SeaDrill: The Pause That Accelerates Demand

SeaDrill remains an interesting investment with one of the highest dividends for a large-cap stock and premium assets desired by the offshore drilling market.

Mar 4, 2014 at 11:37AM

While Seadrill (NYSE:SDRL) confirmed that exploration and production firms had recently cut back on capital spending budgets for 2014 due to escalating costs, the company actually sees a very positive scenario on the future outlook. Other deepwater drillers have speculated that the pause to drilling growth is needed for crews and suppliers to catch up with demand in order to refresh the market. Seadrill actually predicts the pause is greater undersupply of rigs by 2016.

Seadrill is a leading deepwater driller with a focus on aggressively building out new rigs for what it forecasts as a major undersupply in rigs by 2020. Ironically, fellow deepwater driller Transocean (NYSE:RIG) expects a weak market yet recently ordered two ultra-deepwater drillships.

Is Transocean signalling that Seadrill is on to something with its long-term forecast?

Seeing 2020 demand
If Seadrill is accurate about ultra-deepwater production reaching five million barrels of oil equivalent per day in 2020, than a rig shortage will develop very quickly. The market current only produces roughly one million boepd from those depths requiring compounded growth of approximately 30% during the time period. Based on a slowdown in growth during 2014, the growth rate will need to expand rapidly beyond 30% to reach those targets.

With Transocean being a leader in the deepwater drilling market, the company is far from progressive when it comes to rig orders. Considering the recent order extends all the way into 2018 and the company is unlikely to make another order anytime soon, its order book of nine ultra-deepwater rigs over the next four years isn't overly impressive. The company currently lists 46 deepwater related rigs, so adding nine in that time period might only replace aging rigs rather than actually expanding with the market growth forecast by SeaDrill.

2016 rig supply  
Seadrill went so far as to exclaim that the market was already facing an undersupply situation for drilling programs targeting 2016 based on a recent conversation with a contract manager that had previously pulled spending from 2014. When questioned on the conference call about ordering new rigs for 2016, the CEO actually spun it that in the last six years new orders by Seadrill typically spurred competitors to move newbuild programs forward. By taking a patient approach to newbuilds, Seadrill expects to benefit from an undersupply scenario developing for 2016. It sees no reason to get too far over its skies while the market pauses.

While Transocean announced the ordering of two drillships at an estimated cost of approximately $620 million each, the delivery dates aren't until 2017 at the earliest. In addition, the company obtained option agreements for three additional drillships. The deal turns out to not be that aggressive considering nobody expects the current pause in the market to last beyond 2015. With the second rig not due until the first quarter of 2018, Transocean is actually being overly conservative by delaying the construction time to four years.

Solid contracts
Seadrill sits in a perfect situation to weather any downturn in 2014 with only one rig having exposure to the 2014 slow down. Contracted rig days are more concerning in 2015 with signed contracts only covering 66% of the rigs, but it claims to have deals for two rigs that will push the number up to 72%. With oil prices remaining consistently high and pushed further by the dispute in Ukraine, it is doubtful that the company will have a difficult time closing on more contracts during the year.

Bottom line
While a lot of debate continues to swirl around the current market situation in the deepwater drilling sector, the companies that focused on building new fleets stand by strong demand and limited impacts. The companies with the largest fleets of older generation rigs continue to suggest a significant pause will occur in the market. In this regard, the recent weakness in Seadrill provides a buying opportunity with the stock rewarding investors with a 10.6% dividend yield to wait for the market to turn. Investors in Transocean only obtain a 5.3% dividend and the agony of an aging fleet.

If Seadrill is accurate about the current pause accelerating demand, investors will enjoy the spoils from buying the stock at current levels for years.

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Mark Holder has no position in any stocks mentioned. The Motley Fool recommends Seadrill. The Motley Fool owns shares of Seadrill and 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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