Design of Drilling Contracts – Economic
Incentives and Contractor’s Focus on HSE
Presented by Anders Toft
SPE International Conference on
Health, Safety & Environment
29-31 March 2004
Work hours offshore, Norwegian continental
shelf
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1992
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Contractor employees
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Operator employees
2002
Economic incentives - definition
 Definition

The contractor undertakes a complicated project for the operator. The effort is
not observable for the operator

To secure a satisfying result the operator makes the compensation dependent
on the contractor’s performance
 Generally, the operator motivates the contractor by transferring
economic risk

The contractor is made economic responsible for his action

High level of risk gives strong incentives
The theory of multi-tasking
 Usually, the operator wants the contractor to focus on more than one aspect of the
product

Perform a drilling operation efficiently and to a low cost, but also appreciate the
importance of HSE, drill a well with good production characteristics and a long
production period
 Performance can be measured easily for some tasks, but be more difficult for
others, for instance HSE
When the operator cares about different activities of the contractor, but compensates
only based on the observable subset of these activities, the contractor will exert
greater effort on these activities while neglecting the unobservable ones
 It might be better, even, to provide no incentives at all than to provide them for one
aspect of a job only

Case: Design of drilling contracts
Economic incentives in drilling contracts
 Compensation format
 Maintenance and repair clauses
 Incentives schemes
 Allocation of financial liability in the event of accidents
 Consequences associated with violation of safety regulations
 Bidding process
Compensation format
 Day rates that include all costs

The contractor covers costs associated with training, maintenance etc.

Money saved will accrue to the supplier
 Compared to turnkey contracts (fixed price), day rates may give
stronger focus on safety, but give significantly weaker cost incentives
 Day rates motivate cost reduction, but do not contain strong tempo
incentives (as is the case with a fixed price contract)
 To keep the rig in operating mode as long as possible the day rates
are differentiated
Day rates - example
 Operating rate per day (OR)
 Stand-by rate per day
OR*0,90
 Moving rate per day
OR*0,80
 Suspension rate per day
OR*0,50
 Re-drilling rate per day
OR*0,25
 Lay-up rate per day
OR*0,50
 No payment rate
No payment rate
”If the drilling unit is unable to perform the drilling work (exhibit xx) or the performance of the work is
delayed due to repairs, maintenance and/or modifications to the drilling unit, slow progress or other noncompliance with the contract”
Maintenance and repair clauses
 Differentiated day rates – incentive to keep the rig in operational
mode and not stop the drilling operation for maintenance and repair

Postpone/omit maintenance and repair

Maintenance and repair are conducted while the rig is in operational mode
 Use of maintenance and repair clauses to curb this incentive
Press Release E211:02 - 21 November 2002
”The report identifies maintenance, drilling and deck operations as the
highest risk activities…”
Maintenance and repair clauses

Example 1
20 hours of repair and maintenance at the paid operating rate.
 Accumulation from month to month, max. 120 hours over a period of six months. No transfer
between six-month periods.
 Accumulated time can only be used for planned maintenance (at least 7 days planning
perspective)


Example 2






Repair rate, estimated at accumulated time during a calendar month (cannot be transferred to the
next month).
0-8 hours, operating rate (+ USD 30,000).
8-16 hours, 80% of the operating rate.
16 hours and above, zero rate
Incentive bonus of USD 30,000 per calendar month if the repair time is less than eight hours.
Example 3

No maintenance and repair clause
Incentives schemes
 Compensation in excess of fixed day rates
 Usually linked to progress
 Used to a varying extent and with varying force
Ex post discussions related to criteria
 Uncertainty with regard to effect
 Damaging effects on safety focus

 Example 1

USD 10.000 per day (24 hours) or pro rata thereof for the
time saved on the well subject to zero Loss Time Accident
 Example 2
USD 115,000 per day if less time spent than stipulated.
 Time spent: based on average for the three previous wells

Allocation of financial liability in the event of
accidents
 The greater the share of accident costs the contractor must bear, the
greater is the incentive with regard to safety focus
 Financial liability related to



Damage/injury/loss of personnel, property and indirect loss
Damage to reservoirs and wells
Third party claims, pollution, removal of rig/equipment from seabed
 Example: damage to wells

Who is responsible for damage to wells
– Criteria for contractor’s liability
– Re-drilling rate
Violation of the safety regulations – financial
consequences
 Operator’s right to terminate the agreement because of violation of safety
regulations/company specific safety requirements
”Contractor shall comply with Company's safety requirements at anytime.
Failure to comply with the provisions of this Article shall be deemed to be a
substantial breach of Contract”
 Dependent on the operator’s attitude (formalistic versus pragmatic)
 Economic consequences
Bidding process
 The principles of bid evaluation constitute the most important
incentive format for suppliers

What the contractors experiences as the most important bid evaluation criteria
and hence focus on – constitute an incentive format
 Emphasis on safety versus economic factors
 The effect of using e-auctions
Contractor’s progress considerations
 Rapid progress



Avoid reduced rate/zero rate
Achieve bonus
Obtain new assignments/options
 Avoid accidents



Termination of agreement
Delay
Other costs, for example costs related to effects on reputation
 Market situation

Rates and conditions in new assignments
Contractor’s progress considerations
 Probability analysis

Delay means economic loss the for rig owner with a high probability

Faster progress means loss with low probability, and the relationship between
action and effect may be complex

Horizon (discount factor)

Weigh certain loss now against possible loss later

Considerations will be affected by companies’ liquidity
What determines behaviour?
Economic
incentives
Social norms
Behaviour