On September 20, Brazilian oil and gas giant Petroleo Brasileiro SA Petrobras (ADR) (NYSE:PBR) announced a "strategic plan and business management plan" targeted largely at making the company safer and reducing its debt leverage over the next five years. This is a laudable and reasonable strategy for Petrobras, which is buried in $123 million in debt and has suffered heavily under low oil prices. Factor in a disaster of an economy in Brazil, and Petrobras' leadership is taking necessary steps for that company.
This news is likely to be good for Petrobras investors over the next several years, and the initial reaction is that it's bad for offshore drillers, particularly Seadrill Ltd (NYSE:SDRL), which counted on Petrobras for 20% of its work in 2015. However, it's not so clear that Petrobras' new strategic plan, even though it does call for a 25% cut in capital spending, is actually going to be bad for its offshore drilling contractors. Here's a closer look at why that might be the case.
A closer look at Petrobras' plan
Two years into the oil downturn, there remains a glut of global supplies. But at the same time, the sharp reduction in capital spending over the past year or so is starting to catch up to the oversupply, with production at existing oil sites set to decline without further investment. Because of this, a popular expectation is that major oil producers would start spending again in 2017, even if at an only moderately higher level than the past few quarters. So, when one of the world's largest producers, Petrobras, says it will cut another 25% from its spending plan over the next five years, it's worrisome for investors in companies such as Seadrill, which rely heavily on producers to invest in developing and growing their production.
But it may not be as bad for Seadrill and its peers as it seems on the surface, for three reasons:
- Divestments of multiple oil and gas assets.
- Petrobras' exit of several non-oil and gas industries.
- Plans to focus on existing deepwater reserves.
At least part of the reduction in planned spending is tied to the decision to exit the fertilizer, biofuels, and some petrochemicals businesses, the divestment of a number of non-core exploratory assets (including a recent $2.5 billion deal with Norwegian Statoil), which means the company's capital spending should fall. At the same time, the company's plans to focus on existing deepwater reserves are probably a good thing for offshore drillers like Seadrill.
Petrobras' new strategic plan could be good for Seadrill, but...
It's really too early to know for sure. At this point, Seadrill and its subsidiaries only have three vessels working for Petrobras, and they're all under contract into 2018. But at the same time, if the company does indeed plan to emphasize its currently producing offshore reserves, it will almost certainly need to invest in more drilling work there.
Whether that work goes to Seadrill or not, though, is far from clear. At this stage, Petrobras has only announced the rough outline of its strategic plan, and it's not likely to become clear for many months if the "picks and shovels" work actually involves Seadrill.