European Oil Services DB 221008

Europe United Kingdom Oil & Gas

22 October 2008

European Oil Services

Reality check

Christyan Malek Research Analyst (44) 20 754 58249 [email protected]

Lucas Herrmann, ACA Research Analyst (44) 20 754 73636 [email protected]

Jonathan Copus Research Analyst (44) 20 754 51202 [email protected]

Deutsche Bank AG/London

All prices are those current at the end of the previous trading session unless otherwise indicated. Prices are sourced from local exchanges via Reuters, Bloomberg and other vendors. Data is sourced from Deutsche Bank and subject companies. Deutsche Bank does and seeks to do business with companies covered in its research reports. Thus, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. Independent, third-party research (IR) on certain companies covered by DBSI's research is available to customers of DBSI in the United States at no cost. Customers can access IR at http://gm.db.com or by calling 1-877-208-6300. DISCLOSURES AND ANALYST CERTIFICATIONS ARE LOCATED IN APPENDIX 1.

FITT Research

Fundamental, Industry, Thematic, Thought Leading Deutsche Bank Company Researchs Research Committee has deemed this work F.I.T.T for investors seeking differentiated ideas. Here our European oilfield service team undertakes an in-depth analysis on unique data sourced from Wood Mackenzie that seeks to identify which oil service themes and names should remain resilient in the face of deteriorating macro conditions & commodity prices. Fundamental: dealing with the reality of a potentially lower oil price world Industry: backlog should fuel impressive EPS growth and cashflow visibility Thematic: a unique analysis of license terms and drilling contracts Thought leading: ultra-deepwater and rig construction most attractive Playing the trends: Lamprell, Seadrill top picks; Amec, Saipem well placed

Co

mp

any

Glo

bal

Mar

kets

Res

earc

h

Europe United Kingdom Oil & Gas

22 October 2008

European Oil Services Reality check

Christyan Malek Research Analyst (44) 20 754 58249 [email protected]

Lucas Herrmann, ACA Research Analyst (44) 20 754 73636 [email protected]

Jonathan Copus Research Analyst (44) 20 754 51202 [email protected]

Fundamental, Industry, Thematic, Thought Leading Deutsche Bank Company Researchs Research Committee has deemed this work F.I.T.T for investors seeking differentiated ideas. Here our European oilfield service team undertakes an in-depth analysis on unique data sourced from Wood Mackenzie that seeks to identify which oil service themes and names should remain resilient in the face of deteriorating macro conditions & commodity prices.

Deutsche Bank AG/London

All prices are those current at the end of the previous trading session unless otherwise indicated. Prices are sourced from local exchanges via Reuters, Bloomberg and other vendors. Data is sourced from Deutsche Bank and subject companies. Deutsche Bank does and seeks to do business with companies covered in its research reports. Thus, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. Independent, third-party research (IR) on certain companies covered by DBSI's research is available to customers of DBSI in the United States at no cost. Customers can access IR at http://gm.db.com or by calling 1-877-208-6300. DISCLOSURES AND ANALYST CERTIFICATIONS ARE LOCATED IN APPENDIX 1.

FITT Research

Top picks Seadrill Limited (SDRL.OL),NOK77.00 BuyLamprell (LAM.L),GBP129.50 BuySaipem (SPMI.MI),EUR13.02 BuyAMEC Plc (AMEC.L),GBP468.25 Buy

Key changes

Rating/TP changes From ToAcergy - TP NOK 125 NOK 90Aker Solutions - TP NOK 140 NOK 85Amec - TP 960p 760pLamprell - TP 650p 400pPetrofac - TP 680p 500pSaipem - TP EUR 30 EUR 22Seadrill - TP NOK 210 NOK 170Subsea 7 - TP NOK 125 NOK 100Technip - TP EUR 70 EUR 55Tecnicas Reunidas - TP EUR 53 EUR 47Wood Group - Rating Hold SellWood Group - TP 430p 215p

Expiry profile of deepwater exploration licenses awarded

050

100150200250300350400450500

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

2016

2017

2020

2021

- 20

37

Lice

nses

exp

iring

-2%0%2%4%6%8%10%12%14%16%18%

% e

xpiri

ng

Exploration % expiring

Source: Wood Mackenzie, Deutsche Bank

Deepwater rig rate outlook > 2290m/7500ft

0200400600800

100012001400160018002000

2000

2001

2002

2003

2004

2005

2006

2007

E

2008

E

2009

E

2010

E

WM

dril

ling

days

0

100

200

300

400

500

600

700

Day

rate

('00

0$k/

d)

drilling days day rate


Current expectations for E&C growth rates and potential for margin gain

-15%

-10%

-5%

0%

5%

10%

15%

20%

25%

30%

35%

40%

- 25 50 75 100 125 150 175 200 225

Absolute margin upside 2008-10E(bps)

Ave

rage

cap

ex g

row

th 2

008-

10E

LNG

Deepwater subsea

Refining & Petrochemical

Deepwater Facilities

Frontier Developments

Onshore Upstream

Oil Sands

GTL

Regas

Middle East

Shallow water

Broadly similar margin outlook vs. 2007 study

Increase in capex momentum vs. 2007 study


Fundamental: dealing with the reality of a potentially lower oil price world Our mid-term outlook for global capex, done in conjunction with Wood Mackenzie (WM), suggests that growth will be robust; the long-run oil price implicit in WMs bottom up capex forecast is $60/bbl. With the market arguably focused on the longer-term impact of potentially lower commodity prices, our top picks centre on themes that offer impressive structural characteristics supported by unique data sourced from WM.

Industry: backlog should fuel impressive EPS growth and cashflow visibility We perform a 360 on the oil service industry and marry our renewed outlook for capex growth across the oil chain with each companys respective exposure. Our forecasts equally take into account the rate of margin expansion within each sub-sector, National Oil Company (NOC) positioning and companys ability to execute.

Thematic: a unique analysis of license terms and drilling contracts Proprietary analysis, done in conjunction with WM, reveals that between 2009 and 2012, 62% of the worlds deepwater exploration licenses are due to expire. A sharp rise in ultra-deepwater (i.e. >2800m) license expiries in 2009 and 2012 should place additional strain on the demand for deepwater rigs capable of drilling in these depths. Our bottom up contract analysis also shows that oil companies are signing up these rigs for longer periods of time (100% this year signed on 4+ years vs. 15% in 2005). For those drillers exposed this extends their cashflow visibility well into the next decade.

Thought leading: ultra-deepwater and rig construction most attractive With spare newbuild capacity (i.e. yet to be contracted) lowest in ultra-deepwater, drilling activity continuing to surge and a sharp rise in license expiries expected medium term, we believe the day rates at this end of the drilling spectrum will continue to climb. Elsewhere in the exploration complex we favour rig construction services.

Playing the trends: Lamprell, Seadrill top picks; Amec, Saipem well placed Our preferred names are Seadrill and Lamprell given their exposure to ultra-deepwater and rig construction, respectively, and the structural dynamics supporting them. Within E&C, we seek diversified plays exposed to our highest conviction themes (detailed overleaf), as well as NOCs. We believe those best placed are Saipem and Amec. In contrast, Wood Group (downgraded to Sell) is exposed to themes/regions that appear most susceptible to negative oil price risk. We have raised our company WACCs, which in part drives our PT revisions (see page 45). Nonetheless, we still see significant upside potential to our top picks. Key downside risks include oil prices sinking lower than $60/bbl for a sustained period, macro conditions deteriorating significantly and poor execution.

22 October 2008 Oil & Gas European Oil Services

Page 2 Deutsche Bank AG/London

Table of Contents

Executive summary ........................................................................... 3

Global exploration capex outlook.................................................... 7

Exploration drilling trends.............................................................. 10

Exploration industry dynamics and relative profitability ............ 22

Global engineering and construction outlook .............................. 31

E&C industry dynamics and relative profitability......................... 36

Company positioning by theme, region and NOC........................ 38

Sector valuation and company overview...................................... 42

Top picks and key recommendation changes............................... 45

Appendix A: Valuation matrices..................................................... 48

Appendix B: Global oil service spectrum ...................................... 51

Appendix C: Explanation of historical capex revisions ................ 59

Appendix D: Strategic analysis of the E&C themes...................... 60

Appendix E: Porters 5 forces on key service segments............... 62

Appendix F: Detailed specifications of yards in Eastern Hemisphere ...................................................................................... 68

Appendix G: License expiry in shallow water and onshore......... 72

Appendix H: GOM deepwater licenses expiry by depth.............. 73

Appendix I: Drilling activity the complete picture..................... 74

Appendix J: Regional spread of contracted newbuild rigs.......... 75

Appendix K: Snapshot of each companys financing ................... 76

Appendix L: Glossary of terms and simplifications...................... 81


Deutsche Bank AG/London Page 3

Executive summary Global outlook

Exploration-related activities (i.e. exploration, appraisal and development) represent c. 40% of global capex in 2009E (we forecast $660bn for 2009, up 10% from last year) with the balance comprising engineering and construction (E&C) spend (commercialisation of oil and gas). The long run oil price implicit in our bottom up forecast is $60/bbl. This is consistent with Deutsche Banks commodities team (average $60/bbl for 2009/10E) but below their long-run assumption of $80/bbl from 2011. Despite modest negative revisions to our 2008/09 forecasts (vs. last years expectations), we expect exploration spend to grow by an average 15%/yr to the end of the decade. Wood Mackenzies outlook points to double-digit growth across all sub-segments that we have analysed. Capex employed in drilling-related activities should boast the highest momentum across the exploration complex.

