The offshore drilling industry has been under pressure for the last several years. Its troubles started in 2014 when oil prices crashed, which forced oil producers to slash spending. Producers continued doing so for the past several years, even though oil prices have improved. Instead of increasing spending on offshore wells, oil companies either allocated that money to cheaper onshore shale plays or sent it back to shareholders via higher dividends and share buybacks.
Offshore spending, however, appears poised to end its five-year slump, with it on track to grow about 4% in 2019, according to an estimate by industry consultant Rystad Energy. That outlook has companies focused on the sector growing increasingly bullish about what's ahead.
It's finally here
"The offshore recovery is under way today," stated Jon Baksht, the CFO of offshore driller Ensco (VAL) at a recent industry conference. That's becoming increasingly evident as oil companies sanction new projects. After only making a positive final investment decision (FID) on 20 major projects in 2017, the industry sanctioned 30 last year and had "30 more queued up for 2019," according to David Demshur, the CEO of oil reservoir specialist Core Laboratories (CLB).
The increase in new project announcements is having a direct impact on oil-field service and equipment companies. "Customer demand for offshore drilling rigs continues increasing at a measured rate as evidenced by higher levels of contracting and tendering activity, particularly for assets that deliver the greatest efficiencies for offshore well programs," said Ensco CEO Carl Trowell in the company's fourth-quarter earnings release. Ensco has been a direct beneficiary of this improvement in activity, winning several new contracts and extensions for its drilling rigs in recent months as customers gear up to drill more offshore wells.
While the rebound in oil prices back up toward $70 a barrel has helped fuel the renewed enthusiasm for offshore drilling, the significant improvement in the cost profile of offshore wells has also helped drive more investment. In some regions, the return on investment can be higher than the top shale plays. One of those is Guyana, where ExxonMobil (XOM -1.79%) and Hess (HES -0.95%) are developing a massive discovery. The first phase of their Liza project will cost $3.7 billion and produce 120,000 barrels of oil equivalent per day at its peak, which will come just three years after the FID and have a low supply cost of around $30 a barrel. For comparison's sake, it would take more than 10 years and $12.8 billion to produce that much oil out of the Delaware Basin, where the supply cost is around $40 a barrel. Overall, Hess and Exxon estimate that they can pump 750,000 barrels of oil per day from this region by 2025 as they sanction five phases.
Expect a return to growth in 2019
With new oil projects like Liza from Exxon and Hess, as well as others around the world, offshore service and equipment companies expect 2019 to be the year that they return to growth. Core Labs' head of investor relations, Gwen Schreffler, stated on the fourth-quarter earnings call that "international recovery on a more broad-based scope is expected to improve as 2019 unfolds. The company believes that the 2019 international growth is expected to reach mid- to high-single-digit levels." That should "have a positive impact on financial performance in 2019," according to Schreffler.
Offshore-focused equipment and services company Oceaneering International (OII -3.16%) also sees brighter days ahead due to the pickup in drilling activity this year. On its fourth-quarter earnings call, CEO Rod Larson said, "Operationally, we anticipate all of our segments, with the exception of Asset Integrity, to generate improved results, with the largest increase in profitability occurring in Subsea Products and Advanced Technologies." This outlook leads Oceaneering to estimate that its EBITDA will increase by about 12% at the midpoint of its guidance range, which is quite an improvement from 2018, when EBITDA plunged 38%.
Offshore drillers should also see a noticeable improvement in their results. While the sector is in a transitory phase after a string of mergers in the past few years -- Ensco has already acquired rivals Atwood Oceanics and Rowan -- earnings and contract backlogs should start improving in the coming quarters as oil companies move forward with new projects.
Check out the latest earnings call transcripts for the companies we cover.
It's about time to start diving into offshore drilling stocks
It seems as if the long-awaited offshore drilling recovery has finally arrived. After years of declining, spending on new offshore projects is on track to increase this year, which should bolster the financial results of companies operating in the sector. Investors would be wise to start taking a closer look at offshore drilling stocks.