A few weeks ago, offshore drilling contractor Seadrill (NYSE:SDRL) announced that it has secured a five-year contract for its new drillship, the West Jupiter. This contract promises to increase Seadrill's revenues and cash flows once the rig begins carrying out its contractual assignment later this year. However, Seadrill Partners (NYSE:SDLP) may end up being the ultimate beneficiary of this contract award.
Seadrill Partners' business model could lead to rig purchase
Seadrill Partners is a publicly traded LLC that was set up by Seadrill as a tax-advantaged vehicle to manage Seadrill's offshore drilling rigs that are covered by long-term contracts. The partnership also provides liquidity for the heavily indebted Seadrill by buying rigs from the parent company, thus providing infusions of cash and allowing Seadrill to convert long-term cash flow producing assets into immediate cash.
Seadrill Partners' purpose as a vehicle to manage Seadrill's rigs that secure long-term contracts is the reason why it could be the ultimate beneficiary of this contract award. Seadrill Partners has the right, but not the obligation, to purchase any rig in Seadrill's fleet that secures a contract of at least five years of length or longer. Thus, the West Jupiter would now be eligible for purchase by Seadrill Partners due to the newly awarded contract.
Total to pay $1.1 billion to use rig
Now, what kind of an impact is this contract likely to have on Seadrill Partners' financials, should that company purchase the rig from Seadrill? Well, the contract calls for Total S.A. (NYSE:TOT) to pay a maximum of $1.1 billion over the five-year period that it will be using the rig. This is approximately $220 million per year. However, this assumes that the rig will operate continuously over the five-year period, which is unrealistic. This is because offshore drilling rigs are extremely sophisticated pieces of machinery that require regular maintenance to continue operating at peak efficiency just like any other machine. This regular maintenance results in downtime for which the rig is not compensated.
Not paid for downtime
So, how much downtime is the rig likely to suffer? Well, for this, we can look at the average downtime suffered by the other rigs in Seadrill Partners' fleet and assume that the West Jupiter will incur about the same amount of downtime. In the first quarter of 2014, Seadrill Partners had total fleetwide downtime of 18%, but nearly all of this was due to equipment failures on two of the company's rigs.
Excluding this, Seadrill Partners had a total downtime of 2% fleetwide. Meanwhile, in the fourth quarter, Seadrill Partners had a total downtime of 9% fleetwide. If we assume that West Jupiter will suffer from the average of the two values (excluding the equipment failures), then it will have an average downtime of 5.5% and generate approximately $207.9 million in revenue. This would represent an increase of 20% over Seadrill Partners' annualized first quarter revenues.
There is no guarantee that Seadrill Partners would get all this revenue even if it does buy the West Jupiter. This is because all of the LLC's ultra-deepwater drillships are owned by one of two operating companies in which Seadrill Partners shares ownership with Seadrill. For example, the West Auriga ultra-deepwater drillship that Seadrill Partners purchased earlier this year was actually purchased by Seadrill Capricorn Holdings LLC. Seadrill Partners owns 51% of Seadrill Capricorn Holdings and so Seadrill Partners does fully consolidate the results from this company into its financial reports but it doesn't actually receive all the money.
So, for example, if Seadrill Capricorn Holdings bought West Jupiter then Seadrill Partners would report all the revenue from it but would not actually receive all of it and so could not pass out all the cash flow that results from it.
In conclusion, it is uncertain whether or not Seadrill Partners will purchase West Jupiter. It certainly has the right to, but there is no obligation for the partnership to make the purchase. If Seadrill Partners does make the purchase, then it is uncertain which of the operating companies will make the purchase or if it will be Seadrill Partners itself that buys the rig as it did with the tender rigs that the company operates. Regardless of how the deal is structured however, purchasing West Jupiter will be accretive to Seadrill Partners' revenue. With the rig's new five-year contract, Seadrill Partners has the right to purchase the rig.