Diamond Offshore Drilling Inc (DO) 2006 Q3 法說會逐字稿

Good morning my name is Melissa and I'll be your conference operator today. At this time I would like to welcome everyone to the Diamond Offshore Drilling's third quarter 2006 results conference call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question-and-answer session. (OPERATOR INSTRUCTIONS) Thank you. It is now my pleasure to turn the floor over to your host. Les Van Dyke, Director of Investor Relations. Sir, you may begin your conference.

Morning and thank you for joining us. With me on the call today are Larry Dickerson, President and Chief Operating Officer, who's on the phone with us from Scotland; Gary Krenek, Vice President and Chief Financial Officer; and John Gabriel, Senior Vice President Contracts and Marketing. Before Larry begins his remarks, I should remind you that statements made during this conference call may constitute forward-looking statements and are inherently subject to a variety of risks and uncertainties that could cause results to differ materially from those projected. Forward-looking statements include, but are not limited to, discussions about future revenues and earnings, capital expenditures, industry conditions and competition, dates that drilling rigs will enter service as well as managements plans and objectives for the future. The discussion of the risk factors that could impact these areas and the Company's overall business and financial performance can be found in the Company's reports filed with the Securities and Exchange Commission. Given these concerns, investors and analysts should not place undue reliance on forward-looking statements. The Company expressly disclaims any obligation to release publicly any updates to any forward-looking statements to reflect any changes in the Company's expectations or any changes in events, conditions or circumstances on which any forward-looking statement is based. With that, I will turn the meeting over to Larry.

Good morning, everyone. I want to make some comments, obviously about the results that we achieved in the quarter. This was is the first quarter where we didn't achieve a quarter-over-quarter income growth really since 2004. And so obviously that's of concern. I think everybody deserves some commentary on that. Gary Krenek will go over, in a little bit greater detail following my comments, I'll also talk about the market and a couple other issues.

I think the key thing to focus on is the lack of top-line growth that we had in the quarter. From quarter-to-quarter, as long as we can keep that top line growing at a more rapid rate, then we have had cost growth, and that's been the case going back through 2004 as we bought rigs in the service, new rigs into foreign locales and incurred higher operating costs we've been able to manage that with increased revenues and so we've netted and increase quarter-over-quarter. We knew, going into this quarter, and I believe we gave guidance at the last quarterly conference call that we did not see, coming up in the fourth quarter, any significant contract rolls which would help move that line. Additionally, we knew that we were coming up on some surveys and I'll talk about surveys a little bit more. Surveys have cost and they deprive you of revenue. We had a little more surveys and more survey time than we thought we were going to have in the quarter, so that impacted us.

And then finally, we did have some rolls where contracts actually renewed at lower rates. And this is a result of previously we'd committed to a well, as we escalated through there, but then the sequencing may have changed where an operator wasn't quite ready and an operator that had a subsequent commitment, often at a very much higher day rate, brought his well forward. That happened in this quarter in particular on the Bounty and we've got a couple more of those scheduled out of our Gulf of Mexico fleet coming up in Q4 and on down the road. Fortunately all of those are fairly short duration and again, as long as we can continue to roll our rates to higher across the fleet then most of that stuff shouldn't even show up.

On the cost side, our costs -- operating costs for the quarter went from $200 million to $225 million, just a hair under that. So a little bit more than a 10%, 10, 11% growth rate in the quarter. And let me break that down. I think the first item I'd like to talk about is the hurricane mooring upgrades. That cost about $9 million in the quarter. And that consisted of we're renting some anchor chain in that the chain that we were purchasing did not arrive and it was not going to arrive in time for certain rigs so we went ahead and rented some anchor chain so we would have all the mooring kit available. We've since taken delivery of that, but some of that anchor chain is still actually deployed until we finish the well. That was about $1 million. We had some stand-by charter boats for the quarter that cost us about $6 million.

And then, on one of our rigs, the Ocean Voyager, we were never able, as we went through the quarter, to have sufficient bed space to get the welders on board that we needed to make the modifications. By and large, our modifications were made without down time occurring throughout the fleet and so that was very significant for us. But the Ocean Voyager, we finally, just, realizing that we needed to make our deadline, we were shooting for mid-August, we took that rig out of service and that cost us about $2 million. So all that adds up to about $9 million. Some of those costs will continue on into the fourth quarter. We still have some boat costs going on past that point. But the Voyager will drop out. And then as we look forward, most of that was prep materials that we had for this particular quarter. And really, what we're looking at all of that is if you carry an umbrella, it won't rain because we had no hurricanes in this season, so it was very quiet for us. But going into next year, we will be relying on operator boats, so we won't have the boat cost, and most of those costs will diminish quite significantly going into next year. Now, obviously if we have a hurricane, then we could have down time, we could have repair cost, we could have all kind of things that relate to that, but on an on going prep basis, we won't have that.

