Hercules Offshore Cold-Docking Rigs, Cutting Costs in 2009

• The Company: Hercules Offshore, a provider of offshore contract drilling, liftboat and inland barge services.
• The Filing: FORM 10-Q filed with the SEC on October 31, 2008.
• The Finding: Expanding its geographic footprint is a fundamental element in Hercules Offshore’s business strategy. Nonetheless, the world’s largest operator of jackup rigs in the shallow waters (water depth of 350-400 feet) of the U.S. Gulf of Mexico remains vulnerable to depressed U.S. natural gas prices, as energy exploration companies in the region continue to reduce their E&P capital drilling budgets for 2009 (by approximately  25 percent).

The Upshot: Crew wages represent a significant operating cost. As market conditions soften, Hercules is taking measures to reduce labor costs and limit its downside exposure. The company is stacking five inland barges in the U.S. Gulf of Mexico, according to its December fleet status report. In addition, the company has cold-stacked (crews are either redeployed or laid-off) five submersible rigs and four jackup rigs in the inland Gulf Coast area, too.

Chief Executive Officer John Rynd told analysts on the third-quarter 2008 earnings call that with a growing international contract backlog (working mostly for national oil companies), coupled with more than $325 million in liquidity, nominal capital commitments (of about $100 million in 2009), and a debt structure with minimal scheduled principal maturities until 2013 (minimum principle repayment requirements are approximately only $9 million per year), the company remains well positioned for any downturn in domestic customers’ capital spending.

Average revenue per international offshore rig increased 52.4% to $130,704 per day in the third-quarter 2008 ended September 30, helping to offset a comparable third-quarter 2008 decline of 12.7% to $67,384 in average revenue per day per rig in the domestic offshore market. In less than three years, the company has transitioned from 100% operations in the Gulf to international exposure of 37 percent.

At September 30, the company had 27 and 12 offshore rigs operating in the domestic and international markets. Short-term contracts remain the norm in the shallow waters of the Gulf, with the average contract length for 52 days, compared with 511 days for international offshore contracts. An estimated 16 domestic rigs are up for contract renewal in the first quarter of 2009. Management believes monthly contract rates in the $50,000 to $55,000 per day in the Gulf of Mexico are defensible at this point. The good news is that fleet utilization should remain stable as rigs leave the Gulf area; and, during 2009, five rigs in the international arena will commence three-year contracts, contributing to a total of about $800 million in backlog revenue.

The Question: More than 80 newbuild jackups are set to hit the water by the end of 2010, according to ODS-Petrodata. At December 01, the overall current demand of jackup rigs in the U.S. Gulf of Mexico was 55, down from a peak of 88 jackups in January 2006. As most of these rigs do not have contract commitments, what does this mean for forward shallow water day rates and utilization at Hercules Offshore?