Transocean's (NYSE: RIG) CEO Jeremy Thigpen has recently stated that at least three years will pass before day rates for rigs beginto rise. These thoughts are in line with my own expectations, which I recently presented in "Offshore Drilling: Rally Is Fading". In this article, I will evaluate the impact of the low day rate scenario for Seadrill (NYSE: SDRL) and related companies.
As many readers already know, Seadrill announced that it will be restructuring its debt load and that it will announce its plans in the first half of this year. A lot will depend on whether Seadrill subsidiaries continue operating as standalone entities or not. I have little doubt that North Atlantic Drilling (NYSE: NADL) will become a part of Seadrill once again - there is just no way how North Atlantic Drilling could continue operating as a standalone entity.
The case of Seadrill Partners (NYSE: SDLP) is more interesting, as Seadrill's management indicated that Seadrill Partners were not a part of their plan during the latest quarterly earnings call. The statement sounded reassuring to Seadrill Partners' investors and reinforced the case for the company as a dividend play at least for this year.
However, the more I think about this statement, the less I am inclined to take it for granted. The first worry is, of course, the cross-default provision between Seadrill and Seadrill Partners. Also, it might make sense for Seadrill to directly access the Seadrill Partners' healthy cash flows instead of relying on distributions.
Think about it - if Seadrill Partners were to eliminate its distribution, the whole Seadrill Partners' backlog will be basically dead for the parent company. In this environment, cash is king, and one can expect that Seadrill will be focused on attracting as much cash as possible.
It's not surprising that Seadrill decided to come up with funding plans in the first half of this year. If we Mr. Thigpen is right in his evaluation of the situation in the industry, Seadrill can hope for a very limited number of contracts at low rates in 2016 and 2017. Given the amount of debt payments, the company won't get past 2017 as a going concern in this scenario. The only possible solution is to significantly decrease the debt load.
In my view, too many investors still look at 2016 and 2017 when evaluating offshore drillers. It is increasingly evident that we should look at 2018, 2019 and even 2020 when judging offshore drilling stocks. One might argue that predicting the oil price for the next half a year is a difficult task and that we have no clue what oil prices will be around in 2019. This is true, but I think that the offshore drilling market is more predictable than the oil price.
First, there is a lag between the actual increase of oil price and the corresponding increase in contracting activity. Second, oil prices below a certain threshold (arguably $50 - $60 per barrel) barely generate any new contracts, at least for now. Third, the industry itself faces a major oversupply problem which will weigh on day rates in 2018 and beyond when postponed newbuilds are finally delivered.
It's difficult to evaluate how many contracts will Seadrill be able to sign for its 2018. For my scenario, I assumed that existing contracts that last through 2018 will be honored. Also, I assigned flat rates to all rigs which currently do not have contract coverage for 2018. I also assumed that they will work for half a year. I used rates of $250,000 for semis and drillships and $100,000 for jack-ups.
This is simplistic, but I see no point in trying to predict the exact outcome for each rig - there are too many factors, and the outcome will be just another guesstimate. My conclusion: Seadrill needs to eliminate debt repayments in 2018 completely to feel comfortable in this scenario and be prepared for 2019.
In the beginning of this year, Nordea estimated that Seadrill needs a $1 billion equity offering. I think that such a decision will be a patch rather than a solution if we consider Mr. Thigpen's views as our base-case scenario.
What about newbuilds?
I did not include newbuilds in my calculations. If payments for newbuilds are included, I can't see anything that will save Seadrill in the lower-for-longer scenario. My best guess is that Mr. Fredriksen will use his Sandbox venture to collect Seadrill's newbuilds.
Also, I think that the $510 million he recently got from the sale of his Marine Harvest stake will be used for Sandbox rather than Seadrill. This sum is tiny relative to the problem of Seadrill's debt, so the company will have to deal with the problem itself rather than rely on a cash injection.
Yes, the news that Seadrill's founder just got half a billion dollars of cash created a historic short-squeeze in Seadrill, but such moves are often based on speculation rather than on fundamentals. Similar moves in beaten-down oil stocks already faded and Seadrill is also on its way to pre-squeeze levels.
If Mr. Thigpen is right in his evaluation of the drilling market, Seadrill is in real trouble. In order to deal with the problems which will arise in 2018 and beyond, Seadrill will have to significantly reduce its debt. Creditors are not philanthropists and history tells us that such moves end bad for common shareholders. I remain bearish on Seadrill although I won't be surprised if another rumor or two sends its shares higher for a moment.
P.S. For direct evaluation of Mr. Thigpen's views on the offshore drilling industry, consider reading "Transocean Does Not Expect Dayrates To Pick Up Until The End Of The Decade" by fellow contributor Henrik Alex.
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.
Additional disclosure: I may trade any of the abovementioned stocks.
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