The tide is turning: ideal conditions for rig recycling

Recycling has been widely described as the ’fourth pillar of the shipping industry,’ behind the newbuilding, chartering and sales and purchase sectors. Most shipping professionals have heard of, or were involved with an asset that had to be recycled, was about to be recycled, or liquidated an asset in a constantly active market to guarantee the minimum residual value of their vessel. Despite the fact that everyone has heard of recycling bulkers, tankers and container ships, when it comes to offshore assets (jack-ups, floaters, rigs in general, offshore support vessels), the understanding of the industry is not the same as for normal commercial vessels.

The reason behind the fundamental lack of experience in this sector can be justified.

Such units are not considered part of the normal shipping industry, but part of the oil and gas/energy sector, as they have been used on exploration, drilling and support, not in the actual transportation of the commodities.

Owners of these assets have not been considering the residual value of their units, since the spread between newbuilding prices and recycling rates is the biggest across the shipping sector. For comparison, while the price of a VLCC tanker in the newbuilding market would be US$70M-US$80M, its residual value would be US$16M-US$20M, indicating approximately a 25% return when selling for recycling.

On the other hand, if the newbuilding price of a jack-up rig is US$250M, its recycling value will be on average US$3M, which indicates a 1%-1.5% return on the investment. Commercially, rig owners were never dependent on the recycling market for cashing out on their units.

Regarding the charter hire for the offshore units, ’when it rains, it pours.’ Re-examining the jack-up rig as an example, the units, depending on the region and specification, when on charter – can easily earn from US$50,000 to US$150,000 per day, exceeding the typical historical average earnings of commercial vessels. In times of turmoil in the oil industry – when oil prices fall to between US$25 and US$30/bbl – the decision was clear for owners to lay up their units and wait for the next upside instead of immediately sending them for scrap; who would get rid of a cash cow, if it can be laid up cheaply and have proper maintenance at logical rates to avoid huge reactivation bills?

On the two points above, we have taken only the example of the jack-up rigs. When looking into floaters, such as semi-submersible rigs, or even drill ships, the newbuilding prices as well as the daily earnings, are even more significant.

Furthermore, let us not forget the ownership of these units. Rig owners tend to be either mainly state-owned companies or stock-listed companies – both of which have easy access to substantial financing lines to perform their operations and stockholders that need to be involved in the process. Owners described above have always been hesitant to sell their units for recycling, especially in the subcontinent, in view of the lack of a necessary framework and regulations governing the recycling activity. Owners had to wait for the IMO guidelines of the Hong Kong Convention to be exercised and implemented, with India leading the charge and Bangladesh slowly following, for considering the recycling of their assets as a viable solution.

Additionally, we cannot avoid the logistical nightmare of transporting these assets. Most drilling rigs operating around the globe are located in the middle of oil fields, or in layby berths/anchorages in jurisdictions and locations far away from the recycling destinations. Taking into account the weather restrictions on transporting the units (US hurricane season, COGH winter season, monsoon season in the subcontinent), the principal dimensions (ie, leg protrusion on jack-up rigs, thrusters in semi-submersible rigs, increased beam, heavy draughts, reduced stability), the means of transportation (wet or dry tow), transporting these units is never a ’stroll in the park’ compared with normal towing of a ship-shaped unit. It requires tremendous logistical preparation and increased costs to bring these units to subcontinent destinations. Adding to the above, the low ldt of such units (ie, jack-up rig has on average 6,000-10,000 ldt) can make the exercise futile, and the transportation cost may overcome the residual value of the asset.

Finally, the values of the drilling rigs in terms of recycling are heavily dependent on the extra equipment that remains on board at the time of the recycling, which is included in the recycling sale. While price fluctuations in normal vessels could be in the range of US$10 to US$20/lt for two similar-sized vessels, two rigs are most probably never the same, and one can observe US$40 to US$50/lt differences in the recycling rates for two similar rigs. The main reason behind this is the extra equipment, especially on the drilling side. Riser pipes, BOP, cementing units, mud pumps, raw water towers, and thrusters are equipment that can considerably increase the value of the asset if left on board. Rig majors though, due to the value of these items, tend to remove the equipment for further use in other assets (or due to these being third-party-hired items), literally stripping them and leaving only the basic shell to be recycled, which will not demand any premium over a normal, more accessible to cut, bulk carrier. Discounting the already reduced recycling price of a rig does not lead owners towards seriously considering the demo market.