Transocean Ltd (RIG) 2006 Q2 法說會逐字稿

Good day, everyone, and welcome to the second quarter 2006 earnings release conference call for the Transocean. [OPERATOR INSTRUCTIONS]

And now for opening remarks and introductions I would like to turn the call over to Mr. Jeff Chastain. Please go ahead, sir.

Thank you, Dixie and good morning and welcome to our review of the financial results for the second quarter of 2006. A copy of the press release covering our financial results along with the supporting statements and schedules is posted on the Company's website at deepwater.com. Also a copy of the Company's fleet status update report covering the contract status of the Transocean fleet, that was issued on July 31 and can also be found on the Company's website. In addition to highlighting contract signings since the last fleet update, the report includes currently expected schedule of mobilization and contract preparation and shipyard or project out-of-service days by rig through 2008. The next fleet status update is expected to be issued on August 31. Information is also available on the analyst meeting to be hosted by Transocean management on the morning of Monday, August 7th in New York City. Those of you wishing to attend at the meeting should notify the Company by close of business tomorrow.

Participating in this morning's call are the following Transocean senior managers: Bob Long, President and Chief Executive Officer, Jean Cahuzac, Executive Vice President Chief Operating Officer, Greg Cauthen, Senior Vice President and Chief Financial Officer, Rob Saltiel, Senior Vice President of marketing and planning, and David Tonnell, Vice President and Controller. Before I turn the call over to Bob Long remember that, during the course of this conference call, participants may make certain forward-looking statements regarding various matters relating to our business & Company that are not historical facts, including future financial performance, operating results, and the prospects for the contract drilling business.

As you know, it is 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 and operational and other risks, which are described in the Company's most recent Form 10-K and other files with the U.S. Securities and Exchange Commission. Should one or more of these risks or uncertainties materialize or underlining assumptions prove incorrect, actual results may vary materially from those indicated. Also please note that we may use various numerical measures in the call today which are or may be considered non-GAAP financial measures under regulation G. You will find the required supplemental financial disclosures for these measures, including the most directly comparable GAAP measure and an associated reconciliation, on our website and for your convenience, non-GAAP financial measures and reconciliation tables are included with today's press release.

That concludes the preliminary details of this call and I'll turn the call over now to Bob Long.

Thanks, Jeff. Good morning, everyone, and thanks for joining us this morning. I think our press release provided a fair amount of detail on the quarter, so I don't plan to spend any time on the numbers, other than to say the quarter and the first six months of the year came in pretty much as we expected, with $0.49 for Q1 and $0.42 for Q2. You may recall that we expected the first two quarters to be about flat with the fourth quarter of last year where we earned $0.45, and then we accelerated some of the earnings from Q2 To Q1 because we were unable to complete a number of projects. Those projects got pushed into Q2, and as we indicated would happen in our last conference call, Q2 came in correspondingly lower than the $0.45. Greg will give you a little more detail on the numbers in a minute, and because of the potential impact on our costs and quarterly earnings volatility going forward, I'm also going to ask Jean Cahuzac, our Chief Operating Officer, to comment briefly on our projects year to date and what we expect for the remainder of the year. Rob will then give you a quick overview on what's happening in the market, before we take a few questions

First, a few high level comments on the market. I continue to be pleasantly surprised with the level of demand for rigs, particularly for deepwater and high-speck floaters. There just isn't enough capacity available today to meet the operator's requirements. There seems to be an increase in interest from operators in awarding term contracts for new builds. At the same time, the number of new builds on order, or contemplated being ordered, is getting to a level that has to cause some concern about what the market will look like in 2010 or 2011. Petrobras recent reporting seven contract awards for new builds and their intent to build a rig in joint venture with [Matsuei] is going to bring a lot of new capacity into the market eventually. If activity develops as we expect in Mexico, the South China Sea, coupled with new requirements off Canada and Norway, and continued growth in the historic deepwater areas, all the new capacity will likely find work. However, while I continue to be very optimistic about the outlook for the next three years, I'm a little more concerned about the impact of the capacity additions in the out years now than I was three months ago.

In regards to our challenges in the areas of cost control and operational excellence, I'm delighted to be able to say our safety performance is the best in the history of the Company. Despite the increase in activity and dilution of experience that results, our people are focused on the right things. One of the biggest challenges we have is our efforts to minimize out-of-service time caused by long lead times in getting equipment and repair parts, coupled with very poor service quality on equipment sent out for repair and return. This has led to a number of delays in getting upgrades and overhauls completed on time, as we've been delayed in getting high dayrate contracts started. These factors also make it difficult to give very accurate cost guidance. For the present time, we expect operating cost for the remainder of the year to approximate the second quarter run rate, although third quarter is likely to be a little higher and fourth quarter a little lower. Finally we also made progress on our announced stock repurchase plan, having bought back $800 million of stock since our last call, $400 million in Q2 and $400 million in July. We see nothing to suggest that we should not continue to buy back stock as and when excess cash is available, so the plan in that regard remains unchanged

At this point, Jean, why don't you give a brief summary of our projects

Thanks, Bob, and good morning to everyone. In 2006, our [inaudible] can be placed in three categories: Reactivation, special periodic surveys and contract preparations, and upgrade to deepwater and new builds. I would like to give you first an update on our reactivation project. As you know, we are presently reactivating three of the last idle units that we have, the Prospect, the Winner, and the C. Kirk Rhein. In the second quarter, approximately $39 million of expenditures were incurred on the reactivation of these three rigs. We have encountered some problem on the Prospect during [inaudible] and while starting the remobilization for the contract with [inaudible], as two of the thrusters have been damaged while getting out of the Rotterdam shipyard. These problems have led to further delays for the contract start-up, which is now expected to be late August. On the other hand, the Winner reactivation project is well under way, and we expect the rig to start operation within the next week. With the completion of the C. Kirk Rhein [inaudible] in December and her mobilization to India early '07, all our reactivation projects should be completed by the end of the first quarter next year.

