Seadrill Ltd Takes Steps to Ride Out Downturn, but When Offshore Will Recover Remains Unknown

Seadrill, is fighting for less and less work in the ongoing downturn.The good news is, its costs are falling, and debtors have been amenable to negotiations so far. 

When Seadrill Ltd (SDRL) reported financial and operating results on May 26, the numbers came in pretty much as expected, with revenue and profits sharply lower, while the debt picture remains only slightly improved. However, operating costs continue to fall, and management says it's making progress on improving its debt profile after a recent round of talks suspended several key covenants and delayed the maturities of several large notes that were set to come due over the next year. 

At the same time, Seadrill's prospects are tied to a recovery in demand for offshore drilling, and that's a prospect that doesn't feel like it's getting any nearer, as the offshore market continues to deteriorate with a still-oversupplied global vessel fleet.

Let's take a closer look at Seadrill's earnings release, as well as what management had to say about the state of the industry, and how they see things playing out. 

The numbers

Revenue and earnings in millions. Backlog in billions. Data source: Seadrill.

As you can see, Seadrill's revenue and earnings continue to deteriorate, as more of its vessels are idle versus the year-ago period. At the same time, the company had essentially the same number of vessels operating in the first quarter as it did in the fourth quarter of 2015.

However, since the end of the first quarter, Seadrill has had multiple contracts expire. According to its February fleet status report, Seadrill and its affiliates had nine active vessels out of contract. In its most recent fleet status report, issued with its earnings report dated May 26, that number had increased to 12 vessels. Furthermore, Seadrill and its affiliates have another 10 vessels with contracts set to expire by the end of 2016. Of that 10, two have options that may or may not be picked up.

What happened in the quarter

While the offshore drilling environment has only continued to deteriorate since the beginning of 2016, Seadrill has made some progress on several important fronts:

• Seadrill creditors agreed to extend the maturities on several of its credit facilities as follows:
• $450 million maturing June 2016, extended to December 2016 maturity.
• $400 million maturing December 2016, extended to May 2017.
• $2 billion credit facility of Seadrill subsidiary North Atlantic Drilling Ltd. maturing in April 2017, extended to June 2017. Seadrill is a guarantor of this debt. 
• Seadrill creditors also agreed to these covenant amendments:
• A reset of the leverage covenant.
• A revised definition of the equity ratio to exclude the impact of any change to the market value of its rigs.
• A suspension of the provision that allows lenders to receive a prepayment under their secured credit facilities if rig values decline below a minimum value relative to the loan balance outstanding.

This agreement was the first step in a broader, ongoing negotiation Seadrill is having with its debt holders. Seadrill sacrificed some liquidity with this deal, agreeing not to withdraw any of the $467 available under its revolving credit facilities, and to increase the minimum liquidity covenant in its credit facilities to $250 million. 

• Seadrill also reported a significant drop in operating expenses, with the $568 million this quarter 22% lower than the year-ago quarter. 
• The company said both lower active vessel operating costs as well as lower operating cost for idle vessels played a part in this decline. 

While overall backlog has declined so far this year, Seadrill has been able to win some contract extensions, though they are almost all either negotiations to lower day rates on existing contracts, or short-term work for less than one year. The following vessels have received contracts or contract extensions so far this year:

• West Tellus: 18 months at reduced day rate.
• West Eclipse: 2 years, though contract value for West Polaris was reduced as part of agreement.
• Sevan Brasil: Day rate was reduced for remaining term of this agreement as a part of a broader negotiation with Petrobras.
• Sevan Driller: 60-day contract with two 30-day options. 
• West Mischief: Day rate was reduced as part of a broader agreement with Saudi Aramco.
• AOD I: 3-month extension with Saudi Aramco.
• West Cressida: 9-month contract awarded. 

Recently, Statoil terminated the remaining term of its contract for the West Hercules, and it will pay $61 million plus demobilization costs, instead of the $94 million-plus it would have paid to keep the vessel operating. 

Seadrill also reached agreements to delay virtually all of its newbuild ships on order:

• January: Agreement with DSME to defer delivery of two ultra-deepwater drillships until the second quarter of 2018 and first quarter of 2019.
• April: Agreements with Dalian to further defer deliveries of all eight jack-ups under construction. Following this latest deferral agreement, five units are now scheduled to be delivered in 2017, and three units in 2018.
• April: Subsidiary Sevan Drilling and shipbuilder Cosco agreed to exercise the second six-month deferral option for the Sevan Developer, which extends the deferral agreement until October 15, 2016.

Looking ahead

While Seadrill has made good progress with lowering costs and working with creditors and shipbuilders to delay its obligations, the big challenge remains simply riding a downturn that's shown no sign of ending. Seadrill management estimates that 58 floating vessels have been scrapped since 2014, but that another 40 or so need to be scrapped simply to balance the market.

The Jack-up market is even more over capacity, with 133 idle units that are more than 30 years old, and 42 more over 30 years old with contracts expiring this year. Factor in a complete lack of appetite for new long-term drilling contracts from oil and gas producers, and the global fleet will only shrink further from here before the offshore market starts to recover. 

Seadrill's second-quarter guidance is for similar financial performance in the second quarter as in Q1, but it will have three vessels coming off contract during the period, and three more earning lower day rates because of contract negotiations. Higher utilization of two other vessels is expected to help offset that somewhat, but the reality is, Seadrill's next several quarters were largely cast in stone years ago, when the current contracts were first awarded. The big concern remains how long before offshore starts to recover. 

Many in the industry expect global oil supply and demand to start balancing by year-end or early 2017, but it could take even longer for offshore demand to recover. That's why Seadrill is working with its creditors and shipyards: It's buying as much time as possible to ride things out. There's no promise those efforts will pay off, but they've proven to be necessary so far.