May 8, 2014
Executives
Thad Vayda – IR Steven Newman – President and CEO Esa Ikaheimonen – EVP and CFO Terry Bonno – SVP, Marketing
Analysts
Ian MacPherson – Simmons & Company Intl David Smith – Heikkinen Energy Advisors Harry Mateer – Barclays Investment Bank Lucas Doll [ph] – ABG
Operator
Good day, and welcome to the Transocean Q1 2014 Earnings Conference Call. Today’s conference is being recorded.
At this time, I would like to turn the conference over to Thad Vayda. Please go ahead, sir.
Thad Vayda
Thank you, Travis. Good day, and welcome to Transocean’s first quarter 2014 earnings conference call.
A copy of the press release covering our financial results, along with supporting statements and schedules, are posted on the company’s website at www.deepwater.com. We’ve also posted supplemental materials that you may find helpful as you update your financial models.
These materials can be found on the company’s website by selecting Financial Reports under the Investor Relations tab. Joining me this morning’s call are Steven Newman, Chief Executive Officer; Esa Ikaheimonen, Executive Vice President and Chief Financial Officer; and Terry Bonno, Senior Vice President of Marketing.
Before I turn the call over to Steven, I’d like to point out that during the course of this call participants may make certain forward-looking statements regarding various matters related to our business and company that are not historical facts. Among others, these include future financial performance, operating results, estimated contingencies associated with the Macondo well incident, anticipated results of our cost savings initiatives, strategic projects and corporate financing activities, capital allocation and strategy, new build projects and the prospects for the contract drilling business generally.
Such statements are based on the current expectations and certain assumptions of management and are therefore subject to certain risks and uncertainties. As you know, it’s inherently difficult to make projections or other forward-looking statements in a cyclical industry, since the risks, assumptions and uncertainties involved in these forward-looking statements include the level of crude oil and natural gas prices, rig demand, the effects and results of litigation, assessments and contingencies, and operational and other risks, which are described in the company’s most recent Form 10-K and other filings with the U.S.
Securities and Exchange Commission. Should one or more of these risks and uncertainties materialize, or underlying assumptions prove incorrect, actual results may vary materially from those indicated.
Transocean neither intends to nor assumes any obligation to update or revise these forward-looking statements in light of developments which differ from those anticipated. Also note that we may use various numerical measures on the call today that are or may be considered non-GAAP financial measures under Regulation G.
You’ll find the required supplemental financial disclosure for these measures, including the most directly comparable GAAP measure and an associated reconciliation, on our website at www.deepwater.com under Investor Relations, Financial Reports and Non-GAAP Financial Measures. Finally, to give more people an opportunity to participate in this call, please limit your questions to one initial question and one follow-up question.
Thank you very much and I’ll now turn the call over to Steven Newman. Steven?
Steven Newman
Thanks, Thad, and welcome to all of our employees, customers, investors and analysts. Thank you for joining us on the call today.
As you saw from our first quarter press release last night, we reported net income attributable to controlling interest of $456 million or $1.25 per diluted share. After adjusting for net unfavorable items of $64 million, we delivered adjusted earnings from continuing operations of $520 million or $1.43 per diluted share.
Our revenue efficiency for the first quarter was 95.7%, the highest we’ve achieved since early 2008. Ultra-deepwater revenue efficiency was 96.4% in the first quarter compared with 90% in the fourth quarter of 2013.
The central factor contributing to these strong results was reduced downtime related to well control equipment. During the period, about 44% of total downtime was due to unplanned maintenance of the BOP and associated control systems compared with approximately 64% and 60% in the fourth and third quarters of 2013 respectively.
While April’s revenue efficiency was also generally in line with those achieved during the first quarter, I reiterate my usual caution that our progress will not necessarily be linear. However, I am very pleased and encouraged with the results our operations teams delivered in the first quarter, and I thank them for their tireless efforts.
In addition to strong revenue performance, our first quarter results also reflected lower out-of-service days and progress on our ongoing cost control efforts across the company. Esa will provide a bit more color on these items when he reviews the numbers in a moment.
Recognizing that we are currently in a challenging business environment, I think that it is useful to reflect on Transocean’s strategy in the context of our long-term view of the offshore drilling market. We remain very bullish on the long-term fundamentals available to deepwater business premised on a growing demand for energy and a belief that a majority of this new energy demand will be satisfied by hydrocarbon sourced from deepwater and harsh offshore environments.
