Global jackup market is still soft to terrible. Is there anywhere to go but up?

By Linda Hsieh, assistant managing editor

While it’s true that appearances can be deceiving, it’s worth noting that as of early October, drilling activity appeared to be on the rise. Actual increases in drilling activity still ranged from minimal to barely noticeable, yet drilling contractors say they are fielding more inquiries for rig contracts than the early parts of the year.

Hercules Offshore – hard hit as the US Gulf of Mexico jackup market practically disintegrated in the summer – received 17 bids for their rigs in September. In comparison, they received only three such bids in January.

“A part of it is we’re coming out of hurricane season,” said John Rynd, Hercules CEO and president. “But people are also getting more constructive on the forward-look on natural gas… Capital markets are firming up too, so people do feel a little more comfortable spending money.”

Mr Rynd said he feels confident that the GOM has already hit bottom – that happened when only 14 jackups were under contract in the Gulf earlier this year. Currently, 18 out of 41 marketed jackups are contracted, which equals a roughly 45% utilization. On top of that, 30 more jackups are cold-stacked in the region.

“That overhang does look large, but if you step back and look at it from a relative basis, there were 156 jackups in the Gulf of Mexico in the summer of 2001. When you see activity in the Gulf rebound – and it’s not a matter of if, it’s a matter of when – the market can get tight fairly quickly,” he said.

Most of the cold-stacked rigs, including nine from the Hercules fleet, can be brought back fairly easily once demand picks up, Mr Rynd believes. “Most have been recently stacked, within the last six to nine months, by and large in decent shape. The time and money to get them in the market is not that great.”

No doubt, the shallow-water segment of the US Gulf has bottomed out, agreed Judson Bailey, managing director at Jeffries & Company, a Houston-based securities and investment banking firm. But bottoming out doesn’t mean a whole lot if it’s not followed by a strong market comeback.

“I think the magnitude of the increase is still in question. In other words, how much will the rig count go up next year? It’ll be entirely dependent on natural gas prices,” Mr Bailey said.

As of late September, Jeffries & Company was forecasting gas prices to average between $5 and $6 in 2010. That pricing level “would facilitate some sort of recovery, but a very modest one,” he said.

Mr Rynd was more optimistic, however, noting that energy investment group Tudor, Pickering, Holt & Company recently raised its average 2010 natural gas price forecast from $5.50 to $7.50. More than just being a show of confidence in the economy, that pricing level “could put a number of rigs back to work and be a profitable business for those of us who drill offshore,” Mr Rynd said.

Onshore, too, the US land rig count has recovered slightly and will likely continue to inch upwards if gas prices hit $5, Mr Bailey said. “We think the rig count on current levels will be up maybe 200 to 300 rigs by the end of 2010,” he added.

The bright spot for US land drilling continues to be the new shale plays Haynesville and Marcellus. Looking at the drilling activity in those regions, one might question whether they even need a natural gas price comeback. They appear to be doing just fine in this downturn, even with $3 to $4 gas.

As drilling programs were being shut down across the US, activity in the Haynesville and Marcellus have actually gone up. “It looks to be a very lucrative basin, so operators are dedicating resources to that,” Mr Bailey said.

The Marcellus has gone from 23 rigs to 50 over the past year (117% increase), while the Haynesville has gone from 24 to 85 rigs (254% increase), he said.

Mr Rynd also pointed to the way in which shales have shifted the balance of the natural gas market. “If you go back to Katrina and Rita, before the real upswing in shale gas drilling, we shut in roughly 50% of the gas production along the US Gulf Coast, and gas prices doubled,” he said. “After Gustav and Ike, 50% of the natural gas was shut in, and prices fell by about $2 per mcf. That shows you how robust the production coming out of the Lower 48 was.”

GLOBAL RIG MARKETS

Outside the US Gulf of Mexico, Hercules currently has 11 jackups in operation: offshore Qatar, India, West Africa, Malaysia and Mexico.

The West Africa jackup market is operating at around 50% utilization, Mr Rynd said, but “we believe the market in Nigeria is poised to recover.” There likely won’t be enough work to get the market to full utilization, but rigs should start going back to work over the next three to six months, he explained.

A recovery in West Africa would also boost Hercules’ liftboat business. The company just mobilized four liftboats from the US GOM to Nigeria in October, pushing their West Africa fleet from 18 to 22.

Mr Rynd also said that he would like to move more Hercules rigs out of the US Gulf. However, most of their GOM fleet are mat-supported jackups, and the one other major market for those rigs is offshore Mexico for PEMEX. “But they’ve been lessening their desire for mat-supported rigs, and incremental work appears to be more for independent-leg rigs.”

Other than Mexico, the current worldwide jackup supply would make mobilization a difficult feat, he acknowledged. “The opportunity for us to move any of our domestic jackups internationally are probably few and far between over the next year.”

OVERBUILT AGAIN?

Indeed, the market is flush with idle jackups, and the fact that more than 60 additional units are still on order or under construction compounds concerns about overbuilding.

