Pacific Drilling

The Preferred Offshore Driller From June 2014 to January 2015, the market price of oil fell from US$115 per barrel down to $49 per barrel. As oil prices went down, so did the appetite of energy companies for offshore exploration. Further com-pounding the problems was the oversupply of rigs, due to drillers having overbuilt during the boom times. As of March 2015, there was no near-term recovery in sight for oil prices, which had major implications for Pacific Drilling, a growing offshore drilling company based in Texas. Founded in 2006, Pacific Drilling owned and operated a fleet of eight high-specification drillships operating in ultra-deepwater drilling environments in depths up to 3.7 kilometres (km) and offered the most advanced drilling technology available. As of 2015, the company had nearly 1,600 employees and had generated more than $1 billion in annual revenue .With growing competition from rivalsboth emerging and more established companiesPacific Drilling sought to expand its customer base. However, the close relationships that it had cultivated with its existing partners (which had helped its early stage growth) raised concerns that the driller had become too closely linked to them (in terms of culture, processes, and technology) to effectively translate its efficiency gains to new producer partners. The company's chief executive officer (CEO), Christian J. Beckett, and his team received a range of opinions about what the company should do to weather the storm and emerge stronger. Investors also felt the pain from the company's stock price sliding from $11 per share in 2014 to less than $4 per share, as did the stock price of all offshore drillers during that time . As he considered the available options, Beckett faced another critical crossroad. The company had survived tough times beforein the early stages of the company's development, the team had successfully manoeuvred through the 2008 financial crisis as the credit markets collapsed. But as Beckett admitted, the current challenge was unique in many ways, and Pacific Drilling was a different company from earlier. However, it remained to be answered to what extent Beckett and his team could rely on what they had successfully done in the past, and to what extent they would need to adapt The Offshore Drilling Industry The offshore oil industry involved the exploration and production of oil and gas from underwater wells, often in locations off continental coasts but sometimes in inland seas and lakes. Offshore sites held greater promise than onshore sites for oil producers to develop their oil reserves, and achieve higher production rates, especially in less explored deepwater sites. For instance, in recent years, the greatest increases of any offshore drilling region had been the demand for ultradeepwater rigs in the Golden Triangle of Oil, which consisted of the Gulf of Mexico and the waters off the coasts of South America and West Africa .Over the past decade, deepwater discoveries had far outpaced those in shallow water. Developing a well usually involves two main players: the oil producer and the driller that physically drills the well in accordance with the producer's specifications. A small number of oil companies owned a few offshore rigs and conducted drilling in-house. Most companies, how-ever, outsourced the work to drilling contractors. Some producers, known as independent producers, focused solely on the upstream, or early stage, activities of exploration and production (e.g., Anadarko). Others were integrated multinational corporations (e.g., BP, ExxonMobil, Chevron, and Shell) and state-owned companies (e.g., Brazil's Petrobras and Saudi Arabia's Aramco) that also performed downstream or later stage activities, such as refining and marketing of the extracted oil and gas. Oil exploration began with geological and seismological research on a potential well. Next was the purchase or lease of the promising ocean terrain, almost always from governments. Once sufficient due diligence was completed and the rights to explore the site were secured, producers typically contracted with drillers to drill exploratory wells. If the results were encouraging, drilling began on development wells in the area for eventual oil extraction. How quickly drilling, and then extraction, could be accomplished depended on the supporting infrastructure (e.g., pipelines connecting to processing facilities) around the drilling site, weather conditions, and geological characteristics. Another fac-tor was productivity, which was a function of the drilling technology used and the working experience of the producer-drilling teams. Offshore drilling typically used three types of rigs: jackups, semi-submersibles, and drillships. Jack-ups were used in shallow water (up to approximately 0.12 kms of water), and their operating deck was supported by multiple legs that extended down to the ocean floor. Semi-submersibles (semis) could operate in water depths of up to 3 kms. They floated on submerged pontoons with an operating deck that was well above the water's surface. Drillships could operate in water depths of up to 3.6 kms. They looked like large, ocean-going freighters with a drilling derrick mounted in the centre of the ship. They offered greater mobility and deck space than semis and were therefore often preferred in remote locations. Their larger size also allowed them to provide greater operational efficiency through enhancements such as dual derricks and additional drilling equipment. Drillers competed to lease their rigs to producers. The drillers were usually paid based on day rates, Which varied widely across rig