The Outlook for the Offshore Drilling Industry Continues to Deteriorate
In February I wrote an article on the state of the offshore drilling industry and how, although analysts had taken a negative view on the industry's outlook, Seadrill still looked to be in good shape. Since then things have changed drastically.
In the past two weeks Seadrill has come out and ripped up its own forecasts for the industry over the next few years. That said, the company still remains upbeat on its own outlook, while the outlook for its peers, Transocean (NYSE: RIG)and Diamond Offshore (NYSE: DO), is not as strong.
But first, a quick look back
When I originally covered the offshore drilling industry, I drew on comments from analysts at Citigroup who were warning investors of a possible slowdown in the offshore drilling market. Usually, a view from one group of analysts is not enough to sway investor opinion. However, the comments were supported by further data from analysts at Barclays, Raymond James, and UBS who believed that theday rates for ultra-deepwater, or UDW, drilling units will drop by around 16%, to an average of $475,000 per day over the next few years, as a result of a 12 to 18 month industry slowdown. Sector earnings estimates were slashed by 18% as a result.
The reasoning behind this slew of downgrades? Analysts believe that the market for jack-up drilling units is becoming oversupplied; couple this with slowing exploration and production spending as oil companies seek to reduce expenditures, and you get somewhat of a perfect storm.
Somewhat surprisingly, despite this negative outlook from analysts, Seadrill and its management remained upbeat on the drilling market outlook through 2020, mainly due to the fact the company has one of the most modern drilling fleets in the biz. For example, the average age of Seadrill's drill ship fleet is around five years, the youngest of all the offshore deepwater drillers. In comparison, Diamond's average floater unit age is slightly under 30 years and Transocean's average age is over 20 years. Both Diamond and Transocean do have a number of new drilling ships slated to be delivered during the next few years.
Further, according to numbers supplied at the beginning of the year, Seadrill believed that a huge imbalance was building in the market for drilling units. The company expected that the market for drilling units will be undersupplied by around 189 units based on estimated 2020 figures. Seadrill saw further imbalance in the jack-up market. In particular, the company estimated that by 2020 the majority of the global jack-up fleet will be over 35 years old and will need to be replaced.
All in all, this outlook meant that Seadrill was well positioned to ride out a market downturn over the next few years, but Transocean and Diamond are badly positioned -- to some extent this is still true. The biggest problem for both Transocean and Diamond is the age of their fleets, which is likely to be a sticking point for customers requiring their services. Although, as mentioned above, both companies do have a number of new builds under construction, these will not be enough to offset the decline in revenue from older units.
Specifically, the average age of Transocean's drillships is over two decades, and the average age of its jack-up rigs is just under 15 years. Meanwhile, the average age of Diamond's floater units is over three decades.
The new outlook
Seadrill's new outlook explains why day rate levels for ultra-deepwater assets have come down from third quarter: "[when] producers work through the forward budgeting process the entire spending complex tends to slow down. Oil companies suffer from limited free cash flow and claim that capex is inflated because of higher rates for offshore services. They are trying to ease this situation by reining in spending levels."
The company also noted that, "Since 2005, 314 additional rigs... increasing the fleet by approximately 53%. The production of oil offshore has in the same period decreased from approximately 24 million barrels per day to 22.5 million barrels per day."
So in reality, for big oil it is costing more to extract less. Still, as management puts it, "The key question in the market today is what the duration of the spending slowdown may be...this pause in spending has not been caused by oil price declines [which] gives us confidence that this is a momentary pause."
We see no significant reduction of our cash flow if the market is hit by a temporary setback. Medium to long term the current reduction in capex by the oil companies is expected to lead to less production, a tighter oil market and a rig market with fewer newbuilds...better fundamentals for drilling companies with modern assets and solid financing structures.
So, it would appear that the global market for offshore oil and gas drilling services is about to enter a cyclical decline. Still, some companies are better placed than others to ride out this cyclical downturn and Seadrill, with its new fleet of high-spec UDW drilling units, believes that it is going to be able to ride out this downturn.
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The article The Outlook for the Offshore Drilling Industry Continues to Deteriorate originally appeared on Fool.com.Rupert Hargreaves has no position in any stocks mentioned. 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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