DQ and CLA for case studies “Pacific Drilling: The Preferred Offshore Driller”
Case 11: Pacific Drilling: the Preferred Offshore Driller C-147
CASE11 ~ IVEY I Publishing
Pacific Drilling: The Preferred Offshore Driller
From June 2014 to January 2015, the market price of oil fell from US$1151 per barrel down to $49 per barreU As oil pr ices went down, so did the appetite of energy companies fo r offshore exploration. Further com- pounding the problems was the oversupply of rigs, due to drillers having overbuilt during the boom times. As of March 2015, there was no near-term recovery in sight for oil prices, which had major implications fo r Pacific Drill ing, a growing offshore drilling compan y based in Texas. Founded in 2006, Pacific Drilling own ed and
Exhibit 1 Pacific Drilling Income Statement s, 20 12-20 14
Revenues
Contract d rilling
Cost and expenses
Cont ract drilling
General and administrative
Depreciation
loss of hire insurance recovery
()pet'atlng income
Other income (expense) Costs on interest rate swap termination
Interest ex pense
Total interest expense
Costs on extinguishment of debt
Ot her income (ex pense)
Income before income taxes
Income t ax expense
Net income
Earnings I common share, basic
Weighted average number of common shares, basic
Earnings I common share, diluted
Weighted average number of common shares, diluted
Source: Company documents.
operated a fleet of eight high-specification drillships operating in ultra-deepwater drilling environments in depths up to 3.7 kilomet res (km) and offered the m ost advanced drilling technology available. As of 2015, the company had nearly 1,600 employees and had generated more than $1 billion in annual revenue (see Exhibits 1, 2,and 3).
With growing competition from rivals- both emerg- ing and more established companies- Pacific Drilling sought to expand its customer base. However, the dose
s 1,085,794 s 745,574 s 638,050
(459,617) (337,277) (331.495)
(57,662) (48,614) (45,386)
(199,337) (1 49,465) ( 127,698)
(716,616) (535,356) (504,579)
23,671
369, 178 210,218 157,14 2
(38,184)
(130,130) (94,027) (104,685)
(130,130) (132.211) (104,685)
(28,428)
(5,171) (1,554) 3,245
233,8 77 48,025 55,702
(45,620) !22,523) (21 ,713)
s 188,257 25,502 33,989 s 0.87 0.1 2 0.16
217,223 2 16,964 216,901
s 0.87 0.1 2 s 0.16 21 7,376 217.421 21 6,903
Haiymrg U, Fridiric }ncqutmin, and Toby U wrote tlris casesolely to provide materinl for dnss discussion. 11Jt authors do rrot inttrul to i/lustmte either effocti>-e or ineffoctio-e handling of a managerial situation. Tire authors may hm-e disguised cmain names and other iikntifying irrformntion to prot«! amfidentia/ity.
This publicatimr may not be tmnsmitted. plrotocopi.J, digitiztJ, ur otherwise reproduc.J in any form or by any mtt~ns widr0111 d1t pemrissimr of the copyright holder. Rtprodr~etimr of this mattrialu not coo-ered under authoriz1Jti011 by any reproduction rights organization. To orrkr copies or rt.qut:St pemrission to reproduce mnteriD/.s, contact lvey Publishing. 1•'1!)' Business School. Western Unn-ersil)l London, Ontario, Canada, N6G ONI; (t) 519.661.3208; (t) "marlto:~vey.co" ~''I!J'.CD; "httr./lwww.n~m· www.n't)'OU<S.corn.
Olpyright 0 2016, Ridlard lo-ty Sdtoo/ tf BusilldS Foundation Vmiotc 2016-04-08
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C-148
Exhibit 2 Pacifi c Drilling Balance Sheets, 2013-2014
Accounts receivable
Materials and supplies
Deferred financing costs, current
Deferred costs, current
Prepaid expenses and other current assets
Total current assets
Property and equipment, net
Deferred financing costs, current
Other assets
Total assets
Liabilities and shareholders' equity
Accounts payable
Accrued expenses
long-term debt, current
Accrued interest
Derivative liabilities, current
Deferred revenue, current
Total current liabilities
long-term debt. net of current maturities
Deferred revenue, current
Other long-term liabilities
Total long-term liabilities
Common shares. $0.01 par value per share, 5,000,000 shares authorized, 232,770 and 224, 100 shares issued, and 215,784 and 217,035 shares outstanding as of December 31, 2015, and December 31, 2013, respectively
Additional paid-in capital
Treasury shares, at cost
Accumulated other comprehensive loss
Retained earnings
Total shareholders' equity
Total liabilities and shareholders' equity
Source: Company documents.
relationships that it had cultivated with its existing part- ners (which had helped its early stage growth) raised concerns that the driller had become too closely linked to them (in terms of culture, processes, and technology) to effectively translate its efficiency gains to new pro- ducer partners.
