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NEW ORLEANS Growing demand for new offshore oil rigs, partly driven by the Gulf of Mexico spill last year, has led to a spurt of building in shipyards and raised tough questions about what to do with the old rigs.
The average offshore drilling rig is now about a quarter of a century old and, despite having been upgraded, many of the older ones look more obsolete by the year.
"There's no doubt in my mind that we are on a verge of an acceleration of the level of retirements of older equipment," Matt Ralls, chief executive of shallow-water rig contractor Rowan Cos Inc (RDC.N), told Reuters in an interview this week.
"It's just a function of the age of the equipment and the amount of new high-level competition that's come into the market."
By the end of 2013, more than 100 new rigs will join a global fleet that is now less than 600, according to Ensco Plc (ESV.N), which will have the world's second-largest fleet once it completes its $7 billion purchase of Pride International Inc PDE.N.
Dozens of these new rigs were announced in the past two quarters, as shipyards in Singapore and South Korea have bid aggressively for more work, and drilling contractors took advantage of low financing costs.
Building a new rig is not an easy decision, since deepwater units have a price tag of about $500 million. But they are often built with long-term contracts attached to support the cost and, in any case, contractors must keep upgrading to compete.
Oil and gas companies increasingly want the best available rigs to drill for new resources, particularly as they live under the shadow of last year's blow-out disaster at BP Plc's (BP.L) Macondo well in the Gulf of Mexico.
Seadrill Ltd (SDRL.OL) CEO Alf Thorkildsen, whose average rig is just eight years old, said at this week's Howard Weil Energy Conference in New Orleans that age-related issues were underestimated by Wall Street investors.
"Today, after the story on Macondo and other issues, I am more convinced that that is the future for the drilling industry," Thorkildsen said, referring to the newer rigs.
Ralls explained that the "option value" of old rigs sitting in the shipyard has decreased as the potential cost of revamping them up to standard has risen to tens of millions of dollars in some cases.
"They're not all alike," said Mike Breard at Hodges Capital Management, adding that some older rigs are simply not capable of modern drilling techniques. "Many of those older rigs are essentially obsolete."
DON'T DIE, FADE AWAY
So rig contractors are grappling with what to do with them and the heads of industry leader Transocean Ltd RIGN.VX and rival Noble Corp (NE.N) sought to tackle that question in their presentations to the Howard Weil conference.
Transocean CEO Steven Newman, fresh from taking a $1 billion charge to write down the value of the company's 54 older shallow-water jackups last month, said it might consider a spin-off of part of its fleet.
That is also an option being considered by Noble, along with possibility selling some off one by one.
But who would buy?
"It could be private equity, it could be some contractor that wants to scale up," Noble CEO David Williams told Reuters on the sidelines of the conference, adding it was probably too early in the process to discuss such possibilities.
Ralls, who had been chief operating officer at GlobalSantaFe before Transocean bought it in 2007, said rigs are often sold to private players in regions such as India.
"It used to be Mexico, though they're wanting to high-grade now," Ralls said.
Pemex PEMX.UL demanded last year that rigs be less than 10 years old, but the state oil company appears to have eased up on that requirement recently.
Breard at Hodges Capital said other buyers might be small independent players looking to work off areas such as Africa, which made even more sense now with oil prices so high.
"Operators are saying: I can hedge oil at better than $100 and go get a little jackup right quick and drill some of these small fields, drill some development wells, and put it on production real quick and make a pretty good profit," he said.
Plus, selling rigs is often preferable to retirement because of the cost of moving them to where they are scrapped.
"The trade-off is really whether you can get enough for them to justify the expense to get them to the break-up yard," Ralls said. "Contractors are just slow to pull the trigger on that decision."
Some older rigs even spend some of their twilight years as roving hotels for workers on other operations, such as the four jackups that Noble has doing "accommodation work" off Qatar.
Yet generally speaking, retirement is only a matter of time for outdated models.
"At a certain point it just doesn't make any sense to upgrade them or put another 5-10 million bucks into them," said John Tasdemir, an analyst at Canaccord Genuity. "Better just to scrap them and either start over, or just do something else."
(Reporting by Braden Reddall; editing by Andre Grenon)