December was a great month to own shares of Atwood Oceanics, Inc. (ATW), Transocean Ltd (RIG -2.29%), Seadrill Ltd (SDRL), and Seadrill Partners LLC (SDLP).
Transocean, Seadrill Partners, and Atwood Oceanics also wrapped up what turned out to be a solid year of gains, with all three delivering 17%-plus stock price gains. Unfortunately for a lot of investors, Transocean's share price finished 2016 nearly 2% below where it started, a particularly disappointing result, considering that the S&P 500 was up 11% in 2016 and oil prices closed the year up 50%:
Let's take a closer look at what lifted the stocks of these offshore drillers higher in December and see if we can divine the outlook for these companies going forward.
What happened in December?
Easily the biggest news in the oil industry came early in the month, with OPEC's huge announcement that the cartel would reduce total output by some 1.2 million barrels per day. Rumors that a group of non-OPEC oil nations, including Russia and others, would also commit to cutting another nearly half-million daily barrels of supply and a significant amount of future oil supply could send oil prices sharply higher in coming months.
Image source: Getty Images.
On the surface, oil output cuts would be bad for companies that make a living drilling for oil, right? After all, less output means less drilling is needed. And while that's true to some extent, the bigger-picture benefit of this move is what the market is focusing on: Offshore oil producers aren't likely to invest in developing new resources with oil near $50 per barrel, simply because they can't afford to.
So, a short-term plan to cut output should -- on paper -- drive oil prices higher in the course of 2017, and higher oil prices will help producers rebuild capital and encourage them to start investing that capital in offshore oil fields.
What it means for offshore drillers
Frankly, in the next six months to year, it probably doesn't mean much of anything. Oil producers have already established capital budgets for 2017, and the expectations are that spending levels will fall below 2016 levels, which were down from 2015 levels (which were down from 2014 levels). In other words, these companies are going to have to ride out a very bad 2017 mostly with the work they already have lined up, no matter what oil prices do. There will be some short-term work to be had, but it's not likely that oil producers will start awarding long-term contracts before later this year at the soonest.
2017 is going to be rough for offshore drillers, but there's opportunity for patient investors who can ride out the turmoil. Image source: Getty Images.
Looking ahead
As I recently wrote, there's potential value in almost all of these offshore drilling stocks, but there's risk as well. There's a chance that cash flows won't be enough to cover costs, particularly in the second half of 2017 as more vessels come off contract. The question is whether these companies can count on their balance sheets and lines of credit to bridge the gap before the recovery starts.
If you have a strong stomach, can take on the risk of permanent losses, and ride out the turmoil for likely more than a year, there's opportunity for very big gains. Consider the risks, whether you're willing and able to ride the downturn out, and invest according to what you can withstand and afford to lose.
