Operator ownership of rigs may drive significant performance gains, let contractors focus on operations

As oil price finds lower equilibrium and contractors are unable to earn returns justifying investments, industry’s roles and responsibilities may need to be redefined

By Linda Hsieh, Managing Editor

Gary Rich is President, Chairman and CEO of Parker Drilling.

Looking at the short term, what do you see as the most critical issues facing our industry?

In the short term, the challenge is to preserve cash and manage costs in a way that you survive to take advantage of the recovery when it comes. The recovery will come, but we don’t know when, and you have to protect your cash flow.

What about in the longer term?

We have to figure out how we’re going to transform as organizations and as an industry. We enjoyed $100 per barrel oil in the five or so years before this downturn, but there are very few people forecasting oil to go anywhere near that again. The average point of view is that we’re going to have longer-term equilibrium in the $60 to $75 range. That means we have to find a way to be successful with $60 to $75 per barrel when a lot of us have invested over the past several years for $100 per barrel oil. That’s a big challenge.

It feels like there is growing optimism in the industry though -— would increased drilling activity in 2017 help with the cash flow challenge?

Yes, people are expecting 2017 to be better than 2016, especially on land, but we’re still dealing with very depressed pricing. Further, the industry will need capital to bring rigs back into service. Working capital demands increase as your business picks up. Therefore, I think that many in the industry will face cash demand challenges even though the market is recovering.

Is this going to force a lot of companies out of the business?

In the past, they typically would borrow money, but the banks aren’t too excited about loaning money to this industry now. So companies may have to use other methods of raising capital. I suspect that most companies that can show they have a good business will be able to get the cash they need. It just won’t be easy.

So is everyone still focused on more cost reductions right now?

Customers are still pushing for cost reductions, but we’re not looking at cost reduction today because we’ve already done a good job reducing our costs. The important thing now is maintaining cost efficiencies as the business starts to recover.

Do you think cost reductions so far have just been dayrate decreases and personnel reductions, or have they been more focused on efficiency improvements?

Some efficiencies have been achieved, but from a customer point of view, the biggest cost reductions have been absolute price decreases. That’s not sustainable, especially if they continue to expect new equipment or even refurbishing of old equipment. Contractors won’t be able to earn adequate returns to justify those investments.

So how can the industry achieve cost reductions that will be sustainable? Where do we need to look?

There needs to be a concerted effort between contractors and customers to look at everything that goes on in the process of drilling and completing a well. We need to question what parts of the process add value and what parts don’t. There’s still a lot of opportunity to question who does what in the business – a redefinition of roles and responsibilities among operators, contractors and the service industry so we can all be more efficient.

That’s probably going to require a lot more conversation and collaboration among the parties than what we’ve seen in the past.

Absolutely, and I think we’re already seeing it, particularly on the international side – places like Russia, Iraq, Kuwait and Papua New Guinea – where there are significant complexities associated with working in very remote locations. To be as efficient and effective as possible, you really need to have that collaborative, team-type discussion.

How are demands for rig equipment or technology different in those markets?

Historically you want a rig that can drill any type of well. You might be drilling a shallow well today but a deep well tomorrow, and you don’t want to have to bring a new rig into a relatively small market to drill each unique type of well. It’s a very different environment than in the US, where you might have 400 wells that are almost identical so you deploy a rig that’s optimized for that type of well.

In the US, 1,200- or 1,500-hp rigs are common, but a lot of our rigs on the international side are 3,000 hp. These much larger rigs provide the flexibility that’s needed.

That said, there are now some areas outside the US with larger pockets of activity where optimally sized rigs make a lot of sense.

I think the international market will also continue to move toward a preference for AC rigs and rigs with walking systems, particularly in markets where they have a lot of wells of the same type in an area.

With the oversupply of rigs in both the onshore and offshore markets, how do you think contractors can bring value to their customers with the older rigs?