Our survey cost cost us about $12 to $13 million. We had included in there, we moved the Summit, which is a jack-up forward, from quarter four and then we had some other material -- other activities in the North Sea. With the Princess we had, Yatzy was down. All of these are costs over and above that we thought we were going to incur. Either the surveys lasted longer or in case of the Summit and Whittington, we didn't have them planned at all during that quarter. Surveys will decrease we believe in Q4 and Q1 of next year. But we -- 2007 will be a high survey year and so we'll pick up some of those surveys again starting in Q2 and Q3 of next year is our current projection on when would begin to realize those.

And then finally, we had higher operating cost in the quarter and those things obviously will continue. I think they're exposed to everyone. That was about $3 million in there. We cited, I think in our press release, the cost of boats to get rigs in and out of the shipyard. Some of that's here rather than in the additional survey cost. Boats are chartered on the spot basis. We had an example in the North Sea where we came to an arrangement where our customer agreed that they would pick up the boats in and we would pick up the boats out as just a contractual settlement. In our end of it, the boats out were twice as expensive as the boats in as that market has moved. So that's some of the exposure that we had.

Then there were some other costs, probably about another $3 million in there such as the Whittington. The Whittington was working in Mexico. It was cancelled on us. So without an ability to do much advance planning we had to mobilize that unit back to the Gulf which cost us almost $2 million. And then we went into immediate survey. And there were some additional costs all in that process that we wouldn't have incurred had we been able to plan for the contract termination as it was scheduled. So Gary will give some additional costs on that and emphasize what are the numbers that we see going forward and what are the numbers that are one-time costs in there in this particular quarter.

Secondly, I would like to comment on some personnel changes. Obviously, David Williams have been on our conference call for -- going back many years. David was Executive Vice President in charge of Marketing and Operations. David left us, I think as everyone knows, for a position at Noble. Subsequent to that, we lost our head of operations, Rodney Eads that went to Pride. And I think this is a testament on how much good people are valued within the industry. Both these guys left for promotions and we expect they'll do a good job for the new companies. We are comfortable with replacements that we have in-house. A lot of David's work has moved down to marketing and to some other areas. I'm covering some of that. So we pretty much split that -- those assignments up. We're joined by John Gabriel, as indicated who's head of the marketing group and will be making the market commentary that David ordinarily would do.

Rodney Eads was replaced by Lyndol Dew, who's now in charge of our worldwide operations. Lyndol's been with us since the early 80s. He comes, has a bachelor's degree from Florida State and a masters from Tulane in Petroleum Engineering, served in the U.S. Navy, has worked overseas, has worked as a part of his training program as a tool pusher on rigs, ran rigs in the North Sea and then ran our entire Asia division before coming over here to assume the Gulf of Mexico. So we're very comfortable with that. And I think both David and Rodney would have told you that he was one of their key guys that they relied upon. So we're comfortable with that.

On the market front, I think John will obviously answer your questions and provide some further detail, but we're -- we continue to see very strong market and high demand around the globe, particularly for floaters. And I think most of our high spec units are committed well into the future, so the action that we're seeing on second and third generation units and we're seeing high levels of demand there. We see high demand internationally for jack-ups. During the year we've taken a jack-up out of the Gulf to Tunisia. It now has a subsequent follow-on committment in Egypt, which takes it out pretty far. And then the Ocean Nugget mobilized during the quarter down to Mexico where it started its particular job down there for term. And I think, in retrospect, those are obviously wise moves. We made them to diversify our fleet, made them to seek out term because the one area that we see some weakness is the U.S. Gulf of Mexico. And in fact, today we have a rig idle in the U.S. Gulf of Mexico. However, the rest of our rigs are working and are still working at decent rates. So we'll -- sure we'll take some questions on that particular area. So with that, let me turn it over to Gary Krenek who will provide you a little more guidance on some of the cost issues for the quarter.

Thanks, Larry. Well since Larry went over third quarter results in some detail I'm not going to repeat that in my opening remarks, but as Larry indicated we'll talk more about what we see going forward. If anyone needs further clarification about third quarter numbers, I'd be happy to address that during the Q-and-A session.

