Resurgence in the Gulf

The biggest news story of 2013 – aside from the Red Sox winning the World Series – is the U.S. regaining the number one spot in global oil production. That’s right, folks, the U.S. is once again number one, after a lapse of some 30 years, leapfrogging Russia and Saudi Arabia in the process. We were already number one in natural gas, having nosed past Russia on the heels of the explosive increase in shale gas production from fields in Pennsylvania and Ohio. (Trivia question: What country is number three? Hint: It’s not in the Middle East.) 

Can the once far-off dream of U.S. energy independence be close at hand?

Current U.S. oil production of just over 12 million barrels per day includes not just crude oil but also what are called “natural gas liquids” (NGLs) – byproducts of natural gas processing like propane and butane and ethane, which are used for things like heating, plastics and petrochemical production. It also includes biofuels and something called “refinery gain,” a measure of efficiency in the refining of crude oil.

Measured in terms of crude oil alone, the U.S. ranks number three, at nearly 7.5 million bpd, about three million bpd behind both Russia and the Saudis. Nearly one-third of that total comes from – you guessed it, savvy MarEx readers – shale oil. In the last three years the U.S. has seen the greatest surge in energy production, thanks largely to shale oil and gas, since the Saudis opened wide their spigots during the early 1970s. But it’s not all due to shale. The Gulf of Mexico is making a statement too.

“Elephant Fields”

This year the GOM will produce about 1.5 million bpd of oil, about the same as the two largest shale plays (the Bakken in North Dakota and the Eagle Ford in Texas) combined. Over the next three years it’s expected to add another 700,000 bpd, almost all of it from new deepwater fields – “elephant fields,” as they’re known in the trade. They have colorful names like Mars and Mad Dog and Tiber and Thunder Horse. 

But the prize for best name goes to Blackstone partner LLOG Exploration’s new floating production facility dubbed Delta House, from the movie…“anyone, anyone?”… “Animal House,” and whose two main fields are named Bluto and Marmalard, after characters in the movie. You remember Bluto, don’t you? He’s the character immortalized by John Belushi. How do they come up with these names?

You have to be big to play in the deepwater Gulf. These mammoth fields lie thousands of feet below the surface of the sea and thousands more beneath the seabed. We’re talking miles here. A single well can cost in the hundreds of millions, even billions, of dollars, compared to less than $10 million on land. It’s a whole different ballgame, but the rewards can be great – fields that produce for 20 years or more. Delta House is expected to reach peak production of 100,000 bpd. Chevron’s Jack/St. Malo field has an initial production capacity of 170,000 bpd. Thunder Horse could produce more than 200,000 bpd. Estimates of potential reserves in the so-called Lower Tertiary of the Gulf, located 200 miles from shore and in 10,000 feet of water, range up to 15 billion barrels.

“The Gulf of Mexico, and especially the deepwater, is essential to our nation’s energy independence,” says Jim Adams, President of the Offshore Marine Service Association (OMSA) in New Orleans, a trade group representing vessel owners and operators. “The more energy we have, the better off we’ll be. It keeps the economy going.” 

It’s a remarkable turnaround, really, from what could have been in the wake of the 2010 Deepwater Horizon spill. Drilling companies fled the Gulf, seeking greener pastures elsewhere and fearing a moratorium that could have lasting negative effects. In late 2010 there were maybe a dozen working rigs in the Gulf. Today, according to Baker Hughes, there are 62 (37 “floaters” that work in the deepwater and 25 jackups that work in shallow water) – with 21 more expected over the next two years. 

And it’s not just the deepwater that’s booming. Shallow water is making a comeback too, borrowing horizontal drilling techniques from the fracking industry to make old fields more productive. Rates for jackup rigs are going through the roof.

Each rig requires anywhere from two to five boats per drilling operation. The smaller jackups can get by with two. The bigger floaters and drill ships need more than two and as many as five, depending on the size of the boat. Producing platforms, where the well has already been drilled, can manage with one.

How Big Is Your Boat?

All of this spells opportunity for offshore vessel companies. And a new report from J.B. Lowe of Cowen and Company tells you just which companies to play. Lowe likes Gulfmark Offshore (NYSE: GLF), Hornbeck Offshore (NYSE: HOS), and Tidewater (NYSE: TDW) because of their significant exposure to the deepwater and their big, new and high-tech fleets. “Our top pick is Hornbeck Offshore,” he says, “given its aggressive fleet expansion, exposure to the robust GOM market, significant earnings growth and 40% upside potential.” He is less keen on French operator Bourbon (GBB: FP) because of its heavy reliance on crewboats and highly leveraged balance sheet.

