Capital Investment in Drilling Operation
The article under critical analysis is the article written by Kaiser, M., & Snyder, B, 2013, Capital Investment and Operational Decision Making in the Offshore Drilling Industry. The Engineering Economist, Vol.58, pp.35-58. The authors of the article were aimed at establishing models that can be used by drilling contractors in making investment decisions in a new building or the use of rigs in the offshore drilling industry. Kaiser & Snyder (2013) were concerned with providing a solution to drilling contractors who are found to have a problem in making investment and operation decisions. Contractors need to make effective decisions when to increase new builds as well as decrease fleet capacity. In making such decisions, the capital intensity of the new building will be considered.
However, complications arise due to uncertainties that govern the conditions of the market. This dilemma in making investment and operation decisions is a gap that Kaiser & Snyder (2013) were aimed at filling. The authors were also aimed at filling a gap presented by Corts (2008) in relation to stacking that had not yet been examined in academic literature earlier.
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Critical Analysis
According to Karri (2000, p.93), drilling contractors face challenges when deciding when to expand capacity as well as making idling decisions. The reason is that these two aspects of decision-making have a huge as well as significant impact on the profitability of a firm. In coming up with a solution to the pressing issues, Kaiser & Snyder (2013) came up with two models that can be used by drilling contractors’ incapacity decision-making. The use of models in analyzing financial problems was recommended by Levisauskait (2010, p.9). Models are very effective items of decision-making when the investment problem allows for a modeling approach. They are relevant methods for research as well as decision-making. Clarke (2005, p.13) states that, in research methodology, models are essential instruments that researchers are recommended to use in describing the overall framework that is used in looking into reality. Models are important instruments that help a researcher in identifying the basic concepts of the phenomenon as well as describe the reality and the conditions by which it can be studied.
The two models include an investment model and a decision model. The investment model was based on building a jack-up rig that had an operational life of about twenty-five years speculatively without an initial contract (Kaiser & Snyder 2013, p.43). It was based on the net present value estimation. The decision model was built on stacking criteria. It was based on the assumption that firms usually experience cold-stack rigs at a time when the stacking costs are less than the net operating costs (p.53).
The study by Kaiser & Snyder (2013) was qualitative research. It was not based on quantifying any data relationships but on evaluating a scenario to get a solution for a specific problem. The authors of the article we’re working through established options are selecting the most optimal solution to the problem. Hancock, Ockleford & Windridge (2009, p.7) describe qualitative research as one that involves the development of explanations of social phenomena. It helps researchers understand how opinions are formed and how events that surround people affect them. Qualitative research is used when exploring the real-life context and sensitive topics that require flexibility.
The researchers of the article under analysis Kaiser & Snyder (2013) made use of the parameterization method to evaluate the models under different scenarios. The investment model used Parameterization to evaluate the model under the expected and optimistic scenario (p.47). Parameterization in the decision model was only done for a low-spec jack-up. The reason is that low-spec jack-ups are the cold-stacked rigs that are common. Its cost information is also available reliable and available from various contractors (p.54).
The results/findings of the two models were presented. The investment model results revealed that at break-even rates and utilization, the combinations of day rates as well as utilization yield a positive NVP when it’s above the indicated lines in the graph while a negative NPV is indicated when it is below the indicated lines in the graphs. There is an inverse relationship between the rate of utilization and the day rate at break even. An increase in the rate of utilization leads to a decrease in utilization rates at break even on the investment. The reason is that utilization rates that are higher usually translate to cash flows that are greater. Additionally, the increase in utilization rates decreases the difference between the expected as well as optimistic scenarios. When the utilization rates are high the difference in the two scenarios is also significant (p.47). The results concluded that so as to make a justification for investment, high utilization, as well as day rates, are needed.
The decision model results revealed the benefit of rig stacking for a period of one year at different day rates. The findings show that the negative values observed are an indication that stacking is a strategy that should be preferred by drilling contractors when making operation and investment decisions in the offshore drilling industry. Stacking is a strategy that should be preferred under any circumstance of the utilization rate even when the day rate is higher than the operating costs.
On the other hand, the results revealed that rig operation is preferred even when the day rate is less than the daily operating costs. In relation to time/duration, stacking was revealed not to be a preferred strategy when utilization is held constant even when the rig is still making money at $40,000/day. However, at $30,000/day, rig operation is the strategy that is preferred when the market conditions are adverse and expected for 500 days or less. The reason is that there are high fixed costs that are associated with stacking. When the expectation of the adverse market conditions is more than 500 days, then stacking was considered the best strategy that should be used.
Recommendations:
- When making investment decisions, drilling contractors must combine day rates and high utilization to make good investment decisions
- When making operation decisions, drilling contractors can use the stacking strategy in any circumstance of utilization rate
- They should prefer using rig operation under all circumstances even when the operating costs are higher than the day rates
- They should be careful not to use stacking as a strategy in relation to time.
Conclusion
The article written by Kaiser & Snyder (2013) is a good source of knowledge for drilling contractors in making investment and operation decisions. The content presented by the authors is valid and evidence-based. It is reliable information that is based on research with the use of models that prove their findings. The results of the article proved the validity of the research methods used. A model method is a valid tool of research that provides researchers with findings that are reliable. As per the authors, the best way to make investment and operation decisions for contractors in the offshore drilling industry is through high combinations of day rates as well as utilization. These are necessary for justifying new build investment. Additionally, idling capacity can be preferred as a good strategy even when the daily operating costs are higher than the daily revenue.
Reference list:
- https://citeseerx.ist.psu.edu/viewdoc/download?doi=10.1.1.1087.5015&rep=rep1&type=pdf
- https://www.bcci.bg/projects/latvia/pdf/8_IAPM_final.pdf
- https://www.scirp.org/(S(351jmbntvnsjt1aadkozje))/reference/referencespapers.aspx?referenceid=2672744
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