This view underpinned our decision in February to commit to construct two ultra-deepwater floaters that are scheduled for delivery in the second quarter of 2017 and the first quarter of 2018. Not only are these investments consistent with our long-term asset strategy, they also reflect the benefits of the company’s balanced approach to capital allocation which allows us to act opportunistically.
In this instance, at a time when we were able to secure extremely attractive construction costs and commercial terms. Regarding the rest of our new build program, the Deepwater Asgard is expected to commence operations later this quarter.
And the Deepwater Invictus is expected to commence operations in late June or very early July. The remaining five high specification floaters under construction are backed by attractive long-term contracts with key customers, Shell and Chevron.
The five premium jack ups under construction remain on track and we are engaged in early discussions with the customer community. We are very pleased with the strong interest in these units.
Furthermore and representative of the continued execution of our asset strategy, earlier this week we disclosed our intent to pursue the creation of Caledonia Offshore Drilling Company comprised of our eight U.K. North Sea midwater drilling rigs.
The U.K. North Sea remains an important market for Transocean.
And we are committed to maintaining a presence in the region. With this in mind, we are evaluating various options for the eventual separation of Caledonia.
And we’ll provide updates to the market in the future as we progress this effort. While we continue to execute our long-term strategy, in the near term we are focused on optimizing the utilization of our assets achieving improvement of our margins and enhancing our financial flexibility such that we can continue to create value for our shareholders in the context of a cyclical industry.
Our margin improvement efforts are on track. And I am pleased with the way our people have responded to the challenge of improving our financial results to eliminate the gap between us and our comparable peers.
We are continuously working to accelerate the implementation of these measures, something I believe will be even more visible in future earnings reports. Our plan to implement an MLP-like yield vehicle also remains on track with an IPO plan for Transocean Partners LLC in the third quarter.
All these efforts are critical to our long-term capital strategy including the sustainability of our dividend which currently represents one of the highest estimated payout ratios in the implied yields in our industry. Regarding Transocean’s specific uncertainties, we are awaiting rulings from various courts and jurisdictions in the Macondo litigation.
First, from Judge Barbier regarding phases 1 and 2 of the multidistrict litigation trial. Second, from the Texas Supreme Court on the question of BP’s claim as an additional insured on our excess liability policies.
Third, from the U.S. Fifth Circuit Court of Appeals regarding the BP SC settlement as well as other pending motions and appeals.
Additionally, Judge Barbier has recently set January 2015 for the phase 3 Clean Water Act penalty portion of the trial. As a reminder, Transocean settled its Clean Water Act penalties as part of the January 2013 agreement with the U.S.
Department of Justice. We remain confident in our position in the merits of our case, and throughout the various court proceedings, there have been no new facts relative to Transocean.
And we have not been found guilty of any post-incident misconduct. Finally, in Norway, we are awaiting the criminal court’s ruling regarding our tax disputes with the Norwegian authorities.
While we await that ruling, we continue to belief that our Norwegian tax returns are materially correct as filed. And we will dispute any allegation to the contrary.
In conclusion, there is no question that the market is challenging right now. But we have experienced cyclicality in the past.
Transocean will remain disciplined. Our objective as a management team is to continue to focus on improving those things within our control and to position the company to compete effectively regardless of market conditions.
I believe our first quarter results provide clear evidence the management team’s focus on delivering value. I would like to remind all of our shareholders of our annual general meeting to be held next week.
We recommend along with proxy advisers ISS and Glass Lewis that shareholders vote for all of the company’s 16 proposals. If you have not already done so, I encourage you to vote your shares.
With that, I will hand it over to Esa for a brief review of the quarter’s results. After which, Terry will provide some further perspective on the market.
Esa?
Esa Ikaheimonen
Thank you, Steven. And good morning and good afternoon to everyone on the call.
As an opening remark, I belief that our first quarter results very clearly demonstrate our commitment as well as our ability to improve those things that are within our control and to deliver a strong performance even in the context of a challenging market. As I normally do, I will discuss the key elements of our results and then comment on our 2014 guidance as necessary.