Lowe would also like Edison Chouest and Harvey Gulf, but they are privately held and so not part of his coverage universe. Galliano, Louisiana-based Chouest is the biggest player in the Gulf and by far the biggest in the deepwater Gulf with a fleet approaching 250 highly specialized vessels. Not all work in the Gulf, however, as Chouest has farflung operations in Brazil, West Africa (where one of its vessels was recently hijacked), and the Arctic (supporting Shell’s efforts). Chouest is in the midst of a 40-vessel fleet expansion program that includes 17 massive, 312-foot PSVs that can hold 22,000 barrels of liquid mud and boast 14,450 cubic feet of cargo space. The newbuilds also include two icebreakers designed for Arctic service (bringing its total to six) and four subsea construction vessels. Although the company does not disclose costs, but to give you an idea of what we’re talking about here, one of its existing Arctic supply vessels, the Aiviq, cost $200 million to build.

Competitor Harvey Gulf, backed by private equity firm The Jordan Company, has been busy acquiring other companies and building new vessels of its own under a $540 million expansion plan, raising total capital expenditures since 2008 to $1.7 billion. The acquisitions included the BeeMar (2012) and Gulf Offshore (2013) fleets and, in October, the much larger Abdon Callais fleet of 48 OSVs. Among the newbuilds are the first LNG-powered workboats in the world, six of which are being constructed at the Gulf Coast Shipyard Group in Mississippi. To service its new green fleet, the company is building its own LNG bunkering station in Port Fourchon, Louisiana, the jumping-off point for 90 percent of the boats in the Gulf.

Meanwhile, top-pick Hornbeck is in the midst of a 24-vessel newbuild program dubbed Project Spartan. It includes 20 new 300-Class, DP-2 PSVs and four huge MPSVs (multi-purpose service vessels). The 300-Class is becoming the preferred deepwater vessel in the Gulf with its high-spec features and 20,000 barrel+ mud capacity, 14,000+ cubic feet of cargo space and 300-foot length. These vessels command day rates in the $40,000 range and can service the most sophisticated rigs and drill ships. The MPSVs, a Hornbeck innovation, are more than 400 feet in length and come equipped with DP-3, moon pools, cranes, winches, helipads, whatever the customer wants. They fetch dayrates approaching $100,000 and can be used for everything from crew accommodation to repair and maintenance, decommissioning and subsea operations.

Beyond the Gulf

The demand for new, high-spec offshore vessels extends well beyond the Gulf. In Lowe’s report, titled “Open Season on the Open Seas: Initiating on the OSV Space,” he makes the point that it is a global phenomenon, extending from the Gulf of Mexico and Brazil to the North Sea, West Africa, the Middle East and Southeast Asia. He says the industry is in the early stages of a multiyear expansion that will still leave it 120 vessels short of expected demand in 2015 because of the number of new drilling rigs coming on the market. As a result, “we see continued upside in both OSV dayrates and utilization as supply/demand tightens through 2015.”

On the macro-level, Lowe says there are currently 3,276 OSVs in the world servicing 639 working offshore rigs. Using the key vessel-to-rig ratio as his primary metric for forecasting future market conditions, he calculates that “There are currently 168 offshore rigs scheduled to be delivered by the end of 2015 (103 jackups and 65 floaters) or 26% of the current working rig fleet. In the same period there are 456 OSVs currently scheduled to be delivered, or 15% of the current OSV fleet.” After accounting for attrition in both rigs and vessels due to retirements and scrappings, he concludes that the rig fleet will grow by 19 percent versus only 10 percent for OSVs. Hence the 120-vessel shortfall.

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And it gets better. OSVs do more than service drilling rigs. They also work on subsea operations like pipelaying and seismic work, the decommissioning of old platforms (“idle iron”), and on wind farm construction and maintenance. These activities, in Lowe’s view, will soak up any additional vessel supply and ensure a tight market for the foreseeable future. 

Has there ever been a better time to be in the offshore boat business? I don’t think so, so grab it while you can. Oh, and the third-largest producer of natural gas? Our neighbors to the north.