In line with previously announced plans, we have also a number of other [inaudible] project for [inaudible] surveys or new contract deliberation. Due to various factors, including equipment delivery date and the change of plans from the operator, it's sometimes difficult to define accurately the schedule of these projects. However, excluding reactivation, during the second quarter we have [inaudible] for about 520 days. We expect this number to go down to 440 days in the third quarter and to 300 days in the fourth quarter. As Bob mentioned, our biggest challenge is to minimize out-of-service time caused by long lead delivery in getting equipment and repair parts, and improve our suppliers performance whenever ordering major equipment in the repair shops. We have assigned additional resources to monitor the progress of our suppliers and improve quality control processes on all major projects. Total out-of-service time, which includes [inaudible] time, reactivation but also remobilization when you move from one contract to another, is expected to decrease from 30 [inaudible] months in the second quarter to 22 [inaudible] months in the third quarter and 19 [inaudible] months in the fourth quarter.

And finally the third category of projects is rig upgrades to deepwater and new builds. We are still at an early stage of our two new big projects, the two drills ships which are being built for the Chevron and Hydro, but things are going well and I do not have any specific concern at this point. Our upgrades to the semi-sub rates of the Sedco 702 and Sedco 706 are also progressing as they are planned. The Sedco 702 is expected to commence a three-year contracts in October '07, while the Sedco 706 should commence it's three-year contract in July 08. One point to mention, the 706 continues to be utilized in the North Sea [inaudible] until August '07.

With that, I will turn it to Greg to discuss the financial outlook.

Thanks, Jean, and good morning to everyone. In the second quarter of 2006, we had net income of $249.5 million or $0.75 per diluted share, or $0.42 per diluted share after adjusting for gains from asset sales. This compares to net income of $205.7 million or $0.61 per diluted share in the first quarter, of $0.49 cents after also adjusted for asset sales in the first quarter. Total revenues for the second quarter improved to $853 million from $817 million in the first quarter. $48 million of this increase in revenues resulted primarily from the commencement of higher day-rate contracts, with another $17 million coming from the return to active status of the Jim Cunningham and Trident 4 after the completion of their mobilization. In addition, revenue in the second quarter benefited by approximately $16 million from reduced operational down time, the effect of a longer quarter, and the [inaudible] effect of a weaker dollar on revenues denominated in foreign currencies. As expected revenues were negatively impacted by $36 million, due to shipyards, reactivations and mobilizations during the quarter.

Operating and maintenance expenses in the second quarter were approximately $549 million versus $475 million in the first quarter, with the reasons for this increase fully described in the press release. Although the increase was consistent with our expectations for the quarter, some components of our second quarter costs were higher than expected due to cost over runs on shipyards and reactivations, and the weakening of the U.S. dollar. These adverse factors were offset by the postponement of several shipyards and maintenance projects from the second quarter into the third and fourth quarters of 2006, resulting in overall costs for the second quarter in line with our expectations. Although the weaker U.S. dollar has added almost $8 million per quarter to our operating and maintenance costs, this was mostly offset by a corresponding increase in revenues.

In the third and fourth quarter 2006 we expect that our operating and maintenance costs will be approximately in line with the level incurred in the second quarter, with third quarter costs trending slightly higher and fourth quarter costs trending lower. This level of cost for the remainder of the year is higher than previously expected, due to the previously discussed ship -- shipyard and other projects from the second quarter into the third and fourth quarter and expectation of a weaker U.S. dollar and continued inflationary pressure on supplies and services. Capital expenditures in the second quarter 2006 were approximately $98 million and are expected to be approximately $600 million for the remainder of the year. Of the $900 million of capital expenditures expected for the full year, roughly $230 million relates to the two 700 Series upgrades and $325 million relates to the two deepwater drill ships. Capital expenditures for 2007 should be approximately $1 billion before falling to to $700 million in 2008. Depreciation will not be impacted by capital expenditures related to the 700 Series upgrades and the two new builds until they actually enter service. As such, depreciation will be relatively stable during the remainder of 2006, rising from $102 million in the second quarter to $105 million in the fourth quarter.

The completion of an additional $800 million of share repurchases has reduced our levels of cash by roughly another another $100 million since the end of June, and during July we also borrowed approximately $360 million on a revolving credit facility. The reduction in cash should decrease our interest income to roughly $2 to $3 million per quarter. Although interest expense will be impacted by the increased borrowings, this will be mostly offset by an increase in capitalized interest, as our upgraded new build programs progress. We expect interest expense for the next several quarters to average roughly $20 million per quarter. And finally, for the remainder of 2006 we expect our annualized effective tax rate, before gains from rig sales and discrete items, to be approximately 18%, roughly the same rate seen in the first and second quarters.

And with that I'll turn it over to Rob to discuss the market outlook.

Thanks, Greg, and good morning to all of you on the call. We've had another strong quarter of fixture activity since our May conference call, highlighted by our second new build Enhanced Enterprise class drill ship anchored by a long-term contract. We achieved some excellent dayrates in term commitments for our non-fifth generation deepwater floaters, as rates for this rig category advanced to new all-time highs. Our contract backlog now stands at more than $19 billion, approximately $2 billion better than it was on our last call. The market outlook remains excellent for each of our major asset classes, as demand visibility improves against the continuing back drop of limited rig availability.

As usual, I'll start with a discussion of our high specification fleet, which includes our deepwater and harsh environment assets. We recently announced our second committment for a new build Enhanced Enterprise Class dual-activity drill ship for the Gulf of Mexico, this time with [North Hydro], at $475,000 per day for a four-year term. This rig will have the same market-leading capability as our first new build drill ship being constructed for Chevron, with the ability to operate in 12,000 feet of water and drill up to 40,000 foot wells. In realizing this opportunity, we benefited from the excellent relationship we enjoy with Hydro in Norway and from Hydro's recognition of our leading experience in drilling deepwater wells here in the Gulf of Mexico. As part of the same deal, the Hydro signed the Henry Goodrich, a fourth generation harsh environment semi-submersible to a two- year campaign so they could drill some of their Gulf of Mexico wells prior to the arrival of the new build in late 2009. Hydro will fund an upgrade to the Goodrich to allow it to drill in 5,000 feet of water versus current water depth of 2,000 feet, increasing the rigs marketability for follow-on work.

