Deepwater Driller Plunge: Legacy Drillers

Over the last several months, several analysts have come out with dire warnings of a further plunge in shares of deepwater drillers. The market, which had already soured on the sector from several warnings of a pause in demand for offshore drilling in the deepest areas, is questioning the timing of the analyst calls.

The cyclical offshore-drilling market faces an interesting dynamic of customers rethinking capital projects while oil and natural gas prices sit near recent highs. On top of that dynamic, a bifurcation is occurring in the market where the newest high-specification rigs remain in solid demand while the oldest rigs face idle time and the potential for being cold-stacked or dismantled.

Naturally analysts are negative on the legacy drillers -- Diamond Offshore (NYSE: DO  ) , Ensco (NYSE: ESV  ) , and Transocean (NYSE: RIG  ) -- which face the issue of older rigs being replaced by modern drillers.

Due to the Macondo well explosion and the need for more advanced technologies, the market is facing a real dynamic that the age of the rig matters more than the dayrate price. No longer are rigs valued on a sliding scale where they slowly lose value every year. Now a rig over 30 years old has very limited options for finding contracts. This bifurcation in the market makes understanding the fleet age of rig owners more important than ever and is setting up a distinction between legacy and modern drillers in the sector.

Idled rigs
A couple of weeks back, Credit Suisse analyst Gregory Lewis listed nine floating rigs as idle and another 18 rolling off contract through the second quarter. All but three of those rigs are outdated fifth generation or older rigs facing the real possibility of being warm-stacked for future service or being cold-stacked. Of the rigs currently idle, Transocean owns five and Diamond Offshore owns three. On top of that, Transocean offered up that it had 12 rigs without contracts this year, placing the company in a terrible contractual hole.

Back in late January, Barclays analysts James West and Zachary Sadow suggested that stocks in the sector could plunge 35% or more. The analysts suggested that earnings and EBITDA numbers for 2015 would fall some 30% below current estimates. The forecast was for Diamond Offshore to plunge 45% and Transocean to fall 24% with the possibility of substantially larger drops in a stock market sell-off.

Late analysis  
Considering most deepwater driller stocks peaked back in late 2013, a lot of this analysis is late to the game and doesn't distinguish nearly enough between those with old rigs and those with aggressive new-build programs and a fleet of modern rigs.

Due to its own recent admission, Transocean faces the most risk with 12 rigs lacking contracts. As mentioned in the previous analysis, Diamond Offshore already has three rigs without contacts while Ensco has one, and both of those drillers have more rigs without contracts covering all of 2014.

Based on a recent analysis by Seadrill, the biggest risk comes with rigs over 20 years old. It provided the following slide in a recent presentation showing the vast difference in age of rig fleets.

Source: Seadrill presentation

Bottom line
In general, the analysts were correct that the deepwater drillers face the risk of declining stock prices -- if the analysis had been completed at the end of 2013. Most of the stocks sit with limited losses since these dire analyst reports from January and a couple of weeks back. At this point, the biggest concern would be with the stocks of the legacy drillers that face uncertain scenarios with numerous rigs lacking legitimate contract options. Transocean and Diamond Offshore appear to face the biggest risks with old deepwater fleets. Conversely, though Ensco has a more modern deepwater fleet than those two, it does have a very old jack-up fleet. The legacy drillers aren't attractive stocks until these fleets are modernized.

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  • Report this Comment On April 08, 2014, at 4:28 PM, spokanimal wrote:

    Last October, IHS reported dayrates for midwater floaters at record levels at the end of a 3 month surge in rates. To me, it appeared to be due to the very high rates being inked on new contracts for the ultra-deeps... in essence, substituting midwaters where possible to economize.

    Once rates began to break for the ultra-deeps as winter approached, some companies began to favor the highest spec. rigs again, while others chose to delay writing new contracts until rates began to subside more going into 2014.

    As day rates continue to slip this year, look for more and more of those contracts to get written. All of this is just an adjustment in the market, borne out of record high rates for the ultras last year, and the subsequent records for older and midwater units that followed that.

    That fact that the fallout has been a significant number of un-contracted rigs this spring, exploration companies are not blind to the fact that the idle rigs, combined with delays in signing contracts, will deliver them a better deal once they get their price.

    In the end, currently firm oil prices will provide the capital, and incentive, for the contracts to get signed and the capacity utilizaion to firm up. To the extent that allows a lower entry point into these stocks, patient investors (like Carl Icahn) will eventually be rewarded...

    ... in a market that otherwise, is within a week of it's latest record highs.

    Spokanimal

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