All results included in the comparison periods have been restated for the sale of ADTI that was completed in January. As Steven already mentioned for the first quarter of 2014, we reported net income attributable to controlling interest of $456 million or $1.25 per diluted share.
These results included $64 million or $0.18 per share in net unfavorable items that are detailed in our press release. Excluding these items are adjusted earnings from continuing operations with $520 million or $1.43 per diluted share.
This compares with similarly adjusted earnings of $0.71 per diluted share in the fourth quarter of 2013. Consolidated revenues from continuing operations were $2.34 billion, $87 million increase relative to the fourth quarter.
This increase was primarily due to two reasons namely an increase in revenue efficiency to a very encouraging 95.7% from 91.7%. It added about $100 million to revenue sequentially.
And an increase in fleet utilization to 78% from 75% which added about $70 million to revenues. This was mainly the result of decrease in planned [ph] shipyards.
About half of this total increase was offset by the combination of idle time on the Sedco Energy and the Transocean Marianas and fewer days available to operate during the quarter when compared with the prior period. First quarter operating and maintenance expenses were $1.27 billion, about 13% lower than the $1.43 billion incurred in fourth quarter of 2013.
Shipyard maintenance cost decreased by about $110 million primarily due to changes in timing. Additionally, approximately $35 million was directly associated with our cost reduction initiative and approximately $25 million was related to changes in activity.
The remainder of the decrease is the result of several individually smaller cost savings achieved throughout the company. General and administrative expenses decreased to $57 million from $75 million in the previous quarter.
The decline was mostly due to professional fees and personnel costs incurred in quarter four and not repeated in this quarter. The first quarter annual effective tax rate from continuing operations which includes adjustments for unusual items was 15.1% compared with 17.7% in the prior quarter.
This decrease was primarily due to higher pre-tax earnings in the quarter and a blend of income that is taxed based on cross revenues versus pre-tax income and rig movements between jurisdictions. You recall that Transocean’s annual effective tax rate varies based on several factors.
One of which is the overall level of income before income taxes as pre-tax earnings increase our annual effective tax rate generally declines. Net cash flow generated from operations was $136 million down from $773 million in the fourth quarter of 2013.
This decrease was primarily due to the payment of $472 million to the U.S. government associated with the 2013 Macondo agreement with the Department of Justice and some seasonal increases in working capital.
To date, we have paid just over $1 billion of the committed $1.4 billion under the Macondo agreement. Capital expenditures were $1.1 billion up from $948 million in the prior quarter.
This increase was due primarily to our ongoing new build program including milestone payments on the Deepwater Asgard and the Deepwater Invictus. I will spend a moment now reviewing our guidance for 2014.
We still expect to achieve fleet revenue efficiency of approximately 94% for 2014. Our revenue efficiency results for the first four months of 2014 were in excess of this guidance and provide increased confidence in our ability to more consistently deliver improved performance.
However, as Steven highlighted, our progress may not be linear. The shipyard activity disclosed in our most recent fleet status report still represents our current best estimate of planned out-of-service time in both 2014 and in 2015.
We continue to expect the annual effective tax rate for 2014 to be between 18% and 21% which also reflects our best estimate of the impact of the proposed U.K. tax law discussed in our 10Q filing.
Our expectations for depreciation expense, general and administrative costs, net interest expense and capital expenditures remain within the respective guidance ranges provided in February. We are encouraged by the results of our cost reduction efforts and continue to pursue opportunities to accelerate incremental savings.
As a result, we adjust our estimate for full year 2014 operating and maintenance expense slightly downwards and expect to be between $5.1 billion and $5.3 billion. You recall that the original range of $5.2 to $5.4 billion already included approximately $200 million of onshore overhead cost savings compared with our 2012 days as well as a portion of our offshore initiatives.
We maintain an intense focus on our entire cost base including our offshore activities and continue to refine our shipyard project execution. These steps are expected to continue to improve our profitability and cash flow in 2014 and thereafter.
Recognizing that it may still be challenging to see the real impact of our efforts to improve the financial performance of the company, I’d like to highlight some achievements in the area of cost management. You already know about our $300 million cost savings target on our shore-based cost by 2015.
Most of these onshore costs are personnel-related. Therefore, it has been natural to focus our efforts on increasing our onshore efficiency by reducing manpower.
