Diamond Offshore Drilling, Inc. (NYSE:DO) rents drilling rigs to gas and oil companies mostly in the Gulf of Mexico and Asia and is the second-largest contract driller by market capitalization. From 2005 to 2008, the company's revenues increased nearly three fold, as the worldwide demand for energy and geopolitical conflicts in oil-rich nations drove up the price of oil. However, oil prices plummeted after a peak of about $140 per barrel in July 2008 and have fluctuated between $70 and $80 barrel in 2010. Falling oil prices reduce the revenue generated by oil companies and thus make drilling in deep-water locations prohibitively expensive. Declining demand for oil has had an adverse effect on the offshore drilling industry because lower oil prices reduce day rates earned by offshore drilling rigs. Additionally, declining interest in offshore drilling and oil exploration reduces contract activity.
Though Diamond Offshore Drilling has seen the effects of the economic downturn, it is partially shielded from decreasing day rates because most of its drilling rigs are contracted through 2010. Diamond owns one of the largest drilling fleets in the world (a total of 46 drilling rigs), and continues to rent its drilling rigs at steady dayrates. In the second quarter of 2010, the company's average dayrate for high specification floater rigs was $373,000 per day, compared to $360,000 in the first quarter of 2009. Despite weakness in the economy, Diamond has managed to sign new contracts with oil producers such as the Brazilian firm Petrobas.
One mostly uncontrollable factor for DO or any other company involved in offshore drilling in the Gulf of Mexico is the threat of hurricanes, which occur most frequently from June 1 to November 30. Hurricanes can shut down drilling rig production for several days and also cause significant damage to rigs.
Diamond Offshore Drilling (DO) rents drilling rigs to gas and oil companies. DO earns revenue through dayrates collected by its rigs as specified in its contracts with oil companies. The upkeep and upgrades of rigs make up most of Diamond Offshore's operating expenses.
Dayrates and utilization rates have fallen slightly as the demand for offshore drilling has declined, mainly due to the falling price of crude oil. For example, the average dayrates for high specification floaters fell from $381,000 in the second quarter of 2009 to $373,000 in the second quarter of 2010. Similarly, the utilization rate of high specification floaters fell from 79% during the second quarter of 2010 to 69% in the second quarter of 2010. Intermediate semis and jack-ups, two other types of offshore drilling rigs, also saw a decline in dayrates between the second quarter of 2009 and the second quarter of 2010. Interestingly, the utilization rate of jack-ups increased from 63% to 76% between the second quarters of 2009 and 2010. Jack-ups are used for drilling in water depths from 20 feet to 350 feet and are in high demand due to the offshore drilling moratorium in the Gulf of Mexico.
Diamond's rigs are used to find new oil or gas deposits, or to prepare existing deposits for production.  DO owns one of the largest drilling fleets in the world, a total of 46 ships, including 30 semisubmersibles, 15 jack-ups and one drillship.
For the third quarter of 2010, Diamond Offshore reported a 45% drop in earnings due to a contractual dispute related to the Gulf of Mexico drilling moratorium. Lower utilization rates of rigs in the Gulf of Mexico and transportation of rigs out of the Gulf of Mexico to less regulated areas also imposed additional costs. Overall, Diamond Offshore has the lowest EBITDA growth in the offshore drilling industry of -5.3%.
DO reported earnings of $198.5 million, or $1.43 a share, down from $364.1 million, or $2.62 a share, a year earlier. Revenue decreased 12% to $799.7 million. The company's operating margin plummeted to 39.7% from 52.8%.
The average day rate for Diamond's high-specification floaters fell 6.4% from a year earlier, and the utilization rate declined to 56% from 75% a year ago and 69% last quarter.
Diamond Offshore announced net income for the second quarter of 2010 of $224.4 million, or $1.61 per share on a diluted basis, compared with net income of $387.4 million, or $2.79 per share on a diluted basis, in the same period a year earlier. Revenues in the second quarter of 2010 were $822.6 million, compared with revenues of $946.4 million for the second quarter of 2009.
The decline in renewal contract dayrates from peak levels continues to weigh down Diamond Offshore's results. Diamond Offshore announced a special quarterly dividend of $.75 per share, representing a reduction of $.625 per share from the previous special dividend. The reduction in the special dividend reflects the lower revenue stream and the continuing uncertainty surrounding a drilling moratorium in the Gulf of Mexico.
