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Offshore rig capacity has (finally) eclipsed 1984 peak. In the Jimmy
Carter/Ronald Reagan era building boom, offshore rig capacity nearly tripled
from 1974 to 1984, rising to 671 units. Despite the fact that oil demand has
increased by 43%, or 25 MMBbls/d, total rig supply did not eclipse 1984 levels
until earlier this month as a result of rig retirements and relatively modest
newbuild activity prior to 2005.
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Newbuild capacity additions cloud outlook. Between 1974 and 2008, rig
capacity rose by a compound annual growth rate (CAGR) of 1.7%. As a result
of significant newbuild order activity, 65 jackups and 83 floaters are scheduled
for delivery to worldwide rig fleets, implying a 2009 to 2012 CAGR of 5.9%,
more than triple the historical run rate. 86% of newbuild jackups and 30% of
newbuild floaters are uncontracted. As a result, the recovery outlook is clouded
given significant capacity adds, particularly in the jackup market.
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Shares have bounced on rising oil price expectations, but dayrate trends
are key. As illustrated in Exhibit 1, offshore rig stocks are highly correlated with
movements in worldwide gross revenues (i.e., commodity price expectations)
and offshore dayrates. The stocks have significantly deviated from dayrate
trends and the upward movement in the equities since March has been driven
by improving oil price expectations. With oil prices now hovering near Credit
Suisse’s long-term oil price of $70/bbl, we believe improvements in dayrate and
utilization trends may be necessary to support further relative gains in the
stocks.
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Jackup utilization has declined to 71%, well below the typical equilibrium
point of 85%. As a result of declining rig demand and rising uncontracted
newbuild deliveries, fleet utilization has declined from 94% from 2005 to 2008 to
less than 80%. While utilization has fallen across all rig classes, the jackup
market has been impacted disproportionately, with utilization plunging to 71%.
Historically, drilling contractors have not been able to push dayrates
meaningfully higher until utilization eclipses approximately 85% of total supply.
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Supply side analysis. Investor focus has shifted towards recovery and the
potential re-tightening of rig markets through increases in demand as well as
favorable supply side impacts from attrition given the mature age of the rig fleet
at 22.2 years. In order to gauge the potential impact to the supply side, we have
analyzed historical rig attrition owing to accidents, retirements, or conversions
to non-drilling uses from 1953 to 2008. Importantly, our supply side work
includes total capacity additions, adjusting for survivorship bias evident in most
industry representations of offshore rig capacity.
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Further rig attrition is necessary to balance market. As a result of secular
declines in the U.S. GOM shallow water and soft conditions internationally, we
believe meaningful rig attrition owing to technical capabilities and economical
factors will be necessary to eventually balance the markets, particularly given
the onslaught of uncontracted newbuild deliveries.
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