In 2014, oil was all the rage. After spending nearly all of 2013 above $100 per barrel, Brent crude stayed above the century mark for the first half of 2014, peaking at $115 per barrel in midsummer. Triple-digit oil, or so it seemed, was here to stay. At the time, onshore oil was steadily getting harder to find and more expensive to extract. Shale oil was getting started, but pulling oil out of those tight formations was very expensive and required constant drilling of new wells since output declined quickly.
So, a lot of attention went to offshore drillers. After all, the biggest untapped oil reservoirs on earth were under the world's oceans, and while it would take a lot of time and money to reach it, when brought online, it would prove very profitable. So, investors piled into this opportunity for profits from the next big phase of oil resource development.
Things have not gone as expected. Not at all.
Some of the names have changed, but we can draw a line back in time to see just how much damage has been done to people who invested in the big offshore drillers when everyone thought $100 oil was here to stay, specifically Transocean (RIG 5.83%), Seadrill (SDRL), Noble Corp (NEBLQ), Valaris PLC (VAL), and Diamond Offshore (DO) (or one of their predecessor companies).
What's a $10,000 investment in 2014 worth today?
Let's say someone with $10,000 to invest in offshore drillers decided to spread it equally across the five stocks (or their predecessors) at the start of 2014. What's that $10,000 investment worth today?
$76.83. That's a 99.2% loss of capital.
I can't think of any other subsector that's wiped out more shareholder value over a sustained period of time. Here's what it looks like on a chart:
The crest of the wave
Back in 2013 and 2014, there were good reason to be bullish on offshore drilling. These companies were cranking out gobs of cash flow as producers lined up for their services.
Seadrill is absent from this chart due to its 2018 bankruptcy and reemergence that cost shareholders 98% of their equity. But a quick glance back at that company's filings shows that it also had a great year, generating $1.7 billion in operating cash flow in 2013.
2014 was another great year:
You can add $1.6 billion in operating cash flow from Seadrill to the numbers above.
However, there were cracks showing in the thesis for offshore, as U.S. shale production ramped up and caused Saudi Arabia and its OPEC partners to flood the market with excess oil. By the end of 2014, oil prices were cut in half, and they would fall below $30 in early 2016. It wasn't until well into 2017 before crude prices started moving consistently above $50 per barrel in a sustained way.
Leaks in the hull
Initially, the decline in oil prices didn't take a big bite out of offshore drillers' results. Most of the offshore fleet was under contract, and competition for their services had pushed dayrates -- how much a driller charges for each day a drilling rig is operating -- to very high levels.
But as contracts expired, producers stopped renewing. Earnings and cash flow collapsed:
Even when oil prices started to rebound in late 2016, demand for offshore drilling never really recovered. Hundreds of vessels were scrapped, and many offshore drillers went out of business or were acquired. Transocean made several acquisitions at what looked like fire sale prices at the time. Valaris is the product of multiple mergers of smaller companies, including Atwood Oceanics, Ensco, and Rowan. Seadrill has already gone through bankruptcy reorganization once.
Shale's role in sinking offshore oil
A big reason offshore drilling never rebounded is the incredible growth of shale. Since mid-2016, U.S. crude oil production has exploded, up more than 50% from the bottom and breaking 12 million barrels per day before the recent oil crash. All of this new oil, which can be brought online quickly, washed out much of the demand for offshore spending.
During the 2015-2016 oil crash, producers got much better at producing shale, cutting production costs by half and reducing the time to bring a well online from months to weeks.
Offshore oil simply couldn't compete with this quick-turn advantage, taking years to develop and costing billions to bring online. Offshore drillers have paid the price, never seeing a full recovery even as global oil demand set records each year.
This brings us to 2020 and the COVID-19 pandemic that crashed global oil demand. Oil producers have been very slow to cut output -- the early weeks of the pandemic saw Saudi Arabia, Russia, and others actually increase their oil output in a war for market share, compounding the downturn with devastating consequences.
Time for a reset
With the world awash in excess oil, crude prices at multi-decade lows, and demand likely to be down for months -- maybe years -- to come, offshore drillers are in a world of trouble. When we add some newer public names to the list, including Borr Drilling (NYSE: BORR) and Pacific Drilling SA (NYSE: PACD), which didn't exist in their current entities five years ago, we have seven offshore drilling companies that make up the bulk of the publicly traded entities on the brink of bankruptcy.
We've already seen Diamond Offshore file for bankruptcy. Valaris and Noble look to be on the same path; secondary debt markets are pricing their bonds with upcoming maturities at around 10% of face value.
There are no safe bets. Borr and Pacific Drilling don't have any debt maturities in the next year, and Transocean and Seadrill each have more than $1 billion in cash on their balance sheets. But all are a lock to burn more cash than they generate for the foreseeable future, and they have big debt maturities in the next two years they won't likely be able to refinance. A lot of the vessels considered viable cash-generating assets at the beginning of 2020 are no longer competitive or necessary. The next round of scrapping activity will result in many of the names above not having the assets to secure refinancing.
It's time to reset the capital structures of the offshore drilling industry. Eventually, offshore oil will need to be tapped to meet global energy needs. But today's companies aren't build to function in today's global oil market.