Part 4: case Stud ies
231,027 206,078
95,660 65,709
14,665 14,857
25, 199 48,202
17,056 13~9
551 ,401 552,858
5,431,823 4,512, 154
45,978 53,300
48,099 45,728
6,077,301 5,164,040
40,577 s 54,235 45,963 66,026
369,000 7,500
24,534 21,984
8,648 4,984
84,104 s 96,658 572.826 251 ,387
2,781 ,242 2,423,337
108.812 88,465
35,549 927
2.925,603 2,512,729
2, 175 2,170
2,369,432 2.358,858
(8,240)
(20,205) (8,557)
235,710 47,453
2,578,872 2,399,924
6,077,301 5,164,040
T he company's chief executive officer (CEO), Christian J. Beckett, and his team received a range of opinions about what the company should do to weather the storm and emerge stronger. Investors also felt the pain from the company's stock pr ice sliding from Sll per share in 2014 to less than S4 per share, as did
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Case 11: Pacific Drilling: the Preferred Offshore Driller C-1 49
Exhibit 3 Pacific Drilling Cash Flow Statements, 2012- 2014
(m rhousonds) 2014 2013 2012
C.sh flow fTom operating activities:
Net income
Adjustments to reconcile net income to net cash provided
by operating activities:
Depreciation expense
Amortization of deferred revenue
Amortization of deferred costs
Amortization of deferred financing costs
Amortization of debt discount
Write-off of unamortized deferred financing costs
Costs on interest rate swap termination
Deferred income taxes
Share-based compensation ex pense
Changes in operating assets and liabilities:
Accounts receivable
Materials and supplies
Prepaid expenses and other assets
Accounts payable and accrued expenses
Deferred revenue
Net cash provided by operating activities
C.sh flow fTom Investing activities:
Capital expenditures
Decrease in restricted cash
Net cash used in investing activities
C.sh flow fTom tln.ndng activities:
s 188,257
199,337
(109,208)
51,173
10,416
817
18,661
10.484
(24,949)
(29,951)
(56,493)
20,865
117,001
396,410
(1,136,205)
(1,136,205)
s 25,502
149,465
(72,515)
39,479
10,106
445
27,644
38,184
(3,119)
9,315
(53,779)
(16,083)
(30,840)
12,301
94.482
230,587
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172,184
(703,958)
s 33,989
127,698
(95,750)
70,660
13,926
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5,318
(89,721)
(6,640)
(61,548)
33,865
156,967
184,998
(449,951)
204,784
(245,167)
Proceeds from shares issued under share-based compensation plan
Proceeds from long-term debt
95
760,000
(41,833)
1,656,250 797,415
Payments on long-term debt
Payments for costs on interest rate swap termination
Payments for financing costs
Purchases of treasury shares
Net cash provided by financing activities
Increase (decrease) In cash and cash equivalents
Cash and cash equivalents, beginning of period
Cash and cash equivalents, end of period
Sourc~: Company docum~nts.
the stock price of all offshore drillers during that time (see Exhibit 4). As he considered the available options, Beckett faced another critical crossroad. The company had survived tough times before- in the early stages of the company's development, the team had successfully
(7,569)
(7,227)
703.466
(36,329)
204,123
s 167,794
(1.480,000)
(41,993)
(62,684)
71,573
(401,798)
605,921
204,123
(218,750)
(19,853)
558,812
498,643
107,278
s 605,921
manoeuvred through the 2008 financial crisis as th e cred it markets collapsed. But as Beckett admitted, the current challenge was unique in many ways, and Pacific Drilling was a different company from earlier. However, it remained to be answered to what extent
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C·150 Part 4: case Studies
Exhibit 4 High Correlation Between Ofuhore Drillers Stocks and Oil Price, December 2013 to 2014
75
65
55
45
35
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0 0 0 ~ ~ ~ 0 0 0 0 0 0 0 0 0 0 0 0 0 0 ~ 0 0 0 0 0 0 N N N N N N N N N N N N N N N N N N N N N N N ..... ~
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- PACD - Offshore Peer Average - WTI j - Brent - OSX Index
~-- Note: PACD = Padflc Drifting; wn • Wtit T~us ln...,rmed~ate: OSX • Oil SeM<e Sector Index Source: OrganiLltion of the ~t.....,m Exporting Countries; Yahoo finance: and company analysis.
Beckett and his team could rely on what they had successfully done in the past, and to what extent they would need to adapt.
The Offshore Drilling Industry The offshore oil industry involved the exploration and production of oil and gas from underwater wells, often in locations off continental coasts but sometimes in inland seas and lakes. Offshore sites held greater prom- ise than onshore sites for oil producers to develop their oil reserves, and achieve higher production rates, espe· cially in less explored deepwater sites. For instance, in recent years, the greatest increases of any offshore drill· ing region had been the demand for ultra-deepwater rigs in the Golden Triangle of Oil, which consisted of the Gulf of Mexico and the waters off the coasts of South America and West Africa (see Exhibit 5). Over the past decade, deepwater discoveries had far outpaced those in shallow water.3
Developing a well usually involves two main players: the oil producer and the driller that physically drills the well in accordance with the producer's specifications. A small number of oil companies owned a few offshore rigs and conducted drilling in-house. Most companies, how· ever, outsourced the work to drilling contractors. Some producers, known as independent producers, focused solely on the upstream, or early stage, activities of explo- ration and production (e.g., Anadarko). Others were integrated multinational corporations (e.g., BP, Ex:xonMobil, Chevron, and Shell) and state-owned companies (e.g., Brazil's Petrobras and Saudi Arabia's Aramco) that also performed downstream or later stage activities, such as refining and marketing of the extracted oil and gas.