First a look at the -- at our rig operating costs. Looking to Q4 with respect to reductions in rig operating cost, we actually spent about $15 million on surveys and related cost in Q3. And as Larry said, we expect that to come down. That should decrease to somewhere between $10 to $12 million in Q4 as the number rigs -- rig days for survey and maintenance down time decreases slightly. Q3 also included, as Larry said, $2 million to mobe the Whittington from Mexico to the U.S. So when we don't reoccur -- that does not reoccur in Q4. that will have an impact on costs going down. And then the semi-submersible Lexington is currently mobing to its job offshore Egypt and expect to arrive on December 1st. The net effect of the 60 days of mobing and the deferring of those costs and 30 days of working in Egypt should have a net effect of reducing Q4 costs by about about $1 million. And finally, mobe amortization cost on various previous mobes that have been incurred and are being amortized are scheduled to come down about $1 million next quarter.

Adding to the fourth quarter cost will be the cost of working the Nugget in Mexico which began on October 1. The rig spent most of the third quarter preparing for its P-Mex contract and these working costs should add $1.5 to $2 million to Q4. We also have incurred an additional $1 to $1.5 million for equipment repairs on Ocean Confidence and the Baroness in early October, which these rigs were down some 15 and 7 days respectively. Both of these rigs are repaired and back on the payroll today. And finally, at the beginning of the year, we said that due to the budgeting process and long lead times involved in receiving equipment, that major projects that are treated as current expense tend to bunch up in the third and fourth quarters. That statement held true in the third quarter and we could see project expense as much as an additional $4 to $8 million higher in fourth quarter than it was in third quarter.

With respect to the mooring, Larry talked about that in quite a bit of detail. As he said, we had about $9 million worth of costs in Q3. We expect to see that remain close to the same in Q4. Most of these costs are related to the two anchor handling boats that we have on charter. And as we complete those charters, there are some costs that will be incurred to end those. So we see those costs being consistent quarter-over-quarter. As Larry indicated going into the first quarter of 2007, however, we see -- expect to see those costs come down significantly, probably somewhere in the $2 to $2.5 million range for Q1 of 07. These are specific items that we can point to that will effect the fourth quarter. Operating cost, as Larry said, we were also affected by general industry inflation and need to take that into account.

Turning to expected down time. In addition to the repair time that I mentioned earlier as we stated last quarter, both the Whittington the Saratoga will be down for their surveys and steel replacement work for the entire fourth quarter. We also estimate the Summit, which began its survey in the third quarter, will be down an additional 75 days in Q4 and the Heritage 45 days down for its survey in the fourth quarter. The Ocean Yatzy was done an additional 10 days in October as it completed its thruster change out which was begun in Q3. And in addition to the Lexington mobe time, the Ocean Epoch will spend 21 days mobing from Malaysia to 400-day term contract in Australia.

Looking at other line items on the income statement, you can expect to see a slight increase in depreciation expense in Q4, perhaps $2 million or so to account for our continued capital expenditure program. G&A expense has been consistent at approximately $10 million for the past four quarters. We expect to see a slight increase in that, maybe 5% to 7% in Q4 to account for some compensation increases. And finally, the effective tax rate is expected to remain somewhere between 28% and 29%. The tax rate will slightly lower in the third quarter and that was due to a provision -- the book adjustment, as we had -- as we filed some tax returns. We got about a $2, $2.5 million credit which assisted in driving the tax rate a little bit below that 28% this past quarter.

Looking into 2007, as we previously reported, we have 11 rigs scheduled for surveys during the year and, as Larry said, we expect to see those bunched up probably in the second and third quarter. We're in our budget process right now, so we can't tell you exactly when those will occur. But if you continue to watch our rig status report, we'll update it as information becomes available. Until we complete our budget process and give you better information, you need to assume that semi-submersibles will be down on an average from 40 to 45 days and jack-ups approximately 20 days. The one exception, as we stated in our last conference call is Ocean Yorktown which will be down for approximately 150 days for its steel renewal work. Also as previously reported, the Whittington and the Saratoga will see some down in the first part of 2007 as they complete their steel renewals that were begun in actually in the third quarter. The Whittington is scheduled to complete its work by the end of January and the Saratoga by mid-February. And with that I'll turn it back over to Larry.

Okay. I think we're ready now for questions.

(OPERATOR INSTRUCTIONS) Your first question is coming from Waqar Syed with Petrie Parkman.

Hi. I have a question on Gulf of Mexico jack-up market. What do you see there? When do you expect any recovery there and what are the chances of your one warm stacked rig, how soon do you think it could go back to work?