Diamond Offshore reported first quarter net income of $290.9 million, down 16.6% from the first quarter of 2009. Revenues in the first quarter totaled $859.7 million, down 2.9% from the first quarter of 2009. Diamond also announced that it will reduce its special dividend of $1.875 per share by $0.50 per share. Diamond has defended its dividend reduction in anticipation of a decline in renewal contract dayrates. Diamond also wants to retain cash for a potential rig acquisition.
|Q3 2010 Dayrate||Q3 2010 Utilization||Q2 2010 Dayrate||Q2 2010 Utilization||Q2 2009 Dayrate||Q2 2009 Utilization||Q4 2008 Dayrate||Q4 2008 Utilization|
|High specification floaters||$364,000||56%||$373,000||69%||$381,000||79%||$386,000||89%|
For the year ended December 31, 2009, the Company reported net income of $1.4 billion, or $9.89 per share on a diluted basis, compared with net income of $1.3 billion, or $9.42 per share on a diluted basis, for the year ended December 31, 2008. Revenues for the year ended December 31, 2009 were $3.6 billion, compared with $3.5 billion for 2008. During the year, Diamond Offshore saw an increase in tax expenses, a bad debt expense related to receivables for a rig in Egypt, and the sale of the jack-up rig Ocean Tower.
On April 20, 2010, an explosion and fire aboard Transocean's Deepwater Horizon drilling rig off the coast of Louisiana ruptured an oil well, causing the worst oil spill in U.S. history. The rig was operated by BP (BP). The U.S. government is conducting an environmental and economic analysis of the offshore drilling industry in the Gulf of Mexico. President Barack Obama has ordered a six-month moratorium on drilling in waters 500 feet and deeper while a government commission investigates the disaster. The six-month moratorium on exploratory offshore drilling has closed 33 deep water drilling platforms and the Louisiana Economic Development department estimates that 3,000 to 6,000 jobs could be lost in the first three weeks and over 10,000 within the six months. The moratorium could have an adverse effect on Diamond Offshore, which leases six offshore drilling rigs in the Gulf of Mexico.
Media reports in May claimed that oil was leaking from a rig operated by Diamond Offshore. The drilling rig in question was the Ocean Saratoga, which Diamond Offshore leased to Taylor Energy. The Ocean Saratoga is not affected by the six month moratorium on offshore drilling because it is operating at a depth of 450 feet. Diamond Offshore confirmed that there have been no leaks of hydrocarbons from the semisubmersible drilling rig Ocean Saratoga. An unidentified aircraft took photos that incorrectly reported an oil leak coming from the drilling rig Ocean Saratoga. The tanks mistakenly characterized as containing dispersants on the boat's deck, were actually tanks to store and transport oil as it was pumped from the underwater storage system.
Diamond offshore announced in July 2010 that it will move its drilling rig Ocean Confidence to the Republic of Congo. The company has suspended a Gulf of Mexico contract with Murphy Exploration and Production Company in order to move the rig. Diamond offshore also plans to mobilize the Ocean Endeavor from the Gulf of Mexico to Egypt. Combined with a $31 million early termination fee paid by the previous operator of the rig, the move is expected to generate a total revenue of $100 million.
With new contracting severely restricted in the Gulf of Mexico as a result of the uncertainties surrounding the offshore drilling moratorium, Diamond is actively seeking international opportunities to keep its rigs fully employed. In terms of a moratorium on offshore drilling, the Obama administration issued a new order banning deep-water drilling until November 30, 2010. This comes after a federal judge in June 2010 blocked a previous White House six-month moratorium on new offshore drilling projects.
Senators John Kerry, Lindsey Graham, and Joe Lieberman have drafted legislation that would boost the supply of domestically produced oil and natural gas, both on- and offshore. The legislation is intended to maximize tax revenue for states that opt to drill oil. Although offshore drilling was a controversial topic, especially during the 2008 presidential campaign, the government is beginning to move forward legislation that will benefit the offshore drilling industry.
At the state level, legislation is also helping to move forward offshore drilling projects. In California, Governor Arnold Schwarzenegger is planning on addressing California's $20 billion budget deficit in part by allowing new oil drilling from an existing platform off the coast of Santa Barbara. This move will likely loosen California's stance towards offshore drilling and pave the way for future offshore drilling projects in California.
Limited liquidity in credit markets resulting from the global financial crisis has reduced the amount of funding available for Diamond Offshore Drilling's business operations worldwide. Offshore drilling is a capital intensive business, and with limited credit options, DO is under pressure to finance its capital projects with cash flow instead of debt. The latest construction projects DO completed were the $186.8 million upgrade of the Ocean Monarch rig and the $266.3 million construction of two new jack-up drilling units, the Ocean Scepter and the Ocean Shield.
Though Diamond Offshore is partially shielded from the credit crisis, a number of its contracts expire in 2009 (like contracts for Ocean Monarch, Ocean Titan, and Ocean Guardian). The company's ability to favorably renew these contracts or sign new contracts will depend on market conditions. Though it is early to speculate about the strength of contract activity in 2010, Diamond Offshore has managed to sign new contracts in 2010. Diamond, for example, has entered drilling contracts with Petrobas of Brazil worth $1.36 billion. This contract includes a three-year deal for the ultra-deepwater semisubmersible Ocean Valor, a three-year deal for the deepwater semisubmersible Ocean Baroness, and a five year deal for the deepwater drillship Ocean Clipper. Diamond's ability to secure contracts will substantially affect its financial performance as its existing contracts expire.
