Offshore drillers are in the early innings of a long-duration upcycle, particularly for deepwater projects. Rig utilization continues to rise, and average contract duration is lengthening, as operators seek to replenish baseload, low-decline-rate oil production.
JAMES WEST, Evercore ISI
The offshore market is back in focus after a very tough decade. The push into U.S. oil shale, from 2010 to today, kept offshore spending at bay, which led to a painful downturn. The downturn was exacerbated by the massive expansion of offshore assets, especially in deepwater, starting in the early 2000s. The industry found itself extremely over-leveraged, deconsolidated and in need of a serious restructuring.
While some restructuring occurred in 2018-2019, it was the Covid-19 downturn that pushed the majority of the offshore industry into insolvency. Almost every publicly traded offshore asset-heavy company went through a bankruptcy and debt restructuring. What emerged in late 2020 and 2021 was an industry with fewer assets and companies that quickly consolidated.
A change in company focus. No longer are rig and vessel companies fighting for utilization to drive cash flow to service debt. The new industry is leaner, meaner, and focused on returns on invested capital and returning capital to shareholders. The industry also has matured. Management teams are focused on financial returns and no longer on building asset bases and driving market share growth. We believe the sins of the past are unlikely to be repeated.
Fast forward to today, and the global offshore oil and gas markets are heating up and will be the largest drivers of E&P spending growth in 2024. The industry is quickly running out of available, modern offshore rigs, vessels and aviation assets to support the surge in activity. As a result, asset values are surging, and dayrates have jumped considerably. Given the rise in activity, there is a scramble for assets underway that is playing into asset owners’ hands.
In the deepwater rig market, dayrates that bottomed in the low-$100,000s are now closing in on the $500,000 level, Fig. 1. Standard modern jackups that experienced dayrate declines to $60,000-$70,000 are achieving dayrates near $175,000. Utilization of floating rigs that fell into the low-60% range is now close to 80%-utilized, with marketed utilization closing in on 90%. In the jackup market, where utilization fell below 60%, it is now in the low-80% range. Marketed jackup utilization is above 90%.
Offshore rig supply. In addition, there is limited rig supply coming to the market. To order a new drillship today, one would have to wait a year or two for construction to commence and another three years for the rig to be completed. The capital cost is likely in the $900 million-to-$1 billion range. Current drillship dayrates do not justify newbuilds, especially if those rigs were to be built on speculation. We do not anticipate an offshore rig building cycle any time soon, outside of modest jackup building unfolding in Saudi Arabia. We expect the rig owners to maintain capital discipline, and it is unlikely there will be new entrants into the market, at least not in the term or until rates rise significantly higher.
In the supply vessel market, where total annual capacity to construct vessels once approached 1,000, this is estimated to have fallen to around 350. Industry leader Tidewater’s vessel margins are quickly approaching prior cycle highs.
Shift in operator targets. Major oil companies, national oil companies, international independent operators and some U.S. independents are getting in on the action. The majors and NOCs recognize the need to replenish baseload, low-decline-rate oil production, while international independents are attacking prospects divested by the majors in prior years. There is also a shift toward increasingly targeting natural gas—in the Middle East to replace oil in electricity generation and in many other regions to supply the major LNG facilities currently under construction. Energy security concerns are a driver of this trend, as well as the desire for lower-carbon fuels.
Data show that 2023 has been a robust year for both floaters and jackups globally. The tight rig supply and the shift in regional dynamics, with rigs mobilizing from the North Sea to higher-demand regions, such as the Middle East, Asia Pacific, and West Africa, have materially improved dayrates and lengthened contract terms. Average dayrates for ultra-deep water (>7,500 ft) drillships and semisubmersibles substantially increased to $389,000 in 2023 from $326,000 in 2022. Average dayrates for jackups also grew to $127,000 in 2023 versus $104,000 last year, with leading-edge dayrates in the mid-$175,000 range.
Utilization. The ultra-deep marketed utilization of 88.7% is inching up toward 90%, surpassing 2015 levels at 88.3%, while the jackup marketed utilization hit 92.1%, which is slightly below the 20-year high of 94.1% achieved in 2013, Fig. 2. Floater demand has remained healthy across almost all regions, while jackup demand slowed in the North Sea and will remain challenged through the end of 2024. Offshore drillers believe opportunities, particularly in Norway, are limited, despite tender activity slowly recovering in the North Sea, with several contracts commencing work in 2025.
Contract lengths are also lengthening meaningfully across various geographies, Fig. 2. The average contract term for jackups was ~800 days YTD, which increased by 50.1% compared to 2020. The average contract length for floaters was ~300 days, which expanded by 44.8%. We believe the slower-than-anticipated pace of unstacking rigs, combined with extending contract terms and the unlikelihood of newbuilds at current economics, will continue to further tighten supply, driving further upsides to dayrates and utilization.
Activity expansion. We believe that offshore drillers are in the early innings of a long-duration upcycle. Contracting activity continues to gain momentum for select rig classes, in tandem with the slower pace of rigs returning to operation, and lengthening contract terms further squeeze dayrates, strengthening visibility towards $500,000 per day. Leading edge dayrates are unlikely to approach last cycle’s peak anytime soon, but we expect offshore drillers to generate robust free cash flow from rising dayrates, utilization, and high operating leverage as the cycle matures.
We think demand for floaters and jackups will remain strong in 2024, particularly in the Middle East, Asia Pacific, West Africa, and Latin America, attracting rigs from Norway, where demand is expected to remain subdued. As the Norwegian market may be short of supply by as many as 15–18 rigs by 2025, rigs will demand aggressive bidding at higher dayrates to bring back assets to the region.
Ultra-deepwater outlook. The UDW demand is expected to increase by double digits in 2024, driven primarily by incremental requirements in the Americas and West Africa. Petrobras’ total floater fleet is anticipated to expand to 30 rigs next year (from 24 rigs), and major projects across Namibia, Suriname, Angola and Nigeria will drive incremental rig requirements. Jackup demand in the Middle East will experience further growth, particularly in Saudi Arabia, Qatar and the UAE, and longer-duration opportunities will emerge in Southeast Asia, including Malaysia, Thailand and Vietnam.
The offshore oil and gas industry has risen from the ashes. Demand for assets and services continues to rise. Management teams are focused on generating returns, returning capital to shareholders, and providing the safest, most efficient operations to customers. The world needs more oil and natural gas, and the offshore arena is one of the best areas to source these resources. WO
JAMES WEST is a senior managing director at Evercore ISI, responsible for research coverage of the sustainable technologies & clean energy, and oil service, equipment & drilling industries. He provides detailed fundamental research on companies involved in solar and wind power, battery and power storage technologies, EV charging, carbon capture, hydrogen, and the drilling and production of oil and natural gas. Consistently top ranked in Institutional Investor, Mr. West earned a No. 1 position in the oil services & equipment category, as well as ranked runner-up in clean energy in 2023. He also was inducted into the Institutional Investor All-America Research Team Hall of Fame in 2023, a designation for analysts who have earned a No. 1 ranking on at least 10 occasions. Prior to joining Evercore ISI, Mr. West was a managing director and senior research analyst at Barclays and Lehman Brothers. Earlier in his career, he worked at Donaldson, Lufkin & Jenrette. He serves on the advisory board of the Boston University Institute for Global Sustainability. Mr. West received a BA degree in economics with a minor in history from the University of North Carolina at Chapel Hill.