Will Seadrill Continue To Trade Over $40?

Jul. 7.14 | About: Seadrill Limited (SDRL)

Summary

Some political unrest has created supply concerns which has resulted in oil prices going up.

Positive demand outlook of the oil will result in sustained recovery in oil prices and increased capital spending from oil and gas companies.

Seadrill has been able to win contracts for newbuilds as well as out of contract rigs at previous or even better day rates.

Seadrill's partnership with Rosneft will yield considerable benefits as the partnership might result in Rosneft deploying more than 9 rigs over the next few years.

Seadrill (NYSE:SDRL) has been on an upward trend since the last week of April - the stock has gained more than 21%. Over the last few months, there has been a lot of concerns about the off-shore drilling sector in general and Seadrill in particular due to the decreased spending from the oil and gas companies and Seadrill's own debt situation. I have discussed the company's debt and the overall prospects of the sector in my previous articles, and have always maintained that Seadrill will be a solid long-term investment and there are no permanent threats to the valuation of the stock - also, the dividend of the company is under no threat as the EBITDA and cash flows will be more than enough and the dividend coverage will be solid. The stock price has again crossed $40 after spending five months below $40. Will the stock be able to maintain its price level above $40? I believe so. I will try to explain my optimism and the future prospects about the sector in this article.

One of the biggest reasons behind the slowdown in the capital spending from the oil and gas companies was the weak demand/prices of oil due to the concerns about the recovery of the global economy. As a result, the oil and gas companies decided to cut back on the capital spending and return more capital to shareholders. However, over the last few months, some political events have caused the oil prices to rise. First, we had Russia-Ukraine conflict, which caused concerns about the global supply of oil and gas and now we are seeing unrest in the Middle East - the friction from Russia has subsided; however, concerns about the Middle East remain - I believe the political conflict in the Middle East will not be resolved anytime soon and it might further affect the oil supply.

Due to the concerns about the supply, crude prices are on the up. In addition, the positive demand outlook is also pushing the crude price up - Brent crude closed above $111 a barrel on Friday and the U.S. oil is also trading close to $104 per barrel. The supply concerns due to the political situation of Middle East might impact price in the short-term even if the conflict is resolved swiftly, but the positive demand outlook will support the prices in the long-term, in my opinion. As the prices continue to rise, the oil and gas companies will start to increase the capital expenditures resulting in better conditions for the off-shore drilling sector.

Let's move onto the company specific factors now - day rates are vital for the off-shore drillers and the prospect of falling day rates did not bode well for the companies operating in the sector. The notion of falling day rates came from the decrease in the CapEx from the oil and gas companies. However, as the recent contract wins by Seadrill have shown; the fears about a decline in day rates were unfounded. Seadrill has been able to win new contracts at attractive rates, and the demand for sixth-generation rigs remains strong. Some of the day rates for the new contracts are even better than the previous contracts. Furthermore, the progress has started on the company's joint venture with Petrobras with its first pipe-laying support vessel, Sapura Diamante. It is the first out of six units contracted to Petrobras and the vessel will be contracted for five years with an option of additional five years - the total revenue potential of the contract is $445 million. The company's ability to secure contracts for its newbuilds as well as its out of contract rigs makes me optimistic about its prospects. Furthermore, partnerships with major oil and gas companies and the strong ties should ensure the future growth of the company.

Finally, Seadrill's partnership with Rosneft will prove to be hugely beneficial in the long-term, in my opinion. Rosneft has been investing capital on the Kara Sea reserves, and the company is looking to exploit the massive reserves. Kara and Barents seas are some of most resource rich areas in the region. There is a possibility that Kara Sea region alone might hold as much as 30 billion barrels of oil - gas reserves are expected to be even bigger as the proportion of gas to oil in the Russian arctic region is close to 80:20%. As I have mentioned before, Rosneft's deal with North Atlantic Drilling (NYSE:NADL), a subsidiary of Seadrill, might expand in the future. Rosneft's decision to buy stake in the company shows that they want to develop their own off-shore drilling arm and we might see Seadrill's participation in area increase over time. Keep in mind these areas are harsh-environment areas and the equipment and rigs operating in these regions will be working at a premium.

Click to enlarge Source: U.S. Energy Information Administration and U.S. Geological Survey

Bottom Line

The fundamentals of the sector and the company specific factors indicate that Seadrill will be able to grow over the next few months. On the back of solid fundamental growth and positive outlook for the sector, I believe Seadrill will be able to hold its position above $40 per share, and it might even start to move towards $50 in the next 6-8 months. Over the next 6-8 months, we will see further positive news about the sector and the company as the company secures contracts for its newbuilds - I believe Seadrill will be able to secure solid contracts as the demand for ultra-deep water rigs will remain strong.

Additional Disclosure: This article is for educational purposes only and it should not be taken as an investment recommendation. Investing in stock markets involves a number of risks and readers/investors are encouraged to do their own due diligence and familiarize themselves with the risks involved.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.