types. Deepwater oil reserves were much more difficult to tap and required more advanced equipment and expertise than some other locations. As a result, day rates for semis and drillships could be three to five times higher than jack-up rates. Day rates also varied in relation to market conditions and could be further differentiated by the quality and efficiency of the drilling rigs and services, which were often the result of technological and processing innovations that could ultimately provide lower total drilling costs for the producer. Day rates were usually locked-in through negotiated contracts, with the duration of the contracts and the lead time decided on prior to the start of the contract. However, day rates also fluctuated with market conditions. Many factors could affect a producer's choice of driller. For example, national oil companies often held public tenders and chose drillers based on the rig's suit-ability and the day rate. International oil companies had been known to be much more reliant on existing relationships. Because relocating rigs was costly and time-consuming,7 producers seeking to develop wells in a certain region were more likely to contract a driller that already had the required type of rig ready in the area. In certain geographic locations, government regulation and local content criteria could be barriers to entry, thereby playing a significant role in the selection of a drilling contractor. Rigs that were not leased out were usually "stacked" (i.e., idle), or taken out of service, by the driller to minimize operating costs. A "hot-stacked" rig remained fully crewed, standing by, ready for work if a contract could be obtained, and the downtime was used for maintenance and repairs; a "warm-stacked" rig retained some of the crew and underwent a reduced level of maintenance and repairs; and a "cold-stacked" rig was completely vacated and its doors welded shut. The offshore drilling industry rose and fell with oil prices . The early 1970s witnessed a spike in oil prices due to actions by the Organization of the Petroleum Exporting Countries (OPEC) that increased the supply of offshore rigs as drillers rushed to meet the increase in drilling demand. The industry later suffered an overcapacity of rigs when prices came back down during the mid-1970s. Such cycles continued with the oil price spike in 1979, its collapse in early 1986, and its recovery in 1987. Oil prices remained depressed during the 1990s until 1998, due to the economic slowdown in Asia, then started climbing in the early 2000s, which pushed utilization rates, and thereby day rates, to historical highs. The financial crisis that started in 2008 caused utilization rates and day rates to decline sharply again, as oil prices fell below $40 per barrel from their peak of $140 per barrel a year earlier. Players in the offshore drilling industry included both diversified drillers (e.g., Transocean, Seadrill, Ensco, Noble, Diamond, Rowan, and Atwood) and niche drillers (e.g., Ocean Rig). Larger, diversified drillers had fleets that included rigs of various types and typically had a broader geographic presence Chris Beckett: CEO and the First Employee With the initial purchase of a drillship under construction, Pacific Drilling was founded in 2006 as a subsidiary of Tanker Pacific, one of the largest tanker fleet owners in the world. After ordering a second rig in 2007, the company transferred its rigs to a joint venture with 50-50 ownership with Transocean. In 2008, Pacific Drilling expanded its activities beyond the joint venture to include four ultra-deepwater drillships, which had been constructed in South Korea at Samsung Heavy Industries, one of the three largest shipyards in the world. At the same time, Beckett was approached by Idan Ofer, an Israeli tycoon and the principal of Tanker Pacific. Ofer asked Beckett to be the company's first employee and to lead the development of Pacific Drilling as CEO. Beckett, a 2002 MBA graduate from Rice University in Texas, had previously been the head of corporate planning at Transocean, a strategy consultant at McKinsey, and the U.S. land seismic manager at Schlumberger. As the CEO of a start-up, Beckett challenged the industry's conventional wisdom: Back to 2004 and 2005, the industry was coming out of the downturn. . . . There was a belief in most of the estab-lished drillers that they would sit on what they had, and they would own the market. They would have a strong market position. There was an absolutely strong belief that nobody from outside could enter the industry. No clients would take the risk to work with a new driller without any proven record. Also, no lenders would take the risk to build several-hundredmillion-dollar assets with a new player. Despite huge challenges and personal risks, Beckett believed that the offshore drilling industry was changing and provided great opportunity for a start-up such as Pacific Drilling, which focused on premier technology and ultra-deepwater drilling. In particular, he noted: When we started Pacific Drilling, it was with the view that the assets that were being designed, built, and delivered into the market around 2005 and 2006 onwards were, for the first time in the industry, explicitly supposed to out-compete those of the previous generation by being more efficient: by reducing the time to drill a well. A lot of the incumbents missed that as a fundamental change, and they believed that if they didn't build rigs then nobody would build rigs and that they could continue with the technology that they had and control the market. What happens in most industries is that somebody comes in from the outside and