I think people still play a big role in the success of the rig. You can have the newest technology, but if you don’t have the right people and the right culture, you’re not going to get all the benefit out of it. You can also find examples of a good team that operates very efficiently and effectively even using older technology. Automation isn’t necessarily always the best answer. We’ve collected data on operations comparing new technologies versus some of the more conventional approaches. In some cases, we found that the more conventional approach was still more efficient. You really have to make sure that you understand the value of technology, and you have to remember that it’s also about the people and how they work together.

What kinds of innovation do you hope will come out of this downturn?

I hope we’ll see more progress in creating collaborative-type environments where the operator, drilling contractor and service companies can reconsider roles and responsibilities that will allow the operation to become more efficient and effective. We’ve gone a long time in this industry without changing much of the roles and responsibilities of people at the job site. I think that some of that will be redefined in this cycle.

Can you give me an example of the kinds of roles and responsibilities that can be reassigned?

I can give you an example of one of our operations, where we do a lot more than what the traditional drilling contractor would do in terms of managing the operation. It’s a unique situation where the customer also owns the asset, but we operate it as if it were our own drilling rig. We also provide other services on the job site – for example, we run the entire health and safety program for the operation. We do repair and maintenance on equipment that would traditionally not be considered part of the drilling contractor’s equipment, rather than the customer bringing in more people to do that kind of maintenance. There’s no reason why we can’t provide that for them. This allows them and the whole operation to be more efficient, and we’re just utilizing resources and skills that we already have as an organization.

Is there opportunity for that kind of change in North America, as well?

I think there could be. It’s more easily rationalized and accepted when you’re working in very remote locations and there are very high costs to bringing in people and equipment. But even in the US I see some drilling contractors starting to take on additional roles, like directional drilling responsibilities. These are new roles for a drilling contractor to play where they can simply leverage existing personnel at the job site.

What are the challenges to such reassignments of roles and responsibilities at the job site?

I worked at one of the large integrated service companies for 25 years before joining Parker, and I see that the cultures of these organizations are very different. On the drilling contractor side, there are very large and expensive assets with long lives, and contractors are very focused on operational execution. On the service side, there are much smaller and very technology-oriented assets. It will be interesting to see if these different cultures can merge. I’m not convinced it’s going to be very easy to do.

So is there a different way to do this?

As an example, rather than owning both the drilling contractor side and the directional drilling side, maybe I can work differently with a directional drilling company. There are things that the directional drilling company does at the job site that I can probably do more efficiently, such as rigging up and down equipment. I’m not trying to take directional drilling away from them, but I’m going to interface with their personnel in a different way so as to allow the technology-oriented, lighter-asset business model to focus on what they do best. In essence, we’re redefining the boundaries of where we interface to be more efficient and effective because we keep our cultures and general value propositions in place.

What is your view on adoption of new technologies in times like these?

Because of my career path, I’m very technology oriented, but I see an interesting dynamic as I look at the drilling contracting industry over the past five to 10 years. The investments we’ve made in new technology have doubtlessly improved our capabilities, but I have to wonder whether our shareholders and investors are getting much return on that technology. I’m not so sure that all the investment we’ve made in the industry, particularly in the US, is going to generate that much return. It doesn’t show in the financial results of most companies, and I’m not so sure it’s been rewarding to the shareholders.

Are you referring specifically the drilling contractor side?

That’s correct. Look at the amount of money drilling contractors have invested in new technology and new equipment in the US over the past several years. I question whether there’s going to be a favorable return on that going forward. You’ve taken what you had and made it largely obsolete because you brought out newer technology by spending a lot of additional money. Are you generating any more profit than you were generating before, and how is that profit relative to the new investment you’ve made?

Will that prevent additional investments in our industry in the future?

It could.

But weren’t the investments necessary to stay in the market? Because if you didn’t invest, you would have been left behind.

That was the dynamic. If you didn’t invest, somebody else was going to invest, so everyone had to invest. But nobody has gotten the advantage. The value has largely gone to the customer. The drilling contractors haven’t captured much of that value, and now we’re faced with all these rigs that we’ve built, and prices have been pushed down. Has the shareholder been a winner in this? I’m not so sure they have.

Is it the drilling contractor’s business model that’s not working?

