Glen Ashwell, Vice President of Audit Division, OES Asset Integrity Management
I have almost completed 24 years in OES and over the last two decades, I have witnessed three oil crashes, and now our current crisis that being the Coronavirus pandemic. I have witnessed drilling contractors fade away, new ones start up and major acquisitions and mergers of these international drilling companies throughout this period.
These last 4 or 5 years have been extremely challenging, and at the same time exciting for companies like OES. We have always been on the forefront of looking for new ideas, software development and technology advancements to give more back to our clients, and enter a new digital world of inspections from tablets and platforms and RFID tech. All driven to make us stand out from the crowd and all whilst the industry was facing oil crashes, drilling contractor bankruptcies, major acquisitions and mergers and now the coronavirus pandemic.
What is a Fair Market Valuation?
The Fair Market Value is the estimated price at which the assets would be handed over from one willing seller to one willing buyer and both having reasonable knowledge of the relevant facts in the common oilfield market. Determination is based on the comparable method. Recent past sale or offering of the same or similar drilling units or individual equipment is taken in consideration.
A Fair Market Valuation could be used for the following purposes;
- Security to a financial institution.
- Securing financing from a lending institution.
- Financial independent cost or impairment purposes in the company corporate financial statements.
- Providing pertinent values of assets to an interested party that may wish to purchase or acquire the company assets.
- Cost analysis in order for liquidation of said assets
Considerations in any Fair Market Valuation appraisal of an asset includes; market conditions, type, age/remaining expected lifetime of equipment, second hand sales, new building cost, replacement costs.
The offshore rig industry is described primarily by five markets: newbuild market, contract drilling market, upgrade market, second hand market, and scrap market. A brief explanation of these markets I will share below:
Contract Drilling Services Market
In the contract drilling market, rigs are leased to exploration and production (E&P) firms to drill or service wells. E&P firms include international oil companies (IOCs), national oil companies (NOCs) and independents. The contract drilling market is the largest and most closely followed of the five markets and drives the activities of investors in the other markets.
The newbuild market is a specialized shipbuilding market in which labor and capital are used to convert steel and third party equipment into rigs. Drilling contractors enter into turnkey contracts with shipyards for the delivery of one or more rigs or yards may build on speculation.
Regular maintenance is required for safe and efficient operations and as a rig ages, its technology becomes obsolete and upgrades are required to sustain competitiveness and market value. The upgrade market is a ship repair market which both upgrades and maintains rigs for contractors. Shipyards in the newbuild market are often active in the upgrade market.
Second hand Market
The second hand market, rigs are sold among drilling contractors and between contractors and other market participants. Rigs may be sold for use in the service market, may be converted to another use by the buyer, or sold for scrap.
In the scrap market, shipbreaking firms buy rigs on the second hand market, either directly from drilling contractors or from brokers. Equipment is reused where possible and the rig is dismantled with the steel recovered and sold for scrap to mini-steel mills.
Publicly traded drilling contractors are continuously valued by the market. The primary factors that impact valuation are debt and cash, fleet values, current and projected revenues, and net earnings. Factors that are more difficult to observe and quantify that also impact market valuation include insurance liabilities, revenues in the distant future and customer relationships.
Why would a company request one to be completed?
Companies determine the carrying values of jack-up rigs, semi-submersible rigs and related equipment based on policies that incorporate estimates, assumptions and judgments relative to the carrying values, remaining useful lives and residual values. These assumptions and judgments reflect both historical experience and expectations regarding future operations, utilization and performance.
The use of different estimates, assumptions and judgments in establishing estimated useful lives and residual values could result in significantly different carrying values for jack-up rigs, which could materially affect a company’s balance sheet and results of operations.
What is the process of completing a Fair Market Valuation?
In summary, oilfield equipment, in particular drilling units with current contracts, by their nature have an enhanced value through their design, set up and packaging of their purpose built components. Depending on the equipment specification, engineering and purchasing region of these systems, they have a determinable, predictable lifetime
This fair market valuation study is based upon equipment assets, presumed and confirmed condition, potential resources, equipment asset case history, rig specification, data room documentation reviewed and in all aspects the maintenance of the same by review of asset descriptions and additionally measured against similar drilling units available on the current market
Benefits of a Fair Market Valuation
The aim of a fair market valuation is to assess and gain in-depth appreciation of the equipment offered and establish a base line fair market valuation. Companies usually re-evaluate the remaining useful lives of jack-up rigs rig as of and when events occur that may directly impact their assessment of their remaining useful lives. This includes changes to the operating condition or functional capability of rigs as well as market and economic factors.
The carrying amount of jack-up rigs is subject to various estimates, assumptions, and judgments related to capitalized costs, useful lives and residual values and impairments. Jack-up rigs and related equipment are recorded at historical cost less accumulated depreciation. Jack-up rigs acquired as part of asset acquisitions are stated at fair market value as of the date of the acquisition. The cost of these assets, less estimated residual value, is depreciated on a straight-line basis over their estimated remaining economic useful lives. The estimated economic useful life of jack-up rigs drilling rig when new, is 30 years.
What experience does OES have of completing FMVs?
We have undertaken desktop and physical singular and fleet wide Fair Market Valuations over the last two decades from onshore rigs to offshore rigs. This is all based around OES’s own database of equipment, depreciation models, actual condition, market climate and market resources. This spans from various types of drilling rigs [current new and used] as well as extensive OEM equipment in-depth appreciation experience.