With the offshore drilling market in turmoil there are few better places to get guidance on where the industry is headed than from drillers themselves. Earnings reports and conference calls have become one of the few times we get a peek into what is happening with these companies.
In the case of Seadrill (NYSE:SDRL), management recently offered comments that were both reassuring and worrisome for investors. Here are the five biggest takeaways from Seadrill's fourth-quarter conference call.
All quotes below are from CEO Per Wullf.
Contracts are safe... sort of
Seadrill, along with the rest of the industry, is encountering challenges to its contracted backlog as some counterparties request relief to day rate or seek early contract termination. The company is confident that its contract terms are enforceable; however, it may be willing to engage in discussions to modify is [sic] such contracts if there is a commercial agreement that is beneficial to both parties. In the event of early termination for the customer's convenience, an early termination amount is typically payable to Seadrill.
This comment came in anticipation of questions relating to $1.1 billion in backlog that vanished when it was revealed that Brazilian energy titan Petrobras never signed a contract Seadrill thought it had secured in November 2014. Understandably, oil producers are trying to cut costs in any way possible, and one option is to cancel or renegotiate offshore rig contracts. Seadrill should be able to execute contracts as planned, but management left open the possibility of some renegotiations that could prove beneficial over the long term.
Contracts are still coming in, but slowly
In the fourth quarter alone, we were able to sign five contracts and one extension representing $1.3 billion in contract backlog.
Companies are still finding contracts for idled rigs, but it's slowgoing in today's drilling market. Wullf's comment was a small indication that demand won't completely fall off the cliff, but contract activity is undeniably weak these days. That could be exacerbated by a number of new rigs due to enter service in the next few years.
Seadrill is delaying oversupply where it can
At this point, we have delayed eight jack-ups a total of 44 month and Sevan Developer up to 36 month, with cancellation options.
Contracts that might be canceled are a concern when it comes to revenue, but another major concern is cash Seadrill is due to spend on new rigs. Management said it has $3.5 billion in yard installments due in the next two years and is pushing back deliveries and payments as far as possible. Four new rigs due in 2015 were also pushed back to 2016; along with other delays, this should help the balance sheet.
Delaying delivery is the best option available today, and it shows how weak demand looks for offshore drilling in the near future.
The industry is rationalizing supply, which is a good thing for Seadrill
Rig owners are bidding for available work extremely competitively with a focus on utilization over price, which will likely drive rates down two or even below cash spread even levels; however, this is not all bad if you take a longer-term view. The severity of this downturn is forcing the industry to make decisions regarding cold stacking and scrapping of older units. This activity is expected to accelerate, likely delivers, which have not been seen in two decades. Owners of older efficient units face difficult decisions as these units approach periodic classing activities and most seem to be opting not to invest a significant expend as required, instead choosing to stack or scrap the unit. We believe scrapping will ultimately create a more healthy industry as weaker players leave the business and old rigs are retired.
This is a long quote, but it's important to understand Seadrill's position in the offshore market. Older rigs, in both the floater and jack-up markets, will need to be retired over the next few years to bring supply more in line with demand and make way for new rigs that are under construction. If rigs aren't cold stacked or retired, companies will compete for contracts based solely on price, which means low dayrates and low margins for everyone.
Cold stacking and retirements are especially good for Seadrill because it has one of the newest fleets in the industry. This means there's little risk it will retire rigs; instead, it will benefit as its peers retire rigs. Long term, this is a bullish sign for Seadrill as long as it can hold on until the industry recovers.
Management is prepared to be aggressive
Finally, Seadrill's favorable positioning should allow the company to act as a consolidator when the time is right. Current evaluations do not yet justify acquiring companies, many of which have significant uncontracted rig capacity available. Seadrill primary focus will continue to be in cash and commitment management until we have a view on the shape of the recovery.
As other companies struggle to survive in the next few years, Seadrill sees itself as a strong player that can advantageously buy assets at wholesale prices. It remains to be seen when the industry will get to that point, but if you have a bullish view on offshore drilling, and on Seadrill in particular, it's good to see management preparing to be aggressive when the time is right.
Travis Hoium owns shares of Seadrill. The Motley Fool recommends Seadrill. 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.