On the last call I spoke mostly about fixtures on our fifth generation rigs. This quarter a lot of the action was in the strong fixtures for our other deepwater floater rig fleet, which I will now highlight. In South America, we signed a two-year deal at $380,000 per day for the Sovereign Explorer, a third generation rig, that is expected to keep the rig busy into 2010. In the West of the Shetlands area, we signed the Transocean Rather to a three-well deal that guarantees a minimum dayrate of $430,000 a day and offers a potential top-end rate of $500,000 per day, depending on the water depth of the wells drilled. In West Africa, we signed the M.G. Hulme to a 25-month contract at $430,000 per day for work in Nigeria. And finally, in Australia, we added two wells at $475,000 per day to the Jack Bates. prior to its dry tow to the U.S. Gulf. Taken together, these fixtures illustrate how our other deepwater rig rates have closed in on, or some cases surpassed the previous record fifth-generation rates from the past year. Looking forward, we continue to see strong demand in all deepwater arenas. We are still in discussions with a number of operators who are interested a Transocean built and operated new build drill ship, both here in the U.S. Gulf and internationally, and we hope to bring one of these opportunities to closure.

I'll make a few brief comments on our other floater segments. We continue to see rising dayrates and strong demand in the mid water sector across all geographic markets. Despite the fact that we announced only a handful of fixtures since the last call, we have a number of deals under discussion that are expected to achieve closure in the next quarter. With a recent sale of the Transocean Explorer and the pending sale of the Transocean Wildcat, and the two previously announced 700 Series rig upgrades, we will retain another floater fleet of 19 rigs. Nine of these 19 rigs become available for new contracts between now and the end of 2007. If the market continues to stay strong, these repricing opportunities will collectively represent a significant source of revenue and earnings growth for Transocean over the next two to three years.

Turning finally to our jackup fleet, our outlook remains bullish. Despite the migration of rigs out of Gulf of Mexico, where Transocean does not have a jackup presence and despite the appearance of the first new builds into the bidding process, the international jackup market remains very robust. We are seeing new demand materializing in the India and Southeast Asian markets where we have a large pre -- our largest presence. Our internal supply and demand analysis indicates that the markets where we operate will likely remain under-supplied into 2008, with a risk of even greater under-supply if new build jackup deliveries, are delayed. We currently have eight of our 25 jackups with available time before the end of 2007, and seven of these are already being targeted for at least one visible opportunity. As a result, we are growing more confident that our jackup fleet will enjoy strong market conditions for at least the next two years.

That concludes my marketing comments, so I'll turn it back to you, Bob, for closing comments.

Thanks, Rob. One last comment before I open it up for questions. Yesterday, one of our deepwater floaters, the Discover 534, which is working in the South China Sea was caught in a storm while pulling riser and the BOP after it completed a well. The riser parted and we dropped approximately 3,900 feet of riser and the BOP to the ocean floor. It's not possible to assess the financial impact at this point; however the rig was scheduled to drill another 60-day well and then go into shipyard for a major upgrade and overhaul lasting approximately six months. At this point we're hopeful we'll be able to recover the BOP and replace the riser within that time period and, hence, limit the lost revenue to the 60-day well. But again, the incident just happened and we've not had time to fully assess the potential impact, so we'll have to wait and see exactly how that turns out.

With that, we'll open it up for questions.

[OPERATOR INSTRUCTIONS] And we'll go first to Ben Dell for Sanford Bernstein. Please go ahead.

Hi, guys.

Hi.

I had a couple of questions. The first was could you give an indication of what percentage of your fleet has cost escalation and where you think that then should be in sort of 12-months time?

If you look at our backlogs, which is probably a more relevant measure, about a third of our backlog contracts are protected by cost escalation, with most of those being our U.S. Gulf of Mexico contracts.

Okay, great. And we've heard some rumors out there that the majors,Exxon, BP and Shell, are being less interested in signing rigs beyond 2008, given the coming capacity on to the market. Is that something you've experienced or have you seen them sort of looking to take rigs beyond that time period?

I think that we've not seen that at all. I would say Exxon has been the least aggressive of the majors in terms of at least from our perspective in terms of their appetite to take rigs, but the other majors including the two that you mentioned have some real interest in rig capacity going out past 2008.

Okay. And lastly, just on your comments on the jackup market, do you have a view on how many additional jackups you think Saudi will require over the next two years, above and beyond what they've already contracted? And could you just confirm what sort of oil price forecast do you use when you're looking at your supply and demand model going out?

I'm happy to take that. This is Rob. I don't have an exact number for you for increases for jackups by Saudi. We are seeing a number of jobs appearing on the jackup front of -- not just in Saudi Arabia but [Atar] and other mid-east countries, the UAE, but I think that it's a sign that the mid-east market continues to stay strong. We don't actually use an oil price forecast in generating our outlook for the market. I think we rely mostly on our customers in terms of what their programs for drilling entail and we want to stay abreast of those developments. I can tell you that, in my discussions with customers, they remain very bullish on the future outlook of offshore drilling across all asset classes and that's really what drives our business.

Okay, great. Thank you very much.

And we'll go next to Roger Read with Natexis Bleichroeder. Please go ahead.

Yes, good morning, gentlemen.

Good morning, Roger.

Just wanted to get, I guess, maybe a little better handle on this operating cost issue. If you look in -- I guess I'm taking from the press release and everything, roughly $20 million of reactivation cost in Q2, and with the rig reactivation program winding down as you go into the second half of the year, what is driving operating costs in the third and fourth quarter to be approximately the same as the second quarter? What makes up the difference between the two numbers?

