Transocean Does Not Expect Dayrates To Pick Up Until The End Of The Decade

| About: Transocean Ltd. (RIG)


CEO Jeremy Thigpen issued a couple of downbeat comments while presenting at the Scotia Howard Veil Energy Conference.

The company's European listed shares took a fairly large initial beating despite the company's CEO in fact did not offer anything entirely new to industry followers.

The offshore drilling industry remains in the doldrums with things expected to get even worse over the course of 2016 and 2017.

Major improvements in industry sentiment towards the end of the decade remain an imperative given the major debt maturities virtually all industry players will be facing at that time.

Transocean (NYSE:RIG) shares took a severe beating in European trading on Tuesday morning after some downbeat remarks by the company's CEO, Jeremy Thigpen, at the Scotia Howard Veil Energy Conference. While the company's respective presentation does not really offer anything not already well known to investors and analysts following the company and the industry more closely, some comments made by Thigpen obviously caused European investors to head for the exit (remember Transocean is still listed on the Swiss Stock Exchange until the end of this month).

More precisely, Thigpen does not expect rig demand to pick up until the end of 2017 or perhaps 2018 with any potential opportunities for dayrate increases not before 2019 or even 2020.

Taking the same line, oil services firm Schlumberger (NYSE:SLB) CEO, Paal Kibsgaard, noted in his presentation that the fragile financial state of oil explorers means there will be a noticeable lag from when oil prices climb and when exploration and production companies invest again. Profitability and cash flows are "at unsustainable levels for most oil and gas operators which in turn has created an equally dramatic situation for the service industry," he said. "Going forward, the industry is likely facing a "medium-for-longer" oil-price scenario, subject to periods of volatility, as the national oil companies within OPEC can still generate significant returns for their owners in such an environment due to the low cost base of their conventional resources."

Actually these most recent comments out of the on- and offshore oil services industry should not take investors by surprise, as there has virtually been a mutual consent between both company executives and analysts about this downturn to last much longer than initially anticipated for quite some time now.

Unfortunately particularly the offshore drilling industry looks pretty much stuck between a rock and a hard place given the now widely anticipated emergence of shale oil as a future swing producer. As always, there are opposing views, so investors would be well served to also take a look at the other side of the story.

But the writing seems indeed pretty much on the wall here, given recent statements out of oil majors like ConocoPhilips (NYSE:COP) or Chevron (NYSE:CVX) regarding their future deepwater exploration plans. Particularly ConocoPhilips has publicly stated its intent to entirely phase-out deepwater exploration until 2017.

In fact, I have been bearish on the industry ever since the OPEC surprisingly decided against curtailing production back in 2014 and already expressed my deep concerns about the industry's future in an article at the beginning of the year.

So with very little incremental offshore exploration demand expected in 2016 and 2017 the industry's already dramatic oversupply situation will only get worse going forward and won't get back into balance until more of the bigger players finally commit to scrapping large parts of their older rig fleets. Unfortunately the chances for this to happen remain slim at best given the prisoner's dilemma that what's good for the industry might actually be devastating for an individual company, given potential impairment charges, tripping of debt covenants and the massive reduction of future earnings power associated with scrapping own rigs.

Without dramatically increased scrapping activity, the balancing of supply and demand will solely rely on a sustainable recovery in oil prices far above today's levels. According to remarks made by management of fellow offshore driller Pacific Drilling (NYSE:PACD) on its recent Q4/2015 earnings conference call, an uptick in activity is expected at oil prices "north of $55". Investors should be cautioned that this potential pick-up in offshore exploration demand would still not be sufficient to address the industry's large overcapacities and lift dayrates materially from current cash break-even (and sometimes even below) levels.

Moreover, with the vast majority of any additional capex commitments most likely being directed towards bringing more of the oil major's backlog into production, there's seemingly little hope for offshore exploration demand to increase meaningfully anytime soon.

With the once mighty OPEC currently looking more or less dysfunctional and non-OPEC producers having gained sizeable market share over the last few years, the oil price environment is likely to remain volatile going forward, but unlikely to reclaim the levels seen until 2014 anytime soon.

Should the shale oil industry indeed move into the role of a swing producer, oil prices might be capped at a level insufficient for material increases to offshore exploration budgets for the foreseeable future.

There's still hope for the industry though. A coordinated OPEC production cut would still cause a major increase in oil prices, but it would also require some of the larger non-OPEC producers to abstain from filling the gap.

As evidenced by the recent "production freeze agreement"-talks now widely expected to be finalized next month in Qatar, the mere indication of some kind of coordinated action has lead to a more than 50% increase in oil prices from their recent lows.

Unfortunately the agreement will do very little to address the current oil oversupply situation as it basically stipulates oil output at or near record levels with some crucial countries like Iran (which is actually in the midst of increasing its output to pre-sanction levels) refusing to join the deal. Given this initial situation any potential agreement would be basically a poorly disguised attempt by the participating countries to increase margins without giving up on market share or even curtailing production.

Once this catalyst will be gone, oil prices might very well reverse course once again as market participants start to realize that nothing has really changed.

Lastly I am very skeptical with regard to a factual output cut, given that Saudi Arabia is also using the oil price as an instrument to pursue far-ranging political interests.

Looking at the implications of Thigpen's statements for future industry earnings, more and more companies will start to report losses coupled with negative cash flows over time as their old high-margin backlog gets increasingly worked off with new contracts either not available at all or just good for breaking even on the operating level - if lucky. Approaching the 2019-2020 time frame noted by Transocean's CEO, business fundamentals in fact WILL have to show noticeable improvements as most industry players will be facing major debt maturities then. In case of Transocean, the company's $3 bln currently undrawn revolving credit facility will be up for renewal in 2019.

At least Transocean shares were able to mostly shake off the CEO's downbeat outlook during the regular US session with the stock finishing well off its pre-market lows. Unfortunately the sometimes lucrative arbitrage opportunity between Transocean's Swiss- and US-listed shares will be ultimately gone by the end of this month. While Transocean shares will continue to e.g. trade at the German stock exchange, the insignificant volume there does not allow to enter into material positions.

Investors still looking for exposure to the industry might want to take a closer look at my recent assessment of the main industry players listed on US stock exchanges.

Bottom line:

Investors should be wary about the industry's currently challenging business conditions that will most likely get even worse over the course of 2016 and perhaps well into next year.

It seems actually an imperative for the offshore drilling environment to improve considerably approaching the end of the decade as even the industry's strongest players will be facing major debt maturities at that time. Should oil prices continue to remain below a level sufficient to stimulate incremental offshore exploration demand, most industry players will be forced into major debt restructurings over time.

As already witnessed for some time, shares of most offshore drilling companies will most likely continue to more or less trade like an option on oil prices for the time being with some major volatility potentially developing from time to time as evidenced by the outsized moves in many industry shares recorded in the first week of March.

While a potentially lucrative playground for experienced traders, investors lacking a deeper understanding of the industry's fundamentals or simply the time to closely follow the individual developments going on at their holdings, should continue to stay away from the industry as a whole until there will be at least some light at the end of the tunnel.

Given current business conditions, not even an undisputed industry leader like Transocean looks like a safe bet anymore at this point.

Investors looking for some less risky exposure might want to take a look at some of the company's shorter term bond maturities which should provide reasonable returns.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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.