Offshore floating rigs – from bad to worse
May 2015 | Clara Cuvelier, Luciano Di Fiori, Marcel Brinkman
Half a year ago we wrote about the upcoming oversupply in drilling rigs – due to an industry overbuild. Sustained low oil prices since July 2014, further project delays for non-economic reasons, and a freeze in exploration spending are hitting the offshore rig market beyond the softening we expected. With plenty of floaters available and more new builds queuing up to enter the market, the slide in demand is leading to market oversupply, cutting fleet utilization rates, and driving day rates even lower.
Our long-term offshore drilling rig demand and supply reference-case scenario shows that global demand for floating drilling rigs, or floaters, is expected to drop by an average of 8.4% per year in the next 2 years, before starting to show a recovery in 2017. While the trend is worldwide, the regions most affected will be Western Europe, Brazil, and North America. As an indicator of the decline in drilling activity, the number of new contract fixtures globally has seen a steady decline since 2012, with 2013 fixtures being 25% lower, and 2014 fixtures being 50% lower compared to 2012. Year to date 2015 fixtures continue this trend towards fewer contracts.
Much of the fall-off in demand is due to operators delaying development spending on new offshore projects, with more than 50 pre-Final Investment Decision (FID) deepwater projects not currently viable under a $70/bbl scenario – our reference-case scenario assumes that oil prices will stay depressed (i.e. below $65/bbl Brent) in the short-term before starting to come back up. Capital projects already under development are also being impacted by the lower oil prices, as the deterioration in operators’ cash flow drives the operators to renegotiate contracts, even for approved work.
Exploration driven floater demand is also significantly affected. Exploration budgets are more discretionary than post-FID development projects. This is why we expect the cuts in floater demand to be even sharper and more immediate, with exploration demand set to fall by double figures per year in 2015 and 2016.
On the supply side, 55% of the floaters in the backlog of rigs under construction due to be delivered in the next two years do not have a contract lined up as of today. As a result, some major drilling companies are negotiating with shipyards to delay or cancel these deliveries in order to avoid adding costs to their balance sheet and a further deterioration in their own fleet utilization rates. The current size of the orderbook is equivalent to 25% of the active fleet.
On top of the new rigs, a quarter of contracts in place for existing rigs, representing 65 floaters, will expire this year, leaving them to compete with new-builds and existing idle rigs.
The combination of weaker demand and buoyant supply will likely cause full fleet utilization to go as low as 68% by 2017 (see figure 1). Day rates correlate closely with fleet utilization rates, so as they fall, we expect day rates to do the same. Since January 2015, we have already seen a decline in average floater rates of 19%, based on the latest fixtures, with the trend particularly pronounced in the highest cost, ultra-deepwater (UDW) segment. The UDW situation is expected to worsen as new un-contracted rigs add to supply - of the 32 new-build rigs around the world without contracts, 28 are UDW capable rigs.
It is in the offshore drilling companies’ hands to re-balance the market with a supply correction in the short term, as they have the ability to tackle market oversupply by postponing their order book deliveries and retiring the oldest assets from their fleet. Although an expensive proposition, last 15 months have already seen record levels of write-offs as rig owners look to high-grade their fleets - 19 were retired in 2014, along with another 9 by March 2015 (see figure 2). We expect this accelerated fleet retirements to last until we see an uptick in demand in 2017, contributing to healthier fleet utilization levels post 2017.
If day rates and other major project costs stay low, we should observe a progressive but long-term reshaping of the industry cost structure through deflation, efficiency increase and project scope rationalization. This, itself, would help cushion the impact of sustained low oil prices on both operators and OFSE providers and contribute to their resilience.
About the authors
Clara Cuvelier is an Analyst in Energy Insights' London office, Luciano Di Fiori is a General Manager in Energy Insights' Houston office and Marcel Brinkman is a Principal in McKinsey's London office.