It's a couple of factors. One, the total reactivation cost in the second quarter were $39 million, a just $20 million increase over the first quarter. However, in the second quarter, we had several cost over-runs predominantly on the Prospect, which alone was a $13 million overrun. We had a weaker U.S. dollar that impacted part of the quarter that will impact the third and fourth quarters fully. And we had several shipyard projects that were shifted out of the second quarter into the third quarter. So we had some unfavorable variances in the second quarter that were offset by the shifting of shipyard projects. That shifting of shipyard projects was about $24 million and that's going into the third and fourth quarter. You have the full quarter impact of the weaker U.S. dollar and you have the full quarter impact of pay raises and just general supply increases, as we continue to see about a 10% to 15 % annualized inflation on our maintenance supply. We're looking at a 10% annualized inflation on our personnel cost and so each quarter, all those things are starting to add up. And they're -- with the shifting of the shipyard projects in the third and fourth quarter and that continuing inflation it's offsetting the anticipated decline we were expecting to see in the third and fourth quarter.

Okay. Then if I'm looking forward to 2007 and presuming you're not going to have much, if anything, in the way of reactivation expense, take 10% payroll, 10% to 15% maintenance, insurance, et cetera, what do you think is the correct baseline to start from? Kind of what is a clean operating expense number for '06?

You know, although we will have less reactivations, we're going to have more active rigs because now you'll have the Rhein, the Winner and the Prospect all active. The two 700 Series upgrades will -- while in their last phases will also incur costs similar to a reactivation, so you'll have those shipyard costs in our '07 numbers. And so frankly, right now, this same level of cost that we're seeing today in the $550 million range is a good baseline to then inflate into '07. Now, we'll have a different mix and we'll have some less shipyard components, but more active rig components, but not as much less shipyard components because at the tail-end of these upgrades they're going to be ending like reactivation from a cost perspective.

So it's safe to say '07 operating expenses will be up significantly from the 06 level then?

That's right. And right now, although we can't tell, we don't see any lessening of the pressure on cost so our inflation rate for '07 should still be in that 10% to 15% rate. Could be a little lower, could be higher, it's hard to tell. But given the new rigs coming into the market, there's going to continue to be pressure on costs, so we really think inflation will continue to be a challenge for us.

Okay. And then one final housekeeping question there. SG&A was up a bit more than I would have thought, not significantly, kind of year over year and sequentially. Is that the right run rate going forward or was that any one-time blip?

Yes, that was the right run rate with changes in [LSIP] programs and pay raises and things like that. So that $24 million was the correct run rate.

Okay. Thank you.

And we'll go next to Lee Cooperman from Omega Advisors. Please go ahead.

Thank you very much. I'll see you guys on Monday, so I'll probably ask this question again. And the question is really -- it's very important to me, I think frankly every shareholder of the Company, and that is how confident are you that you buy back is the right decision for all the shareholders that are not selling, your employees that own stock, and your employees that have options? And I just want to make sure that I understand the degree of thought that's gone into this? And there's a several part question to that question but that would be the first part.

Well, Lee, as you know, we've had a lot of discussion about this over time here and there's been a lot of thought go into the decision to return excess cash to shareholders by a buyback program. If you expand the question to be more than should we be doing something different than just returning excess cash, well that puts the whole question on another plane and we get into a lot of different theoretical issues there, and I think what you're asking about is whether or not we should be leveraging up than buying back stock now --

No, no, excuse me. Not really. Your principal competitor -- not really, you have plenty of competitors, but Diamond Offshore from 1998 to 2004 bought back about $300 million worth of stock and since 2004 bought back none, and I think their plan is to return money to their shareholders via cash dividend. From the same period 1998 to 2004, we've bought back zero stock, and then we started buying back stock in 2005. To me, buying back stock should be done if we have a view, given everything we know, that we believe the market is undervaluing our Company and that's kind of what's behind the question.

You said a moment ago that you're -- it's a moving target and I apologize for taking a lot of time but it's a very important question. You doubled the buyback program without having bought back a lot of stock, because you wanted to signal to the market that the outlook for the Company was substantially better than it was when you announced the original $2 billion buyback in October of '05 when the stock was $58. And it was a very ethical, open thing to do, even though I, myself, would have bought back the $2 billion before doubling the buyback. Now on the call you said you're more worried about the out year performance than you were three months ago. I'm not interested in stock support operations and I'm not interested in enlarging my ownership in the Company, unless I'm enlarging my ownership in prices less than the business is worth. So even though you're not giving guidance, implicit in your decision is the view that at $73.54, which is the average we pay for $1.4 billion, the market doesn't understand the favorable outlook for this Company and our stock is undervalued.

And obviously, there's no guarantees you're right, but this is implicit in what you're doing because you could return the money via a cash dividend. And it's also a little bit troublesome that -- it hasn't happened for the last three months but earlier this year, there was an enormous amount of insider selling at a time when the Company's buying back stock. So really what I'm looking for is some kind of declaration or some kind of statement -- I realize you could be wrong, I make mistakes every day unfortunately -- but basically that we are buying back the stock because we think those people that are sticking with us and going to keep owning the stock and not selling to us are going to get a leverage return because we're buying back stock cheap to what the business is worth. Is that implicit in your decision or am I just being too almost intellectual, because what I'm saying is frankly very practical. You follow my question?

I follow your question, but I think that your conclusion in terms of our motivation is incorrect. We're buying back stock as a chosen method to return excess cash to shareholders which we think is the most efficient way to do it without taking a view on whether the stock is intrinsically overvalued or undervalued.

