Shale won’t replace deepwater, but offshore industry must reengineer value chain to reach economic parity with onshore

Meanwhile, contractors must remain vigilant on maintenance, look to innovations such as MPD and smart stacking to stay competitive

By Linda Hsieh, Managing Editor, and Alex Endress, Editorial Coordinator

Chris Beckett is CEO of Pacific Drilling. Mr Beckett is also a member of the IADC Executive Committee.

Pacific Drilling focuses solely on the ultra-deepwater market. What are the most critical issues that you see in this space?

We are still in the middle of a pretty substantial newbuild cycle. I think we knew, as an industry, that we were going to deliver more rigs than were needed, although a number of these rigs were expected to be replacements for older rigs that needed to be retired. However, we probably didn’t anticipate the surplus to be quite as large as it became. And when the market declines as it has now, it becomes that much harder for contractors to retire old assets if companies are making any kind of margin with them.

While it is clear to the whole industry that we need to rationalize the fleet by scrapping old rigs to make room for the new rigs, it’s a sort of classic tragedy of the commons because no individual company wants to be the one that has to shrink. For that reason, it’s taking longer than we would hope.

As a whole industry, I think we’ve had 60 floater rigs taken out of the market so far, which is a fairly substantial proportion of the fleet, although we probably need to remove even more. Over the next 12 months, I think we’ll see another 40 to 60 rigs leave the global fleet. There will be an element of natural selection as operators decide to contract newer rigs.

Is it smart in this environment for contractors to cold-stack older rigs that can’t find work, or is it better to scrap?

It’s a lot easier for companies to consider cold stacking rather than scrapping because scrapping is final. However, when you’re talking about a 30-year-old rig, the reality is that cold stacking is pretty final, too. It’s extremely expensive to bring old rigs like that back to working condition.

At Pacific, we use something called smart stacking, which doesn’t necessarily fit with any of the historic stacking models. For us, a smart stack is idling the rig in a way that gets our cost down below $40,000 a day, but there is no capital cost to put the rig into the stack or take it out of the stack. We can both put it in the stack and reactivate it in less than 90 days. We maintain the equipment and turn the rig on periodically to make sure everything is working, but we go down to the minimum manning requirement, which is 12 to 15 people onboard.

It’s relatively easy for us to ramp that back up to a full operation, and we’re able to do it because we only have new rigs. For example, one of our rigs is, unfortunately, going into that mode straight out of the shipyard. It won’t require much work to reactivate. Another rig recently finished a three-year contract with Petrobras in Brazil, and we then spent about three months doing maintenance. Both rigs will basically be in new condition by the time we smart-stack them.

Cold-stacking the latest generation of cyber rigs is not something anyone has really had to do yet, and there is a level of uncertainty about what it will take to bring them back. From our standpoint, we’re getting as close to cold stacking as we can without actually shutting all the systems down. That way we know what we are dealing with when we try and bring them back up again.

When we first started talking about this kind of approach to stacking, the general perception was warm stacking was going to cost $80,000 or $100,000 a day. We’ve been able to get to half or less than half of what anyone was expecting it would cost us to keep the rigs in that condition.

In the midst of today’s downturn, what are the main challenges associated with drilling in deepwater?

Deepwater drilling is inherently on the leading edge of oilfield technologies. When the market is favorable, there is a tendency for all sorts of new technical solutions to be brought to the table. The downside is that some wells become over-engineered and optimized without the same consideration for cost. When the oil price collapses, a lot more cost discipline comes back to the table.

A lot of technological advancements have been made in the past 10-plus years while we’ve been in a good market. In a downturn, we reconsolidate and come back to a much more standardized solution and with a much greater focus on the cost. The drilling industry has been going through that sort of reconsolidation over the past 18 months and will continue to go through it in 2016.

In deepwater, everything has a long lead time, so even though the focus on cost began about 18 months ago, it will take another 12 to 18 months before you see a major effect on the drillship market. You can already see a lot of the major projects getting revisited and reengineered. You see the operators turning to much more standardized, prepackaged solutions instead of the bespoke, optimized solutions they might have used before.

In the deepwater market, rig rates are half of what they were, but the real saving opportunity will come from the reengineering of the whole value chain. My expectation is that the industry will bring development costs down by 30-40% across all services and products that are required in the deepwater market. At that point, you get back into economic parity with onshore drilling, which has seen savings come in much quicker.

There has been lots of talk about how shale may beat out deepwater, but I don’t believe that shale has the potential to replace deepwater in the world’s oil supply. For a major oil company, drilling small shale wells will never deliver the impact on their balance sheet that a major deepwater discovery can. Frankly, deepwater is a necessary part of the future.

Many are worried that China’s economic slowdown will have a negative impact on oil demand. However, the reality of our business is that it’s not about demand growth anymore. It’s about replacing the decline curve, and the decline curve is five-times the impact of the growth. That’s not going to be possible without every element of the oilfield getting a lot more attention than it currently is.

It took five years to grow US shale production to 5 million barrels, and that growth won’t keep repeating itself. It’s impossible for shale to make up the loss of deepwater. We’re going to need all the sources of oil that we can find and develop. The costs will have to work, and that means the oil price probably has to come back up somewhat. Prices don’t necessarily need to be $120 per barrel. If the industry can reach 30-40% cost reduction, I think the balance point will probably range from $70-80 per barrel. However, we may still be a couple of years away from that, and in the meantime, we have to survive.

