The past decade has been a good time to be in offshore oil and gas drilling. Well, for companies such as Seadrill (SDRL +0.00%) that have invested heavily in new high-tech, high-spec drilling units times have been good. Unfortunately, more conservative Transocean (RIG 0.61%) has held back. And now it may be too late for the company to catch up to its more advanced peers.
Cyclical industry
During the past decade or so there has been a rising demand for high-specification drill ships. Drillships can drill deeper, are more mobile, and are generally more flexible than traditional drilling rigs -- for these reasons, they are usually favored over traditional rigs despite their higher cost.
Sadly, Transocean believed that much of this demand was speculative and, until recently, refused to acquire any new drilling units for its fleet. As a result, Transocean has been left with a fleet of old drilling units, with an average age of over two decades. Meanwhile, peers such as Seadrill have built up much newer, high-tech fleets that are in demand.
Current trends
It is widely believed that the offshore drilling industry is going to have a hard time over the next few years. Several Wall Street analysts covering the sector have stated that the day rates for ultra-deepwater drilling, or UDW, units will slide by 16% over the next few years. As a result, earnings forecasts for the industry between now and 2015 have been slashed by a fifth. Industry leader Seadrill's management explains:
[As] producers work through the forward budgeting process the entire spending complex tends to slow down. Oil companies suffer from limited free cash flow and claim that capex[capital spending] is inflated because of higher rates for offshore services. They are trying to ease this situation by reining in spending levels.
And commenting on their own outlook:
[We] see no significant reduction of our cash flow if the market is hit by a temporary setback. Medium to long term the current reduction in capex by the oil companies is expected to lead to less production, a tighter oil market and a rig market with fewer newbuilds...better fundamentals for drilling companies with modern assets and solid financing structures.
So all in all, this implies that drillers with younger fleets will do better than their aged peers. Seadrill estimates that by 2020 the majority of the global jack-up drilling unit fleet will be over 35 years old, and this is bad news, as due to safety concerns, many oil exploration companies are exclusively using sixth generation drilling units with the most high-tech equipment, to prevent a repeat of disasters like BP's Macondo well.
Older fleets are likely to find it hard going during the next few years.
Making changes
Still, Transocean has recently broken away from its mantra of 'not adding to speculative capacity' and has put in orders for 10 high-spec jack up drilling units as well as two drillships. In addition, the company has also embarked on a cost cutting program, although this could be too little too late.
It's too early to speculate on whether or not this strategy will work out for Transocean. Nevertheless, one thing is for sure: The older portion of Transocean's fleet is likely to struggle to find work in the future, so the company is dependent upon the success of its new units.
Tiny peer packs a punch
Elsewhere, in the world of offshore drilling, Vantage (NYSEMKT: VTG) is a relatively small company with a market capitalization of only $533 million.
Still, Vantage is well placed for current industry trends. In particular, Vantage has one of the youngest jack-up fleets in the drilling business, which puts the company in a great position to ride out the trends. The average age of Vantage's jack-up fleet is under five years, approximately one year younger than Seadrill's fleet.
What's more, Vantage is one of only four drillers, with 100% of the jack up fleet able to drill deeper than 350 feet -- deepwater in other words.
But that's not all: Vantage's UDW drillship fleet has an average age of a year, although this fleet is only comprised of four units, one of which is yet to be delivered. Still, this young fleet means Vantage's services are likely to be in demand over the next few years as customers fight over the company's high-tech modern fleet with 100% UDW capabilities.
Foolish summary
All in all Transocean has made a mistake not keeping its fleet up to date and as of yet, it is still too early to tell if the company's recent modernization drive will work.
On the other hand, Transocean's smaller peer, Vantage is well placed to take advantage of current industry trends and the company could outperform Transocean during the next few years.
