Despite over 20 years of operating history, Transocean Ltd. (RIG, Financial) has shown an incredible inability to create shareholder value. Recently, shares hit a 20-year low. With the latest fall in oil prices, investors have lost more than 60% of their investments in the past three years alone.
Is the latest dip a buying opportunity or merely another chance to purchase a value-destroying company?
The business
Transocean is an international provider of offshore contract drilling services for oil and gas wells. The company contracts its drilling rigs, related equipment and work crews primarily on a day rate basis to drill oil and gas wells. It specializes in technically demanding regions of the global offshore drilling business with a particular focus on deepwater and harsh environment drilling services.
Industry update
Unfortunatley, technically difficult wells are typically the most expensive to produce, meaning that they are the first to see capital spending cutbacks when oil prices drop. From the charts below, contract terminations have sent demand for rigs plummeting. The options for contract extensions (shaded light blue) are in serious question, while the area shaded light pink is merely labeled "possibilities" by Transocean's investor presentation. At the current price of oil, the demand situation still has plenty of room to fall.
What Transocean needs to hope for is a better supply-side response from small, less well-financed competitors. Unfortunately, the supply/demand outlook won't improve unless oil prices rise. Because rigs are such expensive fixed costs, most firms will lease them out at seemingly money-losing rates just to cover variable costs. According to Transocean itself, these are the supply/demand outlooks for various prices of oil:
- $50 oil: supply and demand could be in balance in 2015, but supply destruction in out-years is unsustainable
- $70 oil: continued reinvestment keeps market from balancing until 2016-2017, but 2017-plus undersupplied
- $90 oil: longer-term price required to balance incremental supply/demand
So according to Transocean, the massive supply/demand imbalance needs $90-plus oil to sustainably correct itself.
Transocean will survive, but it won't thrive
While much of the backlog will be subject to revisions and cancellations, it should provide enough breathing room for Transocean to continue operating. As of last quarter, it still had $2.9 billion in cash and $3.0 billion in undrawn credit facilities. Through 2017, all of its funding needs should be completely met.
At the end of the day, however, significantly higher oil prices are needed to even start evening out the supply/demand imbalance. Even more concerning is that both higher and lower prices could negatively impact the company. Lower prices beget lower daily operating rates, but higher prices may force additional supply to stay online. At the very least, an investment in RIG shares doesn't make sense over the next few years.
