The contract wins over the last two months show that the demand for ultra-deepwater equipment remains strong.
The day rate for these contracts is still close to the upper limit existing in the market indicating that the high-specification rigs will continue to fetch attractive rates.
Major oil and gas companies continue to direct about 50% of the CapEx to offshore developments, which means that offshore sector might not be impacted by CapEx cuts.
Seadrill (NYSE:SDRL) has made a slight recovery after the recent fall on the back of a contract win for one of its newbuilds. The stock had been falling since the start of July as the market again showed pessimism towards the sector. However, the most recent contract win for its ultra-deepwater rig shows that the day rates remain strong and the demand for ultra-deepwater offshore equipment is likely to remain high.
Seadrill secured commitment for its ultra-deepwater newbuild, West Saturn. The rig will be delivered in September and it will be deployed in offshore Nigeria - the rig has been contracted by a subsidiary of ExxonMobil (NYSE:XOM). The total revenue potential of the rig is about $497 million, including the mobilization costs - the initial contract is for a firm period of two years with an option of a third year. The day rate for the rig including mobilization costs is around $680,000.
This contract win has further backed my opinion that the demand for ultra-deepwater equipment will remain strong despite fears about the reduction in CapEx from the major oil and gas companies. The day rate for this contract and the contract win for West Jupiter at the start of June also justify my optimism about the sector - both these contracts have been agreed at over $600,000 in day rates.
Amid the flurry of negative comments about the sector, we have also seen some positive remarks about Seadrill from Citigroup (NYSE:C) - analysts at Citigroup are saying what I have been saying for a long time - the revenue and cash flows potential of the company is visible and the dividend is under no threat. First of all, the Citigroup analysts talk about the deal signed with Rosneft - this deal is for over five years and accounts for a substantial portion (20%) of the total order backlog. They further say that this deal is exempt from Tier 3 sanctions. I have explained in my previous articles how this deal with Rosneft can be more than just a deal for nine rigs - I believe as Rosneft tries to take advantage of the reserves in Kara Sea and Barents, Seadrill and Rosneft can become major partners and Seadrill might get the opportunity to deploy more rigs in the area. (You can read my previous piece here)
They further talk about the growth rate in EBITDA - Analysts at Citigroup believe that the company will be able to grow its EBITDA at 10% CAGR till 2016 - the growth in EBITDA has been pretty strong for Seadrill and this is also in line with my belief that the company will be able to get its target of $4 billion in annual EBITDA. Furthermore, the current dividends are under no threat as the day rates will have to fall 10% below incentive rates for newbuilds after 2016 for Seadrill to revise its dividend policy, according to Citigroup. Finally, the their long-term views about the oil and gas sector as well as the off-shore drilling sector also echo what I have been saying - I am expecting the cut backs in CapEx to be short-term and I believe the major oil companies will start to spend more over the next 12-18 months as the demand for oil continues to get stronger. Citigroup analysts also highlight that despite a decrease in total CapEx from major oil companies, almost 50% CapEx is still going towards deepwater developments.
When we look at the offshore sector and its future prospects, some of us ignore the strength of Seadrill - the sixth-generation, high-specification, and high-margin ultra-deepwater fleet of the company sets it apart from its peers. It is understandable that price fluctuations tend to follow the sector; if a sector is having a tough time then it is possible that the best stock in the sector might also face trouble. However, Seadrill continues to fight these fears and secure contracts at impressive rates for its newbuilds as well as out of contract rigs. Furthermore, as I stated above, about 50% of the CapEx from the major oil and gas companies is still going towards the offshore developments, which should ensure high-utilization rates for offshore drillers. At the same time, Seadrill's partnership with Rosneft will prove to be another growth driver for the company. In my opinion, Seadrill is the best-positioned company in the sector to grow over the next 2-3 years and the fears about the stock are unfounded.
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