Why Diamond Offshore Is Struggling to Keep Its Head Above Water

Significantly higher costs to upgrade its fleet and Statoil canceling a rig contract will likely weigh on Diamond Offshore this year.

Jun 9, 2014 at 4:07PM

The near-term outlook for deepwater oil drillers is challenged, to say the least. Despite supportive commodity prices, with crude oil trading near $100 per barrel in the United States, and a sound long-term outlook thanks to rising energy demand across the globe, oil drillers face some significant bumps in the road.

In particular, Diamond Offshore Drilling (NYSE:DO) can't seem to catch a break. Its investors have gotten nothing but bad news over the past month. First, in April the company reported a poor first-quarter earnings report in which several of its key metrics deteriorated.

The latest blow comes from one of its key customers cancelling a significant order. Oil and gas exploration and production giant Statoil (NYSE:STO) recently notified Diamond Offshore it would terminate its drilling contract for the mid-water semi-submersible Ocean Vanguard.

Add it all up, and it's clear that Diamond Offshore is in the middle of a rough patch.

Statoil cuts back
Oil and gas companies of all shapes and sizes are cutting back on capital expenditures, which is confusing for a number of reasons. The global economic recovery, while perhaps more sluggish than most would like, is proceeding at a slow and steady pace. In addition, oil prices are still supportive of growth and aren't having a negative impact. Last but not least, demand for energy continues to increase in the emerging markets, as it seems that developing nations across the world can't get enough oil and gas.

Nevertheless, large and extremely mature oil companies are having difficulty generating satisfactory returns from new projects. They struggle to find projects large and attractive enough to move the needle. And, since investors are clamoring for greater cash returns, companies are turning to harsh cost cuts to boost profitability.

Statoil is the latest example of a company trimming capital expenditures to keep its investors happy. According to Bloomberg, Statoil management is seeking to reduce spending to generate $5 billion per year in cost savings. This includes reducing capital expenditures by as much as 25%, and Diamond Offshore seems to be the first victim.

Statoil is terminating a contract that holds a dayrate of $454,000. Analysts estimate the impact of Statoil's decision to be fairly significant to Diamond Offshore's bottom line. Barron's reports the cancellation could shave approximately $0.33 per share off Diamond Offshore's earnings. That will be somewhat mitigated by an early termination payment the oil driller is likely to receive in accordance with the contract, but it's clear that this is a significant event.

Diamond Offshore was already hurting from the downturn in rig ordering activity. Revenue and net income dropped by 2% and 17%, respectively, last quarter. This is on top of a fairly poor performance last year in which the company's operating profit fell by 17%, driven primarily by higher drilling expenses.

Going forward, investors should be concerned about Diamond Offshore's costs. That's because it plans to double its capital expenditures in 2014 to upgrade its fleet. The company expects to spend $2.1 billion on new-builds and other upgrades.

Management under pressure
Diamond Offshore put up a disappointing performance last year, and things didn't get much better in the first quarter. It's seeing less demand for its rigs, and it's about to spend billions to upgrade its fleet. Now, Diamond Offshore will be under even greater stress since Norwegian oil exploration and production company Statoil has cancelled a significant contract.

The long-term economics of offshore drilling are sound, based on the fact that demand is set to rise, especially in the emerging markets. But not all drillers are created equal. Some will sail through better than others, and it appears that for the time being, Diamond Offshore is at a disadvantage.

Do you know this energy tax "loophole"?
You already know record oil and natural gas production is changing the lives of millions of Americans. But what you probably haven't heard is that the IRS is encouraging investors to support our growing energy renaissance, offering you a tax loophole to invest in some of America's greatest energy companies. Take advantage of this profitable opportunity by grabbing your brand-new special report, "The IRS Is Daring You to Make This Investment Now!," and you'll learn about the simple strategy to take advantage of a little-known IRS rule. Don't miss out on advice that could help you cut taxes for decades to come. Click here to learn more.


Bob Ciura has no position in any stocks mentioned. The Motley Fool recommends Statoil (ADR). 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.

4 in 5 Americans Are Ignoring Buffett's Warning

Don't be one of them.

Jun 12, 2015 at 5:01PM

Admitting fear is difficult.

So you can imagine how shocked I was to find out Warren Buffett recently told a select number of investors about the cutting-edge technology that's keeping him awake at night.

This past May, The Motley Fool sent 8 of its best stock analysts to Omaha, Nebraska to attend the Berkshire Hathaway annual shareholder meeting. CEO Warren Buffett and Vice Chairman Charlie Munger fielded questions for nearly 6 hours.
The catch was: Attendees weren't allowed to record any of it. No audio. No video. 

Our team of analysts wrote down every single word Buffett and Munger uttered. Over 16,000 words. But only two words stood out to me as I read the detailed transcript of the event: "Real threat."

That's how Buffett responded when asked about this emerging market that is already expected to be worth more than $2 trillion in the U.S. alone. Google has already put some of its best engineers behind the technology powering this trend. 

The amazing thing is, while Buffett may be nervous, the rest of us can invest in this new industry BEFORE the old money realizes what hit them.

KPMG advises we're "on the cusp of revolutionary change" coming much "sooner than you think."

Even one legendary MIT professor had to recant his position that the technology was "beyond the capability of computer science." (He recently confessed to The Wall Street Journal that he's now a believer and amazed "how quickly this technology caught on.")

Yet according to one J.D. Power and Associates survey, only 1 in 5 Americans are even interested in this technology, much less ready to invest in it. Needless to say, you haven't missed your window of opportunity. 

Think about how many amazing technologies you've watched soar to new heights while you kick yourself thinking, "I knew about that technology before everyone was talking about it, but I just sat on my hands." 

Don't let that happen again. This time, it should be your family telling you, "I can't believe you knew about and invested in that technology so early on."

That's why I hope you take just a few minutes to access the exclusive research our team of analysts has put together on this industry and the one stock positioned to capitalize on this major shift.

Click here to learn about this incredible technology before Buffett stops being scared and starts buying!

David Hanson owns shares of Berkshire Hathaway and American Express. The Motley Fool recommends and owns shares of Berkshire Hathaway, Google, and Coca-Cola.We Fools don't 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.

©1995-2014 The Motley Fool. All rights reserved. | Privacy/Legal Information