Oil exploration began with geological and seismo- logical research on a potential well. Next was the pur- chase or lease of the promising ocean terrain, almost always from governments. Once sufficient due diligence was completed and the rights to explore the site were secured, producers typically contracted with drillers
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Case 11: Pacific Drilling: the Preferred Offshore Driller C-151
ExhibitS The Golden Triangle of Oil That Drove Ultra-Deepwater (UDW) Demand Growth 2009-2014
It o I E. Africa Other/Yard Au•tralia
S . America
90
• 37 • PACD Active
_ _ Basins , ... 2009- .,--20-14L-,1
68 ~ D OtherUDW .____, _ Demand Basins
r'i 2009':-".,., ... 20-14.,,
T otailncrease in UDW Rig Count • 96
PACD Active Basin Increase in UOW Rjg Count• 53
Note: PACD • PacifiC OriUing; USGOM • U.S. Gulf of Mexico; Mex. s Mexico; carib. = the uribbeao; Med • the Mediterraneao; M.E. • Middle Ea5! Soutce: "Uit,....Oetpwat .. Dtmand Growth; ODS-Petrodata. Inc. accessed April12. 201 S; Company analysis.
to driU exploratory wells. If the results were encourag- ing, drilling began on development wells in the area for eventual oil extraction. How quickly drilling, and then extraction, could be accomplished depended on the supporting infrastructure (e.g .. , pipelines connecting to processing facilities) around the drilling site, weather conditions, and geological characteristics. Another fac- tor was productivity, which was a function of the drill- ing technology used and the working experience of the producer-drilling teams.
Offshore drilling typically used three types of rigs: jack-ups, semi-submersibles, and drillships. Jack-ups were used in shallow water (up to approximately 0.12 kms of water), and their operating deck was supported by multiple legs that extended down to the ocean floor. Semi-submersibles (semis) could operate in water depths of up to 3 kms. They floated on submerged pon- toons with an operating deck that was well above the water's surface. Drillships could operate in water depths of up to 3.6 kms. They looked like large, ocean-going freighters with a drilling derrick mounted in the centre
of the ship. They offered greater mobility and deck space than semis and were therefore often preferred in remote locations. Their larger size also allowed them to provide greater operational efficiency through enhan cements such as dual derricks• and additional drilling equipment.
Drillers competed to lease their rigs to producers. The drillers were usually paid based on day rates,5 which varied widely across rig types. Deepwater oil reserves were much more difficult to tap and required more advanced equipment and expertise than some other locations. As a result, day rates for semis and drillships could be three to five times higher than jack-up rates. Day rates also varied in relation to market conditions and could be further differentiated by the quality and efficiency of the drilling rigs and services, which were often the result of technological and processing innova- tions that could ultimately provide lower total drilling costs fo r the producer (see Exhibit 6). Day rates were usually locked-in through negotiated contracts, \vith the duration of the contracts and the lead time decided on
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C·152 Part 4: case Studies
Exhibit 6 Day Rate Trends for Floating Rigs by Rig Quality (2012-2014)
800
750
700
:0 650 c :i g600 ~ "" 550 ~ ., 10 500 a:: i;' 0 450
400
350
300
• -.... . . _;:.--;-• • .. . 1 ..... •
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=-----=---•• • _._ • • ~· • • • -.........:: •
• Jan-12 Mar-12 Jun-12 Sep-12 Dec- 12 Mar-13 Jun-13 Sep-13 Dec-13 M ar-1 4 Jun- 14 Sep-14
Fixture Date
Note: Analysis uses publicly avail.\ble dota; includes rigs with water depth capabi~ty g reater than 1.5 kms and contract day rate ,.venue from mutual
contracts great« than one )'fllr. Source: 'Trends fa< Floating Rigs by RigType,"oos-Petrodata,lnc.. accessed April12. 2015; Ca<npany analysis.
prior to the start of the contract. However, day rates also fluctuated with market conditions.
Many factors could affect a producer's choice of driller. For example, national oil companies often held public tenders and chose drillers based on the rig's suit- ability and the day rate. International oil companies had been known to be much more reliant on existing relationships.' Because relocating rigs was costly and time-consuming/ producers seeking to develop wells in a certain region were more likely to contract a driller that already had the required type of rig ready in the area. In certain geographic locations, government regulation and local content criteria could be barriers to entry, thereby playing a significant role in the selection of a drilling contractor.
Rigs that were not leased out were usually "stacked" (i.e., idle), or taken out of service, by the driller to mini- mize operating costs. A "hot-stacked" rig remained fully crewed, standing by, ready for work if a contract could be obtained, and the downtime was used for maintenance and repairs; a "warm-stacked" rig retained some of the crew and underwent a reduced level of maintenance and repairs; and a "cold-stacked" rig was completely vacated and its doors welded shut.•
The offshore driUing industry rose and fell with oil prices (see Exhibit 4). The early 1970s witnessed a spike in oil prices due to actions by the Organization of the Petroleum Exporting Countries (OPEC) that increased the supply of offshore rigs as drillers rushed to meet the increase in drilling demand. The industry later suffered an overcapacity of r igs when prices came back down during the mid-1970s.9 Such cycles continued with the oil price spike in 1979, its collapse in early 1986, and its recovery in 1987. Oil prices remained depressed during the 1990s until 1998, due to the economic slowdown in Asia, then started climbing in the ea rly 2000s, which pushed utilization rates, and thereby day rates, to histor- ical highs. The financial crisis that started in 2008 caused utilization rates and day rates to decline sharply again, as oil prices fell below $40 per barrel from their peak of $140 per barrel a year earlier.10
Players in the offshore drilling industry included both diversified drillers (e.g., Transocean, Sead rill, Ensco, Noble, Diamond, Rowan, and Atwood) and niche drillers (e.g., Ocean Rig). Larger, diversified drillers had fleets that included rigs of various types and typically had a broader geographic presence (see Exhibit 7).
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Case 11: Pacific Drilling: t he Preferred Offshore Driller C-153
Exhibit 7 Profiles of Pacific Drilling's competitors
Transocean
Seadrill
Ensco
Noble
Diamond
Rowan
Atwood
Ocean Rig
Transocean operated the largest fleet in the offshore drilling industry with B5 rigs (15 jack-ups, 39 semi-submersibles,
and 31 drillships) with an average age of 17 years. The company's market capitalization was approximately $6.B billion,
which was the second largest in the industry. it had an operational presence in the waters of the United States. Norway, the United Klngdom, West Africa, Brazil South East Asia, and Australia. Over the past frve years. the company had de·
livered operating margins of about 22 per cent. which was below the industry average. The company's strategy was to upgrade its fleet and divest its non-core assets.
Seadrill operated 57 rigs (25 jack-ups, 15 semi-submersibles, and 17 drillships). With an average age of 3.4 years. It was
one of the youngest fleets in the industry. The company's market capitalization was S5.9 billion. Over the past five years, the company had also had the second-highest operating margins in the industry at about 40 per cent It had an opera- tional presence in the waters of the United States, Mexico, Norway, Brazil, West Africa, the Middle East. and Asia Pacific.
Its strategy was to maintain its technology advantage by continuing to invest heavily in fleet renewal and growth.
Ensco operated 74 rigs (46 jack-ups, 1B semi-submersibles, and 10 drillships) with an average age of 19.6 years. The
company's market capitalization of $7.1 billion was the largest in the industry, and it generated average operating margins of 40 percent over the previous five years. It had an operational presence in the waters of the United States,
Brazil, the Mediterranean, the Middle East, Africa, Europe, and Asia Pacific. Its strategy was to update its fleet, invest in employee training, and maintain its d iverse geographic presence.
Noble operated 39 rigs (19 jack-ups, 11 semi-submersibles, and nine drillships) with an average age of 15.B years, which
made It the second oldest fleet in the industry. The company's market capitalization was $4.4 billion. It had a diverse op-
erational presence with rigs operating in the waters of the United States, Brazil, Mexico, the United Kingdom, the Middle East. Africa, and Australia. The company performed just below the industry average, delivering operating margins of
around 27 per cent over the previous five years. Its strategy was to update its fleet, invest In employee training, and maintain its diverse geographic presence.
Diamond operated 41 rigs (six jack-ups, 30 semi-submersibles, and five drillships) with an average age of 30.4 years, which made it the oldest fleet in the industry. The company's market capitalization was S5.3 billion. Over the previous
five years, the company delivered operating margins of about 31 per cent. which was in line with the industry average. The company had a very low level of debt relative to its size and in comparison to its peers. At the same time, its older rigs enabled the company to be very competitive on rig pricing. The company strategy was to maintain its attractive pricing and its financial strength.
Rowan operated 34 rigs (30 jack-ups and four drillships) with an average age of 16.4 years. The company's market capi· talization was $2.9 billion. It operated rigs in the waters of the United States. Saudi Arabia, the United Klngdom, Norway,
and Malaysia. The company generated average operating margins of about 23 per cent over the previous five years. The company's strategy focus was to maintain its diverse geographic presence, be more cost-effective, and execute better.
Atwood operated 14 rigs (five jack-ups, five semi-submersibles, and four drillships) with an average age o/9.6 years. The company's market capitalization was S 1.9 biD ion. It had an international presence, with rigs in the waters of the United States, Australia, Equatorial Guinea, and Thailand. The company achieved the highest operating margins in the industry over the previous five years at about 44 per cerrt Its strategy was to continue growing while maintaining its operational efficiency.
Ocean Rig operated 13 rigs and focused on drilling in deeper waters (two semi-submersibles and 11 drillships) with an
average age of 3.3 years. The company's market capitalization was $1.2 billion. It had a rig presence in the waters of Brazil, Angola, Norway, and Ireland. Its operating margins were at the industry average of approximately 30 per cent. The company's strategic focus was to grow its fleet of high-specification drilling rigs and to broaden its geographic reach.
Source: "'il Drillers," ODS·Petrodata, accessed April 12, 20 IS; Yahoo finance; company analysi~
Chris Beckett: CEO had been constru cted in South Korea at Samsung
Heavy Industries, one of the three largest shipyards in the world. At th e same time, Beckett was approached by !dan Ofer, an Israeli tycoon and the principal of Tanker Pacifi c. Ofer asked Beckett to be the company's ftrst employee and to lead the development of Pacific Drilling as CEO. Beckett, a 2002 MBA graduate from Rice University in Texas, had previously been the head o f corporate planning at Transocean, a strategy consul- tant at Mc Kinsey, and the U.S. land seismic manager at Schlumberger.
and the First Employee With the initial purchase of a drillship under construc- tion, Paci fic Drilling was founded in 2006 as a subsid- iary of Ta nker Pacific, one of the largest tanker fleet owners in the world. After ordering a second rig in 2007, the company transferred its rigs to a joint venture with 50-50 ownership with Transocean. In 2008, Pacific Drilli ng expanded its activities b eyond the joint ven- ture to in clude fo ur ultra-deepwater drillships, which
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C·154 Part 4: case Studies
Exhibit 8 Fleet Composition by Rig Capability and Type
59%
• High Spec 1:] Standard Spec 0 Low Spec 0 Jack-up
Source: Company documents;'Fieet Composition by Rig capability; 005-Petrodata.lnc. accessed April12, 2015.
As the CEO of a start-up, Beckett challenged the industry's conventional wisdom:
Back to 2004 and 2005, the industry was coming out of the downturn . ... There was a belief in most of the estab- lished drillers that they would sit on what they had, and they would own the market. They would have a strong market position. There was an absolutely strong belief that nobody from outside could enter the industry. No clients would take the risk to work with a new driller without any proven record. Also, no lenders would take the risk to build several-hundred-million-dollar assets with a new player.
Despite huge challenges and personal risks, Beckett believed that the offshore drilling industry was changing and provided great opportunity for a start-up such as Pacific Drilling, which focused on premier technology and ultra-deepwater drilling. In particular, he noted:
When we started Pacific Drilling, it was with the view that the assets that were being designed, built, and delivered into the market around 2005 and 2006 onwards were, for the first time in the industry, explicitly supposed to out- compete those of the previous generation by being more efficient: by reducing the time to drill a welL A lot of the incumbents missed that as a fundamental change, and they believed that if they didn't build rigs then nobody would build rigs and that they could continue with the
technology that they had and control the market. What happens in most industries is that somebody comes in from the outside and delivers the technology to the market place and supersedes them by using disruptive technology.
In November 2014, Beckett won the Ernst & Young (EY) Entrepreneur of the Year National Award in the Energy, Cleantech, and Natural Resources category for his lead- ership in growing the start-up company into a highly respected niche player in the offshore drilling market. "Chris Beckett is the definition of a high-growth entre- preneur," said Mike Kacsmar, EY Entrepreneur of the Year Americas program director. "He's grown a world- class team based on that entrepreneurial spirit, and he encouraged his employees to make an impact by iden- tifying novel approaches and seeing those ideas through to implementation.""
Firm Strategy Beckett strongly believed that the new generation of rigs would be fundamentally more efficient than the existing generation. Over time, the previous generation would become obsolete. Therefore, his vision of Pacific Drilling was that of a preferred, high-specification, floating- rig drilling contractor. The strategy was to use its con- sistent fleet of ultra-deepwater dr illships, which were built by the top-of-the-class shipyard Samsung Heavy
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Case 11: Pacific Drilling: the Preferred Offshore Driller C-155
Exhibit 9 Number of Floating Rigs in Global Fleet by Delivery Year (1971 - 2014)
30
25
20
15
10
5 f--1
0 Inn m •• 1 • 1111 ••• V) 00 o-
• I I•••• •
§ 8 0 0 <t 0
N N N N
Source< Company documents;•Fioating Rigs by Delivery Year; ODS·Petrodata, Inc., accessed April12, 201S.
industries, outfitted with the newest drilling packages by National Oilwell Varco, and managed by a highly experienced team to provide differentiated drilling ser- vices for its customers. This focus gave Pacific Drilling a strong competitive advantage over companies such as Transocean, which was more diversified and less focused (see Exhibits 8 and 9). Beckett explained his vision of the company:
The benefit that we had and that we foresaw for Pacific Drilling was to be focused on one asset class and not allow ourselves to be dragged into other asset classes. We could therefore optimize our maintenance systems, procurement, operating programs, and safety programs to deliver the best results with this orre asset class.
In 2008, Beckett and his team prepared a thorough technical and safety-drilling manual, but the industry did not seem ready for what Pacific Drilling was offer- ing. One potential client that Beckett pursued requested that the company rework its manual and prepare a new proposal. Saddled with debt and yet to book its first customer, Pacific Drilling considered the prospect of a compromise by revising the manual to align with the standard industry practices. However, Beckett and his team knew that the compromise would mean losing what they believed to be the company's key differenti- ator. So they instead held firm and asked the customer to reconsider.
That potential client was Chevron, the first and ulti- mately most supportive customer throughout Pacific Drilling's growth, eventually contracting more than half
of the company's drillships. As Chevron officials later admitted, the original manual that had been proposed was among the best they had ever seen. Beckett reflected on that challenging but rewarding situation:
So we were able to build a relationship with Chevron based on relatioruhips we had in previous companies. They knew the people they were dealing with, and they could get com- fortable that those p eople would be committed to deliv- ering the product and service quality. They could look at who the finan cial backers were and where we were build- ing rigs, and all the associated pieces came to a comfort factor that we would do what we planned to do.
The collaboration with Chevron also yielded access to a technological innovation: dual -gradient drill- ing (DGD), a process that enabled an oil company to access reservoirs that had previously been considered "undrillable." Unlike conventional drilling that used only one drilling fluid, DGD employed two different fluids in the wellbore-one in the drilling riser, with below- average density, and the other below the wellhead, with above-average density. Using DGD allowed the driller to overcome narrow pore pressure fracture gradient margins and to drill larger and deeper holes using fewer casing strings. It also helped the driller to better man- age downhole pressure as the drill bit moved through various types of geologies such as sand, shale, and tar (see Exhibit 10).
DGD was technologically proven in the late 1990s; however, it had not yet been deployed on a commercial rig. While Chevron expected DGD to reduce the total
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C·156
Exhibit 10 Dual-Gradient Drilling
The Problem: Deep Water Challenges
Conventional drilling methods have potential challenges:
• Well control/lost cirrulation
• Challengingcementjobs
• Mechanical challenges with tight tolerance tools
• Restrictive completions
The industry is drilling even more difficult wells. We now routinely drill nearly •un-drillable" wells:
• More than 9,000.metre well depth
• More than 1,800-metre water depth
New floating rigscapable of drilling to 12,()()()-metre well depth enable the industry to attempt even more deep water projects.
Conventional Casing Program
Deepwater Casing Program
The Solution: Dual Gradient Drilling Conventional Drilling Dual Gradient Drilling
With DGD, we literally replace the mud in the
drilling riser with a seawater-density fluid and
use a denser mud below the mudline to achieve the
same bottom hole pressure.
Note: OGD • dual gradient drilling; ppg • pore pressure gradient
Part 4: case Studies
Source: Chevron, Dale Straub Presentation at the lntemaUonal Association of Drilling Contractors' Dual Gradient Drilling seminar, Madrtd, Spain (April 7, 201 4).
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Case 11: Pacific Drilling: the Preferred Offshore Driller
cost to drill a well , the company had not yet worked with a drilling contractor to fully implement the tech- nology. Pacific Drilling management was aware of the potential for DGD and embraced the possibilities to work with Chevron on developing processes and pro- cedures. It took about six months before Chevron was comfortable that Pacific Drilling was the right partner to commercialize DGD. leading to Pacific Drilling's first drilling contract.
Pacific Drilling's dose relationship with Chevron was among the few relative constants in an often vola- tile and unpredictable market. Chevron had contracted four drillships with Pacific Drilling to date for operations in the Gulf of Mexico and Nigeria. The justification was simple: Pacific Drilling rigs were equipped with the capa- bilities that Chevron desired, and collaboration among the companies' employees, both onshore and offshore, had become seamless.
After Chevron had signed the frrst contract, opportu- nities from other producers emerged for Pacific Drilling. Chevron's willingness to repeatedly work with the new company was an endorsement of the substantial value that Pacific Drilling could deliver to its customers. With a more established reputation, Pacific Drilling was able to broaden its customer base to include Total (one drillship in Nigeria) and Petrobras (one drillship in Brazil). By the end of 2014, the company had signed $2.7 billion in con- tracts (see Exhibit 11).
Working with Chevron to implement DGD also helped Pacific Drilling improve and refine its oper- ating and management systems. Implementation of DGD technology demanded that Pacific Drilling work closely with Chevron on the development of operating procedures and employee training. At the time, Pacific Drilling operated two drillshlps that were DGD-capable (i.e .• the Pacific Santa Ana and Pacific Sharav). Frederic Jacquemin, the director of the DGD program at Pacific Drilling at the time, noted that "with DGD, integrating
Exhibit 11 Pacific Drilling Growth Profile
C-157
a new technology is not only about equipment but it is also about defining new processes and training people:·
Although the full deployment of DGD technology was still a work in progress, Pacific Drilling's close col- laboration with Chevron led to a corporate emphasis on process innovations and technological leadership. Pacific Drilling continued to invest in technological innovation in an effort to keep its fleet as up-to-date as possible. For example, its newest rigs were equipped with automated drilling systems that reduced the number of personnel on the drilling floor, substantially improving drilling speed while also reducing safety risks. The company also equipped its rigs with a higher than usual amount of drilling mud storage and processing capability, which allowed the rig to move more quickly through the drill- ing process and also to be more self-sufficient: a partic- ular advantage in remote operating locations, where the cost of support vessels was high.
Pacific Drilling im plemented SAP software on all of its drillships to better monitor daily rig operations and respond in real time to unforeseen problems. Traditionally. workers on a rig monitored their tasks using pen and paper and provided hard-copy reports to their supervisors. The SAP software helped to continually update information across functions during the drilling process, improving operational efficiency. The com- pany reduced the amount of downtime (non-operating time due to malfunctions) and ultimately improved safety, both of which increased profitability and benefit to customers.
Pacific Drilling developed its own company manage- ment system using the highest standards (see Exhibit U). The company had the advantage of being able to imple- ment this system from the beginning. whereas most of its peers had to adapt management systems to their legacy corporate practices. The company also emphasized con- sistency in its processes and procedures. For example. the company went through an exhaustive exercise to develop
First Quarter of 2011 Fourth Quarter of 2014
Number of rigs
Number of operating rigs
Number of drilling contracts
Contract backlog (in S billions)
Number of employees
Market capitalization (in S billions)
Souru: Company documents.
4
0
2
$1.5
Approximately 500
$2.1
8
6
6
S2.7
Approximately 1,600
$1.0
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C-158
Exhibit 12 Pacifi c Drill ing Management Syste m (Ms)
Onlhng Operations
MilfrtJme Operations
T echn1cal Support
Support Functions
Source: Company documents.
a standardized framework for making operations and maintenance decisions related to a key piece of equipment on its rigs. When Pacific Drilling showed the framework to its clients, it was told that no other driller had made this type of effort to better manage the equipment.
Firm Culture and Organizational Structure Pacific Drilling had set clearly defined values that pro- vided a fram ework fo r corporate decision-making and employee beh aviour. The compan y's core principles were cleverly embodied using the mnem onic of its name PACIFIC (see Exhibit 13).
To build the company's legitimacy and credibil- ity, Beckett recruited highly experienced experts \vith
Exhibit 13 Pacific Drilling Compa ny Va lues
Policies and O.rectJOn
Organization and RHOUrce Management
Management
Monitoring, Analysis and Improvement
Part 4: case Studies
proven track records from a variety of professional back- grounds. In doing so, he aimed to fm d the best solutions and processes for the start-up company. Beckett also knew that in this industry, talent and connections were key. To attract star employees, he offered promotions from their current positions, as well as the opportunity of a lifetime-helping to build a new company. Beckett also promised less organizational hierarchy, and he kept his word by creating a leaner, flatter company.
Pacific Drilling's organizational structure provided advantages through shorter commun ications p aths, ease of collaboration, and efficient d ecision-making (see Exhibit 14). For example, the marketing of rigs was traditionally done by a dedicated marketing team, which then handed over the contract to the operations depart- ment to run the rigs. However, the company encouraged
f roactive: Continually refining its approach to ant icipate stakeholder needs
Accountable:
l:ustomer oriented :
Integrity:
Taking responsibility for actions and performance as individuals and as a company
Striving to exceed customer expectations
Acting honestly and fairly in all they do
f inancially responsible: Maximizing long-term value creation for shareholders
Innovative: Seeking creative solutions in every aspect of its business
!;;ommunity focused: Ensuring a sustainable and positive impact on the communities where they work
Source: Company documents.
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Case 11: Pacific Drilling: the Preferred Offshore Driller C-159
Exhibit 14 Pacific Drilling Organizational Chart after Reorganization in February 2015
CEO Chris Beckett l
SVP Corporate VPGeneral EVP&COO VP Quality & HSE EVP&CFO
SVP Sales & Business Services Counsel CeesVan Development
Edgar Rtncon Kinga doris Die men Paullinlcin Paul Reese
Michael Acuff
I I I 1 I VPHR SVP O perations Director HSE VP Treasurer
Director Sales Ame ricas
I I I I I Director
Director Sales VPPSC Ope rational Directo r Q uality VPT IT & Faciltties
Europe & Afr ica Exc elle nce
I I 1 I Director HR Director Subsea
VP Controller D irector Corporate
Employee Services Support Planning
I I 1 Director New D irector Technical VPAudtt & Construction Support Compliance
I I Director Major VP IR & Communica·
Projects tions
I I Sr Engineering
VpTax Advisor
Note: CEO • chief e«<utive olfar; SVP • senior Yice-pres;dent VP ~ Yice-pres;dent EVP = executive ~t; COO • chief ope<;oting olfKer, HSE • health. sarety, and environment CFO • chief financial officer; HR • human resources; PSC = procurement and supply chain; IT • Information tedvdogy: lR • if"'YeStor relations; Sf a senior. Source: Company documents.
its marketing and operations teams to work together with the client from the first stage of negotiation until the end of the drilling campaign, which resulted in greater con- sistency between what the marketing team promised and what was actually done, increasing the company's credi- bility and building stronger relationships with the client.
Beckett also recognized that the company needed a culture of entrepreneurship and accountability. 12
Employees were empowered to make suggestions and take ownership of processes and projects. Pacific Drilling focused on hiring employees who fit with the company's culture. Every potential employee was inter- viewed by three established employees. Through this process, the company selected recruits who were ded- icated to performing above the average and who had
enthusiasm for building a unique company. These qual- ities were reflected in a commitment the company made to its employees: "Pacific Drilling is committed to be the employer of choice in the offshore drilling industry and provide the tools and resources to enable its people to deliver consistently exceptional performance:'
Given the inherently dangerous nature of the indus- try, Beckett and his management team consciously strived to develop a culture of safety, even at the expense of stopping drilling operations. The company implemented the Stop Work Obligation, which dictated that it was the responsibility and duty of any individual to stop any work that the employee felt had an unacceptable level of risk or other concern . This directive went beyond the traditional Stop Work Authority that was an industry
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C· 160
Exhibit 15 Pacific Drilling's Safety Performance as of The End of2014
2.5
2.0
~ 1.5 !:::;
1.0
0.5
2008 2009 2010
Part 4: case Studies
20 11 2012 2013 2014
I• PACD LTIF 0 IADC LTIF I Notes: lost Timelncidenu Frequency (LnFI Is the number of lost-time incidenu per m~lion work hours. • International Association of Or'dling Contractors OAOCI data include all land and water regions up to and including 2012. • IAOC data only include wa1er regions who~ Paofic DnUing (Po\CD) was working in 2013 and 2014 fo.e.. the United Stat~ Africa. and South America) • • IAOC data for 20141$ up to the1hlrd quarter~ar-to-clate information only. FuU 2014data -re unavaaableat the time of writing.
Key 2014 safe<y achleverner>ts:
• Pacific Bora a<hiewd 3.75 years without an lJ1 and 1.75 yeon without a recordable incident. • Pacific Sciro«o a<hiewd 3.5 years without an m and 1.5 years without a recordable incident. • Pacific Khamsin a<hiewd 1 year without an m and almost 1 year without a recordable incident. • Pacific Sharav had ze<o llls since commer>cing contract. • •A• rating on the ChevYOn Contractor ~aim. Environmen~ and Safety (HES) Management (CHESM) program in both dHpwa1er and the Nigerian bu,.ness units.
Source: Company documents.
practice and gave employees the right to stop work but didn't require them to do so.
In an industry where producers valued drillers' rep· utation for safety, Pacific Drilling had achieved multiple years without any lost-time incidents on several rigs. Its safety performance had been recognized with an "A" rat- ing on the Chevron Contractor Health, Environment, and Safety Management program in the Gulf of Mexico and in Nigeria. Pacific Drilling was also the first drilling con- tractor to certify its safety and environmental management systems with the Center for Offshore Safety (see Exhibit 15).
Challenges Growth and Customer Base Challenges Beckett and his team had planned to expand the com- pany's fleet from the current eight drillships to 12.
The need to contract out these ships pushed the com- pany to broaden its customer base beyond relying on Chevron. In this industry, producers had usually been more likely to contract drillers with whom they had worked with before, in part because of the efficiency gained from a prior working relationship.
As Pacific Drilling sought to broaden its customer base, there was some concern that the company was tied too closely to Chevron. The technology, processes, and culture that Pacific Drilling had developed were significantly influenced by the company's close collab- oration with Chevron. There was a concern that effi. ciency would be lost, even if only temporarily, when changing to a different drilling partnership. Evidence had shown that a given producer demonstrated pro- ductivity gains in a partnership with one driller, resulting from having acqui red "relationship-specific"
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Case 11: Pacific Drilling: the Preferred Offshore Driller
capabilities over the time that the two companies had worked together. However, these gains often did not translate to the same level of productivity gains in part- nerships with new drillers,u which seemed to explain Chevron's preference to continue to contract Pacific DrilJing. Chevron's support was fundamental in Pacific Drilling's success as a new entrant, but its ability to grow as a more mature company was likely to be con- strained by that very same factor.