Well, forgive me for saying this but I think that that is a totally inappropriate view to have, because you could return the money to shareholders via a cash dividend. You own stock in the Company, you have options in the Company, if you're buying back stock at prices that turn out to be inappropriate, you're hurting the value of or out right ownership and the value of your options going forward. And you're doing a disservice to other people that are maintaining a position in the Company and I really have har -- I don't want to monopolize this call because I'm going to see you on Monday, but I have a real hard time with that answer. I really do. I think it's a cop out. You have no business engaging in stock repurchase if you're not buying back what you think to be undervalued stock, because you could return money to shareholders in a different way.

We recognize your view, Lee, and I appreciate hearing it again, but my answer is still the same.

Well, I would like to speak to the [inaudible] director to basically express this view; okay? I don't think we should engage in stock repurchase unless we believe the stock is undervalued, because with tax rate on dividends of 15% and tax on capital gains being 15%, we should be indifferent. And if we're not buying back undervalued stock, we should return the money in a different manner to shareholders.

Okay your view is noted.

We'll take our next question from Dan Pickering with Pickering Energy Partners. Please go ahead.

A little bit calmer question, I think here. I want to come back to the cost side because I'm still not sure that I understand the components of the numbers here. Greg you mentioned reactivation costs. We know we've got other shipyard costs and then we've just got ongoing operating and maintenance costs. You told us of the $549 million, the reactivation costs in the second quarter were $39 million and what I'm trying to understand is Jean said that our shipyard days for special surveys were going to be down in the second quarter, our total out-of-service time is going to be down in the second quarter -- sorry, the third quarter and so I'm trying to understand why -- are O&M costs up that much that it keeps the total cost flat? Do we have over runs going on in this other shipyard upgrade category?

Well, the challenge with just looking at days in shipyard is that, at different stages and projects and different types of projects, the costs vary dramatically. Because you can have some projects where most of the costs are just the same ongoing crew costs that we have, because the shipyard involves things that are capitalized, that improve -- enhance the value of the rigs. And you could have other shipyards where most of the costs are repair and maintenance and so there's a very high incremental increase in costs during that shipyard. So even though we're expecting a decline in shipyard days as we look at the actual nature of those projects, including the continued reactivation of the C. Kirk Rhein, including the 700 upgrades and other shipyards, we're seeing cost levels staying higher. Now in addition, you've got the quarter-over-quarter impact of the inflation on our base cost. You have higher operating costs because now you got the Winner and the Prospect as active rigs, so all those factors are leading to the costs staying level for the remainder of the year.

Okay, and the operating and maintenance cost inflation, has it changed that much in the last quarter? We talked about this one quarter ago and now it sounds like we're up another 10% in the past three months.

What's changed in the last quarter is the weakening of the U.S. dollar. A lot of our costs are non-U.S. dollar cost. So all of our crews, for example, in the North Sea are either pound payroll or Norwegian Krona payroll, So as the dollar has weakened dramatically in the last three months, since our last call, that alone around the world is adding about $8 or $10 million a quarter to our cost structure. Now there is an offset on revenues because we have natural hedges in place and so our revenues will also go up by almost the same amount, because we get a proportion of our dayrate in those countries in local currency. But it is impacting the cost line and so that's a big in impact. Although we've been monitoring the inflation on supplies as been running at the 10-15% rate, it's actually had a muted impact on our actual maintenance cost until recently, as we've had major supplier agreements that are starting to rollover and reprice, so we're seeing more of an impact. I wouldn't say the inflation rate has gone up, but the impact on Transocean is starting to go up.

Okay. Last question. Are you guys changing or doing anything different on your maintenance capital spending to potentially avoid higher shipyard costs as you go forward or is this just something that's inevitable?

We constantly have initiatives to be more efficient. We've been implementing the last few years various initiatives to better manage our Asset Management, our maintenance programs and everything, so it's clearly a focus , but in this market with the pressure from vendors, John mentioned that we're getting a lot lower quality from the vendor sources that we used to, that ends up causing higher costs because we've spent longer in shipyard and we have to rework things and all those things, all those pressures frankly are making our cost mitigation efforts a lot more challenging than they were even a year ago.

Thank you.

And we'll go next to Robin Shoemaker from Bear, Stearns. Please go ahead.

Yes. Thanks. I wanted to ask since you're guiding to kind of a continuing inflation on the 10% to 15% level, in terms of operating costs, what percentage now of your rigs have cost escalation provisions? I know that this has been a standard part now of recent contract signings that are of the multi-year nature that you've got an annual cost adjustment, and what portion of your fleet would not have such cost escalation provisions built into the dayrate?

If you look at our backlog, about a third of our backlog has those cost escalation provisions. And it's only a third because, primarily, you only see those provisions in long-term contracts, two, three, four-year contracts. And also you don't tend to see those provisions in contracts with national oil companies. So although our longer term contracts do have those cost escalation-type provisions, you certainly don't see them in the majority of our contracts, like I said about a third. And even when we do have them, each of the contract mechanisms for cost escalations are different. Sometimes they only reset once a year or once every six months. They don't always fully cover our costs because some of them are based on indexes, some of them are based on actual costs. So I wouldn't expect a full offsetting of our cost, even in those contracts that have cost escalation.

Okay. So anything two years or under, in terms of a contract term, generally doesn't have cost escalation provisions?

That's a good rule of thumb.

Yeah, okay. My other question then for -- is Bob, I just wonder your comment about the deepwater market 2010 and beyond. I'm sure you'll talk more about this next week, but what was the point at which we reached a level of new rig construction that triggered your concern about a potential over supply of rigs in 2010 and beyond? We've seen the steady build up. I guess there's 35-plus deepwater rigs now. At what point did we pass that level that you felt comfortable with?

Well, first, I don't want to overstate my concern here. I'm still pretty bullish on the market moving forward but I think that following Petrobras's announcement where they essentially enticed six new builds all of a sudden into the market, and I think there's an open question on where those rigs are going to be built and when they're going to get delivered. But that's a lot of new capacity ordered all of a sudden, adding to what's been a slow build up already. So I think that if you assume that by 2011 most of this new capacity is going to be here, you at least have to ask yourself a question, are we approaching the point at which supply is going to exceed demand? My sense would be if demand stays what it is today, there's so much unsatisfied demand, that the market will be able to absorb those. But there's along time between now and 2011, so that's why I just add a cautionary note.

