Miss. (OGJ, Nov. 4, Newsletter).

None of the three units has a contract, but they're expected to command premium rates because they'll be capable of simultaneous drilling and production and rated to work in 400 ft of water in harsh environments.

The Gorilla V is due out of the yard in June 1998, and day rates are expected to fetch $160,000-180,000 once a contract has been committed.

Company financial strength and other factors combined to give Rowan and its lending institution a mutually beneficial way to build the rig, said Rowan Chief Financial Officer Ed Thiele. Rowan obtained a loan guarantee from the Maritime Administration of the U.S. Department of Transportation for its $153 million, 12-year Gorilla V loan through Citibank of New York. The Marad guarantee, under Title XI of the Merchant Marine Act, lowers the interest rate. Rowan obtained a floating 6.1% rate (based on London Interbank Offered Rates), and it has the advantage of fixing the rate subsequently.

Cash flow will be used entirely to pay for Gorilla VI, the next unit in line, said Thiele. No decision has been made yet on how to finance Gorilla VII.

Meanwhile, the company has channeled about $20 million into improvements at its LeTourneau complex for rig component upgrades. "We think we'll have the capability of delivering 2 rigs/year" ultimately, said Chairman C.R. Palmer.

Turnkey drilling

Most turnkey contracts involve wells being drilled on the Outer Continental Shelf.

Global Marine's Applied Drilling Technology Inc. (ADTI) turnkey unit had robust activity to end the third quarter. About 95% of ADTI's work is carried out using jack ups.

To support increased drilling activity, ADTI has contracted for 12 jack ups from other companies for periods of 6 months-1 year. Eleven of the rigs are in the Gulf of Mexico, and one is in West Africa. Another two rigs will be needed. Also, it has commitments on 5-6 additional rigs that are not under long-term contracts.

ADTI expects to drill more than 80 wells in the Gulf of Mexico this year; through the end of October, it had drilled 64, and 82 wells were projected to be completed by yearend. Predicted ADTI Pres. Douglas K. Vrooman, "We should be the No. 1 driller in the gulf this year, surpassing Shell."

"The problem is getting rigs," Vrooman added. "Even though I've got 12-14 rigs, the customers want even more than I have. Last year and the year before, we did quite a bit of deep water (work) from 300 ft to 2,100 ft," said Vrooman, "but right now the majors have tied up all the semis, and we couldn't get one for a spot market if we needed one.

"You're almost inclined to do a long-term contract with a floater just to get it. Then you're up in the $100,000 range for a well, and that's a gamble."

Outlook

For the foreseeable future, deepwater and ultradeepwater action in the gulf will hold the activity center stage, followed by steady activity levels in shallow and moderate depths.

If prices hold, activity levels could intensify, which is prompting operators to look at novel ways to get their wells drilled at the least cost and risk.

One such project is the recently announced Conoco Inc.-Reading & Bates Corp. ultradeepwater 50-50 joint venture. It covers 60 Gulf of Mexico ultradeepwater leases using a new, first-of-its-kind, dynamically positioned drillship (OGJ, Nov. 11, p. 34).

Projections by Petrodata Inc., Aberdeen, indicate overall demand for deepwater units worldwide could double by 2000 from 1994-95. After 2000, even more worldwide demand growth is likely. Projections are based on Petrodata's model, using current success rates and conservative estimates on wells required for appraisal and development drilling, typically, in deep water.

According to Simmons & Co. International, there has been a 70% increase in the number of deepwater leases in depths of 2,600 ft and greater just during April-September.

Said Pres. Matthew R. Simmons: "A rough estimate of deepwater rigs needed in the Gulf of Mexico alone indicates the current supply needs to triple."

Copyright 1996 Oil & Gas Journal. All Rights Reserved.