3 Pressing Questions for Rig Companies in 2014

The offshore rig market has been a rather puzzling one over the past year or so. Despite the almost insatiable appetite for offshore rigs from Big Oil players and National Oil Companies like Saudi Aramco, the largest players in the space didn't even outperform the broader market on a total return basis.

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Many of the factors that affected rig companies in 2013 will remain the same, but some new challenges could also affect them this year. Let's take a look at three questions, the answers to which could have a deep impact on rig companies in the new year.

Source: Transocean Media Relations.

1. Will Seadrill (NYSE: SDRL) flood the market?
Seadrill is in the middle of a massive fleet expansion, and it brought 12 new rigs online in 2013. That was double next-closest competitor Transocean , and it isn't showing any signs of slowing, with another 17 rigs slated to come online over the next two years.

One thing of concern, though, is that we could start to see a decline in activity. Nearly every member of Big Oil has said they plan to reduce capital expenditures over the next couple of years, which could result in a slowing of the market. If this were to happen, and Seadrill and others continue on these wild growth plans, then it's very possible we could see lots of excess rigs sitting in the docks. And no company wants to see their assets sitting onshore and not making money. 

2. Who will follow Noble (NYSE: NE) and start to turn over their fleets?
Back in September, Noble announced it would be spinning off its legacy -- aka, old -- and lower-specification fleet of rigs into its own entity some time this year. For Noble, which has one of the oldest fleets out there, this deal was necessary to get less productive assets off its books and get an injection of capital that will help fund any further development. By doing so, it's hoping to compete with the companies that have newer rig fleets, like Seadrill.

Noble isn't alone, though. Less than 20% of the floating fleets of Transocean and Diamond Offshore  are less than 20 years old. Also, Ensco and Hercules Offshore have jack-up fleets with an average age of 28 and 33 years, respectively. According to a recent Ensco presentation, over half of the worlds jack-up fleet and 36% of floating assets are reaching the end of their economic lives. With so many older assets sitting on balance sheets, don't be surprised if companies start to follow Noble's lead and make some drastic changes to their fleets. 

3. Who has contracts with questionable credit clients?
In the third quarter of last year, both Ensco and Diamond Offshore got bit by the bad credit bug. Two companies, Brazilian driller OGX and Canadian company Niko Resources, both defaulted on payments owed to Ensco and Diamond for contracts related to deepwater floating rigs. Not only did it cause a hit to both companies' earnings in that quarter, but Ensco and Diamond now need to get contracts for these assets. Diamond estimates it could take into the middle of 2014 before all four of these rigs find new contracts. 

Three companies facing a credit crunch that could hurt rig companies are Talisman Energy, EPL Oil & Gas, and Stone Energy. Both EPL and Stone have less than investment-grade ratings from Moody's, and Talisman has recently been teetering very close to a non-investment grade rating. Seadrill, Transocean, Diamond, Hercules, and Ensco all have rigs contracted out to these three companies, and a default could bite into earnings. The one consolation is that all three of these companies have jack-up rigs contracted out. With the average jack-up getting day rates less than half of a floating rig, it won't hurt as much as when OGX and Niko default. 

What a Fool believes
2014 is looking to be a very exciting year for the rig industry. We could likely see some major assets turnarounds over the year as companies shed old assets and bring on new ones. Based on the current market, the company best positioned is Seadrill. It has an extremely young fleet of both jack-ups and deepwater floating vessels that are garnering a premium on the market today. One worth staying away from right now is Diamond Offshore. It's probably next on the list of companies to make some major changes, and it would probably be better to wait and see what the company has planned before making any investment decisions.

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The article 3 Pressing Questions for Rig Companies in 2014 originally appeared on Fool.com.

Fool contributor Tyler Crowe has no position in any stocks mentioned. You can follow him at Fool.com under the handle TMFDirtyBird, on Google+, or on Twitter, @TylerCroweFool. The Motley Fool recommends Seadrill. The Motley Fool owns shares of Seadrill and Transocean. 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.

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