Since late 2012, we have reduced our shore-based organization by about 1,100 positions. On the offshore side, we’re equally focused on ensuring that we have what it takes to operate the rigs safely and with operational integrity in line with our standards and regulatory and customer requirements.
We have had a critical look at the management and global optimization of labor cost, extras as well as our permanent rig staffing and have reduced our offshore headcount by about 650 during the last 12 months on a like for like basis. Additionally, we have also reduced the number of onshore and offshore expatriated stuff by about 400 since the beginning of 2013.
Even though we have very significantly reduced headcount, our underlying operational performance has improved which is due to the quality of our remaining offshore crews. As a further example now on the maintenance side, we have continued to improve the way we do rider [ph] inspection and repair, and expect to generate some $25 million of savings this year in this area compared with 2013.
And a final example that has to do with our shipyard execution which is a major source of expenditure and revenue lots. Through better organization, more focus, improved front and loading and more rigorous scope and schedule reviews, we have significantly reduced our out-of-service time for 2014 and 2015 shipyards.
Now back to guidance. With respect to the balance sheet, we continue to work towards reducing our growth long-term debt to below $9 billion.
Schedule of debt maturities for the remainder of 2014 are about $85 million. We are about 80% complete with our goal of earlier retirement of approximately $1 billion in debt by the end of this year.
There’s also no change to our short term liquidity target which remains between $3.5 billion and $4.5 billion. Yesterday, we submitted a confident form, S-1 registration statement to the SEC for Transocean Partners LLC or MLP.
And we remain on track to launch the IPO during the third quarter. As you know, the IPO remains subject to favorable market conditions and final approval by the Transocean board.
Steven also mentioned our decision to create a U.K. North Sea focused drilling company, Caledonia Offshore Drilling.
The announcement we’ve made on Monday allows us to efficiently proceed with this effort with the intention of eventually separating a business into an independent entity. As we have indicated previously, we are considering and preparing for all available options including the direct sale to a public or private buyer, to spin, or a public offering.
Our objective is to maximize the value of these assets in the context of their capability, age, cash flow, backlog, and the unique market in which they operate. We have no additional details to provide at this time, but you should expect updates on our progress in the future as appropriate.
To conclude, our efforts to reduce our costs improve our operating performance, optimize the value of our non-core fleet and the IPO of Transocean Partners all contribute to our financial flexibility enabling us to continue to execute our balanced capital allocation strategy. Even in the context of the near term market challenges, we are confident in our ability to achieve our objectives including our commitment to pay a sustainable competitive dividend to our shareholders.
In the context of modest debt retirements, our current forecast of capital expenditures and the proposed $3 per share dividend recommended for approval by shareholders at next week’s AGM, we expect to maintain our liquidity well within the target range through 2014. This finally concludes my comments.
And I now hand over to Terry to provide you with an update on market conditions. Terry.
Terry Bonno
Thanks, Esa, and good day to everyone. Before we cover specific markets, I would like to make a few general comments.
Year-to-date, we generated $800 million of contract backlog including securing contracts for the GSF Development Driller II, the Paul B. Loyd, Transocean Marianas and Constellation II.
Importantly, we are returning the Marianas to active status in the South African market. We’re entering the Black Sea market with a versatile ultra-deepwater semi and extending our harsh environment presence west of Shetland.
The majority of this backlog was successfully executed within the last 40 days and then it is the result of the intensive work of Transocean’s marketing and global support teams. And I commend them all for their efforts.
Although overall pace of tendering remains slow in the first quarter, we are seeing a few opportunities, all of which were anticipated finally coming to the market. The outlook for 2014 and 2015 remains challenging with respect to oversupply of ultra-deepwater.
However, it is encouraging to see some life in the Golden Triangle with a few expected awards in West Africa, Brazil and the U.S. Gulf of Mexico.
Floater opportunities are now pushing into 2015 and ‘16 while customers are competing with us via form outs for the one off well opportunities with their available rigs. We also continue to see weak deepwater and midwater markets and as in previous oversupply cycles, the most capable rigs will compete down potentially displacing lower specification units.
While we believe that the floater market will continue to be difficult through 2015, we expect year-on-year customer demand to continue to grow assuming healthy relatively stable oil and natural gas prices. The jack up market remains steady with new supply coming to the market currently being absorbed.
