Pressure Rising On Deepwater Rigs

BMI View: After a slowdown in the coming quarters, we expect the market for deepwater rigs to begin to recover over the medium term. Rig rates will suffer in 2014 from a slowdown in demand and a ramping up of supply, though increased investment in Africa and the Americas should support the market to a greater extent over the medium term.

After a strong showing in 2013, we believe that the coming quarters will see downward pressure on deepwater drilling rigs' utilisation rates and prices. Indeed, with a large number of rigs set to come online in coming quarters, compounded by a simultaneous move by E&P players to consolidate gains and limit spending, we expect demand to ease and rig day rates to fall. That said, over the medium term, with growing West African production potential and rising investment into the US Gulf of Mexico and Latin America, this should help to ensure a tighter market and support prices.

Investment Slowing In 2014

Lots Of Newbuilds In The Pipeline
Rig Fleets

BMI View: After a slowdown in the coming quarters, we expect the market for deepwater rigs to begin to recover over the medium term. Rig rates will suffer in 2014 from a slowdown in demand and a ramping up of supply, though increased investment in Africa and the Americas should support the market to a greater extent over the medium term.

After a strong showing in 2013, we believe that the coming quarters will see downward pressure on deepwater drilling rigs' utilisation rates and prices. Indeed, with a large number of rigs set to come online in coming quarters, compounded by a simultaneous move by E&P players to consolidate gains and limit spending, we expect demand to ease and rig day rates to fall. That said, over the medium term, with growing West African production potential and rising investment into the US Gulf of Mexico and Latin America, this should help to ensure a tighter market and support prices.

Investment Slowing In 2014

In the next one to two years, we believe demand for new deepwater drill rigs will ease as companies begin to rein in E&P spending. Indeed, as we had highlighted at the start of this year, many of the large independent firms and supermajors seem to be exiting the cycle of capital expenditure growth, preferring to consolidate gains from their investments as the current five-year project cycle draws to a close ( see 'E&P Capex Tapering Amidst Shifting Fundamentals', January 6). For example, Shell, ExxonMobil and Chevron have all indicated plans to reduce or keep their capital spending for 2014 broadly flat.

Announced Spending Budgets, US$bn
2013 Capex 2014 Capex
Source: BMI Research
Total 28 26
Gazprom 32 21.1
BP 19.1 25
ConocoPhillips 16 16.7
Chevron 42 39.8
Exxon 42.5 39.8
GazpromNeft 8.2 8.5
PTT (Thailand) 12 10

Moreover, the impact of this slowdown of E&P investment is only likely to be exacerbated by a spate of project delays and further softening market demand. Namely, for projects including BP's Mad Dog and Hess' Stampede (both in the Gulf of Mexico) and Block 32 in Angola, we have seen issues ranging from rising costs and slow approvals processes push back project deadlines, delaying the need for new rigs.

Meanwhile, the number of newbuilds entering the market continues to grow. Indeed, attractive financing terms and expectations of surging demand on the back of new ultra-deepwater technology had supported a noticeable uptick such that toward end-2013, Transocean was faced with 14 of its deepwater rigs coming off contract at once.

Lots Of Newbuilds In The Pipeline
Rig Fleets

These factors have begun to put downward pressure on utilisation and rig rates. According to Bloomberg data, drillships capable of operating in water depth of 4,000 feet and over have seen their utilisation rate fall from 90.9% in 2013 to 87.2% in 2014, which we expect will begin to weigh on the prices such vessels can command. Even rates in the lucrative ultra-deepwater market, which had hit almost US$625,000 a day in 2013 have fallen to US$575,000 per day this year for 'sixth generation rigs' according to Rigzone. This is likely to weigh especially heavily on those firms which have older, less nimble fleets, and thus have little ability to command any sort of market premium.

Ticking Down
Rig Utilisation Rates, %

More Attractive Longer Term Outlook

Despite our short-term cautious view, we highlight that the outlook is likely to brighten over a multi-year period. First, we note relatively promising offshore lease sales. This suggests that despite a temporary slowdown in investment, there remains a high level of interest among E&P companies in developing the US Gulf which should help to buoy rig counts. Most recently, as part of Lease Sale 231, the Department of the Interior announced that it garnered US$872mn through the sale of 1.7mn acres in the Gulf. Importantly, this was the first licensing round that major BP was allowed to participate in since 2012 following a ban put into place by the EPA for the company's "lack of business integrity" in the wake of the 2010 Gulf oil spill. We witnessed a surge of interest from the oil giant, which submitted winning bids for 24 blocks. Moreover, we also see upside to Gulf of Mexico production from a series of other projects set to come online, not least ExxonMobil's Julia, set to start-up in 2016 with capital costs of US$4bn. Indeed, while production levels are still sluggish in the region, we believe that over the medium term we will see significant growth, supporting greater demand for rigs.

Second, while delays in Nigerian offshore projects may contribute to a softer market in the short term, we note that rising demand from other West African producers are likely to offset the impact over a more prolonged timeline. Despite huge potential, our forecast for Nigerian liquids production is relatively cautious as rising incidents of oil theft and pipeline vandalism, as well as the country's failure to pass the crucial Petroleum Industry Bill have begun to deter investment. Indeed, it has been estimated by Nigerian Federal Ministry of Finance that the theft of crude oil was costing Nigeria some 350,000b/d, which equates to about US$1bn a month in lost revenues at US$100/bbl. While some companies will doubtless prefer to keep a foothold in the country and see if the situation improves, we believe others may refocus their funds towards assets which are capable of generating more stable returns.

Angola Moving Into Poll Position
Angola & Nigeria - Crude & Other Liquids Production

Nigeria's loss may benefit the rest of West Africa over the medium term though. This is especially true for Angola, which we believe will surpass Nigeria as Africa's top crude producer over the coming decade. As such, while we retain a cautious view of Nigerian production, believing it may weigh on rig counts in the coming quarters, the longer term outlook is far brighter.

Third, Brazil which has perennially struggled to see on-time delivery of rigs due to combination of stringent local content requirements and technical difficulties looks set to see an uptick in orders. While we cannot completely rule out further setbacks to drillships coming online in Brazil, state-owned Petrobras has laid out an ambitious agenda for new installed capacity, with first oil expected from a number of platforms ( see ' Delay Risks To Temper Liquids Production Gains', March 24).

Finally, we also see increased scope for an uptick in rig counts over the coming years on the Mexican side of the Gulf as investment in the Latin American country begins to tick higher in the wake of recent landmark energy reform. At this stage, the government has promised a 'round zero' in late 2014, during which time Pemex gets a one-time chance to pick which fields it wishes to keep and develop, either by itself of with international partners. Following thereafter in 2015, the first international bid round is expected to be open to private oil and gas companies. While this suggests that 2015-16 is likely a little early to see a huge upsurge in rig counts, pending the passage of secondary legislation we would expect to see some increase.

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Related sectors of this article: Oil & Gas, Upstream, Development, Deepwater, Rigs
Geography: Global, Angola, Brazil, Mexico, Nigeria, United States
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