Sheila McNulty Pressure is on smaller companies in Gulf of Mexico

When Hercules Offshore agreed to buy Seahawk Drilling’s 20 jackup rigs, the obvious question was whether it planned to use them in the Gulf of Mexico. After all, Seahawk is only focused on the Gulf, and it is pricey to move rigs.

But Hercules chief executive John T. Rynd says he got a good deal on the rigs. Seahawk agreed late Friday to sell substantially all its assets to Hercules in a cash and stock deal. The deal includes $25m in cash and 22.3m Hercules shares, which, based on the February 10 closing price of $3.62 per share, put the value of the transaction at $105m.

The asset sale is to be done through a Chapter 11 bankruptcy filing in which Seahawk will seek expedited hearings to obtain court approval. The companies expect to the close the transaction – subject to the various approval required – in the second quarter of 2011.

Once the deal is done, Mr Rynd told me, he will be prepared to move rigs to international waters if there is a demand for the equipment. The bottom line is that drilling in the Gulf remains restricted by regulators.

That is compounding the already grim reality for shallow water drillers that the Gulf is a mature province. Even as deepwater drilling has been expanding, Mr Rynd says the rig count has been declining in the shallow water gulf over the past decade, with 73 rigs leaving since 2001.

You layer on what is compounding the issue – the uncertain regulatory environment – and you put the shallow water drillers in the Gulf of Mexico under a lot of stress.

There could be more deals to emerge from this stressful situation. But while Hercules remains “opportunistic” it is not in active discussions to pick up any other assets. It has a right to keep Seahawk’s staff and needs those that come with the offshore equipment. But he has yet to evaluate whether Hercules needs all those based onshore. It remains unclear when – and by how much – activity in the shallow waters of the gulf will pick up.

Until we can get a template that both the administration and the industry agree on, people are going to be reticient about diving in with both feet. It’s a very challenged environment.

Hercules itself reported $130m in cash at the end of the third quarter of 2010 – the last period for which it has reported. And it has $800m in gross debt. But with with operations in nine countries it can – unlike Seahawk – offset the loss in activity from the slowdown in the Gulf.

That said, there are 487 shallow water rigs in the world and 51 more under construction. And contractors typically are reluctant to fund the move of a rig from one region to another.

Mr Rynd says it can cost up to $6m to move a rig to west Africa and up to $12m Asia. But without more activity in the Gulf, drillers may not have a choice. Randy Stilley, Seahawk’s chief executive, made clear the inactivity is due to the actions by regulators:

Seahawk was forced to seek strategic alternatives only after an unprecedented decline in the issuance of offshore drilling permits following the Macondo blowout. The decision by regulators to arbitrarily construct unnecessary barriers to obtaining permits they had traditionally authorised has had an adverse impact not only on Seahawk but on the sector as a whole.

Of course he is right. Others are searching for buyers, as it becomes not only more difficult but more expensive to operate in the Gulf.

But the regulators are unapologetic for this. Michael Bromwich, the lead regulator of the US offshore oil, said the issuance of permits would never return to levels seen before the accident, when many viewed regulators as a “permitting mill” without adequate reviews. “We have a new normal,” he has said. “It’s going to take more time than in the past.”

James West, analyst at Barclays Capital, sums up the situation:

People are just waiting; they’re all hanging on. There will be a shift of smaller independents out of the Gulf of Mexico because of the challenges of doing business.

It’s just a matter of time.