Rates in utilization remain healthy and tendering activity is solid. It is our view that longer term fundamentals remain positive for future growth as global energy demand will continue to increase and our customers will return to the business of drilling offshore wells to replace reserves and increase production volumes to satisfy this demand.
Now to the quarter. Fleet utilization increased to 78% from 75%, and the average daily revenue increased to $413,000 per day from $393,000 per day.
We have experienced another quarter where the outstanding tenders for ultra-deepwater units particularly in West Africa were not awarded. However, we expect that the four contracts will be awarded soon.
Additionally, during the first quarter, form out activity increase slightly and we have a number of our rigs currently being formed out. Now the specific markets.
Utilization for the global ultra-deepwater fleet is currently around 98% with three units available including our rigs, Sedco Energy and the DD1, which we are actively marketing and hope to have positive news soon. However, we do anticipate more idle time for these units.
Right expectations for ultra-deepwater units have shifted downward from the previous quarter to between $375,000 per day to the low $500,000 per day depending upon specifications, area of operation and duration of the contract. Obviously, still fixtures negotiated late last year and earlier this year will exceed this level of pricing.
We also anticipate to see day rates for short term opportunity bridging to longer term work to be somewhat lower than this range. That said, the older lower spec units are fully capable to drill in most markets.
And we expect that an improving market for ultra-deepwater assets will provide ample opportunities in the future. While ultra-deepwater demand is being driven by Sub-Saharan Africa, other emerging markets in the U.S.
Gulf of Mexico, we expect demand in Brazil to increase in the near to medium term. In addition, the DD2 which was contracted through direct negotiation recently, we expect to see more tendering opportunities promptly.
In balance, the market remains oversupplied through to 2015 and with the objective of optimizing fleet utilization, we will continue to fight for every opportunity that comes with a market for our available fleet. Longer term, we expect anticipated exploration success to lead to significant development drilling as our customers resume their focus on reserve replacement and increasing production.
We were pleased to contract the GSF Development Driller II for almost one year of work in the Black Sea with Lukoil. We wanted to relocate this rig out the U.S.
Gulf of Mexico due to increasingly demanding well programs and the capabilities offered by new build drilling units and found the right opportunity to do so. We were competing against a deepwater award unit and the $360,000 per day rate reflects this circumstance.
Also, we are pleased to announce that the backlog from the Sedco 710 has now been officially transferred to the Sedco 706 in Brazil. The types of tendering continues to be slow for the deepwater market and actively marketed utilization has dropped to about 90%.
The day rate range is expected to be around $365,000 per day to $400,000 per day although there have been relatively few new indicative data points. We secured a contract for the Marianas to return to work as the result of the direct negotiation with PetroSA in South Africa for almost a year’s worth of work at $370,000 per day.
While we are in active discussions with our customers on several deepwater floaters available in 2014, we expect to see some idle time between contracts in the near term. Midwater and harsh environment tendering activity remains slow in the first quarter.
While there are relatively few data points, the current day rate range for harsh environment assets depending on specific capability is between the low $400,000 to $500,000 per day. We are very happy to announce that we extended the Paul B.
Loyd for two years at $430,000 per day. The rig will be operating for BP west of Shetland.
Additionally, we contracted the Transocean Arctic for almost four months of work in Norway at $519,000 per day. We are actively engaged in discussions on several units for extensions in the North Sea and Norway for availability in 2015.
Outside this U.K. harsh environment areas, we are seeing idle capacity and midwater rates in the low to mid $200,000 per day.
Utilization and day rates for premium jack ups remains stable due to demand in Mexico, India and Southeast Asia. We expect demands to remain high through 2014 and anticipate that the new builds will be absorbed by the market in the near term.
Rates remain stable for high specification jack ups at $160,000 to $180,000 per day, and $180,000 to $200,000 per day in the U.K. We were pleased to extend the Constellation II for the one year price option at $160,000 a day in Gabon.
In summary, the ultra-deepwater market is in a corrective cycle in the near term due to deferred customer demand and an oversupplied market. While the pace of fixtures and contract direction has been decreasing steadily, over the last three quarters, we currently believe that demand will increase as our customers refocused our efforts on 2015 and beyond.