delivers the technology to the market place and supersedes them by using disruptive technology. In November 2014, Beckett won the Ernst & Young (EY) Entrepreneur of the Year National Award in the Energy, Cleantech, and Natural Resources category for his leadership in growing the start-up company into a highly respected niche player in the offshore drilling market." Chris Beckett is the definition of a high-growth entrepreneur," said Mike Kacsmar, EY Entrepreneur of the Year Americas program director. "He's grown a world-class team based on that entrepreneurial spirit, and he encouraged his employees to make an impact by identifying novel approaches and seeing those ideas through to implementation." Firm Strategy Beckett strongly believed that the new generation of rigs would be fundamentally more efficient than the existing generation. Over time, the previous generation would become obsolete. Therefore, his vision of Pacific Drilling was that of a preferred, high-specification, floating-rig drilling contractor. The strategy was to use its consistent fleet of ultra-deepwater drillships, which were built by the top-of-the-class shipyard Samsung Heavy Industries, outfitted with the newest drilling packages by National Oilwell Varco, and managed by a highly experienced team to provide differentiated drilling ser-vices for its customers. This focus gave Pacific Drilling a strong competitive advantage over companies such as Transocean, which was more diversified and less focused. Beckett explained his vision of the company: The benefit that we had and that we foresaw for Pacific Drilling was to be focused on one asset class and not allow ourselves to be dragged into other asset classes. We could therefore optimize our maintenance systems, procurement, operating programs, and safety programs to deliver the best results with this one asset class In 2008, Beckett and his team prepared a thorough technical and safety-drilling manual, but the industry did not seem ready for what Pacific Drilling was offering. One potential client that Beckett pursued requested that the company rework its manual and prepare a new proposal. Saddled with debt and yet to book its first customer, Pacific Drilling considered the prospect of a compromise by revising the manual to align with the standard industry practices. However, Beckett and his team knew that the compromise would mean losing what they believed to be the company's key differentiator. So they instead held firm and asked the customer to reconsider. That potential client was Chevron, the first and ultimately most supportive customer throughout Pacific Drilling's growth, eventually contracting more than half of the company's drillships. As Chevron officials later admitted, the original manual that had been proposed was among the best they had ever seen. Beckett reflected on that challenging but rewarding situation: So we were able to build a relationship with Chevron based on relationships we had in previous companies. They knew the people they were dealing with, and they could get comfortable that those people would be committed to delivering the product and service quality. They could look at who the financial backers were and where we were building rigs, and all the associated pieces came to a comfort factor that we would do what we planned to do. The collaboration with Chevron also yielded access to a technological innovation: dualgradient drilling (DGD), a process that enabled an oil company to access reservoirs that had previously been considered "undrillable." Unlike conventional drilling that used only one drilling fluid, DGD employed two different fluids in the wellboreone in the drilling riser, with belowaverage density, and the other below the wellhead, with above-average density. Using DGD allowed the driller to overcome narrow pore pressure fracture gradient margins and to drill larger and deeper holes using fewer casing strings. It also helped the driller to better man-age downhole pressure as the drill bit moved through various types of geologies such as sand, shale, and tar DGD was technologically proven in the late 1990s; however, it had not yet been deployed on a commercial rig. While Chevron expected DGD to reduce the total cost to drill a well, the company had not yet worked with a drilling contractor to fully implement the technology. Pacific Drilling management was aware of the potential for DGD and embraced the possibilities to work with Chevron on developing processes and procedures. It took about six months before Chevron was comfortable that Pacific Drilling was the right partner to commercialize DGD, leading to Pacific Drilling's first drilling contract. Pacific Drilling's close relationship with Chevron was among the few relative constants in an often volatile and unpredictable market. Chevron had contracted four drillships with Pacific Drilling to date for operations in the Gulf of Mexico and Nigeria. The justification was simple: Pacific Drilling rigs were equipped with the capabilities that Chevron desired, and collaboration among the companies' employees, both onshore and offshore, had become seamless. After Chevron had signed the first contract, opportunities from other producers emerged for Pacific Drilling. Chevron's willingness to repeatedly work with the new company was an endorsement of the substantial value that Pacific Drilling could deliver to its customers. With a more established reputation, Pacific Drilling was able to broaden its customer base to include Total (one drillship in Nigeria) and Petrobras (one drillship in Brazil). By the end of 2014, the company had signed $2.7 billion in con-tracts. Working with