November was a particularly volatile month for offshore drilling stocks. As you can see in the chart above, all four of these saw their stocks climb double-digits by November 23 before falling sharply in the final week of the month -- that is, before one big thing happened at the end of the month.
On November 30, OPEC announced it was cutting oil production by 1.2 million barrels per day. This was a major move by the cartel, which controls around one-third of global output, but has been in a battle with North American shale producers over the past few years to maintain its market share. However, after two-plus years of oil selling for half as much as the four years prior, it looks like OPEC's member states, led by Saudi Arabia, have finally decided the impact of cheap oil hurts more than potentially giving up market share.
Needless to say, the market has been enthusiastic since the OPEC announcement, sending crude oil prices up more than 15% and the shares of pretty much every oil-related stock up double-digits since.
Offshore investors need to understand this
There's no denying that many offshore drilling stocks are incredibly cheap now, at least based on the carrying value of their assets:
As you can see, the market is valuing all four of these companies for far less than the actual value of their assets, which are primarily their offshore drilling vessels. But it's important to remember that the carrying value of those assets today is no guarantee of what they are worth. For instance, this table shows how both ENSCO and Noble Corp have lost book value over the past couple of years, as they have scrapped older vessels and charged off the value of those assets. Rowan and Atwood have increased their book value by adding newer vessels to their fleets:
Three important takeaways:
First, those assets offer some potential backstop since they could be sold off to generate capital if needed, if the market doesn't start to recover soon enough to generate operating cash flows. That's in a worst-case scenario of a recovery taking far longer than anticipated to begin.
Second -- and this is the important point -- if that were to happen, it's almost certain those assets would generate far less than their current book value, so it's probably not a good idea to put too much faith in this metric to indicate any sort of safety for drillers as investments.
Third -- and this is the big one -- the offshore sector is almost certainly going to be at the back of the line of beneficiaries. Oil prices will have to be higher for a sustained period before oil producers start allocating capital to offshore projects in a big way because of the expense, complexity, and length of time between exploration and cash generation.
Because of this reality, investors should acknowledge that it could -- and almost certainly will -- take many more months before offshore drilling investment starts increasing. In the meantime, these companies must continue living on their existing cash flows, fight for the scraps of short-term contracts that will only cover operating costs for vessels, and hope their existing assets are enough to bridge any gaps between cash inflows and obligations.
And until that environment changes, there's little reason to make big investments in any offshore driller. Taking on some speculative risk is one thing -- but until offshore investment recovers, there's a lot more risk than there is reward.