How can the industry work together to promote better asset integrity while cutting costs?

When a rig is working extremely effectively, the last thing the client wants to do is stop for maintenance. But if you never change the oil in your car, it will eventually stop running, and drilling rigs are no different. One of the biggest challenges is making sure everybody is aligned on taking the necessary maintenance time for long-term success versus short-term time savings.

This understanding happens more easily under extended-length contracts. A five-year contract means that it becomes the client’s interest to make sure the rig is reliable, but those extended lengths become harder to come by in a down market like this.

These are all things that we’re going to have to work our way through. In this downturn, the pressures that the contractors will get to minimize costs are going beyond simple dayrate conversations. It’s also going to what will be perceived potentially as nonproductive time for a client to the benefit of a different client down the road. However, if everyone took that point of view, all would suffer from rigs not being maintained down the road.

At Pacific, we try very hard to stick to our procedures on maintenance. Even if we have to take unpaid time off of a contract in order to do that routine maintenance, we know we’ll take a lot more unpaid time later if we don’t do it.

Do you see a need for OEMs to “have more skin in the game” when it comes to deepwater drilling?

I think every driller in the world will tell you they would love the OEMs to have more skin in the game in terms of their exposure to the downside of the risk that their equipment may not be reliable. I think OEMs would tell you that their problem is lack of visibility. The drilling contractors, historically, are not very good at sharing data. Therefore, OEMs will claim they don’t have enough knowledge to understand the issues behind the equipment failure. At Pacific, all of our rigs have a similar drilling package, so we’ve made a point of being much more open with our supplier than is probably the industry norm. We recognize that it if we don’t show them what’s wrong, we can’t expect them to fix it in order to avoid more problems.

If you want OEMs to give up their aftermarket sales revenues, you’re going to have to replace that with something else, maybe aftermarket use revenues. I think operators would be happy to pay more to ensure reliability, and most drillers would be willing to pay more if we knew we were going to capture more of the revenue that’s normally available to us.

The downturn hurts such ideas, however. A downturn tends to hurt innovative business models because there just isn’t enough money to go around. Still, I think a push from regulators is going to insist we do some of this. There’s already a group of ultra-deepwater drilling contractors that is working to create a collective database of all of the BOP maintenance and failure issues that we experience. We’re working in conjunction with IADC, an operator group and the OEMs. The goal is to provide more data to the OEMs to improve reliability, but eventually we hope it will also become something that we can provide to regulators.

If this works, and it should work, it will create a template by which we can start to do this with other pieces of equipment and elsewhere in the industry.

Pacific has been a leader with the adoption of dual-gradient drilling (DGD). Are you seeing emerging technologies like DGD being pushed aside more because of the downturn and aversion to risk?

We see DGD as a type of MPD, and I think MPD is likely to become the accepted and required way in which we drill wells going forward. I think a downturn like this may actually help to accelerate that transition because it will become a much bigger differentiator between those that can do it and those that can’t. To remain competitive in a market where there’s less demand than supply, there’s no question that MPD in whatever form will help make the whole drilling process more efficient and more reliable.

That said, a dual-gradient solution is a much more involved and costly exercise than a simple MPD product. Equipping your rig to be able to accept MPD equipment is relatively easy to do. The last four rigs we delivered have the hookups ready to go, so we can add MPD to the rigs without having to take them out of service. We don’t have the MPD kits onboard at this point because we simply haven’t had sufficient demand to justify it, but that may come soon.

I think everybody will want to understand it better because it is becoming increasingly common in tender requests. As with everything else, it’s more money to spend at a time when don’t really want to have to spend it. But if it ultimately leads to a more efficient, reliable and safer industry, then it makes sense.

How do you think this downturn will change the landscape of the drilling industry?

We see the market getting better and demand coming back in 2017, although the pricing will likely not pick up until we’re rolling through 2018. By then, we will have been in a down market for four years, and that’s going to have profound implications for the industry. We’ll all be much leaner and more cost efficient than we were going into the downturn.

From your personal perspective, what can the industry do differently this time so that we come out of this downturn a little bit better?

Drilling companies have changed quite a bit in the past 10 years. Many drillers have gone outside of the drilling space to find new leadership teams and brought in people from other related industries who could bring in a new way of looking at things.

As an industry, we have historically been driven by the cycle. When the market is bad, everyone retrenches desperately. When the market is good, everybody expands far too fast, which drives the next downturn. Somehow, as an industry, we’ve got to try and find a way to smooth these cycles a little bit. I think it comes down to the business models and the relationship with our clients, which has to become more collaborative.

Somebody once told me the best negotiations happen when neither party is happy and neither party is really unhappy. When a drilling contract negotiation ends with one party really unhappy, that’s a sign that one side has taken too much out of the other. If we can find a way to mitigate these cycles, the industry will be better set up to focus on a lot of things we all know need to happen – the greater focus on efficiency, on improvement of the drilling process and finding new ways to make deepwater drilling more economically attractive, relative to shallow water or onshore equivalents. These things all require a relatively long-term viewpoint and approach to the business. DC