In a previous article, I explored the bifurcation in the deepwater drilling sector with a focus on the legacy stocks having older rigs not suited for modern exploration demand. This article will focus on the group of modern rig operators not facing the issue of rigs over 20 years old.

Analysts are negative on the whole sector, though the modern drillers – Seadrill Limited (NYSE:SDRL), Ocean Rig UDW (NASDAQ:ORIG), and Pacific Drilling SA (NYSE:PACD) – are in the attractive position of having modern drillships replacing older rigs operated by the legacy drillers.

The bigger issue for these modern operators is more whether new rigs obtain solid rates for the rest of 2014 and 2015. This bifurcation in the market makes understanding the fleet age of rig owners more important than ever and is setting up distinct differences between individual names in the sector. 

New rigs
While all of the deepwater drillers have implemented newbuild programs, the legacy operators covered in the first article have only replaced a portion of the previous fleet with the modern, high-spec rigs. In the case of the modern operators, the fleets are made up of virtually all modern rigs.

Seadrill has the largest fleet in this group and a comparable size to the legacy fleets. The company has a near 100% contract status for 2014 with only a couple of rigs in question. For 2015, Seadrill already has over 70% of rigs under contract. A bigger concern with Seadrill sits with the large debt load of $13.9 billion at year-end. Analysts are extremely concerned that during a market sell-off, liquidity concerns would send the stock down over 70%.

Both Ocean Rig and Pacific Drilling are modern firms with all new rigs. Ocean Rig operates 11 rigs counting the rigs under construction. Only two rigs are older than 2011 and only two rigs come off contract at the end of 2014. The rig operator faces some risk in 2015 if contracting doesn't improve or the market worsens for modern rigs.

Pacific Drilling has all modern rigs built within the last few years. The operator has a fleet of eight rigs with three currently under construction. Counting options, the company only has exposure to a new rig with a delivery date in the third quarter that lacks an announced contract. In addition, most of the rigs are locked up for longer than a couple of years, providing plenty of flexibility to survive the current downturn.

Late analysis
Considering most deepwater drillers peaked back in late 2013, a lot of the negative analyst reports mentioned in the previous article focused on the legacy drillers. The modern fleets didn't prevent shares of these drillers from plunging. Though the analysis didn't distinguish enough between the drillers with the modern fleets, the stocks have already rebounded.

Based on a recent analysis by Seadrill, the deepwater drilling market will require significant newbuilds in order to bridge the expected demand gap by 2020. This scenario will benefit these operators that can continue to expand fleets without having to scrap older rigs. According to the demand forecast by Seadrill, it expects another 189 rigs need to be built by 2020, and the market has limited desire to expand right now.

Screen Shot

Source: Seadrill

Bottom line
In general, the analysts were correct that the deepwater drillers face the risk of further declines. But these modern rig operators provide great buying opportunities with investors slowly understanding the bifurcation in the market and the prime positioning of their fleets. Both Ocean Rig and Pacific Drilling have bounced back sharply from Jan. and Feb. losses, leaving Seadrill with the most potential to rally from here. All three stocks sit in a prime situation to benefit from the continuing high prices of oil and the need to drill the deepwater with modern rigs.


Mark Holder has no position in any stocks mentioned. The Motley Fool recommends Seadrill. The Motley Fool owns shares of Seadrill. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.