Steve Gangelhoff, senior vice president – marketing for Northern Offshore, said that there’s “no question in my mind” that the industry has already overbuilt. In the few years leading up into 2008, oil prices stayed strong over a long enough period that it generated an extreme level of confidence in the marketplace, he explained. “So people who had the money and were willing to take the risk, they built on speculation. And there were a lot of them,” he said.

Northern Offshore has three jackups in its fleet, two of which are in the North Sea. The Energy Enhancer jackup is currently uncontracted, while the Energy Endeavor is drilling for Maersk Oil & Gas offshore Denmark. That contract is set to expire in late November 2009.

Mr Gangelhoff explained that he is already marketing the Energy Endeavor for contracts other areas of the world, although the best chances for finding work for the rig remain in the North Sea. As of early October, he said, there were six idle jackups out of a total of 33 in the North Sea, making for a lackluster 82% utilization.

“However, the North Sea jackup market seems to be coming back. There’s a growing number of opportunities for work in 2010 that are hopeful.”

Although the North Sea has traditionally been a higher-cost region than others, that doesn’t seem to be holding it back from a quicker recovery than regions like the Gulf of Mexico.

It could be that the tougher requirements for drilling units to work in the North Sea essentially restrict the number of available rigs. A host of other factors could be at play too, such as gas demand in northern Europe and gas supply through eastern Europe, Mr Gangelhoff explained. “There are probably enough factors to drive a significant enough rig demand in 2010 that the market might be the most improved relative to other markets. But I stress the word ‘might.’ If it’s possible to be optimistic right now, I would apply the word to that region.”

Elsewhere, Northern Offshore’s Energy Exerter jackup finished its operations offshore Greece in August. It has since been towed to Malta and cold-stacked until drilling opportunities in the Mediterranean Sea improve. That market, like many others around the world, has weakened this year, with an approximately 81% utilization, according to Mr Gangelhoff.

His company does have a drillship and a semisubmersible doing exploration drilling in two markets that have held up fairly well during this downturn – India and Vietnam. Both of these mid-water floaters are working for national oil companies (ONGC in India and Vietgazprom in Vietnam), which have proven to be relatively reliable sources of work in this topsy-turvy market.

“National oil companies tend to not have the peaks and valleys in work level that publicly owned companies have… they’re less subject to significant rig market changes. … We’re fortunate to have rigs working in those environments,” Mr Gangelhoff said.

WHERE’S OIL HEADED?

Looking ahead to 2010, Mr Gangelhoff said he’s not quite sure what to make of oil prices and the global economy yet. “The jury is still out. … It appears that growth is ready to move forward in China and India, but there are so many question marks about the American economy,” he said.

Oil prices continue to bounce between the $60s and $70s – a level that would’ve made many operators happy to drill just a few years ago. Now?

“That’s not good enough right now. It’s not bringing the explorers and producers to the drilling table,” Mr Gangelhoff said.

And it’s not that oil has to be $80 or $90 in order to instigate more drilling either.

“I think what our customers really want to see is consistent pricing. If it is in the $70s and consistently in the $70s, with no great concerns in the economy, that would make a lot of people more confident. … Right now, they don’t have a sufficiently high degree of confidence in oil prices.”

Mr Rynd agreed, commenting that “a lot of our business is psychologically driven.” If people feel good about the direction prices are heading, they’re more likely to invest. If they’re concerned there will be pressure on prices, they’ll hesitate.

To that end, it’s interesting to note that investment management group Morgan Stanley has set their base oil price for 2010 at $85/bbl, Mr Rynd said. “In a bull case, they do get to $100,” he continued.

At Jeffries & Company, Mr Bailey was cautious about his outlook for 2010. “I don’t think we’re going to see a broad recovery. … Operators are going to be very careful in how they allocate capital expenditures … and still working to reduce cost,” he said.

PAINFUL CUTS

For drilling contractors, having to let go of trained crews is a heartache they experience nearly every cycle. And despite our best intentions, sometimes layoffs are simply unavoidable.

Mr Rynd acknowledged that Hercules has had to do extensive layoffs globally, but they weren’t done easily. “If you’re a service provider and the service you provide isn’t in demand, unfortunately you have to reduce your costs as fast as you can. You have to weather the downturn. … It’s painful that you have to make the job cuts. It’s just the nature of the beast in our business,” he said.

Hercules has worked to retain its skilled employees in hopes of an easier ramp-up when the market comes back, however. Mr Rynd said he’s also intensified his focus on keeping employee morale high. “Typically, if our business is in a downturn, usually the rest of the economy is doing well. … This one, it hit everybody.”

And with the speed and severity of the downturn catching much of the industry by surprise, he said, it’s become critical that management pay more attention to keeping workers’ spirit up and keep them focused on the future – on the next upturn that is sure to come.

“As we went through this year, the focus was, we have to survive this year. In the first half, it did look like you’re never going to find bottom. … We did what we needed to do to position ourselves for survival, and we’ve positioned ourselves to take advantage of the rebound, and it will come, whether in 2010 or 2011.”