Let me answer that in general and I'll let John Gabriel fill in if he's got some additional information. I think the market here, we've all been through what are some of the negative factors in this market, gas prices, hurricane overhang and then these rigs that are working short-term jobs before departing to the Middle East. But I think you've got to look at a great, potential cure there and that's the departure of rigs. After these rigs leave sometime going into Q1 '07 or in fourth quarter, primarily I guess they're rowing in GSF rigs, that's -- be a huge decrease in the available number of rigs and at really a -- I think you'd be hard pressed to find as few active rigs left in the U.S. Gulf of Mexico as there'll be after that. I think that's got everything that could possibly happen on the supply side to potentially have a recovery. So I think our rig going back to work will somewhat depend upon that and the activity levels in the interim. We're not the only company with a rig idle. What we haven't done is just aggressively seek any type of job and try to cut rates to bring forth jobs. We think that the supply is going to get in balance and that there will be demand for that rig and we'll be able to put it to work. John, you have anything else to say on that?

Well the only thing I would add to that, Larry, is that within the last week or so, we are seeing increased inquiry levels, particularly with respect to start dates for jack-ups in the December '06 to January '07 timeframe and as expected this coincides with the end of hurricane season, the dozen or so scheduled rig departures and the availability of '07 budget money.

Gary, I have a question on the cost side. In the section of press release where you break down the operating costs for different segments, different S classes, you have a line for others where it is $10.1 million charge?

Right.

What is that?

Primarily that is the charter fee on these two anchor handling boats that we have, that we talked about for the mooring and the hurricane preparedness. $6 million of it is that. We had a $7 million increase, another million was repair on some spare equipment.

Okay.

So the $6 million of anchor handling, we had a total of 9, another $3 million were of hurricane preparedness type items are spread through the other cost categories, through the rig categories.

Okay. And just one last question, for you, Larry. You mentioned you've had some senior level departures, management departures. What steps are you going to be taking to stem the flow of senior management from Diamond to other companies or do you think this is normal attrition is not unusual?

Well, I think in this particular market, demand is high. Both people were able to leave for promotions. We have made some compensation adjustments, but I think with demand where it is that there's going to be some losses likely from all companies.

Okay. Thank you very much.

Thank you. Your next question is coming from Ian Macpherson with Simmons and Company.

Yes, good morning.

Morning.

I'm wondering if I could get a little color on a couple of your perspective contract rollovers in the mid-water. The Guardian comes up contract I believe at the end of March. I gather there might be some near term chop in that market with one or more of the major operators paring back their programs for '07. Is there any credence to that? Would you expect the Guardian to go longer term or maybe in the spot market for some of '07?

Well, we don't have a commitment yet at the Guardian. We've been in discussions with several people. It's really too early to say which will come about. We could work it spot because there's some potential demand for the rig that it's capabilities might get a larger premium in the spot market versus term. So it's just too early to say. Certainly, we -- I guess we've seen a couple operators in the North Sea not jump up for this particular rig and so that could be some demand realignment in that market.

Okay, then shifting back to the Gulf of Mexico, the Voyager is available in, I guess, in April? I'm sorry, that's, mid-year, rather the New Era earlier in the year, what's the demand shaping up like in the Gulf of Mexico? Are you sensing kind of more of the same with what we've seen with recent fixtures? Or a little better or a little worse?

I'll let John respond on this one.

I think the demand in the Gulf of Mexico is going to be consistent. I think we're continuing to see opportunities. I think the real bright spot is the fact that we're seeing competing opportunities globally for these mid-water rigs. I would -- supply us tight worldwide and I think we see opportunities for anywhere from let's say 5 to 6 to as many as 8 to 10 mid-water rigs outside of the Gulf of Mexico. So the pressure's going to come from both directions.

How does the unexpected cancellation of the Whittington contract change your view towards responding with PEMEX's incremental rig demand? Is that -- are you approaching that in the same way you would have a year ago? Or are you a little more cautious with them as a customer at this point?

Well I had a meeting in Mexico City with PEMEX on this particular issue and they emphasized that their cancellations of offshore contracts, had been -- and this was the case in the Whittington, in the final portions of the contract where they just weren't able to match-up a job to allocated budget funds within that particular contract award. In the Whittington's case, I guess we had, John, I don't know, 60, 70 days left?

Yes, it was about that, Larry.

