Few investors could have imagined that it would take more than three years for the offshore drilling market to pick back up when oil prices started to crash back in 2014. Yet here we are with companies still retiring rigs and little new work out there. Even though Transocean (RIG +0.80%) has handled the downturn better than others, its results have still suffered mightily over the past several years.
But according to management, there are some signs of life that should give investors hope. As we get closer to the company's earnings release, here are several quotes from Transocean's previous conference call that should give you an idea of what to look for.
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Getting cost savings to stick
Rig companies have been quite quick to mention cost savings over the past couple of years and how that impacts the bottom line. This past quarter, CEO Jeremy Thigpen wasn't any different, as he drove home the fact that cost savings are helping the bottom line.
Across the organization, we are thoroughly evaluating every activity, every process and every dollar spent. As a direct result of this laser-like focus, our first quarter adjusted normalized EBITDA margin was an impressive 48%, despite a 7% sequential decline in adjusted normalized revenue. And through the thoughtful analysis of data, the application of new technologies, our innovative approach with key suppliers and our ongoing exhaustive review of key processes, we believe that we can deliver additional structural cost savings, which should drive best-in-class incremental margins as we come out of this downturn.
There's nothing like a down market that puts an industry on the brink of solvency to see what kind of cost savings can be found in their operations. Based on the company's earnings results, it looks like Transocean has done a reasonable job. The real question now is whether management can indeed make these cost savings stick when oil prices rise. In the past, industries like this tend to have short memories.
The gap between offshore and onshore is narrowing
A significant development that has thrown the offshore rig industry a curveball is that onshore shale drilling became cheap very fast. For some companies, the rates of return on a shale well at today's price are better than a well drilled in 2104 at $90 a barrel. That development has led many investors to flock toward onshore-centric companies and away from offshore players.
It would appear, however, that offshore drilling is starting to catch up. As Thigpen stated, lower service costs, better technology, and improved business practices have drastically lowered the breakeven price for an offshore barrel of oil.
We also see that many of the named Deepwater projects that have been on hold for the last couple of years, now carry break-evens at or below $50 per barrel and, in increasing numbers, at or below $40 per barrel. And finally, we see that cost inflation onshore coupled with structural and sustainable cost savings offshore are narrowing the risk/reward gap between onshore and offshore investments. As a result, our conversations with customers remain constructive. During our last earnings conference call, we stated that a price per barrel in excess of $50 seemed to spark demand from certain independent and national oil companies. We also stated that we are seeing pockets of demand emerging in the U.K., Norway, India and Southeast Asia. Well as noted in our Fleet Status Report, we successfully contracted the harsh environment floater, the Transocean Spitsbergen, with Statoil for work in both the U.K. and Norway beginning in the third quarter and extending into late 2018.
This is encouraging for offshore companies, but it still doesn't address another stark difference between offshore and shale: time. The turnaround time for a shale well to go from a fallow field to a producing asset can now be measured in weeks versus a couple of years for an offshore reservoir. As companies look to replenish their cash coffers, they are still going to opt for shale simply because the payoff period is so much shorter.
Managing the downturn...
While Transocean has had some success in putting some of its rigs to work or extending the terms for rigs already on the water, it's pretty clear that the company is still in capital preservation mode to some degree. So when management had the opportunity to unload some assets at a decent rate of return, it did. Again, Thigpen had this to say:
While we certainly remain hopeful that we will continue to experience incremental demand for offshore drilling services, we acknowledge that we must take the steps necessary to further strengthen our enterprise as we successfully navigate this downturn and prepare for the eventual recovery. One such step includes our ongoing negotiations with Borr Drilling to sell our current fleet of 10 high-specification jackups as well as our 5 jackups under construction, for a total consideration of approximately $1.35 billion...
... or preparing for something big
There may be some alternative motives for this asset sale, though. According to Thigpen, the company wants to focus wholly on deepwater and harsh environment drilling, and unloading these assets gets them closer to that goal while giving it a lot of short- to medium-term liquidity. Considering the cash gained from this deal, the cash on hand, and its available credit lines, Transocean has more than $4.5 billion at its disposal.
As bad as the market is right now, that is much more liquidity than the company needs to see it through this downturn provided it continues on its current track. What's more likely is the company is looking to make a move relatively soon.
[A]as previously discussed, we will continue to look outside Transocean and evaluate opportunities to further grow and enhance our ultra-deepwater and harsh environment fleet. As you well know, many of the distressed players in the industry with attractive assets are now restructuring, which increases their appeal as consolidation candidates. There are also a number of stranded rigs available in shipyards that are highly capable and therefore, desirable. We will continue to closely monitor the entire landscape as we consider opportunities to grow and high-grade our fleet.
Transocean has been mentioning the possibility of a merger or acquisition for some time now. So this should come as no surprise. Likely accelerating that time horizon are this move to free up some cash and the recent announcement that one of its direct competitors inked a rather lucrative acquisition.
The rig oversupply isn't as bad as it looks
Demand is going to pick up; there is little doubt of that happening as breakeven prices decline and oil production outside the U.S. continues to slide. But for rig investors, the question is still whether there are too many rigs to satisfy that demand. After all, there are a lot of idle rigs fighting for table scraps right now. The total number of available rigs may be artificially inflated, however, according to Thigpen:
[I]f you look at the total supply, there are a number of rigs in there that just don't have the technical capability that our customers are demanding in the current environment. And so you can go and you can cut a few out there. Then Terry mentioned that customers are putting a greater focus on financial stability of drilling contractors so you can probably take a few out there. And then we know for a fact that a lot of these rigs that are being stacked are not being preserved the way that they need to be preserved, and so the costs to reactivate them are going to be prohibitive. And so I think if you look at the total -- the absolute number on the supply side, you'd probably be making a bit of a mistake. So I don't think the supply side is near -- and the gap is nearly as wide as it seems just by looking at the absolute number.
If this is the case, then it should lead to a faster tightening of the market and, as a result, more pricing power for rig owners. Transocean management did mention that it is already starting to see tightening in this harsh environment, where the supply of these niche rigs is much smaller than the overall rig count. If several of these seemingly ready-to-work rigs aren't going to get new contracts, then that should bode well for Transocean and just about every other rig company that has the right rigs for the job.
