Transocean (NYSE:RIG) has the largest offshore drilling rig fleet in the world, but it might not hold that title for too much longer. The company announced late last week that it would scrap another seven rigs, raising to 11 the number of lower-specification drilling rigs that are heading to forced retirement. This latest round of rig cuts, which likely won't be its last, will result in the company taking a $100 million-$140 million charge to its fourth-quarter earnings.
Where things stand right now
Transocean's fleet update last week to investors contained some good news to go with the bad news about additional rigs being scrapped. We'll start with the good news, which is that the company signed several rigs to new contracts, adding about $453 million to its contract backlog over the past month. Two of the contracted rigs were previously idle, meaning they will soon be generating revenue for the company. Meanwhile, current customers either exercised or awarded extensions on two more rigs. Unfortunately, both of those contract extensions were at lower dayrates than the previous contracts. However, at least these rigs will earn revenue instead of sitting idle.
Now on to the bad news. The seven additional idled rigs to be scrapped are lower-specification deepwater and midwater floaters that no longer have value to the company, or to the industry for that matter. Instead, the rigs will be dismantled and the parts sold off at scrap value. While this is the future of any rig after its useful life, these rigs likely would not have met this fate so soon if the offshore drilling industry wasn't in a tailspin that has only been exacerbated by falling oil prices. However, current market conditions are forcing the company to permanently retire its oldest rigs as it looks to reduce the overall age of its fleet.
Transoceans's lead is fleeting
As the following slide shows, Transocean's industry leading fleet of offshore drilling rigs encompasses 79 operational rigs and a dozen newbuilds under construction.
Even with 11 vessels retiring, Transocean still will hold a lead over its nearest competitors. However, the company has said in the past that the current makeup of its fleet won't be the same in the future. The company sees both midwater and deepwater floaters eventually exiting its fleet as it shifts toward a fleet focused mainly on ultra-deepwater and high-spec jackups.
Some of these midwater and deepwater floater rigs are just going to be scrapped. However, the company hopes to realize a bit more value for some of those rigs. It had planned to package eight of its noncore midwater drilling units into a new entity it named Caledonia Offshore Drilling, which was to be separated from the company. However, Transocean announced last quarter that it was canceling the IPO due to market conditions. It still hopes to eventually maximize the value of these rigs by either selling them outright or pursuing some other transaction. But current issues in the market will make it difficult for the company to realize much value for these vessels, along with many of its other older rigs, which is why Transocean will likely announce even more retirements in the future.
The weak offshore drilling market, which is only growing weaker due to the decline in oil, is forcing Transocean to make some tough decisions. One of the toughest is cleaning out its fleet by scrapping its oldest and lowest-specification drilling rigs. While these rigs would have had to retire one day, that day is coming sooner than the company had hoped. However, getting rid of these rigs now will take the company one step closer to its ideal fleet, which should put it in a much better position to capture future growth opportunities once the market stabilizes.
Matt DiLallo has no position in any stocks mentioned. The Motley Fool owns shares of Transocean. 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.