And they just weren't able to match a job for it where we could work that out. So that was their justification. And they counted it as a very low percentage of rigs that they cancelled in that area. Of course for us, it was 25% of our four rigs. One of them got cancelled, but it was cancelled at the end. It was a surprise to us because you have a very short notice to get your rig out and not enough time to plan it. So we've had discussions with them. This is a contra -- a legal right that they have. So it's not going to be removed, but we've tried to see if we can't have more notice on that. But that is a risk that you have down in Mexico. It hasn't deterred us, though, in fact we put a jack-up down there and we will -- we have bid some floaters, including the Voyager, down into Mexico. And our viewpoint is, we don't want to take our entire fleet and exposure it there, but our things like the jack-ups that are working in the U.S. Gulf, well to well, I don't think you're necessarily disadvantaged by getting some term with a theoretical cancellation provision. You're back in the position that you would have been well to well. That may apply on some of our floaters as well.

Sure, okay. Thank you.

Thank you. Your next question is coming from Doug Becker with Banc of America Securities.

Thanks. Larry just want to get an update on how much work is left to do in the mooring upgrades. Or, just in other words, how many rigs have been upgraded and are complete? How many does some work still need to be done on?

We are done on our entire fleet in the Gulf of Mexico. Now we had the Whittington come out of Mexico and we haven't added anything to that. So our goal is to place the Whittington outside of the U.S. Gulf of Mexico. And one thing I didn't emphasize. We talked to the operators of our equipment and generally struck details where we had increases in day rates that will help offset these costs. But that increase in day rates shows up on the revenue line and doesn't really -- accounting doesn't really allow you to net them. So we have some coverage on that. So we are done, we believe, with this unless we got a really nice job for the Whittington in the U.S. Gulf of Mexico and we had to deal with it. I think some of the cost that we allocated was rental chain that we just needed to have and we were concerned about availability of boats and we didn't quite know, because we were -- we committed NNS and we committed to customer base that we would be prepared for this hurricane season. It was in the middle, we knew we couldn't make it, and we knew we'd have logistic problems, but it was done in August, largely, which is the heart of the difficult part of the season. So we accomplished that, but our boat charters and our boat commitments, we've since found that we can generally utilize the operators boats for that. So, that's some of the cost that will continue forward into the fourth quarter as we disengage those commitments and recharter the boats out.

That makes sense. And then Gary, just to clarify the cost guidance, if I sum up the individual items that you mentioned, it sounds like on an aggregate basis, costs will be up just maybe or flat to maybe up just a little in the fourth quarter? Is that reasonable?

I think you did the math pretty good.

Okay. And I guess I'll direct the next question to John. We know Petrobras is looking for some incremental rigs. Just kind of hoping to get a little more color on what type of rigs they're actually looking for and what type of discount should we be expecting for term contracts with Petrobras?

The incremental fleet they're looking for is generally going to be, I would characterize it as second generation primarily though there may be some third generation type floaters involved and one of them was a 15K requirement, but it's generally in the 500 to 700 meter water depth range. The term that was being discussed was in the oh, 4 to 5 year range. What kind of, I mean, we would certainly discount to short-term markets for term. I would hate to just throw a number or a percentage out here, but we will do that. We will discount to market or short-term market for the term that's down there and we will recognize the duration of that term.

I think you can look at Pride made commitments and took some of that term. You can look at the discounts that they gave versus what our current commitments are, either in the U.S. Gulf of Mexico or what bid rates are in Mexico and what we're able to -- we took the Lexington out of the U.S. Gulf for three years in Egypt at 285. So I mean you can measure that sort of difference and as John indicated we've been with Petrobras for a long time. We intend to service their needs, but I just -- I don't think it's in our interest to take a significant portion of our fleet and take a discount to current rates.

That's helpful. One last quick one, some of the operators have mentioned how much of their fleet has cost escalators. Do you have some type of number to kind of help us quantify that?

Yes, we did a calculation on that the previous quarter when I think Transocean said their number and I believe that number, Gary, was 60%.

It was in the 50% to 60% range.

And -- but I think everyone should understand that those are not 100% cost pass throughs. They generally covered labor. It's difficult to cover other oilfield costs. You can use a general purpose index. We find that index is not always spot on and in materials, there's both a quantity issue, quantity of repair as well as a cost. So you don't always get that. And then there's different triggering dates. Some of them provide every six months. So although you may have 60% of your contracts containing some sort of cost escalator, the effectiveness of those cost escalators, I would say in general, do not -- they cover 50% to 60% of your costs and then not always immediately.

Understood. Thank you very much.

Thank you. Your next question is coming from Arun Jayaram with Credit Suisse.

Good morning. Larry, I was wondering if you could comment or elaborate a little bit more on some of the pros and cons of working in Mexico. And maybe you could talk about operating cost and tax differences relative to the U.S. Gulf of Mexico?

