The offshore industry's 2Q: A slow-motion decline

Our thoughts on the offshore industry's second-quarter results

Stephen Ellis 24 August, 2009 | 3:02PM
Facebook Twitter LinkedIn

The offshore industry's second-quarter results saw gloomy forecasts for jackups and midwater rigs. Negative customer expectations surrounding commodity prices and difficult well economics mean lower demand for offshore drilling. Drillers are trying to tighten their markets by stacking rigs, but day rates are down 30%-40% for most jackups, and we expect to see falling day rates and more cold-stacking for many midwater rigs as soon as they come off contract. Still, the hefty backlogs for many of our companies give them ample time to strip out costs as long-term rig contracts slowly roll off.

However, there are still some positive data points for the offshore industry as it deals with a bleak near-term outlook. The short- and long-term opportunities for new rig contracts and equipment sales in Brazil remain tantalizing, and the massive rig needs of Brazil's Petrobras is keeping ultra-deep-water rigs in high demand. There are also some signs that the jackup market may be stabilizing, a trend that runs counter to our current industry thesis. Finally, selected companies such as National Oilwell Varco and Rowan Companies are taking advantage of the downturn to pursue new growth avenues. After reviewing the industry's second-quarter results, we think there are several key takeaways.

Second-quarter takeaways
First, the demand for ultra-deep-water rigs is still high. Ultra-deep-water demand remains quite strong because of the limited supply of available rigs during the next few years and numerous project needs. During the quarter, Transocean obtained a very favourable day-rate fixture for its ultra-deep-water rig, the Cajun Express, at $510,000 per day for three years with Petrobras. This is a particularly impressive fixture, considering the peak in ultra-deep-water day rates was $652,000 in late 2008. The relatively minor decline from peak levels compared with the 30%-40% decline in many jackup day rates, which could still fall further, helps show the continuing imbalance between supply and demand in the ultra-deep-water rig market. Offshore drillers continue to report strong levels of customer interest for ultra-deep-water rigs available in the next year or two.

Second, the jackup market could be recovering earlier than our expectations. Several companies commented that inbound tenders for jackup work were up sharply during the last few months and were modestly bullish about the near-term outlook for the rigs. We believe customers may be inquiring after selected quality rigs for short-term needs. However, the increase in tenders is not enough to offset the fact that there are 50-60 jackups that are being delivered in the next few years without contracts in place. We expect the additional rig deliveries will continue to cause substantial rig oversupply and lower day rates.

Third, drillers are taking advantage of cash-rich balance sheets. The majority of the offshore drillers that we cover are extremely well capitalised, which could create bidding wars for distressed rigs being put up for sale. Noble was actively involved in the bidding for PetroRig I, which was eventually bought by Diamond Offshore for around $500 million when all costs are included. The situation could mean that distressed rigs may not be as heavily discounted as many drillers expect, and the drillers may not be able to duplicate the outstanding returns they earned during the last down cycle by purchasing rigs from distressed owners. On the other hand, if the credit markets remain closed to the riskiest financial speculators, the current trickle of distressed deep-water rigs may become a flood, driving down prices for our drillers.

Fourth, subsea contractors such as Acergy, Subsea 7, Technip, and Saipem continue to win new projects. Despite the near-term uncertainty surrounding commodity prices, international and national oil companies with long-term developments in mind, are pressing forward with offshore projects. For example, Acergy has won contracts in Nigeria, Brazil, and Australia over the past few months. For the subsea contractors, the constant flow of complex and risky subsea work means good profit margins. In the near term, we will be paying particular attention to project awards from Brazil's Petrobras, due to the massive size and complex subsea needs of the company’s discoveries. We think Petrobras' projects will set the standard for complex subsea work over the next few years, and the contractors who deliver the projects on-time and on-budget will have a powerful marketing tool to use against peers in bidding for other projects worldwide.

Page 1 of 3. Go to page 1, 2, 3.

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

Facebook Twitter LinkedIn

About Author

Stephen Ellis  Stephen Ellis is a senior stock analyst on the Energy Team.