Our outlook for E&C spend points to a plateau in the medium term, albeit one exposed to upside pressure on our capex projections for 2010 and beyond if projects get delayed. We slice up the capex pie and reveal deepwater FPSOs/facilities, SURF and refining/petrochemicals to boast the most impressive momentum across the service spectrum. Furthermore, we expect the accelerated shift into ultra-deepwater drilling to spur a proportionate increase in deepwater E&C capex (particularly on ultra-deepwater subsea and, in turn, on facilities/FPSOs) in the mid term. The Middle East still remains the highest growth region whilst Africa and Canada appear to have moved significantly up the ranks since our last study in June 2007. Conversely, North America and Russia now demonstrate a negative growth profile. We believe there is downside risk to our E&C forecast if the oil price falls significantly below $60/bbl for a sustained period of time (see Risks section below).

Proprietary analysis, done in conjunction with Wood Mackenzie, reveals that between 2009 and 2012, 62% of the worlds deepwater (i.e. >400m) exploration licenses outside of the Gulf of Mexico (GoM) are due to expire. Beyond 2012 our analysis shows that expiries will continue well into the second half of the decade driven predominantly by the GoM and that the incremental global demand to drill should gravitate towards there. Longer-term fundamentals should also be supported by rigs continuing to be employed on (successful exploration) wells that form the basis of appraisal and development activity. Nearer term, a sharp rise in ultra-deepwater (i.e. >2800m) license expiries in 2009 and 2012 should place additional strain on the demand for these types of rigs (5th/6th generation semi-submersibles and drillships). Our positive outlook for deepwater drilling activity is equally based on additional analysis that leverages drilling days. We forecast that deepwater will represent over a third of the global drilling demand (onshore and offshore) by 2010 and of that the ultra-deepwater contribution will double to 12%.

In contrast, shallow water licenses appear to be generally more periodic in their expiry (around every 3-4 years). Having collectively reached a peak this year, the pressure to drill to the end of the decade is reducing. Against a lacklustre drilling outlook, we remain cautious on demand to drill at this end of the depth spectrum (related to jack-up rigs).

We note that whilst the downside pressure on rig demand linked to macro and credit conditions deteriorating further cannot be ignored, we believe that near to medium-term drilling programmes, particularly those in South America and West Africa (where a large bulk of the worlds license expiries exist), should be least impacted.

We expect exploration

spend to grow by an

average 15%/yr to the end

of the decade; our outlook

for E&C spend points to a

plateau medium term

The oil price implicit in our

(bottom up) forecast for

global capex is $60/bbl

Longer term, Wood

Mackenzies (top down)

view is that global capex

should remain flat. DBs

forecast of a rise in oil price

from 2010 places upside

pressure to this expectation

Our proprietary analysis of

license expiry terms

suggests that even if oil

prices were to fall

significantly below current

levels, the access to reserves

will remain a priority over its

near-term commerciality

and development

the risk to this assumption

is that if macro conditions

deteriorate severely, we

could see a reduced appetite

from NOCs/governments to

explore; in turn, this could

see them easing the

pressure on oil companies to

drill



Latest ODS Petrodata figures suggest a 34% increase in global offshore rig capacity by 2012 (40% of which will be deepwater). The common market perception is that this should be more than sufficient to quench any future surge in drilling demand. With spare newbuild capacity (i.e. yet to be contracted) lowest in ultra-deepwater, i.e. depths >2800m (c. 26% across 2008-12), drilling activity continuing to surge and a sharp rise in license expiries expected near term, we believe the day rates at this end of the drilling spectrum will continue to climb (we estimate up to $700k/day by 2010 from current leading edge of $650/day). Note that using the same model last year, we forecasted day rates would reach $650k/day (vs. a consensus expectation from leading industry consultants of $550k/day).

Beyond 2010, whilst impossible to quantify (our model only extends to the end of the decade), we expect ultra-deepwater day rates to stabilise. We believe that there will be modest downward pressure (i.e. no more than -10%/year) on deepwater rig rates in depths lower than 2800m. This is the case because even though drilling activity at these depths appears to be tailing off, this should be partly offset by the renewed pressure to drill (driven by continued license expiries beyond 2010 not to mention the need to appraise and develop successful exploration wells). In contrast, shallower water day rates are expected to decline more rapidly mid term. Our bottom up contract analysis also shows that oil companies are signing up deepwater rigs well ahead of their release and for longer periods of time (100% of rigs this year signed on 4+ years vs. 15% in 2005). As a result the cashflow visibility for deep water drillers now extends well into the next decade.

With the above in mind we believe that the construction for deepwater newbuild rigs will remain strong in the medium term, albeit continuing at a lower pace than 2006-08. We believe jack-up newbuild demand, whilst slowing will be supported by 1) increased demand for premium jack-up rigs capable of working in harsh environments and 2) direct investment by National Oil Companies who appear to be taking a more explicit role in exploration drilling than ever before. Our analysis also suggests that upgrade and refurbishment spend will continue to remain strong well beyond our forecast horizon.

Varying degrees of exposure to our preferred segments should power impressive earnings growth medium term (we expect sector EPS of 24% CAGR 2008-10E). Within exploration, we favour plays that have high absolute leverage to ultra-deepwater or rig construction. Most exposed are Seadrill and Lamprell respectively. As these themes possess structural characteristics that remain intact below $60/bbl, it makes them our top picks across our entire coverage universe. Within the E&C complex we seek diversified plays that are well exposed to our highest conviction themes as well as NOCs (with particular emphasis on South America, the Middle East and West Africa). Against a backcloth of a falling oil price and lack of certainty around timings on project awards, we believe this combination reduces the downside risk on company backlog growth relative to a niche player (i.e. in a specific theme or region). We believe those best placed are Saipem and Amec.

Key recommendations (in order of priority)

Seadrill: Buy, PT NOK 170 (previously NOK 210): Sector leading exposure to ultra-deepwater and managements choice to maintain a degree of rig liquidity in their portfolio (two rigs remain un-contracted) leaves them with sufficient exposure to further capture the expected up-tick in day rates. A current backlog of $12.5bn fuels sector leading earnings growth (49% 2008-10E CAGR) and provides it with excellent visibility given the current length of contract terms (on average 4-6 yrs).

Lamprell: Buy, 400p (previously 650p): Sector leading exposure to rig construction services provides it with the best earnings potential across the sector. Coupled with its Middle East positioning and robust execution capabilities, a greater profile post its main market listing this November should see it outperform.

Nearer term, a sharp rise in

ultra-license expiries in 2009

and 2012 should place

additional strain on the

demand for deepwater rigs.

with this in mind and

spare newbuild capacity (i.e.

yet to be contracted) lowest

in ultra-deepwater, we

believe that day rates here

will continue to climb.

The cashflow visibility for

deepwater drillers now

extends well into the next

decade.

Elsewhere in the exploration

complex rig construction

services emerges as a

distinct winner

Within exploration we

favour plays that have high

absolute exposure to ultra-

deepwater or rig

construction. Our top picks

are Lamprell and Seadrill

Within E&C we seek

diversified plays that are

well exposed to our highest

conviction themes; Amec

and Saipem are best placed



Saipem: Buy, PT E22 (previously E30): Sector-leading NOC exposure, in addition to presence in several of our preferred themes (exploration and E&C), provides continued earnings visibility and momentum across the mid term. An excellent execution track record should reduce the probability of negative earnings surprises vs. its peers.

