Newbuild start-ups to bring inevitable bumps

Critical D&C issues with Larry Dickerson, Diamond Offshore

By Jerry Greenberg, contributing editor

Larry Dickerson is president and chief operating officer of Diamond Offshore Drilling.

DC: We are currently experiencing the longest and strongest up-cycle the offshore drilling industry has ever known. What is different about this cycle compared with the past?

Dickerson: The temptation is always to say this cycle or that is different. To me, the most striking difference is the fact that, for the first time, the increase in oil prices has been driven by supply/demand fundamentals for the commodity. As we begin 2008, we are in uncharted territory because we will be entering the fifth year of this up-tick. We have never had a cycle as strong as this that lasted this long.

Because previous cycles were event driven, when the event, such as the threat of war in the Mideast was resolved, oil prices returned to lower levels because there was sufficient underlying supply. This time, global hydrocarbon demand is outpacing our ability to replace supplies and supporting higher prices over a longer term.

So, here we sit, five years into this cycle, with very strong oil prices and not a lot on the horizon that suggests those oil prices should not stay strong. That is what makes this totally uncharted.

A huge amount of new capital is being devoted to the construction of new rigs, both jackups and floaters. On the floater side in particular, the existing deepwater fleet is largely contracted through 2010. That means if an operator needs additional capacity, they have to turn to the new construction market. And even the bulk of the newbuild floater capacity is contracted until 2010/2011 deliveries. There are some exceptions, of course, but essentially that is the current market environment.

As we attempt to chart the future today, history may not be an accurate guide to how this cycle will play out. I believe we are entering an exciting new world of long-term high activity.

DC: What challenges do you think this new world of long-term high activity will create?

Dickerson: I believe that one of the greatest challenges will involve the commissioning and initial start-up of the newbuild floater equipment. The industry has not had to deal with this issue in this cycle, because the first of the newbuild deepwater units are only now beginning to be delivered.

As these 70-odd newbuild rigs are commissioned and go into service, there inevitably will be some start-up problems. For example, if 10 rigs are simultaneously having problems with one type of equipment, or one rig finds an issue to be fixed throughout the entire newbuild fleet, there will be immense pressure to quickly remedy the problem and to affect the repairs almost simultaneously. This type of challenge is always difficult, but I am confident the industry will be up to the task. Adequate crewing will be another issue.

DC: Concern about adequate crewing has been an issue for a number of years. I can see how that will continue to be a concern with the high-tech deepwater rigs and equipment. How do you address that challenge and find the people you need?

Dickerson: We have increased our training programs, and I am sure that is what everybody else has done. I have not seen evidence that any of the new entrants to the business are strictly planning to target crews from other drilling companies for hire. There is obviously some movement of personnel back and forth, but that doesn’t appear to be a preferred fix. If we all chase the same human resources, we will just be playing musical chairs. Everybody recognizes that sooner or later you are going to get caught short. I believe, certainly, the established contractors are relying upon training programs and providing promotional opportunities within their own fleets to help retain workers. And I also have to believe that is what is going on with the new entrants.

I think the established contractors, such as Diamond Offshore, have an advantage with newhires because we have a large fleet with a solid track record in deepwater and experience in drilling deep, heavy wells. Our large fleet also provides a broad and diversified platform for hands-on training.

Obviously, if you have trained personnel in an environment that is short of trained personnel, you have an advantage. But you also must contend with the disadvantage of people trying to hire those trained workers away from you. During this up-cycle, it is incumbent on all of us to make sure our employees are benefiting through higher wages and retention programs. I believe much of that is already in place, and needs to continue.

Another way for the established contractors to retain their people is to enable their employees to work within established systems with experienced crews and knowledgeable support staff, all with a track record of safety. For our employees, I believe that this is an environment in which they would prefer to work, rather than walking onto a brand-new rig with a brand-new company trying to figure all that out.

DC: What other issues will the industry face?

Dickerson: We will be influenced by the delivery of new equipment and the people and the stresses that are introduced into the system to get the equipment deployed efficiently. We have had strong inflation reflected in higher labor costs, and higher costs for everything we use in this business. Shipyard shortages will continue. Those shortages have introduced a longer planning cycle into the drilling business than we normally face. Many key components have two or three year delivery time frames, so you have to plan that far ahead.
When you say shipyard, you typically think about facilities to construct new rigs. But if you think in terms of facilities to do required inspections and maintenance on rigs, there are actually very few shipyards in the US Gulf of Mexico to service that need. Planning becomes more critical than ever before in terms of determining when a rig will need to go into a shipyard, reserving yard time in advance and ordering long lead-time items. That is all complicated by the fact that you don’t know exactly when your wells are going to finish.

DC: What equipment has the longest lead times for delivery?

Dickerson: Deepwater riser has a two- to three-year delivery time. Heavy-weight drillpipe that is often used in deeper wells has an extended delivery time. Other equipment with long lead times include BOPs, top drives — any of the key components that are a factor in new rig construction. Delivery times have also lengthened significantly if you need that equipment for replacement on existing rigs or for spares.

