In regards to contracting drilling rigs, some would say it is more of an art than a science. I tend to agree with that statement, but would add that a fair amount of psychology is applied to the game as well. The offshore drilling industry of late has been punished with downgrade after downgrade while a bleak scenario has been painted all the way out to 2015. When establishing a bull or bear case on offshore drilling, you should ask 4 basic questions:
- Do we still need oil?
- What is the oil majors' RRR (Reserve Replacement Ratio)?
- Are well decline rates better on land or offshore?
- Does rig supply exceed demand?
The first three are readily answered, and in our current environment, speak to the long-term demand for offshore oil and gas. The last question is the one in which all current bear cases are being based. The bottom line question all investors face is "how soon do I need the money?" I, for one, think that a significant amount of money is to be made in offshore drilling, and now is the time to accumulate shares of your favorite drilling contractor.
It is no secret that my favorite is Diamond Offshore Drilling (NYSE:DO). The simple version of the thesis is that Diamond Offshore runs its business, as I would hope to, if placed in a similar situation. Diamond Offshore focuses on slow and steady growth, counter-cyclical equipment purchases, and a focus on returning capital to shareholders. This mandate has been given to Diamond Offshore by its superb board of directors led by majority owner, Loews Corp. (NYSE:L).
My take on offshore drilling in general is that investors are probably okay being invested in any of the drillers for the long-term in this environment (ex-ORIG). I do think, however, that having 20 or so un-contracted rigs built on speculation (no contract) and financed at a variable interest rate would make for some sleepless nights for the leadership of Seadrill (NYSE:SDRL).
Diamond Offshore May 2014 Rig Status:
The entire report can be viewed here.
- Ocean Princess ($345kpd) - Very nice to see this rig continue to work in the North Sea. The day-rate increase is impressive, especially when contracted to a new operator, Ithaca Oil and Gas, as well as in this "sky is falling" day-rate environment.
- Ocean General ($255kpd) - Steady day-rate for this Gen 2 rig, specifically in the SE Asia theater where recently rigs have been moved when they could not find work elsewhere.
- Ocean Lexington ($160kpd) - This day-rate for operator PEMEX will be viewed by many analysts as a failure. However, when talking to people who are integrated into offshore drilling, the name of the game is to keep the older rigs working. This Gen 2 rig has been paid off for a very, very long time. The old rate of $300kpd was in my opinion a bit high for this rig. I view this contract as a success because it keeps the rig working in this low rate environment, it keeps its crew working in this low rate environment and it continues to make money for shareholders.
- Ocean Saratoga: Extension.
- Ocean Scepter: Extension.
1. Ocean Star: I would have liked to see a new contract for this very capable 4th Gen rig. I think it is very likely this rig goes to a ready stack status after its current well with Queiroz Galvao is complete.
2. Ocean Titan: This Jackup Rig will be coming out of major maintenance at the end of this month and as of right now does not have a contract. I would expect this rig to be temporarily ready-stacked and then resume work for PEMEX upon receiving a new contract.
Analysts are currently predicting $.61 in Q214 earnings. My model is currently sitting at $687 in drilling revenue (does not count reimbursable income) with $.69 in earnings. This is a worst-case estimate for Q2 and could easily be beaten if the Ocean Valiant and Ocean Victory maintain a skeleton ready stack crew for the quarter, thereby decreasing drilling costs.
This will likely result in Diamond Offshore beating analyst estimates again as it has in 11 of the last 13 quarters.
Disclosure: I am long DO. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.