Okay. Thank you.

And we'll take our next question from Arun Jayaram from Credit Suisse. Please go ahead.

Good morning. Bob, rising costs are clearly a trend that are going to continue. I was just trying to understand from a management perspective, what are you doing in terms of coping with the rising cost structures and have you done anything differently from a management perspective?

Well, I think that we've done a lot from a management perspective in terms of trying to cope with the cost on the maintenance and operations, and leave aside the people aspect for a minute. We are reorganizing the way that we actually manage the maintenance and operations of our rigs and creating a structure where we have instead of a rig manager responsible for the operations and maintenance to the rig, we're creating an organization where we have a performance manager who is responsible for safety and performance of the rig and an asset manager who is responsible for the maintenance of the rig, both near term and long term. That asset management structure is in the process of being put together. It's in more advanced stages than some parts of the world than in others. And we're able to look at asset classes of rigs. We get individuals who are looking not just at one rig but looking at like-kind rigs to see what we can do to optimize our maintenance procedures and processes. Now, that's not something that results in immediate change in the way we're doing things, the long-term process, but we are focused very hard on how we can maintain our rigs more efficiently.

Okay. Do you have lake a cost czar or do you see any efficiencies just through this kind of review that you could gain?

We don't have a cost czar. I think Mr. Cahuzac is our primary responsibility for the maintenance and operations of the rig so, Jean, you want to make any comments?

I think there is another area we'll be focusing on is to work with our supplier in the appropriate fashion. The problem is cost inflation, as Greg mentioned. It's also sometimes quality of services and [steady] rescheduling which leads to some delays. We have implemented a system with our main suppliers to monitor the projects. We have people who are permanently working now in the industry in the [retail] shop, focusing on the quality control. It's a joint effort with the suppliers and our customer there. So it's a lot of different initiatives which have been in place now for a couple of months and which we are [always] to manage a challenging situation in the next 12 months. But nevertheless, I mean, the supplier stretch and quality control will remain an issue and that's something we are focusing on.

And last question, Rob. You talked about some opportunities to reprice jackups internationally. Can you just give us some details on what you're seeing in terms of -- from pricing standpoint?

Yes. I think generally speaking, prices for 300 foot jackups where we operate are in kind of the high 100's and the low 200's. That's certainly what we're seeing in bidding.

Okay, that's helpful. Thanks.

And we'll go next to Ole Slorer with Morgan Stanley. Please go ahead.

Thank you very much. Sorry about my voice, but I had a question again back to the supply that's coming into the market. If I look at the latest ODS petro data, semi-submersible and riddles drillship utilization numbers, it looks as if they're running about 158 floaters worldwide right now. And if I look to what's coming as new builds and include everything that's funded but exclude any option, it looks as if you're talking about 35-36 units, not including the Petrobras announcements. And top of that reactivations or [cold spec] units maybe if you include Frontier Drilling, what you're do, the latest Viking announcement, you're talking about maybe 17 units.So you're well into the 50's in terms of the new supply that's coming into the market in 2009, well, 2007 and 2010 on top of 158. Where do you see the greatest risk in conflicts or comments a softening or moderation of rig rates? Is it in the sixth generation area? Is it in the second generation? How do you see this playing out?

Well, I think that you have to look at the slow to market as a whole. Most of the new capacity that's coming in is obviously deepwater and ultra-deepwater capacity. The floater market, though, as you look at as a whole, if it gets soft in the deepwater market, then that's going to ripple down through all of the levels of the floater market and the least capable rigs are going to be pushed out of the market. Right now, I couldn't take a view that says the demand for mid water floaters would flag and yet demand for deepwater units would continue to be extremely robust. That could happen, in which case you'd still have a very good market for the deepwater and ultra-deepwater and start to see a softening of rates in the mid water. But it's hard to take a view on how the demand side will develop, so just looking at the overall supply demand for floaters in general, you'd have to say that the risk is that the market gets over supplied and then the lower spec rigs take the brunt of it, but the entire rate structure across the spectrum will be impacted.

I presume that we'll see a rational for selling out of your two [cold spec] units. Will they be refurbished by the new owners and brought into the market again?

I don't know what the new owners plans are, but you would suspect that they're going to do something with them. They didn't pay that much money to just let them continue to sit there.

What do you think about delays and cost over runs on some of the existing projects? We are now one year down the line from when we got the first wave, particularly out of Norway, and some of these people are very experienced in terms of the maritime industries and others not. What's a typical -- what are you looking for in order to gauge the early warning signs that a project might be a little out of control? I mean, there's a lot of stuff coming.

Are you talking about other people's projects?

Yes, sure, sure, sure. I assume you must some of these potential mishaps as opportunities, given your [inaudible] strength.

Well it's a little bit difficult to judge specifically what's going on. We are of the opinion that most of these units are going to be late and incur problems, not necessarily because of the inexperience of the new owners, though that may contribute, but primarily for the factors that Jean talked about. The big issues here of the ability of the suppliers to deliver equipment on time and if they can't, that has a pretty significant impact on shipyard schedules --

Right.

-- write-off schedules and all of that. And then when you get into the commissioning phase, which you won't find out about until very close to the end of the project, we suspect there's going to be a significant number of problems with the commissioning phase of these new rigs, because of lack of having the right expertise in the yard coordinating between the yards and the suppliers. But only time is going to tell whether that really develops.

Thanks, but just one final question. I mean, Costa Singapore I think has together with SembCorp now initiates construction of a new fabrication yard in China that will be used for rig upgrades and also new rig construction. I think the dock is about a mile and a half long. Have you been looking at that project as potential source for you of building new rigs?

