Over the course of the last two weeks, we have been examining the relationship between contract lengths and day rates. While we initially expected to see day rates decreasing as contract lengths increased (a "volume discount"), we found a markedly different pattern. We've seen that for competitive jackups over the last three years, day rates were actually higher for longer contracts than for shorter ones. Among competitive floating rigs, a similar trend was also found with day rates increasing as contract lengths increased. However, for floating rig contracts longer than three years, day rates went back down.

Looking at Lead Times
As a corollary, we wanted to find out if a longer lead time from when the contract was awarded to when it actually began would lead to a higher day rate. The theory in this case was that a longer lead time indicated greater demand for a given rig or type of rig, since the operator was willing to wait a significant period of time before being able to actually use the rig. Consequently, higher demand on a rig fleet with a limited size (supply) would lead to higher day rates.

As we have done over the last two weeks, we will be examining the competitive jackup fleet this week and the competitive floating rig fleet next week.

Jackups < 300' WD
The graph below illustrates the relationship between contract lead times and average day rates over the last three years. What is most readily apparent in the constant upward trend. This indicates that longer lead times each year have lead to relatively higher day rates. It also points to the fact that day rates have been increasing significantly year-over-year for each group of contracts.

Average Day Rates by Lead Time and Year
< 300+ WD Competitive Jackups

What is missing from the graph of day rates by lead time is the relative proportion of contract awards with a given lead time. The proportion of contracts awarded at shorter versus longer lead times acts a general indicator of demand in the market. As demand increases, lead times increase. As demand decreases, lead times tend to decrease. The table below provides the breakdown of contract awards by lead time as a percentage of all the contract awards in each year. It is readily apparent that there have been some shifts in demand over the last three years.

Looking at these numbers, it is clear that for competitive jackups rated for less than 300 feet of water, 2005 was the year of strongest demand and longest lead times. In that year, lead times grew significantly, with lead times of 120 days or more constituting the majority of contract awards. In the other years ('04 and '06), a significant majority of contracts were awarded less than 120 days in advance. This high level of demand carried over into rising day rates that increased very steeply in 2006 in response to the strong demand in 2005.

In 2006, lead times fell back closer to their earlier levels. This decline in lead times tends to indicate a lessening of demand for jackup rig time compared with 2005, a trend which we have noted several times here in the Weekly Offshore Rig Review and in our RigOutlook reports.

Looking at the first quarter of this year, the most interesting statistic is that 75% of the contract awards for < 300' jackups have been for 60 days or less. And the average length of those contracts has dropped almost 50% from 155 days in 2006 to 81 days for Q1 2007. Clearly, a slow down in demand for these jackups in underway.

Jackups 300'+ WD
Jackups rated for 300 feet of water or more have tended to earn more and land longer contracts than lower specification jackups. Those higher average day rates can be clearly seen in the graph below illustrating day rates by lead time. Another key component of the graph below is its clear indication that longer lead times do correlate to higher day rates among these higher spec jackups. There are a few minor bumps along the way, but the trend is quite clear.

Average Day Rates by Lead Time and Year
300'+ WD Competitive Jackups

As noted above for the < 300' jackups, looking at just average day rates is only part of the picture. By looking at the proportion of contracts awarded to each group of lead times, we can loosely gauge demand. The table below provides this breakdown, which shows that over the last three years, the lead times for 300'+ jackup contracts have been steadily increasing. This is an indicator that demand for these rigs has been steadily increasing as well.

For the lower spec jackups, we noted that 2005 was a peak year in terms of demand. That was not the case for these higher spec rigs, which saw both fewer 0 to 60 day contract lead times and more 360+ day contract lead times each year since 2004.

However, looking at the statistics for the first quarter of 2007, it looks like 2006 may have been the peak year for 300'+ WD jackup demand. For the first quarter, a larger proportion of contracts awarded were for 0 to 60 days before the contract start than in any of the previous three years. With 43% of the awards being granted within 60 days of startup, this group of contracts actually represents as large a proportion as all of the 180 day or fewer contract awards from the year before. Whether that trend continues for the rest of 2007 remains to be seen, but it seems almost certain that the contract lead times this year will be dropping off from the level in 2006.

In Conclusion
When we started looking at the contract lead times over the last several years, we began with the assumption that longer lead times would correlate to higher day rates. This hypothesis has been clearly illustrated for the jackup fleet. Longer lead times have generally lead to higher day rates across the board and across the years.

This makes a great deal of sense, given that long lead times point to a high level of demand, since operators are basically "getting in line" for rig time. Conversely, short lead times point to lower levels of demand and/or shorter contracts being signed, an indication that rig time is comparatively easy to come by.

As an indicator of demand, the trend toward shorter lead times thus far in 2007 is pointing towards decreasing demand for jackup rig time. While utilization and day rates are still high, the market does appear to be cooling off a bit.

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