Seadrill and Diamond Offshore Drilling Are Reintroduced to Chaotic Markets

If people were clairvoyant, it would be much easier to find the mythical island of equilibrium. Sadly, markets can only paint rough estimates of how many ships should be ordered years in advance. Big oil still needs quality drilling ships to fight the Hubbert curve, but oversupply in the offshore market is going to compress dayrates. The best drillers can do is batten down the hatches. 

The macro story
The big Norwegian driller Statoil (NYSE: STO  ) just opened a $39 million research facility to try to increase its recovery rate by 10% in the Norwegian Continental Shelf. This development is not too surprising. Many European formations were developed decades ago, and now new methods are needed to fight declining production. 

Statoil is a big company, producing 1.98 million barrels of oil equivalent per day (mmboepd) in the first quarter of 2014. Boosting recovery rates is one way for the company to fight the Hubbert curve, but it needs more tools. Bringing new fields online can be an easier way to boost production once standard enhanced recovery techniques have been employed. Statoil has made a big push into U.S. shale plays, but there are other formations to be explored.

Total (NYSE: TOT  ) has leased a number of ultra-deepwater rigs from Seadrill (NYSE: SDRL  ) . It currently has one of Seadrill's semi-submersibles in Angola, another in the U.K., and an ultra-deepwater drillship in Angola. Seadrill just signed a deal for another ultra-deepwater drillship with Total at $600,000 per day. Total does not have Statoil's home-turf advantage in Norway, so the French company is heading off to Europe's former African colonies. 

In order to grow its 2013 2.3 mboepd production base, Total is focusing on a number of key projects. Of the six big projects it is working on between now and 2017, 50% are deepwater plays.  Total's challenge is to bring these expensive projects online without hurting profits. Its 5.1% profit margin is already worse than Statoil's profit margin of 8.7%. Both companies are looking to use their capital expenditure budgets as effectively as possible in order to avoid further constricting profits. 

The offshore market
While the demand side is not falling away, the supply of offshore rigs is worrisome.  In February there were 87 ultra-deepwater rigs on order, representing almost 66% of the world's existing fleet. The majority of these rigs are expected to hit the market in the next two years.

While the ultra-deepwater backlog has grown in recent years, the deepwater backlog has consistently decreased since 2009. Now Seadrill expects that the deeper end of the market will see dayrates on new vessels fall to $425,000 to $475,000 per day from their recent peak of $650,000.

The market is becoming a buyer's market. The newest rigs will become more attractive, and companies saddled with older rigs will have to accept lower dayrates. Diamond Offshore Drilling (NYSE: DO  ) will face challenges with its older fleet. Including ships under construction, its fleet's average build year is 1992. It is heavily exposed to the deepwater and ultra-deepwater floater markets. Combined they account for 51% of Diamond Offshore Drilling's Q1 2014 contract drilling revenue. 

The encouraging news for Seadrill is that its ships are relatively new. Including ships under construction Seadrill's fleet's average build year is 2011. The downside is that a significant number of Seadrill's new ships will leave the shipyards just as the market heads south. With a total debt-to-equity ratio of 1.32, Seadrill will face financial stress in the coming years.

Get ready for the momentum traders
Seadrill is a prime candidate to see its stock hammered in the coming years as its new ships hit the market. Still, oversupply of ultra-deepwater rigs does not change the fact that big companies like Total and Statoil need Seadrill's rigs to fight off the Hubbert curve. Seadrill's stock could get hammered, but the company still has a good value proposition.

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Read/Post Comments (5) | Recommend This Article (2)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On July 02, 2014, at 10:58 AM, awallejr wrote:

    Can you please link a direct quote from someone at SDRL saying they see the prices for their rigs will be falling to $425,000-475,000 please.

  • Report this Comment On July 02, 2014, at 11:33 AM, malasuerte wrote:

    Agreed with above...this statement is FALSE!! There has never been such a comment made. It is a rumor that people have jumped on and are parrotting!!!!

  • Report this Comment On July 02, 2014, at 8:36 PM, marineoffshore wrote:

    That day-rate is not just a rumor. Seadrill has specifically mentioned price range of $425,000-$475,000 in their 1st quarterly earnings report of 2014. Go to their website, download and read it for yourself.

    That price range may or may not pan out which is for everyone to analyse on their own.

  • Report this Comment On July 04, 2014, at 5:17 AM, marineoffshore wrote:

    Here's a very simple blog post on explaining why offshore drilling sector will remain in a tough phase for some time to come.

    http://marineoffshore.wordpress.com/

  • Report this Comment On July 04, 2014, at 11:24 AM, awallejr wrote:

    Except that was a range they gave at the LOW END of their ranges for the INDUSTRY. You seem to conveniently ignore the the $650,000 UPPER range and the $550,000 middle and what they call the sweet spot range. You really think 30 year rigs deserve the same pricing as spanking brand new ones?

    Here is something too many purported authors seem t ignore putting into their articles. It is called a QUOTE from a PERSON at SDRL:

    This from May cc from CEO:

    "As for expected, normalized rates on sixth gen assets over the long term, the industry requires dayrates to be in the 500 to 550 range to achieve an attractive return on investment and justify newbuild programs. Therefore Seadrill believe that two cycle rates average in the low to mid 500, however, Seadrill swings around the average can be expected."

    And this from Feb cc from CEO:

    "Yes, I think we’ve said several times, in this market when it’s been good and when it’s been bad, we say that $450 low day rate, $650 is a high day rate, $550 is probably the level where we have a very good return when you are talking about the assets generating around five times enterprise value of the EBITDA. While you don’t see a lot of ordering if rigs are just about 600, you’ve seen that few times and then it leads to massive order increase pretty quickly, I think the $550 level, you have a limited amounted of ordering, you have a very decent return on the capital investment around 5x EBITDA."

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