Well, I'll let Gary comment on some of the financial impacts and John, please augment what I say. Mexico has taken a huge number of rigs, and I think it just shows you what can happen when one of these areas gets really serious. We're seeing the Middle East with a huge demand for rigs, India, Australia has been ramping up, so there's huge potential. Not every market I think's going to step up and take the number of rigs that Mexico has, but I think that -- just that marginal demand is huge in our industry. The working down in Mexico, it requires some adjustment to the way they do business.

I mean, I just, as an example, our guys in the oilfield, everybody shows up at 6:00 in the morning and that's the way they work. Well, PEMEX in Mexican office hours start 10, 11:00 in the midday and there's a siesta in the middle and they can calling meetings at 9 or 10:00 at night. So, I mean our guys have to make that adjustments. The administrative adjustments, we have we've got that going now, where we think we're very efficient there on that end of it. We've had issues on making sure we can get crews changed in and out. I think we've conquered all that. We are quite comfortable working there. There is increased cost for various factors that you've got there and the biggest single thing is this cancellation provision that exists by law and the fact that that hangs over your head. And for us, that means that we are less likely to take a rig that has term opportunities in some other market and commit it to go down in Mexico. But otherwise, having developed a infrastructure that can easily support four rigs, I don't say easily, because it's a lot of work. There's a lot of paperwork down there. But, having achieved that, we don't want to lose that. And we think that's a big growing market and we want to be a part of if and so we thing balanced over the long-term that the cancellation in that particular market is something that we can adjust to and live with and I think we intend to have our presence down there, which is shown by the fact that we just took a jack-up down there.

With respect to the cost earned , it cost us $10,000 a day, maybe a little bit more to operate a second generation semi-submersible in Mexico as opposed to the Gulf of Mexico. So you have a little bit more and that's related to travel cost and some burden in country taxes on our X batch down there for the people that we do bring down. As far as the tax rate there, it's slightly lower than the U.S. and so we get a slight break on that. But with -- for us, having three rigs currently down there, actually four with the Nugget now, it lowers our tax rate by fractions of a percent.

Just as a reminder, you're not their boat charter, you're fulling crewed is that correct?

That's correct.

And Larry, just to elaborate a little bit more on Mexico, can you give us some color on what you're seeing in terms of the bids. I know that they're looking for a lot of rigs, but how optimistic are you about what the rate structure will look on the semis and some of the premium jack-ups down there?

Well as you known, we went down there with our semis in 2003 in the face of a weak market and so we've been working quite a bit below market. That's -- was one of the perplexing things about the early cancellation of the Whittington. It was working at a rate -- [INAUDIBLE - two people talking]

Not in the 50s, right?

would earn in the U.S. What it would rebid at. So that's kind of strange. We've seen from the renewals that Mexico understands the rates. It's a very sophisticated oil company up at the top. They certainly understand that and they know what they need to pay. I'm very optimistic on their plans. I mean, you have many of the same geological structures that you've got in the northern U.S. Gulf are believed to be present down in Mexico. The deepest we've drilled on the Ocean Worker, the deepest well they've ever drilled in Mexico, and it was a little over 3,300 feet, if I recall right, John?

Yes, that's about right.

And -- so there's clearly great deepwater potential and there's a lot of work in the 1,000, 2,000, 3,000 foot range that they can deal with. They're talking and they have approved budgets to make absolutely huge capital expenditures to try to deal with the issue that underlying all of this which is the decline in the long-standing PEMEX fields and try to replace them. It's a great future, you just -- you have to learn to deal with the way they do business, but it's something that we will participate in although it's not going to take a portion of our fleet that exposes the Company to too much risk on cancellation side.

That's very helpful. Thank you.

Thank you. Your next question is coming from Pierre Conner of Capital One Suncoast.

Good morning, everybody.

Morning.

Maybe this question really for John. I'd love for you, if you could, without giving away competitive strategies, expand a little bit on where you see that mid-water demand outside the Gulf. You mentioned sort of a 5 to 6 or maybe even more. Would -- could you share with us a little bit of where you see that and timing of course?

I think the previous discussion about Mexico, we see at least in PEMEX's long-range plans, an additional two mid-water units. We see in Brazil, at least from our initial conversations, anywhere from 2 to 5 additional units. I believe they may have contracted one of them already based on the demand that we're seeing in West Africa. I would add two units to that incremental demand. I think one of the real bright spots for rigs across the board is the Mediterranean. We've seen a lot of activity ramp up in Egypt. And now that the sanctions are lifted in Libya, we've got a lot of interest in Libya. I think those two in particular in the Mediterranean are going to be some interesting areas going forward.