One potential trend in the financing of deepwater drilling is investment by private equity firms. A recent Bain & Co. survey of private equity firms that hold an estimated $1 trillion in undeployed capital found that half of them would be interested in investing in energy. Due to its fragmented nature, contract drilling is an ideal investment for private equity firms. Some firms have hired experienced veterans of the energy sector to analyze deals. Increasing interest in contract drilling by private equity firms could mean Diamond Offshore has to outbid private equity firms when acquiring smaller drilling firms.
When the price of oil climbed to $140 in mid-2008, drilling companies invested heavily in new drilling rigs. However, the swift drop in energy prices and the credit crunch led these companies to default on construction payments. Drilling rigs that were ordered by drilling companies were then put to auction at heavily discounted prices. Ocean Courage was one of the drilling rigs up for auction. Diamond Offshore purchased the Ocean Courage for about $400 million in early 2009. If Diamond Offshore had placed the order at the height of the market in 2008, it would have waited three years for delivery and the price would have been more than $700 million. Ocean Courage is now stationed in the Gulf of Mexico.
Diamond's growth strategy is to acquire assets during downturns when iron is priced at a discount. Diamond has been known to acquire drilling assets at discounted prices at auction during economic downturns. The company also buys rigs that other companies fail to see value in. For example, Diamond purchased the rigs Ocean Vanguard and Ocean Patriot for $65 million each when other drilling companies believed those two units would never operate again. Those two drilling rigs have since generated $200 million in value each.
Diamond also upgrades units when possible instead of purchasing new units. Diamond upgraded the semi-submersible rigs Ocean Baroness, Ocean Rover, Ocean Endeavor, and Ocean Monarch. Each upgrade took less than two years and each upgraded rig earned the same dayrates as a new rig.
Higher oil prices makes it more economically feasible to drill for deposits in deeper and more remote waters. The average drilling rig day rates, which are driven by demand for offshore drilling contracts by oil companies, are between $200,000 to $300,000 for rigs that can operate at water depths of 1500-4000 feet. As more advanced rigs can charge higher rates for longer periods of time, DO has followed a policy of continually upgrading their rigs instead of building the same ones. As of February 2009, DO had ten rigs that could operate at over 4000 feet in water depth and 20 more that could operate at up to 4000 feet in water depth.
However, the price of oil has fallen from a record high of almost $150 a barrel in July 2008 to around $70 a barrel as of September 2009, which has caused dayrates to fall significantly. Though contract activity has declined since the global financial crisis began, DO is partially shielded from decreasing day rates. Most of DO's offshore drilling rigs are contracted through 2010, so the short term effects on DO are further buffered by existing contracts. Oil producers that are most affected by declining oil prices operate in the North Sea and the shallow regions of the Gulf of Mexico, two regions in which contract activity has slowed most significantly.
Increases in crude prices not only encourage gas and oil companies to drill for more oil, but rising prices also enable these companies to invest in the exploration of new deposits. Prior to the global financial crisis, an increase in the demand for oil in regions such as China had sustained increasing gas and oil prices. This increase in oil prices drove increased demand for drilling rigs.
In the third quarter of 2008, however, oil prices plummeted due to the financial crisis. Oil trading companies stored the most oil in inventory in 20 years, totaling 80 million barrels aboard 35 supertankers and several smaller tankers. However, demand for oil in developing countries such as China and India has the potential to raise oil prices in the future.
Offshore drilling is adversely affected by severe ocean weather conditions. Storms can delay or even terminate the operation of a rig and rig utilization is usually much lower during hurricane season in regions such as the Gulf of Mexico. In 2005, hurricanes Katrina and Rita ripped through the Gulf of Mexico, and the company recorded a $33.6 million casualty gain for removal of one of their jack-ups, the Ocean Warwick, which was damaged by the hurricanes. Other damages to DO's ships and facilities amounted to $2.6 million. Hurricane season in the Gulf of Mexico is from June 1 to November 30.
After Hurricane Ike in 2008, Diamond's Ocean Tower drilling rig lost its entire drilling package and derrick. The projected cost for the repair of the rig, $2.6 million with accrued salvage costs of $3.7 million, was below the windstorm insurance deductible. In 2008, Diamond's insurance deductible was $75 million per occurrence with an annual deductible of $125 million.
The drilling industry is highly competitive and the the cyclical nature of the oil industry subjects companies to intense pricing competition during cycles of low demand and high supply of rigs. Companies that manage to retain the highest utilization rates are more able to experience longevity in the industry. High utilization rates means that rigs are contracted and making money. If rigs are not contracted, not only are they not earning revenue, they are costing the company resources needed to store these ships. DO has one of the highest utilization rates in the industry.
DO’s biggest competitors include (2010):
|Transocean||Noble||Diamond Offshore Drilling||Rowan Companies||ENSCO International|
|Average Fleet Utilization||69.5%||78.5%||67.4%||57.1%||69.4%|
|Average Number of Offshore Rigs||141||65||46||28||49|
In July 2010, of DO's fleet of 46 rigs, only 31 were actively drilling. Here is a comparison of DO's market share of active rigs and its major competitors: