week 4 assignment

9B16M061

PACIFIC DRILLING: THE PREFERRED OFFSHORE DRILLER Haiyang Li, Frédéric Jacquemin, and Toby Li wrote this case solely to provide material for class discussion. The authors do not intend to illustrate either effective or ineffective handling of a managerial situation. The authors may have disguised certain names and other identifying information to protect confidentiality. This publication may not be transmitted, photocopied, digitized, or otherwise reproduced in any form or by any means without the permission of the copyright holder. Reproduction of this material is not covered under authorization by any reproduction rights organization. To order copies or request permission to reproduce materials, contact Ivey Publishing, Ivey Business School, Western University, London, Ontario, Canada, N6G 0N1; (t) 519.661.3208; (e) [email protected]; www.iveycases.com. Copyright © 2016, Richard Ivey School of Business Foundation Version: 2016-04-08

From June 2014 to January 2015, the market price of oil fell from US$1151 per barrel down to $49 per barrel.2 As oil prices went down, so did the appetite of energy companies for offshore exploration. Further compounding 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 for Pacific Drilling, a growing offshore drilling company based in Texas. Founded in 2006, Pacific Drilling owned and operated a fleet of eight high-specification drillships operating in ultra- deepwater drilling environments in depths up to 3.7 kilometres (km) and offered the most 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 emerging and more established companies — Pacific Drilling sought to expand its customer base. However, the close relationships that it had cultivated with its existing partners (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 producer partners. The 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 price sliding from $11 per share in 2014 to less than $4 per share, as did the stock price of all offshore drillers during that time (see Exhibit 4). As he considered the available options, Beckett faced another critical crossroad. The company had survived tough times before — in the early stages of the company’s development, the team had successfully manoeuvred through the 2008 financial crisis as the credit markets collapsed. But as Beckett admitted, the current challenge was unique in many ways, and Pacific Drilling was a different company from earlier. However, it remained to be answered to what extent Beckett and his team could rely on what they had successfully done in the past, and to what extent they would need to adapt. 1 All currency amounts are in US$ 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 April 12, 2015, www.vox.com/2014/12/16/7401705/oil-prices-falling.

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Page 2 9B16M061 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 promise than onshore sites for oil producers to develop their oil reserves, and achieve higher production rates, especially in less explored deepwater sites. For instance, in recent years, the greatest increases of any offshore drilling 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, however, outsourced the work to drilling contractors. Some producers, known as independent producers, focused solely on the upstream, or early stage, activities of exploration and production (e.g., Anadarko). Others were integrated multinational corporations (e.g., BP, ExxonMobil, 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 seismological research on a potential well. Next was the purchase 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 to drill exploratory wells. If the results were encouraging, 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 factor was productivity, which was a function of the drilling 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 pontoons 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 enhancements such as dual derricks4 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 innovations that could ultimately provide lower total 3 Deutsche Bank Markets Research, “What Is New? Key Stats & Event to Watch,” Oilfield 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 depending 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.

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Page 3 9B16M061 drilling costs for the producer (see Exhibit 6). Day rates were usually locked-in through negotiated contracts, with the duration of the contracts and the lead time decided on 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 suitability and the day rate. International oil companies had been known to be much more reliant on existing relationships.6 Because relocating rigs was costly and time-consuming,7 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 minimize 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.8 The offshore drilling 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 rigs 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 early 2000s, which pushed utilization rates, and thereby day rates, to historical 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, Seadrill, 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).

CHRIS BECKETT: CEO AND THE FIRST EMPLOYEE With the initial purchase of a drillship under construction, Pacific Drilling was founded in 2006 as a subsidiary of Tanker 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 Drilling expanded its activities beyond the joint venture to include four ultra-deepwater drillships, which had been constructed in South Korea at Samsung Heavy Industries, one of the three largest shipyards in the world. At the same time, Beckett was approached by Idan Ofer, an Israeli tycoon and the principal of Tanker Pacific. Ofer asked Beckett to be the company’s first employee and to lead the 6 Ramon Casadesus-Masanell, Kenneth Corts, and Joseph McElroy, The Offshore Drilling Industry in 2011 (Boston, MA: Harvard Business School, 2011). Available from Ivey Publishing, product no. 711543. 7 According to Casadesus-Masanell, Corts, and McElroy, moving a jack-up rig from the Gulf of Mexico to the North Sea took about a month, and mobilization alone cost between $2 million and $5 million, exclusive 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 be actively marketed. 9 Robert B. Barsky and Lutz Kilian, “Oil and the Macroeconomy Since the 1970s,” Journal of Economic Perspectives 18, no. 4 (Fall, 2004): 115–134. 10 Casadesus-Masanell, Corts, and McElroy, op. cit.

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Page 4 9B16M061 development of Pacific Drilling as CEO. Beckett, a 2002 MBA graduate from Rice University in Texas, had previously been the head of corporate planning at Transocean, a strategy consultant at McKinsey, and the U.S. land seismic manager at Schlumberger. 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 established 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 outcompete 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 leadership 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 entrepreneur,” 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 identifying novel approaches and seeing those ideas through to implementation.”11 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 consistent fleet of ultra-deepwater drillships, which were built by the top-of-the-class shipyard Samsung Heavy Industries, outfitted with the newest drilling packages by National Oilwell Varco, and managed by a highly experienced team to provide differentiated drilling services 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:

11 Ernst & Young Global Limited, “Chris Beckett, CEO of Pacific Drilling, Named EY Entrepreneur of the Year™ 2014 National Energy, Cleantech and Natural Resources Award Winner,” November 15, 2014, accessed April 12, 2015, www.ey.com/US/en/Newsroom/News- releases/News-EY-US-EOY-2014-Chris-Beckett-Pacific-Drilling-National-Energy-AwardWinner.

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Page 5 9B16M061

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 one 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 offering. 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 differentiator. So they instead held firm and asked the customer to reconsider. That potential client was Chevron, the first and ultimately 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 relationships we had in previous companies. They knew the people they were dealing with, and they could get comfortable that those people would be committed to delivering the product and service quality. They could look at who the financial backers were and where we were building 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 drilling (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 manage 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 cost to drill a well, the company had not yet worked with a drilling contractor to fully implement the technology. Pacific Drilling management was aware of the potential for DGD and embraced the possibilities to work with Chevron on developing processes and procedures. 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 close relationship with Chevron was among the few relative constants in an often volatile 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 capabilities that Chevron desired, and collaboration among the companies’ employees, both onshore and offshore, had become seamless. After Chevron had signed the first contract, opportunities 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

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Page 6 9B16M061 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 contracts (see Exhibit 11). Working with Chevron to implement DGD also helped Pacific Drilling improve and refine its operating 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 drillships that were DGD-capable (i.e., the Pacific Santa Ana and Pacific Sharav). Frédéric Jacquemin, the director of the DGD program at Pacific Drilling at the time, noted that “with DGD, integrating 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 collaboration 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 drilling process and also to be more self-sufficient: a particular advantage in remote operating locations, where the cost of support vessels was high. Pacific Drilling implemented 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 company 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 management system using the highest standards (see Exhibit 12). The company had the advantage of being able to implement this system from the beginning, whereas most of its peers had to adapt management systems to their legacy corporate practices. The company also emphasized consistency in its processes and procedures. For example, the company went through an exhaustive exercise to develop 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 provided a framework for corporate decision-making and employee behaviour. The company’s core principles were cleverly embodied using the mnemonic of its name PACIFIC (see Exhibit 13). To build the company’s legitimacy and credibility, Beckett recruited highly experienced experts with proven track records from a variety of professional backgrounds. In doing so, he aimed to find 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.

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Page 7 9B16M061 Pacific Drilling’s organizational structure provided advantages through shorter communications paths, ease of collaboration, and efficient decision-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 department to run the rigs. However, the company encouraged 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 consistency between what the marketing team promised and what was actually done, increasing the company’s credibility 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 interviewed by three established employees. Through this process, the company selected recruits who were dedicated to performing above the average and who had enthusiasm for building a unique company. These qualities 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 industry, 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 practice and gave employees the right to stop work but didn’t require them to do so. In an industry where producers valued drillers’ reputation 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” rating 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 contractor 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 company’s fleet from the current eight drillships to 12. The need to contract out these ships pushed the company 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 collaboration with Chevron. There was a concern that efficiency would be lost, even if only temporarily, when changing to a different drilling partnership. Evidence had shown that a given producer demonstrated productivity gains in a partnership with one driller, resulting from having acquired “relationship-specific” 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 partnerships

12 Based on information from the company’s Media and Public Relations department.

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Page 8 9B16M061 with new drillers,13 which seemed to explain Chevron’s preference to continue to contract Pacific Drilling. 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 constrained 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 rapidly and global energy demand had been weakening. For offshore drillers, existing contracts that had been nearing completion had been less likely to be extended. For available 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 permanently 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 for 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 Pacific Mistral, that had been sitting idle. Because modern drillships had rarely been cold-stacked, keeping the crew on board was costly. The company was also concerned about two additional drillships: Pacific Khamsin, which would come off contract in late 2015, and Pacific Zonda, scheduled for delivery from the shipyard in late 2015. 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 confronting 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 significantly below market rates to win the few new jobs available. Looking forward, Pacific Drilling had a significant 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 relatively limited supply, which supported the company’s contracting prospects. Overcoming challenges had been nothing new for Beckett. Yet, with the challenging market environment and other constraints, Beckett made the following 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.” 13 Ryan Kellogg, “Learning by Drilling: Interfirm Learning and Relationship Persistence in the Texas Oilpatch,” Quarterly Journal of Economics 126 (2011): 1961–2004.

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Page 9 9B16M061

EXHIBIT 1: PACIFIC DRILLING INCOME STATEMENTS, 2012–2014 Years Ended December 31

(in thousands, except per share amounts) 2014 2013 2012

Revenues

Contract drilling $ 1,085,794 $ 745,574 $ 638,050

Cost and expenses

Contract drilling (459,617) (337,277) (331,495)

General and administrative (57,662) (48,614) (45,386)

Depreciation (199,337) (149,465) (127,698)

(716,616) (535,356) (504,579)

Loss of hire insurance recovery – – 23,671

Operating income 369,178 210,218 157,142

Other income (expense)

Costs on interest rate swap termination – (38,184) –

Interest expense (130,130) (94,027) (104,685)

Total interest expense (130,130) (132,211) (104,685)

Costs on extinguishment of debt – (28,428) –

Other income (expense) (5,171) (1,554) 3,245

Income before income taxes 233,877 48,025 55,702

Income tax expense (45,620) (22,523) (21,713)

Net income $ 188,257 $ 25,502 $ 33,989

Earnings / common share, basic $ 0.87 $ 0.12 $ 0.16

Weighted average number of common shares, basic 217,223 216,964 216,901

Earnings / common share, diluted $ 0.87 $ 0.12 $ 0.16

Weighted average number of common shares, diluted 217,376 217,421 216,903 Source: Company documents.

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EXHIBIT 2: PACIFIC DRILLING BALANCE SHEETS, 2013–2014

(in thousands, except par value) 2014 2013

Cash and cash equivalents $ 167,794 $ 204,123

Accounts receivable 231,027 206,078

Materials and supplies 95,660 65,709

Deferred financing costs, current 14,665 14,857

Deferred costs, current 25,199 48,202

Prepaid expenses and other current assets 17,056 13,889

Total current assets 551,401 552,858

Property and equipment, net 5,431,823 4,512,154

Deferred financing costs, current 45,978 53,300

Other assets 48,099 45,728

Total assets 6,077,301 5,164,040

Liabilities and shareholders’ equity Accounts payable $ 40,577 $ 54,235

Accrued expenses 45,963 66,026

Long-term debt, current 369,000 7,500

Accrued interest 24,534 21,984

Derivative liabilities, current 8,648 4,984

Deferred revenue, current 84,104 $ 96,658

Total current liabilities 572,826 251,387

Long-term debt, net of current maturities 2,781,242 2,423,337

Deferred revenue, current 108,812 88,465

Other long-term liabilities 35,549 927

Total long-term liabilities 2,925,603 2,512,729

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 2,175 2,170 Additional paid-in capital 2,369,432 2,358,858 Treasury shares, at cost (8,240) – Accumulated other comprehensive loss (20,205) (8,557) Retained earnings 235,710 47,453 Total shareholders' equity 2,578,872 2,399,924 Total liabilities and shareholders' equity 6,077,301 5,164,040

Source: Company documents.

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EXHIBIT 3: PACIFIC DRILLING CASH FLOW STATEMENTS, 2012–2014

(in thousands) 2014 2013 2012

Cash flow from operating activities:

Net income $188,257 $25,502 $33,989

Adjustments to reconcile net income to net cash provided by operating activities: Depreciation expense 199,337 149,465 127,698 Amortization of deferred revenue (109,208) (72,515) (95,750) Amortization of deferred costs 51,173 39,479 70,660 Amortization of deferred financing costs 10,416 10,106 13,926 Amortization of debt discount 817 445 –

Write-off of unamortized deferred financing costs – 27,644 – Costs on interest rate swap termination – 38,184 – Deferred income taxes 18,661 (3,119) (3,766) Share-based compensation expense 10,484 9,315 5,318

Changes in operating assets and liabilities: Accounts receivable (24,949) (53,779) (89,721) Materials and supplies (29,951) (16,083) (6,640) Prepaid expenses and other assets (56,493) (30,840) (61,548) Accounts payable and accrued expenses 20,865 12,301 33,865 Deferred revenue 117,001 94,482 156,967

Net cash provided by operating activities 396,410 230,587 184,998

Cash flow from investing activities: Capital expenditures (1,136,205) (876,142) (449,951) Decrease in restricted cash – 172,184 204,784 Net cash used in investing activities (1,136,205) (703,958) (245,167)

Cash flow from financing activities:

Proceeds from shares issued under share-based compensation plan 95 – – Proceeds from long-term debt 760,000 1,656,250 797,415 Payments on long-term debt (41,833) (1,480,000) (218,750) Payments for costs on interest rate swap termination – (41,993) – Payments for financing costs (7,569) (62,684) (19,853) Purchases of treasury shares (7,227) – –

Net cash provided by financing activities 703,466 71,573 558,812

Increase (decrease) in cash and cash equivalents (36,329) (401,798) 498,643 Cash and cash equivalents, beginning of period 204,123 605,921 107,278 Cash and cash equivalents, end of period $167,794 $204,123 $605,921

Source: Company documents.

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EXHIBIT 4: HIGH CORRELATION BETWEEN OFFSHORE DRILLERS STOCKS AND OIL PRICE, DECEMBER 2013 TO 2014

Note: PACD = Pacific Drilling; WTI = West Texas Intermediate; OSX = Oil Service Sector Index Source: Organization of the Petroleum Exporting Countries; Yahoo finance; and company analysis.

EXHIBIT 5: THE GOLDEN TRIANGLE OF OIL THAT DROVE ULTRA-DEEPWATER (UDW) DEMAND GROWTH 2009–2014

Note: PACD = Pacific Drilling; USGOM = U.S. Gulf of Mexico; Mex. = Mexico; Carib.= the Caribbean; Med = the Mediterranean; M.E. = Middle East Source: “Ultra-Deepwater Demand Growth,” ODS-Petrodata, Inc., accessed April 12, 2015; Company analysis.

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EXHIBIT 6: DAY RATE TRENDS FOR FLOATING RIGS BY RIG QUALITY (2012–2014)

Note: Analysis uses publicly available data; includes rigs with water depth capability greater than 1.5 kms and contract day rate revenue from mutual contracts greater than one year. Source: “Trends for Floating Rigs by Rig Type,” ODS-Petrodata, Inc., accessed April 12, 2015; Company analysis.

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EXHIBIT 7: PROFILES OF PACIFIC DRILLING’S COMPETITORS

Transocean Transocean operated the largest fleet in the offshore drilling industry with 85 rigs (15 jack-ups, 39 semi-submersibles, and 31 drillships) with an average age of 17 years. The company’s market capitalization was approximately $6.8 billion, which was the second largest in the industry. It had an operational presence in the waters of the United States, Norway, the United Kingdom, West Africa, Brazil, South East Asia, and Australia. Over the past five years, the company had delivered 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 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 $5.9 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 operational 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 Ensco operated 74 rigs (46 jack-ups, 18 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 per cent 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 diverse geographic presence.

Noble Noble operated 39 rigs (19 jack-ups, 11 semi-submersibles, and nine drillships) with an average age of 15.8 years, which made it the second oldest fleet in the industry. The company’s market capitalization was $4.4 billion. It had a diverse operational 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 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 $5.3 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 Rowan operated 34 rigs (30 jack-ups and four drillships) with an average age of 16.4 years. The company’s market capitalization was $2.9 billion. It operated rigs in the waters of the United States, Saudi Arabia, the United Kingdom, 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 Atwood operated 14 rigs (five jack-ups, five semi-submersibles, and four drillships) with an average age of 9.6 years. The company’s market capitalization was $1.9 billion. 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 cent. Its strategy was to continue growing while maintaining its operational efficiency.

Ocean Rig 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: “Oil Drillers,” ODS-Petrodata, accessed April 12, 2015; Yahoo finance; company analysis.

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EXHIBIT 8: FLEET COMPOSITION BY RIG CAPABILITY AND TYPE

Source: Company documents; “Fleet Composition by Rig Capability,” ODS-Petrodata, Inc., accessed April 12, 2015. EXHIBIT 9: NUMBER OF FLOATING RIGS IN GLOBAL FLEET BY DELIVERY YEAR (1971–2014)

Source: Company documents; “Floating Rigs by Delivery Year,” ODS-Petrodata, Inc., accessed April 12, 2015.

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EXHIBIT 10: DUAL-GRADIENT DRILLING

The Problem: Deep Water Challenges Conventional drilling methods have potential challenges:

 Well control / lost circulation  Challenging cement jobs  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 rigs capable of drilling to 12,000-metre well depth enable the industry to attempt even more deep water projects.

The Solution: Dual Gradient Drilling

Note: DGD = dual gradient drilling; ppg = pore pressure gradient Source: Chevron, Dale Straub Presentation at the International Association of Drilling Contractors’ Dual Gradient Drilling seminar, Madrid, Spain (April 7, 2014).

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EXHIBIT 11: PACIFIC DRILLING GROWTH PROFILE

First Quarter of 2011 Fourth Quarter of 2014 Number of rigs 4 8 Number of operating rigs 0 6 Number of drilling contracts 2 6 Contract backlog (in $ billions) $1.5 $2.7 Number of employees Approximately 500 Approximately 1,600 Market capitalization (in $ billions) $2.1 $1.0

Source: Company documents.

EXHIBIT 12: PACIFIC DRILLING MANAGEMENT SYSTEM (MS)

Source: Company documents.

EXHIBIT 13: PACIFIC DRILLING COMPANY VALUES

Proactive:                         Continually refining its approach to anticipate stakeholder needs  Accountable:                    Taking responsibility for actions and performance as individuals and as a company  Customer oriented:        Striving to exceed customer expectations  Integrity:                           Acting honestly and fairly in all they do  Financially responsible: Maximizing long‐term value creation for shareholders  Innovative:                       Seeking creative solutions in every aspect of its business  Community focused:      Ensuring a sustainable and positive impact on the communities where they work

Source: Company documents.

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EXHIBIT 14: PACIFIC DRILLING ORGANIZATIONAL CHART AFTER REORGANIZATION IN FEBRUARY 2015

Note: CEO = chief executive officer; SVP = senior vice-president; VP = vice-president; EVP = executive vice-president; COO = chief operating officer; HSE = health, safety, and environment; CFO = chief financial officer; HR = human resources; PSC = procurement and supply chain; IT = information technology; IR = investor relations; Sr = senior Source: Company documents.

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EXHIBIT 15: PACIFIC DRILLING’S SAFETY PERFORMANCE AS OF THE END OF 2014

Notes: Lost Time Incidents Frequency (LTIF) is the number of lost-time incidents per million work hours.  International Association of Drilling Contractors (IADC) data include all land and water regions up to

and including 2012.  IADC data only include water regions where Pacific Drilling (PACD) was working in 2013 and 2014 (i.e.,

the United States, Africa, and South America).  IADC data for 2014 is up to the third quarter year-to-date information only. Full 2014 data were

unavailable at the time of writing. Key 2014 safety achievements:  Pacific Bora achieved 3.75 years without an LTI and 1.75 years without a recordable incident.  Pacific Scirocco achieved 3.5 years without an LTI and 1.5 years without a recordable incident.  Pacific Khamsin achieved 1 year without an LTI and almost 1 year without a recordable incident.  Pacific Sharav had zero LTIs since commencing contract.  “A” rating on the Chevron Contractor Health, Environment, and Safety (HES) Management (CHESM)

program in both deepwater and the Nigerian business units. Source: Company documents.

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EXHIBIT 16: FLOATING RIG UTILIZATION AFTER 1985 BY BUILD CYCLE

Source: Company documents.

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