We haven't been looking at that as a potential source of building new rigs for ourselves. Most of our focus on new rig capacity has been on our new Clearleader design, which the first two are being built by Daewoo, and for efficiencies and project management reasons, we would think that our focus for additional capacity would be with the same design rig in the same yard.

Makes sense. Well, thanks very much.

We'll go next to Doug Becker from Banc of America Securities. Please go ahead.

Thanks. Just wanted to touch base on the third quarter tax sharing agreement with Tarco. How should we be looking at this for this upcoming quarter?

Right now, as we've reported previously, we're in a dispute with Tarco under the agreement that the dispute has to go to arbitration, and so while we are in that dispute under the accounting rules, we can't recognize as income even any of the cash that they have been paying us under that tax sharing agreement. And so until that dispute is over, you won't see us recognizing anything. Right now, we expect arbitration to be heard in October and if that settles it, this may be resolved in the fourth quarter, but right now we don't expect it to be resolved in the third quarter.

If it's resolved in the fourth quarter you would then recognize it on the income statement?

That's correct.

Okay. And wanted to circle back on the cost escalators. Rig supply is very tight. Is there been any thought being given to trying to push for escalators and more contracts, maybe even by giving a discounted dayrate, since costs seem to be such an issue here?

Yes. I'll take that one. We're conscience of the fact that costs are going up, and to the extent that we signed contracts to start further into the future, we are, in jurisdictions outside of the Gulf of Mexico, pushing for the implementation of cost escalators. As Greg said in his earlier response, sometimes that's not as easy as it sounds, especially when dealing with, let's say, national oil companies who may have standard contracts that they go through. But we understand that there's a risk to our revenue from escalating costs and we are consciously trying to get more of those into our contracts as we go forward.

Sounds like it's still pretty hard going?

It depends on where you are. Again, in the Gulf of Mexico, I think it's become an accepted practice. We are making some headway overseas but really, it's contract by contract. And again, we have much less concern on a shorter-term contract and/or a contract that starts relatively promptly. A lot of what we've done in the Gulf of Mexico, as you know, has been longer term and has been starting further out in the future.

Okay, thank you.

[OPERATOR INSTRUCTIONS] And we'll go next to [Walter Lavato] with Passport Capital. Please go ahead.

I had a question on the nine semis that come available between now and end of '07. How many of those are in -- I'll say in active negotiations and how many would you expect to fix on contracts before year-end?

Yes. Are you referring to the nine other floaters?

Yes.

I can say that every one of those nine is being considered for a visible job opportunity, and, obviously, in various stages of discussion and bidding. But as I've mentioned in my comments, we're seeing a lot of visible demand in all the asset classes. The other floater fleet, which is the non-deepwater rigs, is fortunately also seeing same robust demand that we're seeing on the deepwater side. Clearly, it's closer in. It's 2007-2008 work. A lot of it is one year duration, plus or minus. So we're already in the process of marketing those rigs, based on the opportunities that we're seeing.

And on the eight jackups that are available for between here and '07, you said you mentioned seven are already sort of in discussions or entertaining projects. Is there -- how are you feeling if at all, any impact from the new build jackups that are slated to come on in those contract negotiations? Does that impact terms or rate at all ?

You know, we are already starting to see some opportunities where we are bidding against new builds. And to the extent that we understand through the process how these bids are coming out, we believe that the new builds are bidding at levels consistent with or higher than some of the levels that even we're bidding. So we're really not seeing a pressure on rates due to the interest of new builds to secure their first jobs. I think a lot of that has to do with the fact we're all looking at the same supply and demand analysis. In the markets where we operate, there looks to be a shortage of rigs into and probably through 2008. Beyond that, it gets a bit [merkier] to read, but I think most of us in the contract drilling business see that a shortage of supply will suggest that rates stay at or rise from current levels.

Okay, thanks.

And we'll go next to John Brodrick with Permit Capital. Please go ahead.

Yes, hi. Just a follow-up question on the new rig build. You say that you've got personnel cost inflation and I presume that's because there's a limited supply of qualified workers for the rigs that exist today. With all the new demand coming online, I'm curious who's going to operate those rigs if there's such a shortage today?

I think it's go being to be a challenge for the newcomers who don't have the critical mass of operating rigs and the infrastructure to actually train and prepare people. As far as we are concerned, we started to work on that about 18 months ago. We did a lot of [inaudible] and recruitments in different countries, from central Europe to other countries where we work. We've been [inaudible] nationalization and we have plan in place today to man 702, 706 and the two new build Clearleader with individuals who have already been identified and are going to be trained and promoted in the next 12 months. So I think we are in good shape, but it's going to be a challenge for the industry, for the newcomers, to man these rigs. And I think it's going to be one of the things which may lead to some delays on their commissioning and start-up.

And just a follow-up question to that. What's turnover like among the personnel that staff these rigs? Will people just -- will people turnover relatively quickly or do they tend to stay for longer periods as time?

As far as transition is concerned, our level of attrition and turnover is pretty low. It's in line with what we have seen in the last two or three years. With that, I think people see a future in the Company. We have pretty good training plans, We have opportunities of promotion with growth -- organic growth, so things look good for the time being. No doubt that when the new rig comes on the market thee will be more pressure on salaries et cetera, and that's what Greg was referring to. But I think we have good plan in place and I feel, at this stage, comfortable that we have the people in staff these rigs.

I guess just in the anticipation of there being more demand for workers in the future, retention programs that would keep people with Transocean would make sense. It would hurt your competitors.

Yes, it's not only a retention program. it's also training, [inaudible] improvement plan and opportunities for long term in the Company, and I think our work force appreciates what we can offer.

Okay, thank you.

And we'll go next to Geoff Kieburtz with Citigroup. Please go ahead.

Good morning. A couple questions. To come back on the operating expense topic for a moment. You mentioned a number of major supplier agreements that were rolling over. Could you give us a little bit more color on that? Are you rolling into new sort of multi-year type of agreements? How many of your prior agreements have already rolled over? Can you give us any comments on that topic?

