If you are invested in the offshore drilling space, then chances are you are looking for something -- anything -- that shows your investment is headed in the right direction. Well, recently we had one of those announcements when Transocean (NYSE:RIG) said it would send seven of its older rigs to the scrapyard.
Here's the catch: It's not Transocean's shareholders who should really be celebrating this news, it's Seadrill's (NYSE:SDRL). Let's look at how this development is an indication of something Seadrill management has been betting on and how it could help the company over the long term.
According to plan?
The offshore rig industry is going through one of its roughest patches in several years. Even before oil prices went into free fall at the end of the summer, investors in offshore drillers could see there were far too many rigs on the market, and too many of their potential customers -- mostly integrated oil and national oil companies -- were scaling back capital spending as many major projects came online. This major glut of rigs has investors worried that contracts for rigs would become fewer and farther between, and that companies that did get contracts would get less than favorable rates.
Some investors might think these companies' management teams have been overly ambitious with their newbuild programs for rigs, and no company was more bullish about expanding its fleet than Seadrill. The company has 22 new rigs under construction, while its five largest competitors combined are only building 27.
However, another aspect needs to be taken into account when looking at fleets of offshore rigs: Many of these rigs are approaching retirement age. According to a recent survey, about half of the global fleet of rigs will be more than 30 years old by the end of the decade, much older than most were originally built to last.
So many older rigs will soon start to come off the market, reducing the glut. As this happens, companies with newer fleets could grab a much larger market share. Of all the companies out there, no company is in a better position to do just that than Seadrill.
Transocean's decision to scrap seven of its older rigs is evidence this wave of rig retirements could be beginning. The recent plunge in oil prices has further reduced demand for rigs, and older rigs that are less capable of handling more challenging drilling environments, such as water depths of more than 10,000 feet and Arctic environments, will have a harder time getting jobs. Depending on the length of this oil price malaise, it could significantly accelerate the rate of rig retirements. Once it does happen, Seadrill will be in a pretty good position to meet the demands of its clients.
What a Fool believes
This isn't the first boom-and-bust cycle for offshore rigs, and it won't be the last. You can safely assume, though, that oil demand for the next several years will probably grow as the developing world increases its oil consumption. In all likelihood, offshore production will be a major supply source to meet rising demand for oil, which means rigs will need to go deeper and to more exotic places to find it.
So, yes, there is a glut of rigs today, but it probably won't last. Eventually, drilling activity will pick up and companies will put their rigs back into service, and Seadrill will be in position to succeed mightily when that happens.