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RIP, Oil Rigs?

By Toby Shute - Updated Apr 5, 2017 at 8:01PM

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Reports of rig order cancellations are rocking the oil service space.

Forgive me for failing to pick up this thread until now, my fellow Fools. The latest word out of the Singaporean shipyards is simply one of the most important developing stories in the entire energy sector.

The Friday before last, No. 1 rig builder Keppel announced that it's in talks with three different clients about renegotiating contracts on some orders placed earlier this year. Scorpion Offshore and Lewek Shipping probably aren't familiar names, but Seadrill is a Nordic newcomer that has been featured in these pages on several occasions.

You may remember the tie-up rumors with contractor Noble (NYSE:NE), the Pride International (NYSE:PDE) takeover talk, and the feats of financial engineering that turned Seadrill into the first high-yielding driller. That latter turn has put a real strain on the firm's finances, as I began to suspect late last summer. The clearest evidence is this news that Seadrill's looking to tweak two jackup rig commitments. At $210 million apiece, these rigs would prove to be exorbitantly priced if dayrates were to decline dramatically.

Unless Saudi Arabia decides to save the day via some heroic output reductions -- and I don't really see the motivation for such a move -- I'm afraid collapsing rig rates are a very strong possibility. Seadrill has cited more than 50 jackups hitting the water by the end of 2009. That is a lot of capacity to absorb, given the implosion of drilling budgets by smaller offshore players around the world.

That leaves us with two general scenarios. Either cancellations begin to pile up, dinging the backlogs of folks like Keppel and National Oilwell Varco (NYSE:NOV), or financing suddenly starts to flow again, and overcapacity slams the drilling contractors. Between the sorry state of credit markets and the deteriorating economics of offshore drilling, I'm not sure which suboptimal scenario will play out, but we ought to at least entertain the latter idea.

I think that while lower-quality drillers are in for a drubbing, premier operators like Transocean (NYSE:RIG) and Diamond Offshore (NYSE:DO) are not about to have half-idle fleets on their hands. Given the long-term nature of the contracts, not to mention the financial footing of the clients behind them, deepwater commitments remain a critical component of driller backlogs. In that regard, Ensco International (NYSE:ESV) may be making the transition in the nick of time.

In Motley Fool CAPS, Fools don't appear to be fretting about National Oilwell's future, given the firm's five-star rating. I'd be interested in hearing more opinions, which you can post along with your own underperform or outperform call right here.

National Oilwell Varco is a Motley Fool Stock Advisor selection. Drill into any of our newsletters free for 30 days.

Fool contributor Toby Shute gets busy in CAPS under the name TMFSmashy, but he doesn't have a position in any company mentioned. The Motley Fool's disclosure policy is to be savored like a Sauternes.

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Stocks Mentioned

Transocean Ltd. Stock Quote
Transocean Ltd.
RIG
$3.62 (1.12%) $0.04
Noble Corporation plc Stock Quote
Noble Corporation plc
NEBLQ
Diamond Offshore Drilling, Inc. Stock Quote
Diamond Offshore Drilling, Inc.
DO
Valaris plc Stock Quote
Valaris plc
VAL
National Oilwell Varco, Inc. Stock Quote
National Oilwell Varco, Inc.
NOV
$18.62 (1.03%) $0.19

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

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