It really ranges all over the place. I can not give any comments -- the agreements are spread all around the world in different terms, different vendors. The one consistency is the new pricing is certainly much higher than it was on the old agreement. But no, it's so varied we would spend half an hour talking about it.

Okay. Is it typical that you would have a 12-month or longer agreement that would fix costs for you with a major supplier or do they have cost escalation clauses that they effect?

Not during a term and agreement like that. That's just not untypical, but -- and there would not be a cost escalation during a 12-month agreement.

Okay. And is a 12-month agreement common?

Yes. I would say so.

Okay. And so you don't have any sort of particular concentration of these agreements having recently expired and rolled over?

No. It's a continuous process.

Okay.

Put in place over the last five years, a variety of times, variety of vendors, variety of terms.

Okay. And specifically on insurance, have you -- I've just forgotten when you last renewed your insurance?

It's another factor I failed to mention, but we did renew our insurance program on May 1st. And our run rate for insurance is more than doubled. In '05 our hull and machinery was about $17 million a year. In '06 it's going to be $38 million a year, so that run rate for insurance has gone up dramatically, starting in the middle of the second quarter.

Were there any liability caps that were imposed on top of that?

For Gulf of Mexico windstorms, whereas before we had no cap for hurricane -- windstorm is insurance term for hurricanes -- now we have a $250 million cap or a $300 million cap in the case of a total loss of a rig.

Okay. On the asset sales, you mentioned the Wildcat is still pending. I'd seen an apparently erroneous report that it already had been sold. Once that's complete do you have any other significant assets that you expect or at least think might be candidates for sale?

We don't have anything immediate, Geoff. We are looking at a number of our older, less competitive jackups that, if we got the right offer we might consider selling. But I think once we complete the Wildcat sale and the tenders, which we have four tenders which are two, I think, in Africa, two in the Far East, we're looking at a potential sale of those which we hope will close in the third quarter. Once that and the Wildcat close, I'm not sure you'll see much of any additional asset sales in the near term.

Okay. And just finally, Bob, on your comments concerning the post -2010 deepwater market, I understand that you don't want to overstate your concerns at this point, but hypothetically, if future developments in the near term were to make you more convinced that there was a risk, what would you do differently?

Well, I'm not sure that there's a whole lot that we could or would do differently. One thing that -- if you look at the progression of what's happened in the deepwater business, if you step back -- I forget how long it would be, 18 months ago or something, we were avoiding marketing new builds ourselves and trying to convince operators that there was plenty of capacity for fifth generation rigs coming available, and it didn't make sense to look at new builds. That changed some time back for us when we got most of our fifth generation fleet contracted out to 2010 or beyond. Now, at some point, we might transition to the point that says we should stop marketing Clearleaders to the operators who are talking about these programs starting in 2010 and start marketing our fifth generation fleet again, although frankly, my sense is that we might very soon start tying up our existing fifth generation fleet for additional term beyond where it is. So it's hard to say whether we'll reach that transition point or not, but that would be about the only thing that I could see that we could or might do if we become convinced that the concern is a little bit greater than I presently at.

And finally just to clarify, having pointed to potential risks at 2010 and beyond, do we infer that short of some sort of external variable that would cause a sudden collapse in kind of general economic activity or whatever, you don't see any risk in the deepwater market until 2010?

I think that I'd have to say I'm extremely optimistic about the outlook for the deepwater market through 2009. There's just a tremendous amount of demand and virtually, most of the capacity is already contracted, so that market looks very, very good. Now there could be some dramatic events. I guess. that would happen that might cause an upset there. but it's hard to picture what that would be at this point.

Great. Thank you.

And we'll take our last question from Alan laws are Merrill Lynch. Please go ahead.

Good morning. Just a couple questions, most of the ones we had were already asked. Maybe a little lighter question. A couple political issue questions. First,, many are kind of looking to the next Gulf of Mexico lease sale, the next catalyst for the group, kind of deepwater lease turnover and the like, but there's been a lot of rhetoric from the Louisiana governor, kind of suing to stop this sale. Are you concerned about that? And then the second question on this would be do you have any insights into the current efforts to open up more offshore acreage in the outer continental shelf? Kind of your thoughts here on what it might do to rig demand?

I don't really have a lot of insights into what might happen or potential impact of opening up the additional acreage. There's so much interest already in the deepwater Gulf of Mexico deepwater and particularly the new ultra-deep horizons in the Gulf. I think that the opening up of the additional acreage can only help, but to what extent and how quickly that will result in additional demand is hard to say. And as for the governor's actions, I can't say that I've got too concerned about it at this point, but I'm not quite sure where it's going to go.

As far as the potential for it to open up, and we're talking kind of 2010 horizon here, do you think that it could have some impact in that horizon?

Well, I certainly think in that type of horizon it could definitely have an impact. Now, how much again -- and I'm not sure how much of an impact in terms of potential number of rigs and what not, but it would certainly be positive.

And you mentioned the ultra-deep as well and Devon said yesterday the results from his Jack test, lower tertiary test, will come out in the third quarter, I believe, and I'm sure you've been watching this play. I was just wondering if you could offer an opinion on what this could mean for deepwater rig market, if it's successful? Maybe in terms of soaking up incremental demand or incremental supply that you might see further out?

I think that that's one of the really interesting new frontiers for us. If that develops as we hope it develops, it's really going to require Clearleader-type capacity. Most of the fifth generation rigs that exist today are really pushed right to their limits to be able to drill those wells. So if it really develops into a big play, there's a good likelihood that it will generate additional demand for new build capacity that has greater drilling depth than the current fleet.

All right that's all I have. Thanks a lot, guys.

And now I'd like to turn the call back over to the speakers for any additional or closing remarks.

That's really all we had and I don't have any additional remarks to make at this time, so we thank you for your interest and we'll look forward to talking to you again in the near future.

And ladies and gentlemen, that does conclude today's conference and we thank you for your participation.