Technology Challenges The technology advantage that Pacific Drilling had over competitors for deepwater drillships was also being challenged as other drillers upgraded their floater fleets. Competitors' rigs scheduled for delivery in 2016 and 2017 would have incremental technological advantages over Pacific Drilling's first rig.
Market Challenges The price of oil had been tumbling since mid-2014, while North American shale oil production had grown rap- idly and global energy demand had been weakening. For
Exhibit 16 Floating Rig Utilization after 1985 by Build Cycle
Year delivered
C-16 1
offshore drillers. existing contracts that had been nearing completion had been less likely to be extended. For avail- able rigs, competition among drillers became intense as day rates were pushed down.
Over the previous decade, the number of offshore rigs worldwide had increased from approximately 670 to 950. Although the offshore floating rig count increased from approximately 200 to 350 from 2004 to late 2014, average utilization rates also increased over the same time period, from around 77 per cent to 86 per cent. Historically, newer rigs competed down in their day rates, causing older rigs to be stacked, either perma- nently or until the market recovered. Recently, though, the industry seemed to have undergone a fundamental shift. Once demand began collapsing in 2014, there was an overcapacity of deepwater rigs, and drillers struggled to find new contracts for their available rigs. The current industry downturn and significant rig oversupply led to deepwater drillships and semis being cold-stacked fo r the first time in history (see Exhibit 16).
Pacific Drilling's immediate issue was to secure a contract on two of its drillships, Pacific Meltem and
- <1978 - 1979- 1997 - 1998-2006 - >2007
SourU! ~ny documents.
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C·162 Part 4: case Studies
Pacific Mistral, that had been sitting idle. Because modern drillships had rarely been cold-stacked, keep· ing the crew on board was costly. The company was also concerned about two additional drillshlps: Pacific Khamsin, which would come off contract in late 2015, and Pacific Zonda, scheduled for delivery from the shipyard in late 2015.
significantly below market rates to win the few new jobs available. Looking forward, Pacific Drilling had a signif- icant number of high-specification floating rigs available to be contracted. Although there had been weak demand for very high-specification rigs, there had also been rel- atively limited supply, which supported the company's contracting prospects.
Strategic Choices Pacific Drilling had come to a critical juncture, and important decisions had to be made. As a more mature company, Pacific Drilling had been confront- ing a different competitive landscape. During the past year, very few new contracts had been awarded in the industry. Some of the company's peers were willing to bid
Overcoming challenges had been nothing new for Beckett. Yet, with the challenging market environ- ment and other constraints, Beckett made the follow- ing statement in a letter to employees: "Despite the weakening market, we expect further growth in 2015, but we must continue to execute well on our growth plans and secure new contracts to deliver on this expectation:·
NOTES 1. All currency amounts are In USS unless
otherwise specified. 2. Brad Plumer, 'Why Oil Prices Keep Falling-
And Throwing the World Into Turmoil; Vox
Media Inc., updated January 23, 2015, accessed April12. 2015, www.vox.com/2014
112/16/7401705/oil-prices· falling.
3. Deutsche Bank Markets Research, "What Is New? Key Stats & E~t to Watch," 0./frdd Services Chronicle, June 23, 2014.
4. A derrick is a pyramid-shaped structure
above the rig floor where the crown block. monkey board, and racking board are supported. Dual derricks have two drilling units on one hull.
5. Drillers usually charge oil producers on a
daily work rate, which varies dependong on the location, the type of rig, and the market conditions. For example. by March 2015, Pacific Drilling's average day rate was
$558,000 and Diamond Offshore's rate was $450,000.
6. Ramon (asadesus-Masanel~ Kenneth
Corts, and Joseph McElroy, TM Offshor" Driling Industry in 2011 (Boston, MA: Harvard Business Schoo~ 2011). Available from lvey Publishing. product no. nt543.
7. AccO<ding to casadesus-Masanel~ CO<ts, and McElroy, moving a jack-up rig from the Gulf or Mexico to the North Sea took about a month, and mobilization alone cost bl!tween S2 million and S5 million, l!Xdusive of day rates.
8. As a cost-reduction step, a cold-stacked rig is often stored in a harbour, shipyard, or designated offshore area because
its contracting prospects look bleak. It will be out of service for extended periods of time and may not bl! actively
marketed.
9. Robl!rt 8. Barsky and Lutz Kilian, "Oil and the Mac.roeconomy Since the 1970s;
Journal of Economk PM~Iws 18, no. 4 (fall, 2004): 115-134.
10. C.sadesus-Masan~~ Corts, and McElroy, op. dt.
11. Ernst & Young Global Umited. "Chris Beckett. CEO of Paofk Dnlling. Named EY EntreprenEur of the Year• 2014 National Energy, Cleantech and Natural Resources AwNd Winne(,' November tS. 2014, accessed April12. 2015, www.ey.comiUS/en/Newsroom/News
-<~-lJS.EOY-20J4.Chris-8eck
-Paclic-Dnlll~ward'lmner. 12. Based on infO<matlon from the company's
Media and Public R~tions department
13. Ryan Kellogg, "Learning by Drilling: Interfirm Learning and Relationship
Persistence In the Texas Ollpatch." Quarterly Joumol of Economics 126 (2011): 1961-2004.
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