Amec: Buy, PT 760p (previously 960p): Strong execution capabilities and diversification beyond oil and gas activities (power and process represents c. 40% of current topline) differentiates Amec amongst its E&C peers. The company uniquely boasts c. 700mn of its own cash available for return back to shareholders. Whilst Amecs profile does not necessarily play into the trends listed above, these credentials make it one of our key recommendations.

In a scenario where the oil price could sit significantly below $60/bbl for a sustained period of time, we believe the earnings of E&C companies will be negatively impacted beyond 2010 as oil company capex gets pulled back. The reason why our earnings outlook should remain unchanged before then is that existing company backlog provides sufficient revenue cover and that the margins associated with the majority of these projects have already been contracted (subject to execution performance, of course). Even so, share price sentiment will be negative (in anticipation of a slowdown in earnings post 2010 not to mention the sectors strong correlation with oil price). Against this backdrop we believe Saipem and Amec would outperform on a relative basis (vs. their E&C peers); Wood Group and Aker Solutions should underperform (we have downgraded Wood Group to a Sell from Hold). On an absolute basis we prefer Lamprell and Seadrill from our entire coverage universe.

Valuation more cautious view on sector target multiple linked to the added risk of macro conditions deteriorating severely

Our 2009E EV/DACF for the sector is currently 4.0x (market cap-weighted) which represents c. 63% discount to the sectors historical average (2000-07E) of 10.9x. At the industry level, we believe the risk (execution)/reward (primarily revenue) trade off has shifted more into equilibrium. However, together with the heightened lack of visibility surrounding credit markets, particularly in emerging nations, and the risk of macro conditions deteriorating further, on balance we argue that our sector target multiple should trade at a 15% discount (vs. previously in line) to the historical average. Strong cashflow visibility to the end of the decade fuelled by current sector backlog (average revenue cover sits at 18 months) coupled with healthy balance sheets (refinancing risk on debt maturities appears limited see Appendix K) justifies why we believe this sector should not trade at a deeper discount to historical multiples.

Our implied price targets are supported by our DCF valuation in which we assume peak company earnings in 2010 with subsequent linear fade to our mid-cycle scenario in 2013. We have raised our company discount rates to reflect the increased market risk premium, as well as the higher cost of debt driven by the lack of credit liquidity across Europe and US. We detail changes in company WACC in Appendix A. This in part drives our price target changes on our universe of stocks (summarised in Figure 61, page 45). We assume a long-term growth rate of 3%, which is the average mid-cycle rate since 1990 for the European Oil Services.

We have raised our

company WACCs for the

European oil services from

an average of 8.5% to 13%

across the group

together with adjusted

relative valuation targets

this drives downward PT

revisions across our

coverage universe (see

pages 45 and 51 for full

details). We have not

changed our earnings

outlook

Our absolute valuations

remain conservative in that

we model an earnings peak

in 2010 (whilst impossible to

quantify this assumes oil

price reverts to sub $60/bbl).

Nonetheless this still

presents significant upside

potential for our top picks



Risks

Oil price: whilst impossible to quantify, Wood Mackenzie estimates that 2009/10 E&C capex would be c. 20% lower if oil prices sink to $40/bbl. Russia, North America, Europe and Canada in particular could see an even more exaggerated decline. The Middle East will be the least impacted but nonetheless we would expect to see a slow down. Companies most at risk in this context are Wood Group and Aker Solutions (regional and thematic exposures detailed on pages 40 and 41). In contrast, we believe this downside risk for companies exposed to rig construction and ultra-deepwater drilling will be mitigated by the structural need for operators to drill (near- and medium-term) and longer contract lives that drive earnings growth well into the next decade.

Backlog cancellation (e.g. due to lack of client/contractor funding): Our discussions with Wood Mackenzie and Pegasus Global (leading risk consultants) suggest there is very little probability contracted projects will be cancelled given the healthy state of IOC and NOC balance sheets. In the unlikely event that they do, contractors have the right to file for liquidated damages and take control of all cash pre-payments. Equally we show that the refinancing risk on debt maturities of the companies we cover is low (detailed in Appendix K) and as a result we do not expect them to have cashflow issues in executing their contracts.

Execution: Poor execution is another key industry risk. We believe the potential impact this risk can have on company earnings remains impossible to quantify ahead of any material announcement.

Key risks are oil price,

backlog cancellation and

execution



Global exploration capex outlook Exploration-related activities (i.e. exploration, appraisal and development) represent c. 40% of global capex in 2009E with the balance comprising engineering and construction (E&C) spend. The long run oil price implicit in our bottom up forecast is $60/bbl. This is consistent with Deutsche Banks commodities team (av. $60/bbl 2009/10E) but below their long run assumption of $80/bbl from 2011. Despite modest negative revisions to our forecast for 2008/09 (vs. last years expectations), we expect exploration spend to grow by an average 15%/yr to the end of the decade. Wood Mackenzies outlook points to double-digit growth across all sub-segments we have analysed. Capex employed in drilling related activities should boast the highest momentum across the exploration complex.

Where are we in the global exploration capex cycle?

The exploration end of the global capex spectrum that incorporates everything from seismic and drilling to wellhead operations until only a few years ago was dwarfed by a predominantly engineering and construction (E&C) driven capex cycle. National oil companies aside, the decision by the majors to invest a higher proportion of their spend in lower-risk opportunities in order to monetise an established resource base (e.g. stranded gas, tar sands) played a significant role in reducing the incremental dollar invested in exploration. This structural downward shift witnessed across 2000-03 was, however, only temporary. Visible strains on majors long-term production profiles, within the context of an industry decline in reserve replacement, renewed the need for a sustained up-tick in exploration spend, as Figure 1 highlights.

Figure 1: Reversing trends: relative exploration spend re-emerges from the trough of

2002 to become a key driver of global oil and gas capex into the end of the decade

-

100,000

200,000

300,000

400,000

500,000

600,000

700,000

800,000

1999 2000 2001 2002 2003 2004 2005 2006 2007 2008E 2009E 2010E

Cap

ex ($

bn)

30%

32%

34%

36%

38%

40%

42%

44%

Exploration, appraisal & development E & C % total spend that is exploration

Source: Deutsche Bank, Company data, Wood Mackenzie

Visible strains on majors

reserve replacement has

reignited the exploration

capex cycle, spurred by

sustained higher oil prices

(>$50/bbl) relative to

historical levels

Exploration-related capex

incorporates exploration,

appraisal and development

activities



Analysis of the outlook for global exploration by research partner Wood Mackenzie shows accelerated growth in absolute terms. Relative to the E&C capex up-tick (expanded on in later sections of this report) we note a temporary decline across 2007/08. We believe this is a direct function of:

final investment decisions (FIDs) undertaken on projects that saw an acceleration in E&C investment relative to exploration and,

a capacity bottleneck around exploration activity particularly in the availability of drilling rigs which led to a forced decline in investment (albeit a brief one in our opinion given the additional capacity coming online in the mid term).

Momentum is key which themes will drive the up-cycle?

Against this updraft in exploration capex, we believe the key differentiator of performance across the oil services (aside from structural differences between the industries in which they are present) will be their ability to position themselves across the themes and regions that offer the greatest topline growth.

In partnership with Wood Mackenzie we have incorporated National Oil company exploration spend, along with the groups regional and industry expertise in exploration to build a bottom-up assessment of the various components (shown in Figure 2) that drive this part of the spectrum. We also leverage Wood Mackenzie data available to DB in the form of drilling days and licenses awarded both by region and differing depths (offshore and onshore) to update our forecast of rig rates and margins (detailed in the next section).

Figure 2: Global exploration spend outlook (NOC + IOC) by theme (av. yearly growth

rates 2008E-10E shown alongside)

Surface servicing 14%

Surface equipment 17 %

Subsurface servicing 14 %

Subsurface equipment & products 13%

Drilling rigs 20%

Seismic 10%

0

50000

100000

150000

200000

250000

300000

350000

1999 2000 2001 2002 2003 2004 2005 2006 2007 2008E 2009E 2010E

$mn

Source: Deutsche Bank, Wood Mackenzie, Spears and associates, company data

Whilst the above sub-categories of exploration capex appear to demonstrate accelerated growth into the end of the decade, we note in particular that:

absolute exploration spend is shifting toward the drilling segment (employment of rigs offshore and onshore); as more rig capacity comes on-stream and current bottlenecks around their availability loosen, we expect a greater portion of IOC and NOC spend to be allocated here

this in turn should continue to depress seismic capex growth (a trend we have long argued) as the incremental dollar of spend becomes redirected into exploration techniques (i.e. drilling and wellhead operations) that serve to recognise and indeed prove up (crucially in the eyes of the regulators) the estimated reserves originated through initial 2D/3D/4D seismic analysis.

