Where next for the floating rigs market?

Having enjoyed a period of sustained growth the floating rig market has cooled, significantly. New fixtures have evaporated and the few that have been inked have been agreed at significantly lower rates. Competition for tenders has been fierce as a greater number of managers have vied for fewer contracts. To make matters worse, the current environment of demand erosion has coincided with rapid supply-side growth, with utilisation being hit hard as a consequence. With negative pressures persisting on both the supply and demand sides, many market participants are wondering how far the market will fall and when a rebound should be expected.

The offshore industry has long been at the whim of the global economy. On several occasions the market has seen periods of sustained growth followed by acute contraction, the global financial crisis being a prime example. Indeed, the global recession of 2008/09 ended a period of record charter rates and rig counts as assets were laid up en masse amid a commodity price collapse. Despite the severity of the downturn it was short-lived, and as oil prices rallied so to do did investment in deepwater E&P with rig rates and counts following suit. This positive post-recession environment encouraged asset investment, with new players entering the market and incumbents renewing and expanding their fleets.

The latest downturn has had a very different feel. Even before the price of oil began to slide operators margins were being squeezed as a stagnant (albeit high) oil price was met with increasing costs. Consequently, less profitable projects were postponed and exploration budgets cut. The situation deteriorated in the second half of 2014 as global oil demand failed to keep pace with supply and the price of Brent tanked. As of July the oil markets remain oversupplied and the outlook remains uncertain. Indeed, output from OPEC, Russia, the US and Brazil continues apace and gains in Iran are beginning to seem increasingly likely. Brent is unlikely to recover far beyond the US$60 per barrel mark until excess supply is whittled away. Even when a concerted recovery is established, any gains will likely be capped by US onshore tight oil production, the new swing producer. It is hard to see Brent rebounding anywhere near US$100 per barrel anytime soon.

Figure 1: New fixtures for floating rigs (Source: InfieldRigs)

The turmoil of the past 12 months has had a profound effect on the drilling markets. The number of floating rig fixtures has plummeted and average contract durations have shortened, see Figure 1 above. Indeed, just 35 new contracts were signed in the first six months of 2015, many of which related to short-term work or single well programmes. Whilst a handful of more significant fixtures have been signed, a more telling trend has been the renegotiation of current contracts, often for extended duration, as seen with Oranje-Nassau Energie’s deal with Paragon for the C461 jackup.  More worryingly the market has seen many assets idled and a number of contract cancellations, illustrated by BP’s termination of the West Sirius contract, thereby slashing some US$160 million from Seadrill’s backlog. Other high-profile causalities have included the ENSCO DS-9, ENSCO DS-4, Belford Dolphin, COLSLPioneer and Stena Carron. If low oil prices persist the market may well see further examples of premature contract cancellations.

The recent scarcity of new fixtures has meant many rigs rolling off contract have been idled. As a result utilisation rates have plunged and drilling contractors have begun to retire their older less capable rigs. Cold stacking has been a common theme also, and not just for ageing assets. Indeed, ENSCO took the bold decision to stack the 8501 and 8502 semis in order to reduce operating costs until market conditions improve.

According to InfieldRigs data, 51 floating rigs are ready stacked as of July, up from 17 this time last year. With few contracts being signed and many nearing completion, the number of idled assets is expected to increase through 2015 and 2016. Indeed, Figure 2 below shows visible contracted demand (including options) for drillships and semisubs. Current visibility indicates that a minimum of 37 additional floaters will roll off contract this year (assuming all options are exercised), significantly adding to the idled fleet. As a result utilisation will fall further and contractors will be encouraged to remove their less competitive assets from the market.

Figure 2: Contract Gantt Chart(Source: InfieldRigs)

On a regional basis, the majority of the idle fleet is currently situated in South East Asia, the Mediterranean, the US Gulf of Mexico and West Africa. Looking ahead through the remainder of 2015, the North Sea, North America, West Africa and Latin America are expected to see the lion’s share of rigs rolling off contract. 

The number of contracted floating rigs peaked at 275 in September 2014 and has since been in relatively steep decline, with July’s count standing at 230. The steepest declines have been witnessed in Brazil (down from 63 in Sep-14 to 51 in Jul-15, though the market has fallen from 79 at the beginning of 2013), West Africa (down 10 from 39 in Oct-14) and South East Asia (down 6 from 13 in Sep-14).

Figure 3 below shows the floating rig count trend from January 2010 to present day, with three renewal-rate sensitivity scenarios for the coming 12 month period. Current visibility (including new builds, 100% exercised options and no renewals) shows the fleet count to continue to fall to 192 contracted drillships and semisubs by June 2016. The three alternative views, based on the same assumptions as above but with contract renewal rate set at 15%, 30% and 50% respectively shows the fleet to fall to 201, 210 and 223 respectively by mid-2016.

Figure 3: Rig counts with renewal rate sensitivity(Source: InfieldRigs)

Whilst the above assumptions are simplistic in nature, they are grounded in real data and illustrate the likely trend over the next 12 months. However, in reality we may see far fewer options being exercised and a higher rate of renewals, with significant variation from region to region. Moreover, as the current downturn persists the market may witness further contract cancellations, putting further downward momentum on counts. One certainty is that the rig count nadir always lags the oil market downturn, so further declines should be expected so long as Brent remains below US$60 per barrel.

The floating rig market has fallen hard and current evidence is indicative of harder times to come over the next 12 to 18 months, and possibly longer. Consensus suggests that Brent will average around US$65 per barrel in 2016, not high enough to encourage any significant volume of contracting activity or E&P budget increases. The market is therefore likely to remain supressed through 2016, with a tentative recovery expected sometime in 2017. Indeed, given the long-term nature of this latest downturn the market is unlikely to see rig counts reach their previous highs until 2019 at the earliest.