Offshore Drillers Are Coming Under Pressure in the North Sea

Rowan Companies, Transocean, Seadrill, and Diamond Offshore are exposed to a slowdown in drilling activity within the North Sea.

May 26, 2014 at 9:11AM

There has been much speculation and conversation about the possibility of a slowdown in the offshore drilling market. Indeed, Wall Street has been keeping a close eye on the first quarter results of companies like Transocean, (NYSE:RIG) Seadrill, (NYSE:SDRL) Diamond Offshore (NYSE:DO), and Rowan Companies (NYSE:RDC) to try and establish how much of an effect this suspected slowdown is having on earnings.

The reason for this suspected slowdown? Oil and gas majors and reigning in capital spending at a time when a record number of drilling units are set to enter the global fleet. As a result, day rates are coming under pressure and utilization rates are falling.

An area of calm
However, one region of the market that has remained robust during the past two or so years is the North Sea.

The North Sea used to be the UK's version of the Gulf of Mexico, but production has been on the decline during the past few years. In part, this decline is due to the region's aging oil fields, but the North Sea's infrastructure is decades old and the UK government has imposed a crippling tax regime upon the industry. As a result, projects are now being abandoned as they lose economic viability.

Still, some of the region's biggest producers remain, including BP, Statoil, Shell, and Total, and these majors continue to invest in order to drive growth.

For the past two years capital spending on oil projects within the North Sea has expanded at a rate of around 15% per annum. This growth has been driven by the regions' larger players, as listed above with some of the bigger player increasing capex spending by up to 17% per annum for the past five years.

However, so far this year, capex spending within the North Sea has been static. Unfortunately, for offshore rig operators with exposure to the North Sea this is going to be an issue.

Specifically, Rowan has the most exposure to the North Sea with 32% of the company's revenue coming from rigs on contract within the region. 18% of Seadrill's rigs are based in the region, and Diamond offshore gets 17% of its revenues from the region.

Transocean, however, might get off lightly as the company just spun off eight of its North Sea rigs into a new entity called Caledonia Offshore Drilling Company sometime during the next few months. That being said, this new entity has six North Sea rigs coming off contract during 2014, and these could have trouble finding new customers.

Most exposure
As 32% of Rowan's revenue comes from rigs on contract within the North Sea investors are right to be concerned about the company's outlook.

But there is no need to worry, at least there isn't in the short-term. In particular, Rowan's management stated on the company's first quarter conference call:

Now turning to the North Sea. All 6 of our jack-ups are contracted, and we expect these projects to last through 2014 and beyond...Rowan Stavanger will spend more time in the U.K. with talisman before mobilizing the Norway and negotiations are ongoing with the Apache for the extension of the Gorilla VII. The Gorilla VI is expected to begin operations from ConocoPhillips in June, and the Rowan Viking has just arrived at the shipyard in preparation for the lending work in Norway.

So it would seem as if the company's rigs are all contracted out, and the company plans to move one of its rigs out of UK waters toward Norway later this year/early next.

Foolish summary
All in all, it would appear as if offshore drillers with exposure to the North Sea are going to find it tough going during the next few years as rigs roll off contract and capital spending within the region falls. That said, Rowan has so far managed to avoid this slowdown, and management is currently upbeat about the company's future within the region, although as of yet it is not clear if the company's peers will be able to follow suit. 

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Rupert Hargreaves owns shares of Rowan Companies. 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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