Greater exploration activity

combined with a structural

increase in finding costs

(associated, in part with

more difficult basins) is

expected to sustain the up-

cycle in exploration capex at

least till the end of the

decade

The exploration end of the

global capex spectrum will

not only comprise

exploratory activities but

also well appraisal and/or

development



Figure 3: Absolute spend across the exploration complex and expected year-on-year growth rates

$m 2005 2006 2007 2008E 2009E 2010E 2006/2005 2007/2006 2008E/2007 2009E/2008E 2010E/2009EAv. 2008E-

10E

Wellhead operations

Surface

Servicing 22994 30357 34384 36937 43469 51155 32% 13% 7% 18% 18% 14%

Equipment 11730 16893 21483 24609 29178 34596 44% 27% 15% 19% 19% 17%

Subsurface

Servicing 15239 19460 23750 26248 30550 35556 28% 22% 11% 16% 16% 14%

Equipment & Products 35893 45303 49085 52481 60740 70300 26% 8% 7% 16% 16% 13%

Total 85,856 112,013 128,702 140,276 163,937 191,606 30% 15% 9% 17% 17% 14%

Drilling (employment of rigs) 31752 45273 51897 53413 73,365 87,230 43% 15% 3% 37% 19% 20%

Seismic 7793 10908 12870 14801 16281 17095 40% 18% 15% 10% 5% 10%

Total 125,400 168,194 193,469 208,489 253,583 295,931 34% 15% 8% 22% 17% 15%

2007E Total 123,460 160,532 192,560 227,012 264,489 na 30% 20% 18% 17% na na

% change 1.6% 4.8% 0.5% -8.2% -4.1% na

% breakdown by sub-sector

Global exp drilling 25.3% 26.9% 26.8% 25.6% 28.9% 29.5%

Global exp wellhead operations 68.5% 66.6% 66.5% 67.3% 64.6% 64.7%

Global seismic 6.2% 6.5% 6.7% 7.1% 6.4% 5.8% Source: Deutsche Bank, Wood Mackenzie, Spears and associates, company data;



Exploration drilling trends Proprietary analysis, done in conjunction with Wood Mackenzie reveals that between 2009 and 2012, 62% of the worlds deepwater (i.e. >400m) exploration licenses outside of the Gulf of Mexico are due to expire. Beyond 2012 our analysis shows that expiries will continue well into the second half of the decade driven predominantly by the GoM and that incremental global demand to drill should gravitate towards there. Longer-term fundamentals should also be supported by rigs continuing to be employed on (successful exploration) wells that form the basis of appraisal and development activity. Nearer term, a sharp rise in ultra-deepwater (i.e. >2800m) license expiries in 2009 and 2012 should place additional strain on the demand for these types of rigs (5th/6th generation semi-submersibles and drillships). Our positive outlook for deepwater drilling activity is equally based on additional analysis that leverages drilling days. In contrast shallow water licenses appear to be generally more periodic in their expiry (around every 3-4 years) and having collectively reached a peak this year, the pressure to drill into the end of the decade is reducing. Against a lacklustre drilling outlook, we remain cautious on demand to drill at this end of the depth spectrum (related to jack-up rigs). We note that whilst the downside pressure on rig demand linked to macro and credit conditions deteriorating further cannot be ignored, we believe that near- to medium-term drilling programs particularly those in South America and West Africa should be least impacted.

With the above in mind, we believe the construction for deepwater newbuild rigs will remain strong in the medium term albeit continuing at a lower pace than across 2006-08. This is in contrast to the jack-up newbuild rig market. We believe the latters slowdown should be partially offset by 1) increased demand for premium jack-up rigs capable of working in harsh environments and 2) direct investment by NOCs, who appear to be taking a more explicit role in exploration drilling than ever before. Our analysis also suggests that upgrade and refurbishment spend will continue to remain strong well beyond our forecast horizon.

Analysis of license terms reveals all We have utilised Wood Mackenzies global exploration database to analyse expiry schedules of every license awarded around the world to an oil company (Integrateds and Independents) since 2000. Each license tendered by the host government will have a drilling commitment (number of wells that are required to be drilled every year and before a certain date/expiry) in which the operators must keep to. The repercussions of not sticking to this schedule may be severe and could see the oil company in question being prevented from drilling again in the country for an indefinite period. No doubt this is linked to the governments own appetite to drill in the face of deteriorating macro and credit conditions and we expand on this below. Figures 4 and 5 show the total number of deepwater licenses awarded since 2000 and their average-term length split by exploration (looking for first oil) and development.

The repercussions of not

sticking to a drilling

schedule may be severe and

could see the oil company in

question being prevented

from drilling again in the

country for an indefinite

period

no doubt this is linked to

the governments own

appetite to drill in the face

of deteriorating macro and

credit conditions



Figure 4: Deepwater licenses (i.e. >400m) awarded since

2000 has increased almost threefold

Figure 5: Deepwater license average-term length since 2000 has remains broadly constant

-

100

200

300

400

500

600

700

2000 2001 2002 2003 2004 2005 2006 2007

Lice

nses

aw

arde

d

-

5

10

15

20

25

30

2000 2001 2002 2003 2004 2005 2006 2007

Year

s

Exploration Development Source: Wood Mackenzie, Deutsche Bank Source: Wood Mackenzie, Deutsche Bank

The gradual increase in deepwater licenses since the beginning of the decade is fuelled by the up-tick in exploration investment depicted in the previous section and highlights the increasing emphasis on deepwater acreage as technology to drill in these depths improves. Figure 5 shows the contrast in license term lengths between exploration and development. Not surprisingly exploration licenses will have a much shorter life as the IOC will be keen to prove up reserves before making an investment decision related to the fields commercialisation (which can take up to 20 years in some cases). We noted a similar trend in the number of shallow water and onshore licenses awarded since 2000 and the lack of change in exploration and development term lengths (this is depicted in full in Appendix G).

Deepwater license expiries should force accelerated demand to drill across 2009-12 In conjunction with Wood Mackenzie we have tracked all exploration licenses awarded since 2000 with a focus on when they are due to expire.

Figure 6: Expiry profile of deepwater exploration licenses awarded*

050

100150200250300350400450500

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

2016

2017

2020

2021

- 20

37

Lice

nses

exp

iring

-2%0%2%4%6%8%10%12%14%16%18%

% e

xpiri

ng

Exploration % expiring

Source: Deutsche Bank; * note that even though the above depicts licenses awarded from 2000, the scale begins as of when they are due to expire i.e. 2006 onwards

These licenses (shown in Figure 6) tendered by host governments will have been awarded at a time when the appetite to explore was relatively weaker and against a backdrop of excess rig capacity. This is in contrast to the current tight deepwater rig environment which we expand further on in the next section. An important note here is that exploration drilling is typically followed by development and appraisal drilling. These licenses (on successful well discoveries) will revert into development licenses with far longer expiry terms (as shown above). Whilst difficult to quantify the point to make is simply that the demand to drill should continue well beyond the expiry of an exploration license as oil companies employ these rigs (deepwater rigs are equally capable of appraisal and development drilling) to prove up their reserves.

Our analysis shows that

license expiries will continue

well into the next decade

An important note to raise is

that exploration drilling is

typically followed by

development and appraisal

drilling. These licenses (on

successful well discoveries)

will revert into development

licenses with far longer

expiry terms



What is more telling, in our opinion, is which regions and depths are seeing their licenses enter into expiry near term as this would arguably place concentrated demand on rigs in the local vicinity and by rig type respectively.

Figure 7: Given that the majority of the worlds

deepwater rigs* operate outside of GoM

Figure 8: we take a closer look at the expiry profile of deepwater exploration licenses awarded exc. GoM

39%

29%

16%

8%

5% 3%

S America GOM E Hemisphere Europe Africa Russia

0

10

20

30

40

50

60

70

80

90

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

2016

2017

2020

2021

- 20

37

Lice

nses

exp

iring

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

% e

xpiri

ng

Exploration %

Source: Deutsche Bank, ODS Petrodata; * refers to contracted newbuild deepwater rigs (represents 25% of all rigs (existing + new)

Source: Deutsche Bank, Wood Mackenzie

Between 2009 and 2012, 62% of the worlds deepwater exploration licenses (excluding GoM) are due to expire with sharp rises expected to occur in 2009 and 2012.