While we are seeing the potential for incremental deepwater idle capacity in near term, longer term fundamentals will improve with a strengthening ultra-deepwater market. Midwater activity in the U.K.
and Norway and the premium jack up market remains stable in the near term. We could also see some headwinds in rates for lower capacity jack ups due to the large number of new build jack up being delivered in 2015.
Longer term, our customers will return to drilling for reserve replacement and production growth. And as a result, we expect that the market will transition out of this oversupply cycle.
As this plays out, we expect an increase in demand for offshore drilling equipment within the next 12 to 18 months providing ample opportunities of the existing fleet and for future growth. This concludes my overview of the market, so I will turn it back to you, Steven.
Steven Newman
Thanks, Terry. Travis, with that, we’re ready to open it up for Q&A.
Operator
(Operator instructions) We’ll take our first question today from Ian MacPherson with Simmons.
Ian MacPherson – Simmons & Company Intl
Hey. Thank you and congratulations on the good quarter.
Terry, the DD2 going to the Black Sea, that’s a fairly lengthy mob, but I believe one that typically involves some effort with regard to breaking down and rebuilding the derrick on the way through the straits. Does that day rate reflect a considerable amount of CapEx in mobilization or is that 360 what we would call a clean day rate?
Terry Bonno
Well, normally, we don’t need to break down our mobilizations. So I would just say the $360,000 a day is the operating rate.
Ian MacPherson – Simmons & Company Intl
Okay.
Terry Bonno
And we have in the past, we’ve done lump sum mobs, we’ve done per day mobs. So I think that that’s really all that we need to describe on this particular transaction.
Ian MacPherson – Simmons & Company Intl
Okay. My follow up question regarding Caledonia and the asset strategy, Steven, really with regard to non-core asset sales, the Transocean historically has been a consolidator in the industry and some companies are averse to building stacked rigs.
And recently, the market fundamentals have had itself and you’ve embraced speculative new builds and deconsolidation which in a way is sort of counterintuitive. But I think that you could say if you get very good price realizations on non-core asset sales, they’re always good, right?
The shelf drilling sale seems like it was pretty one sided with regard to being favorable to the buyer. And I think the concern going forward would be how do we extract great shareholder value for Caledonia or whatever, non-core floaters are coming down the pipe.
What sort of assurance do you have that you’re going to get accretive separations from these non-core assets going forward?
Steven Newman
So there’s two things I want the market to remember when we talk about the actions we’re taking. And one is strategy and the other is value.
So our asset strategy, I think we’ve been pretty clear. Our desire is to reduce the company’s exposure to low spec, commoditize assets, and increase our exposure to high spec differentiated assets.
And I think with what’s going on in the market right now, I think that strategy should be easily understood in terms of the rationale underpinning the strategy. The execution of the strategy, I think, as I said in my prepared comments, I think we were very opportunistic in agreeing to build the two floaters in Jurong earlier this year.
We’ve got excellent capital costs and very favorable commercial terms and deliveries in 2017 and 2018 which is a favorable time period with respect to the long term fundamentals of this business. The decision to disclose our intent regarding Caledonia is part and parcel of that strategy.
And that’s where you have to remember the company’s objective regarding valuations. We know the assets in our fleet better than anybody else.
We know what it cost to operate them, we know the amount of capital required to keep them running. And so the starting point with respect to any transaction, whatever form the transaction might take, the starting point is what’s the asset worth to us.
And if we can find somebody who’s willing to pay us more than the asset is worth to us, that’s an easy deal to do, and that’s clearly accretive to shareholder value. And so that will be the objective or the lens through which we view any potential transaction regarding Caledonia.
What are those rigs to us? If we can’t find somebody who’s willing to pay us what we think those rigs are worth, then we’ll continue to operate them.
Ian MacPherson – Simmons & Company Intl
Very good. Good answer, thanks.
Operator
Our next question comes from David Smith with Heikkinen Energy Advisors.
David Smith – Heikkinen Energy Advisors
Hi, good morning. Thank you.
Steven Newman
Good morning, David.
David Smith – Heikkinen Energy Advisors
I’m curious about the cost breakdown provided for the ultra-deepwater fleet, particularly the idle cost per day which was about 25% of the in-service cost. So on those 145 days of idle time, how did you get so much cost relief compared to the in-service costs, and is this the cost level we should expect for the ultra-deepwater idle costs going forward?
