Rusting Dinosaurs

Jim Brown
 
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When oil was $100 a barrel it barely made sense to spend billions of dollars to drill multiple wells and build a production platform to set on top of them. At $45 oil it makes zero sense.

Six months ago, analysts were predicting a quick rebound to $75 and even $100 by the end of 2016. Most recently, analysts are questioning if prices will even recover to $75 by the end of 2017. At those prices, the cost of deepwater drilling is prohibitive.

Just two years ago, there was a shortage of deepwater rigs. Every driller on the planet was ordering $500 million dollar rigs from any rig builder that would take their order. Oil hit $110 in the middle of 2013 and the CEO of every E&P company saw dollar signs in his dreams.


Rig utilization in 2013 was approaching 90%. In September 2014 that had declined to 80% but the decline in crude prices was just getting underway. According to Rigzone 593 of the 736 global offshore rigs were contracted a year ago. Today there are less than 460 contracted and the numbers are headed lower.

According to RigLogix there are 67 rigs with contracts expiring in Q4. Only 24 have potential follow on contracts.

During the surge in offshore rig usage the drillers could place an order for a new rig with all the bells and whistles and before it was actually completed they would have multiple lease offers for ever increasing lease rentals.

On October 1st, there were 105 jackup rigs on order but only 10 of them had actual leases in place to begin work when construction was completed. Of the 27 scheduled to be delivered in Q4 only 2 had contracts.

Jackups are actually easier to contract today since they operate in shallow water, cost a lot less to operate and could actually produce oil under $50 a barrel in the right location.

The new deepwater rigs are in trouble. With costs from $500-$650 million and day rates of $250,000-$550,000 there are very few offshore areas where they can go to work today. The accounting of $50 oil simply does not support that kind of capital expense. Drilling a deepwater well is just the first step. If you find oil you have to drill more wells and then build billion dollar production platform and construct pipelines for hundreds of miles in some cases. Some purchasers are delaying newbuild contracts years into the future in order to save their deposits while others are paying a termination penalty to cancel the order.

Conoco Phillips did the math and cancelled a new $500 million rig that was headed to the Gulf of Mexico to drill a new well. The termination fee on the multiyear contract was $400 million but that was far cheaper than what they would have spent in a multiyear drilling program in the deepwater gulf. When production was scheduled to begin 5-7 years from now they had no guarantee oil prices would be high enough to ever return them a profit. They cut their losses gave up on deepwater exploration until prices recover. That could be well past 2020 if some analysts are right.

There are currently 33 active rigs in the Gulf of Mexico. That is down from more than 60 at the same time in 2014. That means 30 of those high dollar dinosaurs are sitting in a bay somewhere growing barnacles and rust.

The energy sector is familiar with the cycles of feast and famine. Approximately every ten years there is a price crash as the result of recessions or over production. In 1998, oil dropped to $10 a barrel when Saudi Arabia opened all the pumps and declared war on the rest of OPEC. After the other nations fell back into line and agreed to produce according to the quota system the production declined, prices began to rise and it took unto 2006 before the rig count recovered and the sector really went back to work. In 2008 oil spiked to $147 because demand increased faster than supply and then the Great Recession cut that demand by 25% and the next crash began.

Eventually this cycle will reverse. We are not yet at the bottom in terms of active rigs and production cuts. One analyst said last week that one-third of oil companies will go out of business or be acquired. One third will file bankruptcy and one third will muddle through and survive to thrive again. We are just now approaching the bankruptcy stage and it will probably be 2017 before prices really begin to rebound because production finally slowed enough to allow demand to catch up.

Even then, it is doubtful if the deepwater drillers will ever see a resurgence to the boom days of 2013. Investors have a long memory and years of losing money will make them shy about rushing to drill for $100 oil in mile deep waters again soon.


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Active Rigs

Active drilling rigs were flat at 787 for the week ended on Friday and that is still a 10 year low. Oil rigs fell -1 for the week to 594. Active gas rigs rose +1 to 193. Active rigs have now declined -1,144 since the high of 1,931 in September 2014. That is a -63% drop. Active offshore rigs were rose +2 to 35.


Oil Inventories

Crude inventories rose +8.0 million barrels to 476.6 million.

Refinery utilization rose slightly from 86.0% to 86.4%. That is down from the high of 96.1% on August 7th.

U.S. production was flat at 9.096 mbpd, down from the 9.61 mbpd and 40-year high in June.

Cushing inventories were flat at 54.1 million.

Gasoline inventories fell -1.5 million barrels to 218.8 million.

Distillate inventories fell -2.6 million barrels to 145.0 million.

In the graphic below green represents a recent high and yellow a recent low.


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