Figure 9: Breakdown of deepwater licenses expiring by depth excluding GoM*

0

10

20

30

40

50

60

70

80

90

2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2020 2021 -2037

Lice

nses

exp

iring

400-799 (Peak 2009) 800-1199 (Peak 2009) 1200-1599 (Peak 2009)1600-1999 (Peak 2010) 2000-2399 (Peak 2012) 2400-2799 (Peak 2013)>2800 (Peak 2009)

Source: Deutsche Bank, Wood Mackenzie, *Given the scale of GoM licenses awards (on average 300/year vs. 40/year for everywhere else in the world) and the fact that 90% of them are below 2800m, we have excluded this region from the chart in order to show clearly the trends occurring in ultra-deep i.e. >2800m

Figure 9 shows that licenses in the majority of depth ranges are due for expiry over the next three years. The sharp rise in ultra-deepwater (i.e. >2800m) license relinquishments should place additional strain on the demand for these types of rigs (fifth/sixth generation) of which there are far fewer of to the end of the decade relative to shallow and mid-water rigs (we discuss the supply/demand implications of this on day rates in the next section titled exploration dynamics).

The sharp rise in ultra-

deepwater (i.e. >2800m) license

expiries should place additional

strain on the demand for these

types of rigs (5th/6th

generation) of which there are

far fewer of to the end of the

decade relative to shallow and

mid-water rigs



Figure 10: Breakdown of deepwater licenses expiring by region

0

10

20

30

40

50

60

70

80

90

2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2020 2021 -2037

Lice

nses

exp

iring

-50

0

50

100

150

200

250

300

350

400

450

GoM

lice

nses

exp

iring

E Hemisphere (Peak 2012) S America (Peak 2012)Europe (Peak 2009) Africa (Peak 2009)N America (Peak 2013) GOM (Peak 2016)

Source: Deutsche Bank , Wood Mackenzie

We draw the following observations from the above:

South America licenses will relinquish between 2010 and 2012. This should see a hike in exploratory drilling activity that in turn should fuel greater demand for rigs near term. Note that the increase in exploration activity triggered by the Tupi find late last year de-stabilised the global market for rigs as the existing ones gravitated towards South America and un-contracted global construction capacity reduced even further (mainly driven by new orders placed by Petrobras). Our analysis of all rigs operating globally shows that 30% has been contracted to work in the region over the next five years (detailed in Appendix J).

The majority of the licenses awards in Africa earlier this decade will expire next year which should see operators continue to bid on un-contracted rigs to ensure that their drilling commitments are fulfilled.

Europe (largely represented by the North Sea and Norwegian shelf) should see a similar surge in drilling near term as expiries approach.

We show the Gulf of Mexico separately given its much larger scale of licenses awarded vs. the rest of the world (albeit that each license is far smaller in block size). This is perhaps not surprising given average license term lengths are typically longer relative to elsewhere in the world. We note that the pressure to drill in this region is less given the first peak in expiry does not occur until 2012. In addition, oil companies have arguably more flexibility in being able to extend drilling programs here relative to other parts of the world.

It is worth noting that the desire to drill as many exploration wells before the license expires will also stem from the need to land grab as much as possible before it relinquishes. Subsequent to which the oil company will (and likely at a less pressured pace) decide whether to go ahead with FID on the field. This process can take up to five years and is equally critical in the eyes of the regulators and investors in ensuring the companys reserve replacement figures appear solid.

But to what extent will these drilling schedules be adhered to in light of worsening credit and macro conditions? What is implicit in the above is that every operator be it oil company or independent will have no choice but to drill in order to fulfil their commitments to the host government. High commodity prices will no doubt influence their appetite to drill more actively. However, even if oil prices were to fall significantly below current levels the access to reserves (particularly

Brazil will emerge as a

swing player in the global

demand for deepwater rigs

Even if oil prices were to fall

significantly below current

levels, the access to reserves

should remain a priority over

its near-term commerciality

and development



those that offer high net margin barrels) should remain a priority over its near-term commerciality and development. The risk to this assumption is that the industry environment deteriorates severely near term. Given the current financial turmoil, we caution that if credit availability and macro conditions were to worsen, governments themselves (committed to social programs and other fiscal pressures) could in turn pull funding and therefore become more accommodating to drilling programs. This would see license expiries extended easing the pressure for oil companies to drill.

This decision process would typically be initiated by the host government or National Oil Company. International oil companies that have left their licenses early or exited countries pre-maturely have in the past found it extremely difficult to return. Note it is not uncommon to see them negotiate with their partners including the host government on the grounds that the block acreage yielded very little in the way of discoveries and should not continue to be drilled upon. This is clearly a sensitive discussion but nonetheless one that again removes some of the pressure to remain overly committed to drilling schedules and in particular those that have not been successful.

Overall, whilst the downside pressure to drill linked to a potentially worsening credit and macro environment is real, we believe that near to medium-term drilling programs particularly those in South America and West Africa should be least impacted. This is based on 1) Wood Mackenzies view that these host governments in particular have greater strategic ambition to increase their countrys oil production and 2) IOCs longer-term production targets are weighted heavily to these regions leaving them with relatively less flexibility to relinquish their licenses.

Following a hike in 2008, shallow water and onshore license near-term relinquishments appear to be reducing mid term

Figure 11: Expiry profile of shallow water and onshore

licenses awarded from 2000*

Figure 12: Breakdown of shallow water and onshore licenses expiring by region

0

20

40

60

80

100

120

140

160

180

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

2016

-202

0

2021

-203

7

Cou

nt o

f lic

ense

s ex

pirin

g

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

12.0%

14.0%

16.0%

% e

xpiri

ng

Exploration licenses expiring % of total licenses expiring

0

20

40

60

80

100

120

140

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016-2020

Lice

nses

exp

iring

-100

0

100

200

300

400

500

600

GoM

& N

.Am

eric

a lic

ense

s ex

pirin

g

E Hemisphere (Peak 2009) Europe (Peak 2012)S America (Peak 2008) Africa (Peak 2012)Russia (Peak 2009) GOM (Peak 2009)N America (Peak 2015)

Source: Deutsche Bank, Wood Mackenzie, *note that even though the above shows licenses awarded from 2000, the scale begins as of when they are due to expire i.e. 2006


Shallow water licenses appear to be generally more periodic in their expiry (around every 3-4 years) and having collectively reached a peak this year, the pressure to drill into the end of the decade is reducing. Looking at the regional splits, the GoM not surprisingly represents one of the largest constituents of shallow water drilling and is to a large degree driving the downtick in license relinquishments to the end of the decade. In theory this should have a negative impact on shallow water global rig demand.

Drilling activity outlook

Wood Mackenzies global exploration database comprises signature bonuses, number of licenses awarded and drilling days. The latter represents the time between spudding and completion of the well and captures exploration and appraisal drilling but not development. It will however encompass operations related to the wellhead (surface or subsurface exploration activities). All data is categorised by depth, region, onshore and offshore. We

the risk to this assumption

is that if credit availability

and macro conditions

deteriorate severely, then

we could see a reduced

willingness from

governments to explore

easing the pressure on oil

companies to drill

Overall, whilst the downside

pressure on rig demand

linked to the above scenario

is real, we believe that near

to medium-term drilling

programs particularly those

in South America and West

Africa should be least

impacted



compare trends across these various datasets below starting with Figure 13, which shows the lag between global capex and levels of drilling activity globally.

Figure 13: Medium term, Wood Mackenzie expects a secular rise in drilling days

25000

75000

125000

175000

225000

275000

2000 2001 2002 2003 2004 2005 2006 2007 2008E 2009E 2010E

Expl

orat

ion,

app

rais

al a

nd d

evel

opm

ent c

apex

($

bn)

40,000

50,000

60,000

70,000

80,000

90,000

100,000

days

wellhead operations drilling seismic aggregate drilling days

Rise in global capex since 2002 has fuelled drilling activity globally

Insufficient historic investment in capacity, with utilisations approaching 100%, placed a bottleneck on Oil Co's ability to drill

Source: Deutsche Bank , Wood Mackenzie

Figure 14: Signature bonuses accelerated in 2008 YTD with an increasing emphasis on

deepwater

0

2000

4000

6000

8000

10000

12000

14000

2000 2001 2002 2003 2004 2005 2006 2007 2008YTD

$mn

Onshore Offshore 400m


WM expects the increase in

drilling days to be spurred

by the ramp up in licenses

awarded; the key downside

risk to exploration and

appraisal activity will likely

be:

1) insufficient rigs to meet

implied demand,

2) reduced appetite of oil

cos to drill in the face of

rising rig rates, and

3) deteriorating IOC and

NOC cash flow linked to

worsening credit and macro

conditions



Figure 15: Shift in licensees awarded has historically been followed with a similar

(directional) change in drilling days (exploration and appraisal shown)

15,000

25,000

35,000

45,000

55,000

65,000

75,000

85,000

95,000

2000 2001 2002 2003 2004 2005 2006 2007 2008E 2009E 2010E

drilli

ng d

ays

0

500,000

1,000,000

1,500,000

2,000,000

2,500,000

3,000,000

licen

ses

(acr

eage

in k

m2)

Onshore Shallow w ater (0-400m)

Deepw ater (>400m) licenses aw arded (RHS)

Source: Deutsche Bank , Wood Mackenzie; *measured by drilling days; this is defined as the time drilled between spudding & completion of well. Beyond actual drilling it will also include time spent on wellhead related operations (surface and subsurface).