Esa Ikaheimonen
Yes, it’s Esa Ikaheimonen here. Recognizing the name of the company you represent, there might be some connection there to my Finnishness but let’s leave that aside.
The cost associated to idle time vary a lot and it is very difficult to give you a very comprehensive answer on that right now and right here. We really need to discuss in a lot more detail as to what drives those costs and so on.
Generally speaking, when we talk about our CPR activity and costs associated to that which is the out-of-service cost, really depends on the nature of CPR and almost every single one of those are a little bit different. And the split between what we capitalize and what we expense may vary very considerably.
I know this is not the answer that you expected. I think if I were you, I would look at a little bit longer term averages in terms of how the out-of-service cost have evolved rather than a snapshot that has to do with a single quarter.
And that gives you a better sort of modeling certainty in terms of how things tend to be on a more average basis. I think further than that, I would really suggest that maybe we can have a separate discussion on some of the more specific questions that you may have.
But that’s what I would say at this moment in time.
David Smith – Heikkinen Energy Advisors
Absolutely. I appreciate it.
I guess I would note that on the idle cost for the ultra-deepwater fleet, looking longer term, in the last couple years, you haven’t had a whole lot of idle days. So separate from the out-of-service costs and looking at – listening to Terry’s commentary about more idle time between contracts, it was just a point I was hoping to understand about when a rig has lost contract between jobs, are you able to get significant cost relief during the idle time?
Because the –
Esa Ikaheimonen
Yes, I probably little bit actually answered a different question. Same apply though because there’s different types of idleness.
In between contracts it’s very difficult actually to immediately reduce the cost base because almost by definition, you’re getting ready to continue drilling as soon as Terry’s team has got the rig on a new contract and therefore given the fact that the cost base is pretty fixed actually, there isn’t an awful lot of change. Then when you warm stack the rig, there’s a step change in terms of what you need in order to keep the rig warm and ready with moderate incremental activity to drill as when the contract comes and then the cold stacked rig is a completely different story again.
So you really have three different types of situations and you got to look at these things on a rig by rig basis to understand what the numbers tell you.
David Smith – Heikkinen Energy Advisors
Sure.
Esa Ikaheimonen
But general rule is that idle in between contract and the OpEx level is not widely dissimilar to an operating rig.
David Smith – Heikkinen Energy Advisors
Okay.
Esa Ikaheimonen
The longer it’s actually released, the more encouraged and incentivized you are obviously to look at ways to reduce manning and lay off people and do that on a temporary basis.
David Smith – Heikkinen Energy Advisors
Well, I’m guessing you planned on cold stacking the ultra-deepwater rigs but I’ll follow up offline for the rest and I’ll finish with that. Thank you.
Operator
(Operator instructions) We’ll take our next question from Harry Mateer with Barclays.
Harry Mateer – Barclays Investment Bank
Hi, guys. Just a question, can you just talk a little bit about how the recent announcement of the potential separation of Caledonia fits into your balance sheet priorities?
There is a good bit of EBITDA from those assets at least at this point, so how do you plan to manage rig debt as those assets move into a separate vehicle?
Esa Ikaheimonen
Harry, it’s a good question. And it’s good to get questions every once in a while from the debt side of things as well.
Thanks for that. You know our balance sheet philosophy and you know the importance of the investment grade rating to us, so that’s one of our capital allocation priorities and I think we’ve demonstrated that we really mean that.
And it just fits perfectly into cyclical and capital in terms of industry and all that. And you’ve heard that story.
And as long as Caledonia is part of our consolidated group and our consolidated balance sheet, nothing changes. So we do intend to manage obviously Caledonia in line with the rest of the business at a consolidated level.
The moment it becomes more independent than that, then we do consolidate and then so on and so forth. Of course, again, we have to recognize the fact that we also stopped consolidating the earnings associated with that business and therefore there is a necessity to use a significant part of the proceeds to reduce our overall indebtedness.
So, again, in order to manage the leverage and in order to manage the leverage in line with our overall balance sheet philosophy and policy. So it won’t change anything.
We will have to manage that on a Transocean side before and after independence and before and after potential detail consolidation as we’ve done it so far. And that includes compensation for the reduced earnings in order to manage the leverage ratio at a level that is comfortably within our range and that is required in order for us to sustain our investment grade rating.
