What: Since May 15, shares of offshore drilling operator Transocean LTD (RIG +0.83%) are down 29.5%, with shares of subsidiary Transocean Partners (NYSE: RIGP), which owns an interest in several of Transocean's drilling vessels, down about 10%:
If we go back a little further in time, Transocean's stock price is down more than 70% since last year's peak, while Transocean Partners' stock is down by half from its peak last September, soon after its IPO.
So what: It's still all about oil prices and demand, and the likelihood that this is going to weigh especially heavily on offshore drillers like Transocean. During the past year, the company has written down the value of its assets significantly, and taken a major impairment as it scraps some of its oldest vessels.
The reality the company and its competitors face right now is twofold: Offshore drilling demand is expected to remain weak for at least the next year, with some estimates that it won't recover until 2017. This alone is putting downward pressure on day rates -- the amount companies charge for each day a vessel performs contracted activity; but there's more at play.
During the past several years, record numbers of new drilling vessels have been ordered, due to the age of much of the global fleet, as well as the limited capabilities and higher cost of operation for older vessels. And while these newer, more-capable vessels will eventually be needed, large quantities of them are scheduled to enter service during the next 18-24 months. That's right in the middle of the weak point in demand.
Yes... many of those vessels are planned to replace existing ones that are scheduled to be retired, but the fact of the matter is that there will be more vessels competing for less work during the next year-plus. And that's likely to put even more pressure on rates.
Now what: Through its June fleet status date, Transocean has identified 20 current floaters that it intends to scrap, which will significantly reduce its operating costs. Furthermore, the company's newbuilds -- 12 ships as of the most recent full status report -- won't start hitting the water until the end of 2016, and even then there will only be about one new ship every six months. In that June update, the company announced that it had reached agreement to delay delivery of two ultra-deepwater drillships -- the most capable, but also most expensive -- until 2019 and 2020.
In other words, it's creating breathing room with its fleet, while the market recovers. However, the company does have a lot of ships coming off contract: More than 30 had contracts expiring in 2015 as of the most recent full status report.
As to Transocean Partners, its fleet status is much more secure, with only three vessels, all of which are under long-term contracts through 2016, 2018, and 2020. It will also have the first option to purchase a controlling interest in several other Transocean vessels should the parent company elect to sell partial ownership. This is a distinct possibility, as Transocean's aging and out-of-contract fleet could create the need for it to generate some short-term cash, and selling assets to a subsidiary will allow it to do so, while also maintaining control, and participating in the profits of those vessels.
Putting it all together, Transocean is still in rough waters, along with the rest of the industry. Transocean Partners looks like it has less downside due to the strength of its long-term contracts; but with only three vessels, a contract dispute with even one would put serious pressure on its bottom line, and that risk shouldn't be ignored.
For now, it's probably best to stay on the sidelines. Long term, offshore drilling should recover, because these massive offshore reserves will be necessary to meet global demand. But until the pressure of newbuilds and weak demand shakes out a little more, there's more downside risk that's probably worth avoiding.