Figures 16 and 17 show how these indicators of IOC and NOC exploration spend reveal differing trends in activity depending on the drilling depth, offshore and onshore. The appetite to drill is not homogeneous across the spectrum of depths or indeed onshore and offshore. Later we use the conclusions derived from these trends along with our earlier observations on license expiries to update our outlook on rig day rates offering an alternative to the methodologies adopted by ODS Petrodata and consultancies alike.

Shallow water drilling outlook shows mixed signals

Figure 16: Drilling activity in depths 0-199m Figure 17: Drilling activity in depths 200-399m

9,00011,00013,00015,00017,00019,00021,00023,00025,00027,00029,000

2000

2001

2002

2003

2004

2005

2006

2007

2008

E

2009

E

2010

E

days

0

50,000

100,000

150,000

200,000

250,000

300,000

licen

ses

(acr

eage

in k

m2)

drilling days licenses awarded

Lacklustre change in licensing expected to pressure drilling activity

0500

1,0001,5002,0002,5003,0003,5004,0004,5005,000

2000

2001

2002

2003

2004

2005

2006

2007

2008

E

2009

E

2010

E

days

0

20,000

40,000

60,000

80,000

100,000

120,000

licen

ses

(acr

eage

in k

m2)

drill ing days licenses awarded

Recovery in licenses awarded expected to support growth in drilling activity

Source: Wood Mackenzie and Deutsche Bank estimates Source: Wood Mackenzie and Deutsche Bank estimates



Drilling outlook appears polarised activity looks set to rise sharply with depth across the medium term

Figure 18: Drilling activity in depths 800-1199m*

Figure 19: Drilling activity >3200m*

0

1000

2000

3000

4000

5000

6000

7000

2000

2001

2002

2003

2004

2005

2006

2007

2008

E

2009

E

2010

E

days

0200040006000800010000120001400016000

Lice

nses

(acr

eage

in k

m2)

drilling days licenses aw arded

Ramp up in licenses aw arded in 2007 should see an equivalent increase in drilling days to 2010; key regional drivers are Asia and Brazil

0

200

400

600

800

1000

1200

1400

1600

2000

2001

2002

2003

2004

2005

2006

2007

2008

E

2009

E

2010

E

days

020000400006000080000100000120000140000160000180000200000

Lice

nses

(acr

eage

in k

m2)


2007 data show s an unprecented w ave of licensing in ultra-deepw ater, This should follow equally w ith a hike in drilling activity

Source: Deutsche Bank & Wood Mackenzie; *for completion we have included similar graphs of drilling days vs. licenses awarded at various intervals between 400m and 800m; 1199m and 3200m in Appendix I

Source Deutsche Bank & Wood Mackenzie; *for completion we have included similar graphs of drilling days vs. licenses awarded at various intervals between 400m and 800m; 1199m and 3200m in Appendix I

Figure 20: Deepwater drilling activity will continue to intensify in depths >3000m

0

2000

4000

6000

8000

10000

12000

14000

16000

18000

2000 2001 2002 2003 2004 2005 2006 2007 2008E 2009E 2010E

Dee

pwat

er d

rillin

g da

ys

400-799m 800-1199m 1200-1599m 1600-1999m 2800-3199m 2400-2799m 2800-3199m >3200m

Shift towards ultra deep water depths >3000m

Source: Wood Mackenzie and Deutsche Bank estimates

Onshore drilling outlook appears supported by renewed appetite from NOCs particularly in the Middle East and South East Asia

Figure 21: Onshore activity

19,00024,00029,00034,00039,00044,00049,00054,000

2000

2001

2002

2003

2004

2005

2006

2007

2008

E

2009

E

2010

E

days

-

500,000

1,000,000

1,500,000

2,000,000

2,500,000

licen

ses

(acg

reag

e in

km

2)


Uptick in licenses awarded should support drilling act ivity to 2010 albeit f rom a lower base

Source: Wood Mackenzie and Deutsche Bank estimates

Our outlook for drilling

demand points to an

exponential rise in ultra-

deepwater drilling (>2400m).

By 2010 we expect this end

of the depth spectrum to

represent 12% of deepwater

drilling days (vs. 6% 2007)



NOC investment should continue to support drilling activity across all depths

Drilling spend sourced from national oil companies will form a larger portion of oil service backlog as they become more involved around the drill bit than ever before. Greater ownership and participation of NOCs in oil and gas developments will naturally work its way up the oil chain as their host governments place greater emphasis on energy security and ensure that future years domestic demand on their resources are met. This is in contrast to IOCs and in particular the independents whose appraisal and development programs will be more commercially oriented, aimed at maintaining their commitments to shareholders and monetising reserves across the commodity up-cycle.

We caution that in the face of deteriorating credit and macro conditions, Norway and Russia NOCs would be most at risk to investment cut backs given the relatively higher cost to explore vs. elsewhere in the world; South America and West Africa exploration appetites will be least impacted. In theory this should provide service companies exposed to NOCs in these regions with a relatively safer harbour to fluctuating oil & gas prices.

Figure 22: NOCs to play a greater role in drilling (both exploratory and appraisal)

0

10,000

20,000

30,000

40,000

50,000

60,000

70,000

80,000

90,000

100,000

2000 2001 2002 2003 2004 2005 2006 2007E 2008E 2009E 2010E

$mn

30%

32%

34%

36%

38%

40%

42%

Drilling capex (IOC + NOC) % NOC

NOCs withdrew from exploration driven, in part by lack of appetite to explore and monetise reserves in a weak macro environment

NOCs are now gradually appearing to take a more direct role in exploration drilling, as they successfully build their engineering and financial capital


Moving further down the supply chain: rig construction services

Our outlook of rig construction spend (newbuild, upgrade and refurbishment) is based on what has already been flagged by the contractors (drillers and E&C companies) and the degree of additional investment (often termed speculative) that could materialise. We determine the latter by analysing the incremental demand to drill measured in the form of drilling days and licenses awarded detailed in the last section. Placing these indicators of exploration demand against the existing newbuild outlook allows us to take a view on the potential rate of incremental spend by rig class.

Robust drilling outlook will continue to support the rig construction market Analysis and prediction of the rate of rig spend can never be a complete science given the number of continually changing variables that effect the operators and oil services perception of how the market will move. Forecasts for rig construction capex are typically based on what has already been commissioned (with yard slots booked against it already) and an assumption on the degree of speculative investment that will come to fruition. Figure

Governments are placing

greater emphasis on

exploration drilling with the

aim of ensuring that future

years domestic demand on

their resources is met

however, as highlighted

earlier, we caution that in

the face of deteriorating

credit and macro conditions,

investment cut backs are

inevitable.

We believe South America

and West Africa exploration

budgets will be least

impacted



23 shows the former which excludes upgrades, refurbishments and re-activations (due to lack of available data).

Figure 23: Capex* invested by drillers appears to lag worldwide rig utilisations

0

2000

4000

6000

8000

10000

12000

14000

16000

18000

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

E

2009

E

2010

E

$ m

n

50%

55%

60%

65%

70%

75%

80%

85%

90%

95%

100%

Capex($ mn) Utilisations

Source: Deutsche Bank, ODS Petrodata *represents the annualised spend across the life of each rig built (typically between 1-3 years)

The large up-tick in spend (based on actual rigs commissioned; i.e., ignores speculative builds) shown above should come as no surprise given the unexpected turnaround in exploration activity. Over time this has led to record-high rig utilisations which in turn forced a decline in drilling activity (due to lack of rig availability) across 2006-07, albeit a temporary one (as shown in Figure 23 above). Of note is the length of time it has taken drillers to regain the confidence to invest in new builds despite an upward shift in utilisation since 2003.