Harry Mateer – Barclays Investment Bank
Okay, thanks for that answer. And then my follow-up question, I guess more for Terry.
But can you just comment a little bit, there’s really been a lot of speculation certainly out there about where rig day rates could bond. Can you give us a sense for new build ultra-deepwater rates, I mean some numbers that have been banding about [ph] out there just some speculation for the lows like $400,000 a day, give us a sense for whether that’s something that’s even possible or where do you think the bottom could be?
Terry Bonno
Hi, Harry. Right now, it’s really difficult to say.
There’s a lot of bids there in the process that everyone’s competing for and I’d say the last couple ones that have come out, we all know that about 18 to 20 ultra-deepwater rigs have actually been bid at those programs. So you can see that the competition is pretty fierce.
I think that it becomes a real challenge for our competitors when new builds that were built on spec during this particular near term softness, I think we have the luxury of having all of ours with back to back contracts that are being delivered during this timeframe. But I think for them to think about how could they reduce the rates to not return the type of economics that they had certainly planned, I think it’s going to be a challenge.
I know that one of our competitors recently said that they did not go to $400,000 a day, but I think with the competitions, they’re going to have to make those decisions or look at what the alternatives are. But as far as trying to tell you where our bottom is, again, we’re in these competitive situations right now and if we start talking about where we think rates will go, then I’m afraid that we’d tipping our hand on the type of things that we’re looking at.
But it’s a really good question.
Harry Mateer – Barclays Investment Bank
Thanks, I appreciate it.
Operator
(Operator instructions) We’ll take our next question from Lucas Doll [ph] with ABG.
Lucas Doll [ph] – ABG
Thank you. Two quick questions.
Hi guys. First one was the – Terry, I didn’t catch the length of the contract on the DD2.
Could you repeat that?
Terry Bonno
It’s almost a year’s worth of work.
Lucas Doll [ph] – ABG
Almost a year, okay.
Terry Bonno
Yes, it’s almost a year.
Lucas Doll [ph] – ABG
And then the second one, on the work that you are targeting right now and you’re obviously competing with some of the new builds, do you see a lot of tenders where fifth generation rigs are being excluded by the technical nature of those tenders or is that the rarity?
Terry Bonno
Well, I think that you’re going to see perhaps a little bit more of that in the Gulf of Mexico than you probably see outside of that environment. So they’re drilling the more challenging deeper wells and they’re needing more hook load capacity.
The fifth generation typically don’t have 2.5 million hook loads. So that’s the type of situation.
That’s why that we’re looking to relocate some of those fifth generation rigs. And having said that, though, there are still opportunities in the Gulf of Mexico that they can drill.
But as far as some of the recent tenders, I think there’s one that is it’s either in the market, about to come to market, that will ask for this 2.5 million hook load. But again, we are actively in discussions on our fifth generation fleet and we do have them in some of the current tenders.
Lucas Doll [ph] – ABG
Okay. And while we are looking for the bottom and awaiting for things to trough, wouldn’t you think what needs to happen to sort of find the inflection point, is that somebody signing on a bunch of rigs or a chunk of rigs being cold stacked?
Would you say it could be the turning point in terms of the supply-demand balance and how it evolves?
Terry Bonno
Luke, I think that it’s pretty easy to look to Africa for the amount of demand that’s been out there for quite some time. If we see those opportunities closing sooner, I think that takes some pressure off.
I mean there’s what, 15 to 20 opportunities there alone. And they’re real opportunities.
So it’s not just possibilities. So I think that that really helps the situation a lot.
We hope that Petrobras will come to the market for more tenders. And by the way, we think they will.
So that will help. And certainly, for some of the older fleet, everyone since I’ve been in the industry in the early ‘80s, always talked about one day that we will stack these older rigs.
But we’re not seeing a lot of that at this moment. But certainly, attrition will help to the situation too.
Lucas Doll [ph] – ABG
Okay, great, thank you.
Operator
It appears there are no further questions in the queue. At this time, I’d like to turn the conference back to management for any additional or closing remarks.
Steven Newman
Thank you all very much for your participation at today’s call. And if you have any follow up questions, feel free to give us a call this afternoon.
We’ll be available. I look forward to chatting with you again when we report our second quarter 2014 earnings.
Have a good day.
Operator
That concludes today’s presentation. Thank you for your participation.