In an attempt to drive growth, offshore drillers including Transocean (RIG +3.73%), Diamond Offshore (DO +0.00%), and Ensco (ESV +0.00%) have been boosting the size of their fleets during recent years.
These drillers are trying to offset falling earnings by ramping up the number of rigs in their fleets, increasing sales and profits -- as well as profit margins. But they are actually damaging the industry's outlook.
Oversupply
Why is this the case? Well, you may have heard that the offshore drilling industry is facing the prospect of a two-year slowdown right now, and this is for the most part due to the rising number of drilling units entering the global fleet.
For example, during June of 2013, 131 jackups, semisubmersibles, drillships, and tender-assisted units were under construction, and another 81 units were on order awaiting construction. During 2012, 143 units were under construction, up from 127 under construction during 2011.
Of course, there is some overlap here. However, these figures do not include so-called "letters of intent," which according to industry insiders, relate to orders such as Petrobras' request to build as many as 26 drillships and semisubmersibles. These are not firm rig orders .
Here's the problem: With a growing number of rigs coming into market, utilization rates and day rates are expected to fall. Many analysts have based their assumptions that the drilling industry is heading toward a slowdown on these trends.
Indeed, the consensus across four sets of analysts at different banks is that day rates for ultra-deepwater, or UDW, drilling units will drop by around 16%, to an average of $475,000 per day over the next few years. You can read more on what falling day rates will mean for drillers here.
Another worrying trend that is emerging is the fact that some of these drilling units cannot find work. According to some analysts, the jackup order book now stands at a record 140 units, of which only 20 have been contracted.
For the most part, it is likely that this slowdown will hit drillers with older fleets. It is estimated that by 2020 the majority of the global rig fleet will be more than 35 years old. A rig in service for more than 25 years is considered old.
With this being the case, it is likely that as rig rates are depressed, drillers with newer fleets will benefit, as customers favor cheaper, newer, safer drilling units over older units.
Pick drillers carefully
It would be reasonable to suggest that the offshore drillers with older fleets are likely to suffer more from industry slowdown during the next few years, compared to drillers with newer fleets.
According to Seadrill's (SDRL +0.00%) investor presentation, this means that both Seadrill and Vantage (NYSEMKT: VTG) are in the best position to benefit, as the average age of the jackup drilling fleets for both companies is less than five years -- the industry's youngest.
Meanwhile, Transocean's jackup fleet has an average unit age of around 14 years, and the average age of Ensco's jackup unit is 27 years. Diamond offshore has one of the oldest fleets in the business with an average age of 25.7 years, and some of the company's jackup units have been in service for 40-plus years.
All in all, it appears that Seadrill and Vantage are the industry's best plays.
Foolish conclusion
The offshore drilling industry is about to enter a recessionary period due to oversupply of drilling units. Fortunately, Seadrill and Vantage are well-placed to ride out this trend, as the two companies have the youngest jackup fleets in the business, and it is likely that demand for their services will remain strong.
On the other hand, Transocean, Ensco, and Diamond are all poorly positioned due to their older fleets.