Chevron to implement DGD also helped Pacific Drilling improve and refine its operating and management systems. Implementation of DGD technology demanded that Pacific Drilling work closely with Chevron on the development of operating procedures and employee training. At the time, Pacific Drilling operated two drillships that were DGD-capable (i.e., the Pacific Santa Ana and Pacific Sharav). Frdric Jacquemin, the director of the DGD program at Pacific Drilling at the time, noted that "with DGD, integrating a new technology is not only about equipment but it is also about defining new processes and training people Although the full deployment of DGD technology was still a work in progress, Pacific Drilling's close collaboration with Chevron led to a corporate emphasis on process innovations and technological leadership. Pacific Drilling continued to invest in technological innovation in an effort to keep its fleet as up-to-date as possible. For example, its newest rigs were equipped with automated drilling systems that reduced the number of personnel on the drilling floor, substantially improving drilling speed while also reducing safety risks. The company also equipped its rigs with a higher than usual amount of drilling mud storage and processing capability, which allowed the rig to move more quickly through the drill-ing process and also to be more self-sufficient: a particular advantage in remote operating locations, where the cost of support vessels was high. Pacific Drilling implemented SAP software on all of its drillships to better monitor daily rig operations and respond in real time to unforeseen problems. Traditionally, workers on a rig monitored their tasks using pen and paper and provided hard-copy reports to their supervisors. The SAP software helped to continually update information across functions during the drilling process, improving operational efficiency. The com-pany reduced the amount of downtime (non-operating time due to malfunctions) and ultimately improved safety, both of which increased profitability and benefit to customers. Pacific Drilling developed its own company management system using the highest standards .The company had the advantage of being able to implement this system from the beginning, whereas most of its peers had to adapt management systems to their legacy corporate practices. The company also emphasized consistency in its processes and procedures. For example, the company went through an exhaustive exercise to develop a standardized framework for making operations and maintenance decisions related to a key piece of equipment on its rigs. When Pacific Drilling showed the framework to its clients, it was told that no other driller had made this type of effort to better manage the equipment. Firm Culture and Organizational Structure Pacific Drilling had set clearly defined values that provided a framework for corporate decision-making and employee behaviour. The company's core principles were cleverly embodied using the mnemonic of its name PACIFIC. To build the company's legitimacy and credibility, Beckett recruited highly experienced experts with proven track records from a variety of professional backgrounds. In doing so, he aimed to find the best solutions and processes for the start-up company. Beckett also knew that in this industry, talent and connections were key. To attract star employees, he offered promotions from their current positions, as well as the opportunity of a lifetimehelping to build a new company. Beckett also promised less organizational hierarchy, and he kept his word by creating a leaner, flatter company. Pacific Drilling's organizational structure provided advantages through shorter communications paths, ease of collaboration, and efficient decision-making. For example, the marketing of rigs was traditionally done by a dedicated marketing team, which then handed over the contract to the operations department to run the rigs. However, the company encouraged its marketing and operations teams to work together with the client from the first stage of negotiation until the end of the drilling campaign, which resulted in greater consistency between what the marketing team promised and what was actually done, increasing the company's credibility and building stronger relationships with the client. Beckett also recognized that the company needed a culture of entrepreneurship and accountability.12 Employees were empowered to make suggestions and take ownership of processes and projects. Pacific Drilling focused on hiring employees who fit with the company's culture. Every potential employee was inter-viewed by three established employees. Through this process, the company selected recruits who were dedicated to performing above the average and who had enthusiasm for building a unique company. These qualities were reflected in a commitment the company made to its employees: "Pacific Drilling is committed to be the employer of choice in the offshore drilling industry and provide the tools and resources to enable its people to deliver consistently exceptional performance." Given the inherently dangerous nature of the industry, Beckett and his management team consciously strived to develop a culture of safety, even at the expense of stopping drilling operations. The company implemented the Stop Work Obligation, which dictated that it was the responsibility and duty of any individual to stop any work that the employee felt had an unacceptable level of risk or other concern. This directive went beyond the traditional Stop Work Authority that was an industry practice and gave employees the right to stop work but didn't require them to