Seadrill (SDRL) entered 2014 to a bit more market uncertainty than normal. Oil companies were struggling to generate a lot of cash flow at $100 oil so they started to pull back on spending directed toward drilling expensive offshore wells. This caused the offshore industry to slow down as drillers struggled to find new contracts for drilling rigs. However, no one foresaw that the industry would absolutely implode in 2014 from plummeting oil prices. Seadrill, like so many others, was blindsided by that shock, which caused its stock to drop an excruciating 70% in 2014.
Here's a replay of how the former darling of the offshore drilling industry missed the turn in oil and burned investors in the process.
Misjudged market
Seadrill, along with nearly every other oil company in the world, severely misjudged the direction of the oil market. This is clear from statements the company made in its second-quarter report, which was delivered after oil prices had started to retreat. The company's market commentary was actually quite bullish as we see in the following statement, which was made at the end of August:
The oil market fundamentals continue to be strong with high and stable oil prices. Except for very brief periods the oil price has remained above US$100 for the last 3.5 years and the global economy continues along its growth path following the financial crisis. Even with these strong macro fundamentals oil companies seem to be unable to generate free cash flow to grow their businesses and have entered into a period of selectivity on projects as costs escalated across their entire portfolio of projects. The current situation has some similarities to the situation in 2002-2003 when oil companies had limited free cash flow to develop new reserves. This led to an increase in oil price between 2003-2008 when Brent moved from approximately US$40 to US$100 and resulted in increased investment by the oil companies. [...] We can thereby assume that the amount of rig capacity which is needed to produce a barrel of offshore oil in the future will increase.
Because of the company's bullish outlook it suggested that its dividend level was "sustainable until at least the end of 2015 [... and ...] we feel increasingly comfortable that this period can be extended well into 2016 without any significant recovery in the market."
Unfortunately, just 90 days later the company retracted that statement in its third-quarter report by saying:
Since our last quarterly report a number of developments have affected these factors that dictate our dividend distributions. The most significant impact has been the uncertainty in the macro environment. The Board views the deterioration in oil prices as an indicator of more broad demand growth concerns and must approach the current macro environment with an element of caution. This, taken into account with the near term oversupply of drilling units makes it all the more important to build a strong balance sheet. In addition, the financing market has become incrementally worse, and although Seadrill still has significant access to funding, some markets have become unattractive. In light of the changes that have taken place since our last report, the Board has taken the decision to suspend dividend distributions for the time being.
By completely obliterating what was thought to be a secure dividend Seadrill blindsided investors, which unloaded the stock in a hurry. However, the company made these moves to ensure that it would not only survive the current downturn, but thrive once things improved.
Long-term vision is unchanged
Seadrill remains very bullish on the long-term future of the offshore drilling industry. The company supported this belief by saying:
Since our last quarterly report in August, the Brent spot price has dropped by 23%, or US$24 per barrel. It remains to be seen how long the current market conditions will persist and during this period short to medium term visibility will be reduced. However, the Company believes the long term fundamentals of our industry remain intact, driven by the fact that the days of easy, low cost oil are over and reserves required to meet long term demand growth are still to be found in the deep and ultradeepwater regions. As mentioned by a number of major oil companies, these reserves are well positioned on the cost of supply curve and can be expected to be produced even at today's oil prices.
While the price of oil has continued to drop, Seadrill, and most other oil companies, believe its stay at current levels will be brief. That's because current oil supplies will eventually deplete and will likely be replaced by more expensive oil supplies, some of which will come from offshore oil wells. Because of this the company continues to plan for that future, even as it adjusts to current uncertainties that are impacting today's oil market. So, while 2014 was rather bleak, Seadrill remains very excited about what its future holds.