We qualify the degree of speculative investment that could materialise by analysing the incremental demand to drill (measured as drilling days). Whilst in theory this should continue to support the rig construction market, as illustrated in the last section, the appetite to drill will vary across the spectrum of depths and indeed onshore relative to offshore.

Placing this demand analysis against the current newbuild outlook to date (shown in detail in the next section) allows us to take a view, admittedly a qualitative one on the potential rate of incremental spend by rig class (with each depth range above broadly represented by the various rig types).

Despite the number of deepwater floater new builds coming on-stream, the relative lack of liquidity here (only c. 26% are accessible vs. 70% for jack-ups) against accelerated drilling activity suggests that the demand for newbuilds will continue to remain strong albeit at a lower pace than across 2006-08. This is in contrast to the jack-up rig market (offshore and onshore) that appears readily accessible and in turn should witness a more exaggerated decline in newbuild investment vs. 2006-08.

Across 2006/07 drilling

activity declined, albeit

temporarily due to lack of

rig availability



Notable exceptions here that place upside pressure particularly on the rate of incremental jack-up spend include:

The demand for premium jack-up rigs capable of working in harsh environments as the global incremental supply of oil continues to be sourced from more technically challenging prospects (e.g. in the FSU).

National oil company investment in rig newbuilds. Figures 24 and 25 show actual capex committed to new builds between 2008 and 2012 sourced by region and origin of the operator; i.e., NOC vs. IOC.

Figure 24: Rig new build spend (2008-12E) by region Figure 25: Rig new build spend (2008-12E) by NOC/IOC

Total 2008-12E capex = $60.6 bn

Asia 16%

Europe15%

Middle East1%

Norw ay 28%

South America 10%

Africa1%

US29%

Total 2008-12E capex = $60.6 bn

IOC (i.e private or publicly listed

drillers)53%

NOC47%

Source: Deutsche Bank, ODS Petrodata Source: Deutsche Bank, ODS Petrodata

On comparing the above to the split of new build spend that occurred between 2003 and 2006, we note that there has been a gradual shift from the traditional investors of rig new builds, such as the US and Europe towards South America and Asia. This move has been underpinned by greater participation of NOCs in rig construction and in turn refurbishment/upgrades. Confirming this is our analysis done in conjunction with Wood Mackenzie which shows direct investment by the NOCs in drilling since 2000 (Figure 22).

Rig upgrade and refurbishment will carry on where newbuilds left off

This sub sector of rig construction services focuses on extending the life of a rig whether it be through maintenance and/or or extra kitting of equipment to improve its technical capabilities. Forward demand will be directly correlated to:

Rig attrition. Figures 26 and 27 show that 38% of global rig capacity is above 25-years-old (typical rig run life is 30 years) suggesting that over the next 10 years, these rigs will require some degree of maintenance. This could vary from refurbishment e.g. replacement of corroded parts (basically returning the rig to its original efficiency and capability thus extending its life) through to enhancement of the rig in order to extract more value from it. Unsurprisingly the latter will materialise into a larger (monetary) contract size given it requires the oil service company to utilise what is often termed as its value engineers in parallel with any necessary refurbishment. It is worth noting that we expect a more pro-active maintenance approach in contrast to earlier parts of the cycle where underinvestment i.e., the bare minimum was accepted (drillers, keen to exploit the strong commodity environment, kept maintenance time as low as possible).



Figure 26: Majority of world rig fleet is above 20 years

old

Figure 27: Average age of world fleet is remarkably high

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

30.0%

35.0%

40.0%

45.0%

25

Age (yrs)

% o

f rig

s w

ithin

age

ran

ge

0

20

40

60

80

100

120

1958

1961

1964

1967

1970

1973

1976

1979

1982

1985

1988

1991

1994

1997

2000

2003

2006

2009

Rig

s d

eliv

ered

per

yea

r

Av. age of global fleet = 24 yrs

Source: Deutsche Bank, ODS Petrodata

Source: Deutsche Bank , ODS Petrodata

Longer lead times on newbuilds (yards are now quoting four years) has led to many operators and drillers, particularly in the US, to opt for rig upgrades often in the form of conversion or re-activation. Interestingly, of the total number of re-activated rigs coming on-stream across 2007-11E, 65% are sourced from the US. It appears that the US drillers have been relatively less inclined to commit to new builds, preferring to upgrade the existing fleet, perhaps to avoid the risk of overcapacity suffered by many of them in previous down-cycles. It also means that they are able to exploit the current commodity environment far more quickly and leverage arbitrage opportunities; e.g., in cases when there is a short-term lack of rigs in a particular region.

Number of new rigs coming onto the market which will require periodic maintenance (regulators deem five years as the maximum). With a 34% increase in rigs expected across 2008-12 (on 2007 base), we believe this will see a proportionate increase in rig maintenance, which coupled with the requirements of the existing asset base as highlighted above should see demand for refurbishment remain strong well beyond our forecast horizon.



Exploration industry dynamics and relative profitability Latest ODS Petrodata figures suggest a 34% increase in global rig capacity by the end of the decade. The common market perception is that this should be more than sufficient to quench any future surge in drilling demand. With spare newbuild capacity (i.e. yet to be contracted) lowest in ultra-deepwater, i.e. depths >7500ft (c. 26% across 2008-12), drilling activity continuing to surge and finally a sharp rise in license expiries expected near term, we believe the day rates at this end of the drilling spectrum will continue to climb (we estimate up to $700k/day by 2010 from current leading edge of $650/day).

Beyond 2010, whilst impossible to quantify (our model only extends to the end of the decade), we expect ultra-deepwater day rates to stabilise. We believe there will be modest downward pressure (i.e. no more than -10%/year) on deepwater rig rates in depths lower than 2400m. The reason being is that even with drilling activity here appearing to tail off this should be partly offset by renewed pressure to drill (driven by continued license expiries beyond 2010 not to mention the need to appraise and develop successful exploration wells). In contrast, shallower water day rates are expected to decline more rapidly mid term. Our bottom up contract analysis also shows that NOCs, IOCs and independents alike are signing up deepwater rigs well ahead of their release and for longer periods of time (100% of rigs this year signed on 4+ years vs. 15% in 2005). This extends the cashflow visibility for deep water drillers well into the next decade. Elsewhere in the exploration complex rig construction services emerges as a distinct winner (offering best relative capex and margin upside).

Drilling services: global rig rate outlook

Analysis and prediction of rig rates can never be a complete science given the number of continually changing variables that affect the operators and drillers perception of how the market will move. Structural factors that influence spot (or leading edge) and long-term (or contracted) rig rates include:

the rate of rig replacement defined as the degree with which incremental rig capacity (confirmed new builds and upgrades) will be offset by ageing fleet due to be taken off-stream

the liquidity of the rig market - operators willingness to sign up rigs at a premium or discount to the current leading edge will, in part be based on the accessibility of incremental supply, i.e. the proportion of rigs that are not yet locked up into long-term contracts

IOC drilling schedule expiries as per their host government obligations, not to mention commitment to shareholders, many of whom will have invested in these companies based on their degree of exploration upside (e.g. the independents) or ability to grow production (e.g. the integrated companies)

We base our short- to medium-term rig rate forecasts on our understanding of the above supply/demand dynamics. Macro and geopolitical factors influencing rig rates include:

oil and gas prices (higher prices will drive appetite to drill and monetise reserves quickly)

the condition of the global economy and level of GDP growth anticipated worldwide and at the regional level



We believe our near- to mid-term day rate outlook remains intact at sub $60/bbl oil on a sustained basis and against deteriorating macro conditions. This is given the bottom up nature of our demand forecast (linked to the structural dynamics detailed above).

DB day rate model

We have modelled short- to medium-term day rates (by depth) within the offshore segment around our outlook for drilling activity and the our analysis on license expiries highlighted in the previous section.

But first.... Whilst we have not quantified the impact of supply on day rates we address below,

albeit qualitatively, the extent to which capacity creep could effect our forecast, if at all. Figures 28-31 show the timing, complexity and degree of incremental rig capacity (already commissioned) expected to come on-stream in the medium term. It is worth noting that rigs capable of drilling in deep and ultra deep waters are also operable in shallower waters. Therefore in periods of low utilisation, owners of fifth/sixth generation rigs (semi-submersibles or drillships) may choose to charter them out in reduced depths.