When rigs come in for a period of 45 to 60 days to do shipyard work, typically you would take certain key components, such as the top drive, and send them out to get completely refurbished. In the past, you could get that accomplished and back on the rig before the unit returns to work. Today, with lead time on top drives a year-plus, a short turnaround like that from the service shops is often not possible. That says you have to have more spares, and that carries throughout your fleet.

DC: Have operators requested any new technology or enhanced capability from existing technology as you move into deeper water and drill deeper wells?

Dickerson: A lot of the new construction rigs are being designed for work in 10,000 ft of water, but initially are only equipped for drilling in water depths up to 8,000 ft. At the same time, our customers are drilling cutting-edge wells and are constantly asking us what we can do to get into deeper water.

In anticipation of this requirement, our two new construction jackups and our last three semisubmersible conversions have all had 2-million-pound hook loads. This was state-of-the-art technology at the time.

We conducted a study of Gulf of Mexico wells that have been drilled with 2-million-pound hook loads and to an extended depth. There really are only two offshore drilling companies surviving today that have that kind of operating experience, and Diamond Offshore is one of them. When you are on the leading edge, you are testing equipment right up to the limits of design capability and finding out where the shortfalls are. Unfortunately, that sometimes relates to downtime, which translates to nonproductive time for our customers. So we have huge efforts under way to make sure that our customers can utilize this equipment to the maximum extent possible to drill these ultra-deep wells.

What they are requesting is higher efficiency from the existing equipment, so anything that we can do to be more efficient is something on which we are focused.

DC: What are some examples of increased rig efficiency?

Dickerson: When you have a heavy load, big casing run or heavy-weight drill pipe, torque and bending motion is induced along your drill string. Controlling these forces and preventing damage to your equipment, and the resultant downtime for your customer, has been a challenge for us and the industry. All of those issues are being dealt with, but I don’t believe anyone has found a “silver bullet” yet.

DC: How is the shipyard shortage affecting new rig construction programs? Is the shortage primarily for new construction, or repair and maintenance?

Dickerson: The shortage is most acute in the established shipyards that are located close to market and accommodate inspections, repairs and maintenance. As far as new construction, the shipyards that have the best and longest track record of delivering vessels on time and on budget have typically been in Singapore and Korea. Those have the largest backlog. But we have seen other Far Eastern countries come on with capacity, such as China and elsewhere. If you are willing to take a risk on a new, less experienced shipyard, there are a number of places you can go. Regardless of your alternate shipyard choice, equipment delivery lead times are still a bottleneck that will likely delay rig delivery until the beginning of 2011.

DC: How many drilling contractors would be willing to take a risk on a new yard when they are building a $700 million semisubmersible?

Dickerson: There is always someone. Again, experience is the key. All of the big, existing drilling contractors have had their experiences with second-tier shipyards. Dealing with these yards can have a huge impact on your construction schedule and cost. I don’t think that most of the experienced drilling contractors have much of an appetite for that risk.

This is why you typically see the drilling contractors, ourselves included, ordering from the long-established shipyards where we have a track record of on-time, on-budget deliveries. On the other hand, some of the new entrants into the offshore drilling sector are typically more willing to take on the risk of a brand-new shipyard.

DC: And get the delivery they need?

Dickerson: They have a delivery scheduled with which they are comfortable. That doesn’t necessarily mean the rig is going to show up on time. There also are speculative builders who went first to Singapore and Korea, and only as those yards got full did they divert to other areas. They diverted for two reasons — either an improved schedule, or a lower cost was quoted to them.

DC: What will the market look like if oil prices decrease?

Dickerson: The drilling contractors have such strong cash flow from the unprecedented revenue backlog on their existing fleets that I think they will all be in a very strong position for a number of years, even if the market turns down. If you are highly leveraged in this business, there is a risk. Nobody knows exactly what oil price is needed to sustain this level of activity. Although oil prices have been flirting with $100 per barrel, there were contracts being signed at high dayrates when oil was $60 and $70 per barrel. Oil companies typically keep their price decks low when judging whether or not a given geologic prospect is economic. And they do not adjust those price decks rapidly in response to every daily change in the price of oil.

I think there is ample room for oil to pull back. If oil does pull back from $100 to, say, $60 dollars, the psychological impact in the short term will be negative in the stock market and potentially somewhat negative for our customers as they see cash flow reducing. But I believe that the level of cash flow will be enough to sustain activity because there is still a shortage of oil.

I am not worried that, in the next couple of years, we are going to see oil prices at such a level that they will imperil the economics of deepwater. But this has always been a cyclical business. There will potentially come a time when oil falls to a price that negatively impacts the market, contracting revenue and idling rigs. We have been through that before. For Diamond Offshore, we have used those down cycles to opportunistically acquire and upgrade our equipment so that we are better able to compete and provide shareholder value in the future.

Larry Dickerson served as IADC’s 2003 chairman.

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