Burgess COMMENTARY

Peter Burgess

Offshore Driller Swaps Newbuild Drillship For Tankers As Market Crisis Intensifies

What happens in the shipyard usually does not stay in the shipyard. Talk of maneuvering and deal-making in offshore rig construction yards tends to spread quickly.

And what is happening in these shipyards right now is of great interest. Offshore drillers are under significant pressure as conditions in the offshore rig markets continue to deteriorate. Some companies with rigs on order are on the brink of financial distress as payments totaling hundreds of millions of dollars are coming due while marketing teams struggle to find respectable work for the newbuilds.

Several contractors with drillships on order are understood to be trying to negotiate deferred payments and postpone deliveries from the rig builders in Asia. This sort of action (requests for delays) has some precedent. But now one driller is charting new territory as it looks to swap rig orders for tankers.

Ocean Rig Attempts To Swap A Drillship For Tankers

Offshore brokers say George Economou is swapping one of Ocean Rig's newbuild drillships for eight tankers (four suezmaxes and four aframaxes) at Samsung Heavy Industries, TradeWinds reported this morning. The cost of the drillship rig being swapped is $728mm, well above the estimated construction cost of the 8 tankers totaling approximately $500mm.

The huge price gap between drillships and conventional ships is surely a sticking point in this reported deal. But Economou is an important shipyard client (between tankers and rigs across his interests), and Ocean Rig has four drillships on order. Brokers have also suggested that Economou has a series of options for both vessel types at the yard, a factor the builder is surely considering in the reported swap.

IMAGE George Economou

The first two Ocean Rig drillships deliver in 2015 and 2016 (the second still does not have a contract for work on delivery). The latter two drillships were expected to deliver during 1H2017 and neither are contracted by operators. One of these latter two was the rig reportedly swapped for the tankers, as steel cutting likely has not yet occurred.

Economou is a savvy player who understands the cyclical nature of offshore markets very well having made his billions in the shipping business. Shipping experiences extreme volatility linked to the supply of vessels available to meet demand. The fact that Economou now finds tanker speculation more attractive than rig building is meaningful.

Ocean Rig's 7 active drillships were delivered in better days

This deal is more likely to be somewhat of a one-off transaction rather than become a new trend. Ocean Rig's link to the tanker business (through Dryships, Cardiff Marine, and Economou) is uncommon among the offshore drillers, most of whom are pure play drilling companies. Additionally, once steel cutting has begun and equipment packages built, order swaps are a more remote possibility. In other words, only the furthest delivery slots are candidates for swaps.

A Subprime Mortgage Crisis Parallel

Even before the 50% collapse in crude, demand for offshore rigs was slowing even as an influx newbuild rigs loomed large in the shipyards. In some ways, the offshore drilling construction market of today recalls memories of the subprime mortgage crisis of 2008/2009.

In the subprime crisis, home buyers with poor credit histories were able to get into newbuild homes with almost no money down. When home prices turned on them, they quickly found themselves upside down. In offshore drilling, many speculative orders have been placed by rig owners with no history and questionable financial backing. Shipyards essentially provided cheap financing - often agreeing to zero or minimal downpayments with the bulk of the cost due at delivery (unlike prior cycles where regular installments were the norm). These rig orders were placed with a much higher expectation for dayrates, utilization, and value than what the rig market can offer today.

While no offshore driller wants to see dayrates collapse further, a construction bust might be welcomed by the established drillers. The new competition is unwelcome, and the established players may seek to consolidate distressed builders should it come to that.

1980s Reruns?

While much has been made of the oil price collapse's impact on US shale, its impact on the offshore market could be even more catastrophic absent a quick rebound. With 135 jackups, 28 semisubmersibles, and 58 drillships on order, the offshore drilling market is rapidly moving towards an oversupplied situation that could become a rerun of the 1980s. In the 1980s, construction exuberance faded into a multi-year period of oversupply.

Last week, Schlumberger forecast deepwater activity to decline 5-10% this year. Meanwhile, newbuild deliveries mean the supply of deepwater rigs will grow 12% this year and 7% next year. Falling demand and rising supply is not a good equation for dayrates and utilization of offshore rigs.

The imbalance (particularly if it is lasting) will likely cause many older rigs to be converted to alternative use, cold stacked, or retired. Meanwhile, expect plenty more maneuvering in the shipyards as distressed contractors try to squirm out of their commitments.