You can argue the business model is a challenge, but it’s the competitive pressures that have caused everybody to run down the path so fast that I think we’ve overrun the opportunity. We’ve over-invested relative to the return opportunities that are there for the shareholder.

As far as the model is concerned, we think part of the solution is for the customer to own the drilling rig themselves. This is particularly true outside of the US in more remote environments where projects have a long life. If the customer owns the drilling rig as opposed to drilling contractors, the asset becomes dedicated to that project. The rig becomes a component of their overall capital investment.

From an operational point of view, this model removes barriers, for example, when a customer wants us to invest in a new piece of equipment. Right now, whenever there is a new technology opportunity, if I’m on the drilling contractor side, I’m going to be hesitant to invest unless you’re going to give me more money to justify my investment. But if the customer owns the equipment, that barrier can be removed completely. The discussion can then be based on the real fundamentals of the project. We can talk about it from an equipment point of view or from a roles and responsibilities point of view. It breaks down the barriers and allows us to have conversations about things that we generally have a difficult time talking about because we’re all trying to protect our own positions.

How would this model be different from years ago when oil companies owned drilling rigs?

In this scenario, the operator doesn’t operate the rig. They still get the benefit of the drilling contractor culture that gets up everyday and figures out how to operationally execute the activities on that job site.

So drilling contractors would essentially not be rig owners but just managers of the drilling operations?

That’s what we’re experts at. We’re operational execution people – that’s what we do.

Why should operators be open to such a change?

Because if I put that heavy asset on my balance sheet, I’m going to charge them a premium off of my balance sheet, which probably isn’t as strong as theirs. Therefore, they’re effectively going to pay more for that rig. Even more importantly, I believe the change would foster a more collaborative environment, leading to significant performance gains. This model removes operational barriers and will allow an operation to be much more successful.

We have been particularly good at creating this type of environment with our customers, and in one operation several world-record extended-reach wells have been drilled. Granted, some of it can be attributed to geology, but it’s also about how we’ve all been able to work together as a team. We’re able to talk more strategically about technology and process improvements because I’m not trying to protect my previous investment.

There have been several projects around the world that function just as I described.  As the industry tries to find ways to be successful in the new $60 to $75 per barrel equilibrium, we need to have more of that kind of model in place to help us be as efficient and effective as possible. The more barriers you have, the more difficult it is to optimize.

Do you think this would be doable in the US market?

Parker doesn’t operate rigs in the Lower 48 on land, but given my time in the industry, I suspect there could be an application for it in the US, as well. I’m sure there will be others who will disagree with me.

What do you think those people would say?

Traditional drilling contractors may say I’m giving up control and responsibility, and perhaps that’s the case, to some extent. You will also have some operators say, why do I want to invest in a rig when I have somebody else who is willing to provide it for me? The reality of the current market in the US is that operators are able to effectively rent rigs for less than economic value.

So you think that in the current model, drilling contractors bear the brunt of both the investments and the risks, but the value is going to the operators?

I’m not denying that operators have a big investment, too. I’m saying that drilling contractors have a huge and expensive asset, and I’m not sure they’re getting rewarded for it. If you look at company returns on capital, I think you’ll find that drilling contractors, over an extended period of time, have not been all that great at generating return on investment for their shareholders.

For the rig that is owned by the customer and operated by Parker, did that arrangement come about because of the operator or because of Parker?

It was a collaborative discussion, and it has been in place for more than 15 years, so this isn’t something that just happened recently. Years ago when this project was being discussed, we recognized that it would need a unique rig capable of drilling super extended-reach wells and there wasn’t much chance it would go anywhere else in the world. Since those early days we have worked with the client to optimize, maintain and operate the rig. It has worked extremely well.

What’s your outlook on more newbuild rigs in the future?

Unfortunately, I think that you will have customers that will effectively demand new rigs. Because you have a number of different contractors that are capable of providing those, you will have contractors that will agree to provide that new rig when in reality we already have more rigs than we need.

I think you will see some new rigs get contracted, and people will beat their chest and say it’s because of their technology. There will be some truth to that, but I question the merits for the industry and whether anyone will get appropriate returns for the incremental investment. DC