The offshore drilling sector has been in steady decline since the oil price crash began in 2014.
The average daily rate commanded by rigs of all types has collapsed as customers have vanished. Offshore drilling is an expensive pastime, and with oil prices trading below $60 a barrel, most offshore projects do not make economic sense. So customers have vanished, leaving drillers holding the bag for millions of dollars in maintenance costs as well as millions in debt interest, which made sense when day rates were around $600,000 but looks disastrous now that rates have collapsed by more than 50%. Some analysts are even beginning to ask if day rates are covering the operating costs of rigs.
A massive rebasing
The offshore drilling industry is having to go through what can only be called a huge rebasing. Offshore drilling has not died completely (as evidenced by Rowan Companies' (RDC, Financial) recent joint venture with Saudi Aramco), but customers are demanding lower prices to make projects viable (as evidenced by BP's (BP, Financial) Mad Dog 2 project in the Gulf of Mexico being developed for under $10 billion, which is 50% less than the original estimates).
These developments signal offshore drilling is not dead nor dying, but it has been rebased. With onshore drilling activity exploding at much lower prices than offshore can ever hope to achieve, it is questionable if the industry will ever return to its heyday.
Huge backlog
According to industry magazine Rigzone, since 2014, 120 jack-up, drillship and semisubmersible (semi) terminations totaling over $19.6 billion of contract value have been executed. Many of the units now out of work have been cold stacked rather than scrapped, with the result being utilization across the industry is now around 50%. This in itself is a huge issue, but one that might be solvable if operators started scrapping rigs rapidly.
Unfortunately, operators are doing the exact opposite. The rig fleet is expected to expand during 2017 as units ordered during the boom period are set to hit the market. Once again, according to Rigzone, as of January 2017, there were 150 jack-ups, semis and drillships on order or under construction, which includes the removal of 15 floating rigs previously on order for Petróleo Brasileiro S.A. (PBR, Financial). Twento-two floating and 73 jack-up rigs are scheduled for delivery in 2017, of which only five have contracts in place.
New normal
The new normal for offshore drilling seems to be low rates and low prices, which suggests the industry is going to have to get used to lower returns. Shareholders may never see the prices shares traded at only a few years ago ever again. Even if OPEC cuts succeed in rebalancing the market, utilization and day rates are unlikely to return to previous levels for many years.
Drillers seem to be adjusting to this new normal already. Companies such as Transocean (RIG, Financial), Ensco (ESV, Financial), Diamond (DO, Financial) and Rowan are retrenching, focusing on debt repayment, cost cutting and surviving rather than growth. So-called blend and extend deals are helping operators extract the most value from their contracts without having to make the painful decision to cold or warm stack a rig.
Overstated assets
There is also the cost of asset values to consider. Some drillers have already taken substantial write-downs on the value of trading assets, but these may not have gone far enough considering the industry’s problems.
Take Rowan’s balance sheet for example. The company has not yet written down the value of its new ultra-deepwater drillships, which were purchased for around $600 million apiece. Based on recent sales, these assets could be worth less than $100 million in today’s market. Such write-downs have yet to take place across the entire industry, which reflects, to some degree, to what extent these drillers are in denial about the state of the market.
Summary
Overall, the offshore drilling industry is not dying just yet, but it has rebalanced to a lower return profile. There could be plenty more write-downs to come as the drilling slump continues.
Disclosure: Author owns no stock mentioned.
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