Transocean Ltd. Faces a Daunting Contract Book

The debate over the current slowdown in the deepwater market covers a wide range of opinion regarding the duration and impact. Regardless of an investor's ultimate opinion, the offshore drilling sector always faces cyclical troughs and peaks. The key is the ability of the driller to take advantage of weakness and thrive during the following rebound.

In the case of Transocean (NYSE: RIG  ) , the company is the largest deepwater driller with 79 rigs in total and 46 of those listed as either deepwater, ultra-deepwater, or harsh environment. The deepwater specialist is now facing a bifurcated market that it is quickly finding itself on the wrong side of the contract ledger. On top of that, Carl Icahn is pressing the company for changes, but his actions can't fight industry momentum. Idled rigs in a weak market might is never a good thing, but will the stock continue to plunge?

Deepwater Market
The deepwater market is unique in that it has consistent ups and downs, yet the typical contract for the new, high-specification drillships are three to five years long. Seadrill (NYSE: SDRL  ) lists the current fleet at 256 rigs with expectations of substantial market growth by 2020. The company sees a need for 455 rigs by that time requiring massive growth in newbuilds. Other market participants aren't so sanguine, as a lot of operators now suggest the pause could last a couple of years, but the debate is whether the pause refreshes the market or, as is expected from Seadrill, that the pause accelerates demand by 2016. The slowdown is forcing limited orders for ultra-deepwater rigs in 2016, evidenced by the recent order of two rigs by Transocean with expected deliveries in 2017 and 2018.

Either way, drillers that entered this pause with the best-positioned backlog are set to survive and thrive. Due to the Macondo blast in the Gulf of Mexico, the market now requires and even requests the newest rigs typically regardless of price. In essence, a new rig typically kicks an older, low-spec rig out of future work. Some of the newest and most aggressive operators appear the best situated to weather the storm, especially with oil prices remaining stubbornly high.

Transocean issue  
In the latest earnings call, Transocean summed up its issue very succinctly. While the market is facing a pause due to oil exploration companies taking a second look at capital budgets, the impact is only to drillers with uncontracted rigs. Of the 38 floater rigs coming off contract in 2014, Transocean owns 12 of them. Most other operators are only dealing with one or two rigs not having locked up contracts for the rest of 2014. For example, Seadrill only has one rig uncontracted for the rest of 2014 while Ensco (NYSE: ESV  ) has only a handful of rigs coming off contract.

Considering the fleet size differences, a more meaningful number is the contracted fleet levels for 2014. Ensco forecasts that 90% of revenue projected for 2014 is under contract, but the forecasted utilization levels are much lower. The floater fleet should only reach a mid-70% level with the jackup segment hitting 90%. The company continued to upgrade the fleet by selling three older rigs during 2013, which helps improve even those low utilization levels.

Seadrill is the leader in the group with only the one rig up for contract in 2014 and up to 72% of the fleet contracted all the way through 2015.

Bottom line
Whether the current pause refreshes the market market or eventually accelerates demand by 2016, the deepwater drillers facing fewer uncontracted rigs in 2014 will thrive and prosper. In that case, Transocean is facing an incredibly daunting task this year with a substantial portion of the fleet uncontracted. The stock has now plunged over $15, and it might not end anytime soon unless the company secures new work for some of the existing rigs facing idle time.

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