This Offshore Driller Has Challenges Ahead, but It's Not Alone

Diamond Offshore Drilling is facing a number of risks this year as analysts expect the rates for drilling units to fall, but it's not the only driller dealing with this.

Jan 8, 2014 at 11:04AM

The oil services market can be difficult to understand and get your head around. There are so many companies within the sector, all of which are specialists in their own fields and renowned for different reasons. Given this, sometimes an ETF is a much easier way to play the industry. One of the more complicated segments of the market to understand is the offshore hydrocarbon drilling market, and evaluating contractors such as such as Transocean (NYSE:RIG), Rowan Companies (NYSE:RDC) and Diamond Offshore Drilling (NYSE:DO) can be a taxing process.

One of the most important factors to take into account is the status of the drilling fleet, as this can be a key indicator of future earnings.

The fleet review
Unfortunately, the state of Diamond Offshore's fleet is concerning. In particular, during the space of the next year, 31 of Diamond's 57 drilling units are coming off contract; that's 54% of the company's fleet.

While such a large number of contract expirations would not usually be a problem, there appears to be what has been called by Transocean, one of the largest players in the offshore drilling space, a 'cold wind' blowing across the oil and gas exploration sector. According to Terry Bonno, Transocean's senior vice president for rig marketing: " this cyclical business, customers often strategically wait for over-supplied markets before pressing ahead with drilling, in order to secure long-term contracts at lower rates."

What's more, recent comments from Citigroup analyst Robin Shoemaker reinforce the view that harsh headwinds are going to hamper the industry during the next few years. Specifically, Shoemaker stated that while drilling contractors previously had the upper hand in negotiations with their customers, the balance of power has shifted recently so that customers are now in control -- as a result, rates for drillships are set to fall broadly.

With this in mind even Transocean is likely to see its earnings take a hit during the next few years due to lower rates.

Secure future
However, one company that is not worried about the near-term outlook for the rig market as much is Rowan Companies (NYSE:RDC). Rowan is set to take delivery of four new high-spec ultra-deepwater drillships during the next few years, which could catapult the company's earnings higher.

Actually, this is one of those rare opportunities where Rowan's earnings are almost certain to drive higher in the next few years, and there is very little risk of Rowan not meeting targets. In particular, three of Rowan's four new units set for delivery during the next year are already contracted out from the date of delivery, for a day rate of just over $600,000, until 2017.

Overall, when Rowan's four new units come online, they will add $2.4 million per day to Rowan's revenue, approximately $876 million per year assuming 100% utilization. Rowan's revenue was just under $1.4 billion during 2012, so we can see how much of an effect this will have on earnings. Still, Rowan has yet to contract out one of its new units.

This gives investors a huge amount of clarity of where Rowan's earnings are headed for the next few years.

New fleets are best
As this 'cold wind' blows over the industry, customers are looking for the most efficient and lowest cost equipment -- this usually means new equipment. Unfortunately, after a quick flick through Transocean's fleet list, you can see that many of the company's drilling units are over a decade old, and some are more than two and a half decades old.

Specifically, according to data from 2011, Transocean's fleet had an average age of 21 years. In comparison, the fleet of Transocean's closest peer, Seadrill, had an average age of five years.

While this has not been a concern before, with competitors like Seadrill bringing new vessels to the market, Transocean is going to be facing increasing competition from peers with newer fleets, which are able to drill faster, deeper, and in harsher environments.

Foolish summary
So all in all, there are significant headwinds facing Diamond Offshore over the next year. However, these problems are not just limited to Diamond, and Transocean is likely to suffer as well.

Nevertheless, as Rowan has already signed contracts to lock in revenues on three of its four new drilling units scheduled to hit the market within the next few years, the company appears to be in a better position than its peers to ride out the industry's slowdown.

The best play on offshore drilling?
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Fool contributor Rupert Hargreaves has no position in any stocks mentioned. The Motley Fool owns shares of Transocean. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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