Figure 28: Latest ODS figures suggest a 34% increase in

global capacity by the end of the decade

Figure 29: Drillships; 116% increase in supply expected (depths greater than 7500ft)

0

10

20

30

40

50

60

70

2008 2009 2010 2011 2012

Num

ber o

f rig

s

Drillship Jackup Semisubmersible Tenders

190 rigs are currently planned tocome on-stream across 08-12E

0

5

10

15

20

25

30

35

40

45

0-2999 3000-4999 5000-7499 7500-9999 >=10000

depth (ft)

Num

ber o

f rig

s

2008 2009 2010 2011 2012

44 Drillships are planned to come onstream across 08-12E

Source: Deutsche Bank and ODS Petrodata Source: Deutsche Bank and ODS Petrodata

Figure 30: Semi-submersibles; 36% increase in supply

expected (bulk occurring at depths >7500ft)

Figure 31: Jackups; 25% increase in supply expected (bulk occurring at depths b/w 300-400ft)

0

5

10

15

20

25

30

0-2999 3000-4999 5000-7499 7500-9999 >=10000

depth (ft)

Num

ber o

f rig

s

2008 2009 2010 2011 2012

54 Semisubmersible rigs are planned to come onstream across 08-12E

0

10

20

30

40

50

60

70

80

0-199 200-300 300-400 >=400

Num

ber o

f rig

s

2008 2009 2010 2011 2012

91 Jackups rigs are planned to come on stream across 08-12E

Source: Deutsche Bank and ODS Petrodata Source: Deutsche Bank and ODS Petrodata

Whilst the rig market appears well supplied into the end of the decade, we highlight two counter dynamics that should remove (in some cases completely) the downside risk on rig utilisations.

Our day rate model is

demand driven and

dependent on license expiry

terms; analysing the degree

of supply coming on-stream

and more importantly

operators ability to access

spare capacity, provides a

more complete picture with

which to forecast future day

rates



Rig attrition. Of the expected 34% increase in global capacity, ODS Petrodata estimates that up to a third of that could potentially be soaked up in replacing older rigs forced off stream over the next 5-10 years.

Rig liquidity. Figures 32 and 33 show the proportion of new builds that have yet to be contracted.

Figure 32: Jackup new build spare capacity 2008-12E

Figure 33: Semi-submersible and drillship new build spare capacity 2008-12E

Number of uncontracted

Jackups70%

Number of contracted Jackups

30%

Total number of contracted semis

and drillships74%

Total number of uncontracted

semis and drillships

26%

Source: Deutsche Bank ,ODS Petrodata Source: Deutsche Bank, ODS Petrodata

Despite the number of deepwater floater new builds coming on-stream, the relative lack of liquidity here (only c. 26% are still accessible) suggests that the market will continue to remain tight in the medium term all else being equal. Conversely, the jack-up rig market (offshore and onshore) appears readily accessible. As the new builds come on stream, we believe this will inevitably place downward pressure on utilisation, assuming that jack-up demand does not vary significantly from current levels.

With regards to the existing rigs already under contract (that could threaten to increase spare capacity dramatically) analysis of the worlds contracted deepwater rigs (detailed further in the next section) shows that the average term length on rigs signed across 2007/08 (>90% of the worlds rigs were re-negotiated during this period) is four years (jackups around 2.5 years). The point to make is that spare capacity of existing rigs, at least those drilling in deepwater will not free up before 2011/2012. We believe this should be more than offset by a significant expected up-tick in drilling demand across the same period keeping supply/demand fundamentals robust into the first half of the next decade.

With the above in mind, we have utilised the Wood Mackenzie outlook on drilling activity and license expiries, highlighted in the previous section, to forecast rig rates at various depth intervals in both shallow and deepwater. Note that our forecasts have been made on a yearly basis. So, for example, a driller currently looking to re-negotiate a contract due to expire during 2009 would, for the purpose of our rig model, lock into the rate we estimate in 2009 (at the relevant depth) for the renewed length of the contract term.

As Figures 34-38 show, excess offshore rig capacity (that drove utilisation 7500ft) will demonstrate the best performance as supply/demand fundamentals tighten further. Shallower water day rates should at best remain at current levels.

The ultra deepwater market

(depths > 7500ft) will

demonstrate the best

performance going forward

as supply/demand

fundamentals tighten

further.



Figure 34: Shallow water rig rate outlook b/w 0m to

199m/656ft

Figure 35: Shallow water rig rate outlook b/w 200m to 399m/656-1300ft

9,00011,00013,00015,00017,00019,00021,00023,00025,00027,00029,000

2000

2001

2002

2003

2004

2005

2006

2007

2008

E

2009

E

2010

E

WM

dril

ling

days

0.0

50.0

100.0

150.0

200.0

250.0

Day

rate

('00

0$k/

d)


0500

1,0001,5002,0002,5003,0003,5004,0004,5005,000

2000

2001

2002

2003

2004

2005

2006

2007

2008

E

2009

E

2010

E

WM

dril

ling

days

0.020.040.060.080.0100.0120.0140.0160.0180.0

Day

rate

('00

0$k/

d)


A mild recovery in drilling activity and an easing of pressure to drill into the end of the decade (as expiries roll out to 2012) against a readily accessible jack-up market should see day rates fall. Source: Deutsche Bank and Wood Mackenzie estimates

Robust drilling outlook and an easing of pressure to drill intothe end of the decade (as expiries roll out to 2012 should atworst help maintain leading edge jack-up rates against a backdrop of capacity creep and high rig liquidity. Source: Deutsche Bank and Wood Mackenzie estimates

Figure 36: Deepwater rig rate outlook b/w between

400m to 914m/1300-3000ft

Figure 37: Deepwater rig rate outlook b/w 914m to 2290m/3000-7500ft

1500170019002100230025002700290031003300

2000

2001

2002

2003

2004

2005

2006

2007

E

2008

E

2009

E

2010

E

WM

dril

ling

days

0

50

100

150

200

250

300

350

Day

rat

e ('0

00$k

/d)


3500

4500

5500

6500

7500

8500

9500

10500

11500

2000

2001

2002

2003

2004

2005

2006

2007

E

2008

E

2009

E

2010

E

WM

dri

lling

day

s

0

100

200

300

400

500

600

Day

rat

e ('0

00$k

/d)


Ramp up of new ultra deepwater rigs that will initially be utilised in depths



Figure 38: Deepwater rig rate outlook >2290m/7500ft

0200400600800

100012001400160018002000

2000

2001

2002

2003

2004

2005

2006

2007

E

2008

E

2009

E

2010

E

WM

dri

lling

day

s

0

100

200

300

400

500

600

700

Day

rat

e ('0

00$k

/d)


Increase in new ultra deepwater rigs (capable of drilling >7500ft) will likely not be enough toquench the ramp up in drilling activity expected at these depths. We expect rig rates to risefurther as licenses expiries approach (expected to peak by 2012 ) and rig liquidity reduces. Source: Deutsche Bank and Wood Mackenzie estimates

Ultra-deepwater day rates will stay stronger for longer as contract term lengths increase

We have undertaken an extensive contract analysis of all deepwater rigs signed under long-term fixtures since 2004 in order to track the term length of contracts over time.

Figure 39: Term length of semi-submersible and drillship contracts since 2004

0%10%20%30%40%50%60%70%80%90%

100%

2004 2005 2006 2007 2008 YTD

Up to 2 years 2-4 years 4+ years

Source: Deutsche Bank, Rigzone, ODS Petrodata

Figure 39 shows term lengths on the rise as clients prefer to lock into longer fixtures on fixed day rates (as opposed to accessing the spot market on shorter term leases typically



Rig construction: strategic outlook

A recurring theme we have experienced amongst investors and industry alike regarding the mid- to longer-term outlook of the rig construction industry is that even against strong demand, excess capacity (particularly from China) could see the industrys margins decline from their current levels (c. 20% EBITDA) as pricing power diminishes. We have analysed current and future capacity across the Middle East, Asia and Australia basically the Eastern Hemisphere. With currently 59 yards in the region operating, two of which are undergoing brownfield expansion and six more being built, we believe that the risk of eventual oversupply is real (notwithstanding yards being built in China that are not public knowledge). However, against our demand outlook and various counter-dynamics discussed below (based on our analysis of capacity by region and industry), the risk of margins deteriorating in the medium term appears low in our opinion.

In Figure 40 we show the current regional yard capacity for construction. Oil and gas activities include newbuild and refurbishment of semi-submersible rigs, jack-up rigs, drillships, tension leg platforms, FPSO, FPO, heavy lift carriers, pipelay vessels, crude oil tankers, container vessels, gas carriers (LNG,LPG) etc. Non-

European Oil Services DB 221008

Documents

Transcript of European Oil Services DB 221008