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Transocean (RIG) is a major player in the deepwater offshore rig market around the world. Although Transocean is large and one of the oldest the companies in the oil services industry, it is losing its competitiveness in the deepwater drilling market because of its aging fleet of floaters. In this article, we will discuss Transocean's position in key deepwater markets like West Africa and the Gulf of Mexico, or GoM, to present a clearer picture of the company's future revenue generation potential. This has impacted the share price, which fell to around $44 in October after reaching a high of around $60 in February.

Age is no advantage in drilling

Transocean is facing a major issue from its aging fleet of floaters. These floaters consist of semi-submersibles and drill ships. The company has around 22 drill ships and around 46 semi-submersibles. The average age of Transocean's floater fleet is around 20 years. In addition to this, the company has six drill ships under construction, with one of them entering into service by the end of this year. As indicated in the chart below, the average age of its floaters is more than that of its major competitors like SeaDrill (SDRL), Ensco (ESV), and Noble.

One of the leading competitors of the Transocean in the deepwater offshore drilling market is SeaDrill. The company has around 11 floaters under construction and around 18 floaters are operating in offshore drilling. The average age of SeaDrill's floaters is around five years, making them part of one of the youngest and most advanced floater fleets compared with peers.

Losing competitiveness in the deepwater markets

A major offshore drilling market for Transocean is West Africa, where it operates around 11 floaters. These markets include countries like Nigeria, Gabon, Ghana, and Congo. The table below shows the number of Transocean offshore floaters that will roll off this year in West Africa. The average age of the floaters that are being rolled off is around 15 years.

Name (Rig type)

Built Year/Rebuit

Month of expiration of contract

Transocean Rather (Semi-submersible)

1988

August, 2013

Falcon 100 (Semi-submersible)

1974/1999

August, 2013

Transocean Marianas (Semi-submersible)

1979/1998

December, 2013

Sedco Energy (Semi-submersible)

2001

November, 2013

Source: Transocean

Due to its aging fleet, Transocean might face problems getting new deals for its floaters in West Africa. This is because newer oil deposits in West Africa's offshore region reach depths of 23,000 feet. This high drilling depth would require the latest floater technology. According to Transocean President and CEO Steven Newman:

Customers appear to be more willing to enter a contract to support construction of a newbuild rig versus six months ago.

Another major market of Transocean for deepwater offshore drilling is the GoM, which is one of the major oil-producing areas in the world. The company operates around 16 floaters in the region. The major oil exploration and producing companies in the GoM are Shell with seven rigs, BP with six rigs, Chevron with five, followed by Anadarko with four. Offshore drilling in the GoM found a new boost after discovery of a new geological layer 20,000 feet below the sea floor, which contains huge reserves of oil and gas. It is estimated that around 78 billion barrels of energy reserves are recoverable with more than 50% being oil.

To extract resources from these huge reserves, it will require drilling more wells to be in the seafloor. As of September this year, U.S. government gave around 807 oil well drilling permits, a rise of around 14% over the last year. The increasing number of well permits will drive the requirement for more offshore rigs. So, we expect the deepwater market in the GoM to create demand for more floaters, which is a great, but challenging, opportunity for offshore drilling companies.

As per Transocean's fleet status report, or FSR, next year Transocean will operate around 14 floaters in the region. This is because the company will roll-off three floaters and add one floater to this year's floater count of 16 in the GoM. Among the three that will be rolled off, two are currently in contract with BP. The table provide the details of these floaters.

Rig name

Customer

Built year/Rebuilt

Contract Expiry

GSF Development Driller II

BP

2005

November, 2013

Discover Enterprise

BP

1999

January, 2014

GSF C.R. Luigs

BHP Billiton

2000

February, 2014

The two floaters' contracts with BP haven't been renewed up to now. Also, the third floater has yet to receive a contract. As noted in the table, the average age of the floaters that are being rolled off is more than 10 years. As the offshore drilling in the GoM starts in more challenging areas, we believe the demand for more advanced and newer floaters will grow. This might put the current fleet of Transocean at a disadvantage compared to its peers.

In the GoM region an upcoming player is SeaDrill. As discussed above, with its young fleet of floaters, the company plans to increase its presence in the deepwater drilling in the GoM. This year in GoM offshore drilling, SeaDrill is operating two floaters and plans to operate four floaters next year. The increase of SeaDrill's floaters in the GoM shows the company's growing interest in the region.

We are bullish on SeaDrill. Please read: Why Seadrill Is An Exciting Investing Opportunity

Another major player in the deepwater market in the GoM is Ensco. The company is operating around eight deepwater rigs in the GoM and plans to operate around the same number of offshore rigs in this region next year. The average day rate of the floaters operating in the GoM is around $500,000. The company entered a contract in June this year with Samsung Heavy Industries to build three drillships, which it plans to deploy in West Africa, the GoM, and other places. It shows that Ensco is focusing on tapping deepwater opportunities in different markets with its young fleet of floaters.

The compression on operating margin

Year

2012

2011

2010

Revenue ($ million)

9,196

8,027

7,949

Operating Margin ($ million)

1,581

(4,762)

2,730

Operating Margin

17.19%

(59.32%)

34.34%

The above table shows Transocean's operating margin for the last three years. We expect the operating margin of the company to decrease in the coming quarters due to its aging fleet. With the increase in the age of its floaters, the maintenance cost of the fleet is also expected to rise. According to Transocean's estimates, the number of out-of-service days for the floaters is around 1016 days for this year and 1152 days for the next year.

Additionally this could result in downtime, which could result in a loss of the floaters' day rate. On average, the day rate of Transoceans' fleet of floaters in deepwater offshore drilling is around $500,000. The number of days of downtime results in loss of this day rate, which will result in a loss of revenue for the company.

The bottom-line is not supporting

Company

Return on Assets, or ROA

Return on Equity, or ROA

SeaDrill

5.72%

33.02%

Ensco

5.65%

10.85%

Transocean

3.15%

10.23%

Source: Yahoo finance

Our above discussion shows how the aging fleet of floaters is causing lower returns for Transocean. This is reflected in the company's ROA and ROE ratio. We observe from the table that the ROA and ROE of both SeaDrill and Ensco are higher than that of Transocean. This is because these two companies are competing in the deepwater market with a younger fleet of floaters. On the other hand, Transocean's aging fleet of floaters is not only corroding its margin, but also resulting in low competitiveness in the deepwater offshore drilling market. We don't expect the ROA and ROE of Transocean to improve significantly because of the lowering of returns from its floaters. We recommend a hold on this stock for now, and advise investors not to make any new investing opportunity.

Source: Dear Transocean Bulls: Aging Fleet Is Definitely A Problem

Additional disclosure: Fusion Research is a team of equity analysts. This article was written by Madhu Dube, one of our research analysts. We did not receive compensation for this article (other than from Seeking Alpha), and we have no business relationship with any company whose stock is mentioned in this article.