A tale of two oil companies and four rigs

— In drilling operations, as in any business venture, there is always the risk that customers may fail to pay.  When the payments total several hundred thousand dollars a day, the ante is upped and the risk becomes especially acute.

That is the situation that deepwater drilling contractors deal with on a daily basis in leasing their pricey floating rigs to oil companies.  A large number of contracts between oil companies and drillers run three, five and in a few cases, as many as 10 years in length at dayrates that sometimes top $500,000/d.

But defaults usually don't occur.  Upstream operators have a vital interest in continuing to drill and produce oil and natural gas, so they have a virtually  spotless payment history--barring some exceptions like Venezuela, which at times has owed money to drillers.  Recently and notably, though, Venezuela state company PDVSA worked out payments for receivables to a large oil services client Schlumberger.

In any case, smaller upstream operators sometimes get into trouble when they try to grow too quickly and bite off too much.  When Brazil's OGX went public in 2008, investor enthusiasm quickly bubbled over for the aggressive new explorer with the chutzpah to take on some of Brazil's most challenging fields.  And OGX for years appeared to live up to the hype, touting what were considered a dazzling string of successes in the country's offshore that the upstream whiz kid kept encountering.

But all it took was a statement from the company--that most of its fields were not economically viable after all--to take down that shooting star.  Now the once high-flier is scrambling to pay off its indebtedness and clinging to the hope that just maybe, at least one of its fields -- the one known as Tubarao Martelo ("Hammerhead") -- could be a heavy-hitter after all.

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In the case of another small company, Canadian junior explorer Niko Resources which has been around since 1987, the rise wasn't as spectacular. Niko started out in the western Canada but soon found itself in India, and later branched out to other countries which now include Indonesia and Trinidad. But it did not have the recent successes in some fields that it had hoped for.

In the last couple of years, OGX and Niko each contracted two semisubmersible rigs from contract driller Diamond Offshore.  Each had a good payment history until recently, according to the driller's CEO Larry Dickerson, speaking on a recent quarterly earnings call.

One of the rigs leased to Niko was Diamond's Ocean Monarch, which the driller had relocated to Asia-Pacific in 2011 as part of its efforts to find overseas work for its Gulf of Mexico deepwater rigs after the April 2010 Macondo oil spill, the largest such event in US marine history.  The contract was to run four years, from 2012-2016.

"At that time we judged Niko of being capable of fulfilling this long-term contract based on the financial strength of their partners in Indonesia prospects, and we were impressed by Niko's knowledge of various basins in that country," Diamond CEO Larry Dickerson said in a quarterly earnings call last week.

Now the Monarch is sitting idle while the other rig OGX contracted, Ocean Lexington, will return to work after Diamond sits out Niko's 30 remaining lease days before the rig goes to work for BG and Centrica, which both time-shared the rig with Niko in Trinidad.  These rigs carried dayrates of $385,000 and $300,000 respectively; Diamond said it does not expect to book revenues in Q4 for either rig, and Diamond suggested the Monarch may not find new work until Q2 2014.

As for OGX, the company had leased the rigs Ocean Quest since last April at $265,000/d and also the Ocean Star at $301,000/d since June 2012.  After recently terminating the rig's contract, Diamond will move the Quest to Malaysia, while the Star will finish its remaining term until year-end under a sublet to another operator in Brazil.  For Diamond, the after-tax impact in Q3 from both delinquent companies was $0.54/share.

Ensco, another driller which also has two semisubmersibles contracted to OGX, reported a total $38 million or $0.17/share of earnings reduction in Q3 from lost revenues and a provision for doubtful accounts, and the driller will not recognize revenues from the rigs in Q4, Jay Swent, the driller's CFO, said during Ensco's conference call last week.  That is on top of $18 million in receivables in the Q2, only $2 million of which was collected in the Q3, according to Ensco's most recent fleet status report.  OGX leased the two Ensco rigs for around $222,000 and $235,000/d respectively.

If there is a moral here, it is not that drillers should not lease big rigs to small companies; that is common within industry and both companies had years of otherwise good payment records and apparent exploratory successes.   Small companies, with the right management teams, technologies and a dose of luck, often grow into big operators after some years.

But sometimes things happen and the impact costs money, and frequently the impact is significant.  Whether from poor exploration results, financial setbacks or bad judgment by managers, the stories of OGX and Niko and the drillers that contracted with them is a sober reminder amid a current bullish oil market that is forecast to continue for years to come, the industry is never without risks.  And you never know when or where the next blow will appear.

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