Helpful for the perspective, thanks. And then, I'll go back one more time to the Gulf of Mexico jack-up market to give a try to put you on the spot. So you had the Summit available, but it looks like mostly, I suppose the Titan with some October availability, mostly carries you through, and can you -- when do you think we'll begin to see -- I know you're beginning to discuss contracts in December and January, so, first, is the rates higher? And when do we begin to see rates structure begin to recover?

Well, I think for -- if we were looking at a start date in November, they could put a rig to work immediately in a -- on a short-term basis. I think we'd be looking at rate structures similar to what you're seeing recent commitmentwise, but if someone comes to us in December, or at any point for a December, January start for term work, we're going to be very aggressive rate-wise in terms of trying to, you know, to head back to pre-hurricane season levels next year. I don't think we'll get there overnight. But the incremental demand for jack-ups leaving the Gulf of Mexico is going to put added pressure on this fleet and I think we'll see a recovery in the first quarter. It's hard to put a handle right now on how quickly and where that rate structure will go. It's obviously going to be driven a little by gas prices as well. But as soon as these rigs start going back to work with the departures, the supply that remains here is going to tighten up very quickly and we'll see rates respond to it accordingly.

Thanks gentlemen.

Thank you. Your next question is coming from Robin Shoemaker with Bear Stearns.

Yes, good morning. I wanted to ask -- focusing again on supply demand dynamics in the Gulf of Mexico. There's several new builds coming out in '07 from Keppel's Brownsville yard, including yours I think at the end of the year, but several others in addition to that and a couple from LeTourneau, and does that increment of supply in your view effect the Gulf of Mexico U.S. market? Or, and/or on the Mexico side, I had assumed that they would pursue work in that market, but I heard things recently that lead me to believe they will not be marketed in the U.S. Gulf of Mexico. Just wondered if on the supply side, in addition to departures you've mentioned early '07, the additions to supply are of a concern?

Well, I think those questions need to be put to Scorpion Drilling who own most of the rigs coming out of Keppel Sales. Ours come out late in the year. And I -- and the factors for a smaller company like that would be whether or not they judge that they can afford the insurance premiums that are necessary right now for hurricanes. And we don't know what the renewal will be like next year. As you know, we opted to go self insured on hurricane provisions. But a larger fleet, a larger company can do that. I don't know that that would be something that they could face and also the cancellation provision. If we look at it on our portfolio basis, we can take some of that risk in our fleet and they may have a different perspective. So I think that the key question is what happens to Scorpion, are they going to go international or are they going to go here. Yes, there are a lot of jack-ups coming out. I don't really think they're significant numbers until you get into '08 and then I don't know what the impact will be here in the U.S. Gulf.

Yes. Okay, just one unrelated question. Gary, you mentioned just general industry inflation pressures on costs, but I was wondering if you'd be willing to offer a kind of a ballpark as to what you believe that general inflationary, not tied to specific issues or projects, but what that level is today? Or prospectively for '07?

For '07, we're seeing the same thing everybody else is seeing and I've seen that range anywhere from 10% to 20%. I personally think it's going to be in the 12% to 15% range going into '07, but somewhere within the range of everybody else's in the industry's talking about.

Yeah, okay. All right. Thank you

Thank you. Your next question is coming from Judd Bailey with Jefferies and Company.

Good morning, couple of questions. First, wanted to follow-up on the question on the cost escalators in your rig fleet. Did you say 50% of entire fleet or was that 50% -- 50% to 60% of your -- just your international fleet?

That's the entire fleet.

Okay. And also wanted to circle back on incremental demand for some of the mid-water floaters. You discussed a few of the markets. What about in India and Asia? Are you seeing any incremental requirements there and if so are they of the nature that you would get some sort of term contracts maybe one to three years?

John, you want to handle the market question?

Well, with respect to-- with respect to Austral-Asia, that's how we'd characterize that area. We feel like the floater supply demand is going to be evenly balanced through '08. There is potentially a need for another rig in Australia on a short-term basis to deal with a consortium of smaller companies needing get some wells drilled. But we do see deepwater demand in India -- India potentially China, and with this new acreage released in New Zealand, probably -- certainly creating an opportunity for additional deepwater floaters in that part of the world.

And if I could, you mentioned West Africa and the Mediterranean earlier and the increment requirements there, those -- are you looking at term types of contracts there as well, or is that more shorter term needs?

I think the shortest thing that we have looked at on a serious basis is a year in that it really -- it really doesn't create a competitive advantage for us or of something an appealing situation for us beyond what we're looking at in the Gulf of Mexico. But some of this incremental demand is at least it's preliminary stages being discussed in the two-year range. And that certainly has some appeal to us.

