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 for a full year or more. 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. Despite weakness in the economy, Diamond has managed to sign new contracts with oil producers such as the Brazilian firm Petrobras (PBR).
Diamond Offshore Drilling 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 as the demand for offshore drilling has declined, mainly due to the falling price of crude oil. 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.
|Q4 2010 Dayrate||Q4 2010 Utilization||Q3 2010 Dayrate||Q3 2010 Utilization||Q2 2010 Dayrate||Q2 2010 Utilization||Q2 2009 Dayrate||Q2 2009 Utilization|
|High specification floaters||$357,000||79%||$364,000||56%||$373,000||69%||$381,000||79%|
FY 2010 (ended December 31, 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). President Barack Obama 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 10,000 jobs could be lost. The moratorium could have an adverse effect on Diamond Offshore, which leases six offshore drilling rigs in the Gulf of Mexico.
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 revenue of $100 million.
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 has traditionally been a controversial topic, 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.
Despite the weak offshore drilling industry, Diamond Offshore has managed to sign new contracts. Diamond, for example, has entered drilling contracts with Petrobras (PBR) 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.
The drop in energy prices and the credit crunch several years ago led drilling 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. If Diamond Offshore had placed the order at the height of the market, 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.
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.
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. Diamond Offshore recorded a $33.6 million casualty gain for removal of one of their jack-ups, the Ocean Warwick, which was damaged by Hurricanes Katrina and Rita. 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, 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. 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:
|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|
Of DO's fleet of 46 rigs, only 31 are actively drilling. Here is a comparison of DO's market share of active rigs and its major competitors: