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Why Is Ocean Rig Going to Scrap Young Rigs?

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Oct. 28 2015, Published 9:07 a.m. ET

Cold Stacking and scrapping

All offshore drillers (OIH) (IYE), including Diamond Offshore (DO), Atwood Oceanics (ATW), Rowan Companies (RDC), Seadrill (SDRL), Transocean (RIG), and Noble (NE), are reacting to depressed rig demand by either scrapping vessels or cold stacking them. Cold-stacked rigs reduce expenses and preserves capital during a downturn. Amid a lack of rig demand, companies are forced to scrap rigs despite lower scrap steel values.

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Ocean Rig’s stacking and scrapping plans

Ocean Rig’s (ORIG) entire fleet is currently active. In 4Q15, the contract on the Erik Raude rig will roll off. Similarly, the contract on the Leiv Eiriksson rig will expire in 1Q16. If the company fails to find employment for these rigs, then they will be cold stacked. The company might also a take a harsh decision to scrap these young semisubmersibles to avoid the costs related with five-year SPS (special purpose survey). The rig Erik Raude is just 13 years of age, while the Leiv Eiriksson rig is 14 years. A rig’s life is around 35 years. In general, we can currently observe that offshore drillers are scrapping vessels more than 30 years of age.

Ocean Rig has another two rigs whose contracts will roll off in 2016. The company will cold-stack them.

What is SPS?

After every five years, rigs need to go through a special-purpose survey (or SPS) where the rig is certified. This is to make sure that the drilling unit was built and maintained in accordance with the rules and regulations of the classification society. If any drilling unit fails such annual or special surveys, the drilling unit will not be able to carry on operations, and will be unemployable and un-insurable. This could also cause violation of certain debt covenants.

The costs associated with SPS can range from $30 million to $50 million, or even more. Currently, the company’s main priority remains cash preservation and maintaining liquidity, and this could have forced it to take the harsh decision of scrapping its younger semisubmersibles whose SPS is due in 2016 and 2017. Ocean Rig’s four sixth-generation operating drillships are due for their SPS in 2016. Its four seventh-generation drillships are due for their SPS in 2018, 2019, and 2020.

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