Great. Thank you.

Thank you. Your next question is coming from Zack Schreiber with Duquesne Capital.

Yes, hi, it's Zack Schreiber from Duquesne Capital. Hello?

Hey Zack.

Hi, how are you? Just a quick question, just a a follow-up on the percentage of contracts that have cost escalations in it . That 50% to 60% of your contract, was that based on the number of contracts or was that based on the dollar value of the contracts? And hence, represents the effective coverage, obviously with the timing lags and the triggers and the basis risks relative to whether or not your costs are inflating at the same rate as the index and so forth. But, i.e., is that 50% to 60% for the number of contracts, or is it really for the sort of dollar value of your contract coverage?

I believe we may have to get back to you on that, but I believe that -- it doesn't make sense to do it except on a dollar value of coverage. So that was the -- of the dollars of contracts that was a percentage of dollars of the gross revenue which had some sort of cost protection in them and -- the cost protection is based upon the cost though, not necessarily the dollars. And as I indicated, those are not 100% protection clauses. They're just -- there's something and they're primarily it functions for labor.

Okay, and uh --

If I could add. Many of our contracts have that, the contracts that don't have cost escalators would be our contracts with -- in Brazil and Mexico don't. In addition, any contracts that are shorter term duration, such as our jack-up work and some mid-water floaters in the Gulf of Mexico. So most of the contracts that are longer term and excluding those that I just spoke, do have some type of cost escalation. Again as Larry said, that doesn't mean it covers everything.

In terms of these index -- indices, which indices do you guys use? Is there some agreed upon indices that people -- index people use for these contracts?

Most of it is just a labor pass through. I think we only have a couple of our contracts that make reference to an index. And John puts those in the contracts and it's a, I forget how it's characterized.

Typically if we're talking about an escalation index, there's a -- I don't know whether it's producers price index or consumer price index, but the reference point is, I believe 11-9102 in that published book.

But it's supposed to be some oil field supply type thing.

Oil field machinery and supply category that's part of the, I guess U.S. Department of something publication.

Okay. Thanks so much

Thank you. We have time for one further question. Our last question is coming from David Smith with JP Morgan.

Good morning.

Morning.

I know that everyone is looking at consulting the speculative new build fleet, but with the group of -- within the group of potential buyers, Stone Contractors are going to be more disciplined at the point in capital than others, I'm wondering how you evaluate the opportunities and economics of buying speculative, deporter rigs, and how flexible your parameters are given the competition for these rigs?

That's a difficult question to answer.

Sure. Especially for the last one.

Yes, I understand. We are, -- I think we have a history of disciplined capital deployment and -- but we deployed capital in different manners in different markets. We bought rigs in 2003 when there were very few buyers. We -- our upgrades have largely been -- 100% have been speculative in this cycle. We would keep one in -- make a commitment to do it, and then once we got contractor, we'd go in and with another one. So that's not always everybody else's ways to do it. We think that that would have advantage. If we're talking about acquiring some of these new builds or becoming involved in them, it's just -- I can't tell you how that would approach. Because it all depends upon the market and how we see various things. All I can tell you is that there would be some discipline behind that and we wouldn't just go in and just see how much we could bid something up.

Okay, I appreciate that.

And Larry, if I could break in. As we said, that was time for only the last question, however, we have some late breaking news that Larry's not even aware of. I'm going to let John Gabriel talk to it.

We had, last month bid the Ocean Voyager and the Ocean New Era to Mexico. Basically these rigs replace the Worker, and the Yorktown in the PEMEX -- in the PEMEX fleet. And we have just been given official notice that these contracts have been awarded. The Voyager contract is for 2.5 years in the 330s and the New Era contract is for 2.5 years in the 260s. And the commencement of those contracts is mid '07.

That's fabulous news. I knew that was outstanding. And we took a question earlier about the New Era and the Voyager's availability. We knew we were low bidder, and that was sort of a public data but we just -- we were hesitant to make a commitment knowing that we were due within the next day or so to hear an announcement on that. So I guess that's an award --= a reward for those of us who act -- those of our listeners who actually stuck with us for the entire hour. So I appreciate that.

That news actually came in in the last five minutes.

We're going to wrap it up. If anybody has a question on those contracts, I guess we could take one.

I don't believe we have anything at this time, Larry.

Okay, good enough. We'll talk to everybody next quarter.

Thank you all for joining us

Thank you. This concludes today's Diamond Offshore Drilling's conference call. You may not disconnect