Seadrill Ltd.'s Offshore Rig Deal Is More Evidence of a Bifurcated Market

Seadrill's big deal with French national oil company Total is not so much an unexpected breakthrough as much as further evidence of a bifurcated offshore rig market.

Jun 18, 2014 at 12:42PM

Seadrill Pic Wiki Source

Image source: Wikipedia.

Seadrill (NYSE:SDRL) just scored a big deal for its ultra-deepwater newbuild drillship, the West Jupiter. Total (NYSE:TOT), the French national oil company, contracted the West Jupiter for five years of service for a total of $1.1 billion. This comes to a dayrate of about $600,000. 

Why is this important? Because many people assumed that the increasing supply of newbuild rigs meant that ultra-deepwater drillship dayrates would drop to $500,000, or maybe even lower. The West Jupiter deal seems to contradict that conventional wisdom. However, this deal is not actually an indicator of unexpected strength in global demand for rigs, but rather of a market in which the newest ships fetch a high premium to older vessels. In other words, we have a bifurcated market. No surprise, then, that the brand-new West Jupiter went for as much as it did. 

Why is the market bifurcated? 
There are two main reasons for a bifurcated market (no pun intended). First, the Deepwater Horizon oil spill in 2010 caused offshore operators to take a second look at safety issues and the risks involved with offshore rigs. Rig manufacturers responded by concentrating on development of technology that would make subsequent generations of rigs safer than ever. Therefore, offshore operators today prefer newer models because those rigs are far safer. 

Offshore Discoveries Sdrl

Chart courtesy of Seadrill Investor Relations

Second, the majority of recent offshore discoveries have come at depths considered either deepwater or ultra-deepwater. Exploration at these depths is relatively new. Because these depths are also the most recently explored areas, it makes sense that the newer rigs are more effective in exploring at those depths. 

Who benefits? 
In this bifurcated market, the companies with the youngest, most deepwater-oriented fleet will also be the most resistant to dayrate declines. But which companies are those? The short answer: Seadrill.

Of the major rig lessors, Seadrill has the lowest average fleet age and the highest exposure to ultra-deepwater. The company's acquisition of fellow Norwegian lessor Sevan Drilling only made Seadrill's fleet even newer. Seadrill is, therefore, the most obvious benefactor from the trend of bifurcation in this industry, and the West Jupiter deal is evidence of that.

Those looking for a smaller company or a company with less debt should try Atwood Oceanics (NYSE:ATW). Atwood is a mid-cap lessor that is considerably less leveraged than Seadrill but still has a fairly young fleet. This company, though, does not yet pay a dividend. 

Foolish takeaway
Expect to see newer deepwater rigs contracted for dayrates considerably higher than that of their older counterparts. This means that companies with young deepwater fleets will also fare considerably better than their peers. The most obvious name in this space is Seadrill, but there are a number of other, smaller lessors that can be looked at as well. 

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Casey Hoerth has no position in any stocks mentioned. The Motley Fool recommends Atwood Oceanics. The Motley Fool owns shares of Atwood Oceanics. 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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