Replacement Cost Economics of Offshore Drilling Rigs

Abstract

Abstract The worldwide oversupply of offshore drilling rigs has decreased rapidly in the past six years. This paper examines the potential for additions to the world fleet and analyzes the required financial return to justify new rigconstruction. Modeling the Offshore Drilling Industry Both the financial and energy communities are notorious for their inability to forecast energy prices. As can be expected, demand for offshore rigs isclosely tied to oil company cash flow, which is in turn dependent on energy prices. Because the basic determinant for future energy industry activity - energy prices - is basically unknown, it appears fruitless to create a complex econometric model to project future rig demand. Therefore, several simple regression models were developed using the price of West Texas Intermediate crude oil (WTI), oil company cash flow, and oil company exploration and production expenditures, versus demand for offshore drilling rigs over the period 1969 - 1993. The best correlation and predictive capability came from a model comprised only of the average annual price of WTI versus offshore rig demand. The only "twist" to the model was the omission of the decade of the 1980's in the data base as an aberration due to unusual industry conditions. Exhibit 1 graphs the annual average price for WTI and rig demand for the period 1969 - 1993. If the actual oil prices for the 1980's and 1990's were inserted into the regression formula, the dotted line labelled "RegressionTest Forecast" would result. Empirically the model shows a fairly good fit. The difference in peaks between actual rig demand and the model's projected demand can be explained by the fact that there were simply not enough rigs in the world to meet the requirements of 1980-81. Therefore, actual rig demand peaked in a time of declining energy prices due to the unfilled demand of the earlier higher energy price period. On the whole, the regression model appears adequate to give us a view of the future.