do so. In an industry where producers valued drillers' reputation for safety, Pacific Drilling had achieved multiple years without any lost-time incidents on several rigs. Its safety performance had been recognized with an "A" rating on the Chevron Contractor Health, Environment, and Safety Management program in the Gulf of Mexico and in Nigeria. Pacific Drilling was also the first drilling con-tractor to certify its safety and environmental management systems with the Center for Offshore Safety. Challenges Growth and Customer Base Challenges Beckett and his team had planned to expand the company's fleet from the current eight drillships to 12. The need to contract out these ships pushed the com-pany to broaden its customer base beyond relying on Chevron. In this industry, producers had usually been more likely to contract drillers with whom they had worked with before, in part because of the efficiency gained from a prior working relationship. As Pacific Drilling sought to broaden its customer base, there was some concern that the company was tied too closely to Chevron. The technology, processes, and culture that Pacific Drilling had developed were significantly influenced by the company's close collaboration with Chevron. There was a concern that efficiency would be lost, even if only temporarily, when changing to a different drilling partnership. Evidence had shown that a given producer demonstrated productivity gains in a partnership with one driller, resulting from having acquired "relationship-specific" capabilities over the time that the two companies had worked together. However, these gains often did not translate to the same level of productivity gains in part-nerships with new drillers,13 which seemed to explain Chevron's preference to continue to contract Pacific Drilling. Chevron's support was fundamental in Pacific Drilling's success as a new entrant, but its ability to grow as a more mature company was likely to be con-strained by that very same factor. Technology Challenges The technology advantage that Pacific Drilling had over competitors for deepwater drillships was also being challenged as other drillers upgraded their floater fleets. Competitors' rigs scheduled for delivery in 2016 and 2017 would have incremental technological advantages over Pacific Drilling's first rig Market Challenges The price of oil had been tumbling since mid-2014, while North American shale oil production had grown rap-idly and global energy demand had been weakening. For offshore drillers, existing contracts that had been nearing completion had been less likely to be extended. For available rigs, competition among drillers became intense as day rates were pushed down. Over the previous decade, the number of offshore rigs worldwide had increased from approximately 670 to 950. Although the offshore floating rig count increased from approximately 200 to 350 from 2004 to late 2014, average utilization rates also increased over the same time period, from around 77 per cent to 86 per cent. Historically, newer rigs competed down in their day rates, causing older rigs to be stacked, either permanently or until the market recovered. Recently, though, the industry seemed to have undergone a fundamental shift. Once demand began collapsing in 2014, there was an overcapacity of deepwater rigs, and drillers struggled to find new contracts for their available rigs. The current industry downturn and significant rig oversupply led to deepwater drillships and semis being cold-stacked for the first time in history. Pacific Drilling's immediate issue was to secure a contract on two of its drillships, Pacific Meltem and Pacific Mistral, that had been sitting idle. Because modern drillships had rarely been cold-stacked, keeping the crew on board was costly. The company was also concerned about two additional drillships: Pacific Khamsin, which would come off contract in late 2015, and Pacific Zonda, scheduled for delivery from the shipyard in late 2015. Strategic Choices Pacific Drilling had come to a critical juncture, and important decisions had to be made. As a more mature company, Pacific Drilling had been confronting a different competitive landscape. During the past year, very few new contracts had been awarded in the industry. Some of the company's peers were willing to bid significantly below market rates to win the few new jobs available. Looking forward, Pacific Drilling had a significant number of high-specification floating rigs available to be contracted. Although there had been weak demand for very high-specification rigs, there had also been relatively limited supply, which supported the company's contracting prospects. Overcoming challenges had been nothing new for Beckett. Yet, with the challenging market environ-ment and other constraints, Beckett made the follow-ing statement in a letter to employees: "Despite the weakening market, we expect further growth in 2015, but we must continue to execute well on our growth plans and secure new contracts to deliver on this expectation."

Please read the case and answer the following questions:

• Summary of the case as introduction of your paper
• Why offshore drilling?
• Offshore drilling typically used three types, what are the three types of offshore drilling?
• What was the reason for the fall of the company's stock in 2014? Was the fall of the company's stock related to the movement of Global Oil prices?
• Was collaboration with Chevron a wise move for the company?
• What were the challenges:
• Competition in the market including the supply of shale oil,
• Technological challenges, and
• Dealing with fluctuations in the international oil prices