Behold the offshore drillers, the juggernaut in the oil and gas industry’s hottest sector. After an extraordinary 2012, the offshore sector enters 2013 with a breezy tailwind amid speculation the sector is in a multi-year secular upswing that could last half a decade – or more.

This is particularly true for deepwater, though trends have been positive for the entire offshore sector. Evidence for a bright outlook can be found in the more than 30 deepwater units capable of operating in water depths of 10,000 feet that were added to global order books in 2012, including 24 drillships. Utilization in this rig class has remained unchanged at nearly 100% of the fleet despite the large increase in the number of ultra-deepwater vessels (UDW).

The trend driving last year’s new rig orders is also responsible for the sector’s bright outlook going forward. The oil and gas industry has embarked on a significant technological revolution over the last half decade that opened access to hydrocarbon deposits that were once considered frontier. With over 120 discoveries in the last five years, deepwater exploration and development has become a routine part of oil and gas rather than an exotic outlier. For the exotics, one has to look to Arctic drilling.

The majors were a primary driver for the deepwater revolution after the companies found capital opportunities limited globally, thanks to resource nationalism and the ascendancy of the national oil companies. That secular trend is creating long-term favorable conditions for companies that supply equipment and services to the deepwater sector.

In 2012, rig rates stair-stepped higher into the $600,000 per day range for UDW fixtures and early 2013 contract announcements are finding isolated spot rates of $650,000 per day – close to average peak rates for similarly configured units in 2008.

Tightness in the highest spec deepwater segment began to trickle down through the rig classes in 2012 with mid-water rates recovering in the post-Macondo environment, though not quite to previous peak levels.

Meanwhile, utilization in the jackup sector moved back above 80% globally at the end of 2012 and contractors are busy retooling the global jackup fleet with more than 85 units added to order books over the last 30 months, including 23 in 2012. As many as 50 newbuild jackups could be delivered to market in 2013, raising the specter of excess capacity later in the year, though the counter-argument is that several of these units will replace aged, lower-spec, commodity jackups.

Globally, jackup demand is associated with the Gulf of Mexico, the North Sea, and the Middle East. In the US GoM, consolidation among oil and gas operators on the shelf in 2012 will increase incremental demand for jackups in 2013.

Pivotal Year: 2013
The offshore story is evolving with 2013 expected to play a pivotal role in a broader transformational trend. A major motivator for rig orders previously, particularly higher spec UDW units, revolved around the healthy queue of global exploration stories, mostly on both African coasts. An overwhelming majority of deepwater discoveries now awaits development, prompting a transition from exploration to development programs over the next half-decade, which will supply steady work for higher spec newbuilds.

Demand for UDW units remains widespread with emerging plays off both African coasts, Southeast Asia and even the Mediterranean. Traditionally, the Golden Triangle – Brazil, the US GoM, West Africa – accounted for 80% of UDW demand. Market share in the Golden Triangle will still dominate in the future though emerging markets in the Mediterranean and Southeast Asia will gain incremental share.

Meanwhile, deepwater demand is growing from old market stalwarts like the US Gulf of Mexico where a Bernstein Research report previously projected a 65% activity increase through 2015. Numerically, Barclays Capital Ltd. projects growth in GoM floater employment from the 30 units at work at the end of 2012 – essentially pre-Macondo levels – to 50 units by year-end 2014.

Recent data points support a bullish thesis for the GoM.

Transocean Ltd. executed a $1.4 billion settlement with the US Department of Justice in January 2013 over violations of the Clean Water Act following the sinking of the Deepwater Horizon in April 2010. The Transocean datapoint is further evidence that the GoM has entered the post-Macondo environment.

Demand for floaters in the GoM is accelerating. The US Bureau of Ocean Energy Management issued 40 permits for floating rigs in December 2012, up from 15 in October 2012.

New Offshore Business Models
Seadrill Ltd. created a master limited partnership (MLP), Seadrill Partners LLC, in 2012 to lower capital costs and pass yield directly to unitholders. The model involves dropping down assets (rigs) with long-term contracts into the MLP, which provides a predictable yield for unitholders as those contracts run their course.

Energy MLPs have been an attractive investment vehicle for upstream oil and gas operators and the midstream as investors look for predictable yield in a low interest rate environment.

Extending the model to oil services, particularly offshore drillers, is a new wrinkle, however. There is discussion that other offshore contractors are also evaluating the MLP model, though analysts have pooh-poohed the likelihood that the Seadrill example will initiate a major transformation, since many offshore drillers are headquartered outside the United States and would not qualify for the tax advantages normally associated with MLPs.

Evolution in business models extended beyond the offshore rig market in 2012 to include the innovative OneSubsea joint venture between Schlumberger Ltd. and Cameron International Corp. The agreement combines Schlumberger’s experience in completions and reservoir modeling and development with Cameron’s expertise in manufacturing and servicing subsea production systems at a very early stage in what is expected to become the most rapidly growing part of the offshore sector over the next decade.

Subsea production, which moves well processing from the deck of a floating vessel to the underwater wellhead, is a relatively new segment in the offshore sector. Mastering the process will provide the industry with an opportunity to reduce costs and increase recoveries from new discoveries, as well as provide a safer environmental alternative in reinvigorating aging offshore fields.

Contact the author, Richard Mason, at rmason@hartenergy.com.

Offshore