It's actually been a good few months for Seadrill Partners LLC (NYSE:SDLP). The company managed to untangle itself from its parent, Seadrill (NYSE:SDRL), prior to the parent's bankruptcy filing. It posted better sequential quarterly earnings in its most recent third quarter. The company's share price has rallied in the second half of December.
But in spite of all that, I still won't buy the stock for one simple reason: uncertainty.
An uncertain industry
The entire offshore rig industry -- Seadrill, Seadrill Partners, and Transocean included -- has been awash in uncertainty for years now. And even the last few months of rising oil prices have done little to change that.
Thanks to those rising prices -- and some aggressive cost-cutting -- many producers are turning profits again. As they look to increase production while controlling costs, though, they may be more inclined to invest in cheaper traditional onshore shale plays rather than the deepwater and ultra-deepwater plays that are the most lucrative for offshore rig operators.
Offshore plays -- particularly in deep or ultra-deep water -- are notoriously risky and expensive to develop. Data compiled by Rystad Energy indicates that while onshore shale plays have an expected breakeven of $50/barrel, deepwater plays have an expected breakeven of $82/barrel. It also takes longer to recoup the investment on a deepwater play.
True, companies are still making promising offshore discoveries, but in a world of $50 to $60/barrel oil, some offshore projects simply aren't going to be as economically feasible as they would have been at $90/barrel oil. That's why, for example, Royal Dutch Shell and ConocoPhillips allowed their Arctic offshore drilling rights to expire last year.
And that makes for an uncertain outlook for companies like Seadrill Partners, Ensco, and Transocean.
An uncertain stake
Although Seadrill Partners managed to escape its parent's bankruptcy pretty much unscathed -- at least, for the time being -- there's still a big reason that Seadrill Partners investors should be concerned about parent Seadrill's future. And that's the 46.6% stake in Seadrill Partners that's still held by the bankrupt Seadrill. That position includes a direct 28.6% stake in the company, with an additional 18% consisting of subordinated units (assuming full conversion).
Nobody knows exactly what's going to happen to that position, because nobody knows exactly what's going to happen to Seadrill. In a recent plan filed with the U.S. Bankruptcy Court for the Southern District of Texas, Seadrill proposes splitting itself up into three separate entities, one of which -- "NSNCo," short for the "New Secured Notes" that would back the new entity -- would own the stake in Seadrill Partners.
If the company's creditors agree to the arrangement, they'd own the stake in Seadrill Partners through NSNCo, and could then simply sell it to the public. That would set up Seadrill Partners as a completely independent entity. But NSNCo could also decide to sell its stake to a larger competitor like Transocean or Ensco, both of which have a recent history of gobbling up smaller competitors. Or it's possible the creditors won't approve of the plan, and something else could happen entirely.
Speaking of something else happening, it's also worth noting that, rather ominously, the bankruptcy plan filing notes that Seadrill Partners -- as a "managed, nonconsolidated corporate group" under Seadrill -- is "assumed to require some form of restructuring or liquidation process." Uncertainty abounds.
An uncertain future
Let's say that a competing rig operator like Ensco or Transocean gets hold of a major stake in Seadrill Partners, either by buying it from NSNCo, or by some other means: Would the buyer try to make a play for the rest of the company?
That would be a logical move, and would likely benefit Seadrill Partners shareholders, who could expect to receive a premium for their shares. With just 11 rigs, Seadrill Partners' fleet would be relatively easy for a larger competitor to absorb.
But if nobody does buy it, Seadrill Partners could just as easily find itself -- and its 11 rigs -- a lone little fish in a very big pond of larger competitors, which would leave it with very little pricing power in a highly competitive industry.
Too uncertain for investors
Given the uncertainty surrounding the industry, its parent, and its future, I won't buy Seadrill Partners.
It's possible, of course, that Seadrill's creditors will approve its bankruptcy plan and sell its stake in Seadrill Partners to a competitor, which will buy the rest of the company at a premium to today's valuation, resulting in a nice payday for investors. But that's far from a sure thing, and shareholders shouldn't expect it.
The bottom line is, there are better values right now in the oil industry that offer less risk and bigger upside potential. Check them out instead until Seadrill Partners' future becomes at least a little less murky.