First Coal, Now Offshore Drilling?

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Includes: ATW, BP, CVX, DO, ESV, NE, ORIG, PACD, PBR, RDC, RIG, RIGP, SDLP, SDRL, XOM
by: Vladimir Zernov

Summary

New regulations for the offshore drilling industry come at unfortunate times.

Let's look at drillers' exposure to U.S. GoM.

Coal companies went bankrupt after significant regulatory pressure, is there such a risk for offshore drillers?

This has happened before - with coal. Strict regulations led to the closing of coal-fired plants and put immense pressure on the industry. Biggest producers like Arch Coal, Alpha Natural Resources and, most recently, Peabody Energy filed for bankruptcy.

Billions of shareholder value were destroyed. Sure enough, regulations were not the only reason for this misfortune. Coal miners took more debt than they could afford and were slow to adapt to low prices. However, one cannot underestimate the role of environmental regulations in coal miners' failure.

This time, the current administration is set to deliver a blow on offshore drillers. As most of you already read from the SA news team, new oil well control rules will be issued to prevent the Macondo-type accidents.

The timing of this move is rather strange, as six years have passed since BP's (NYSE: BP) misfortune without catastrophic accidents and the industry is now in a survival mode due to low oil prices. This decision is a red sign for anyone who followed coal industry in recent years, as we have learned that tougher regulations can lead to a full-blown campaign against the industry.

Initial estimates of the impact vary. The administration believes the added cost is $890.3 million over 10 years offset by $1.3 billion of possible "benefits". I don't know how they counted, but on an intuitive level the calculations of the so-called "benefits" seems plain wrong. If a Macondo-type accident is prevented, the benefit number should be much more than a mere $1.3 billion. If they were not talking about catastrophes, then how is the 'benefit" defined?

Exxon Mobil's (NYSE: XOM) initial estimate of the new rules is $25 billion over 10 years. The difference between the administration's estimate and Exxon Mobil's estimate is striking. The real number of damages to the industry probably lies somewhere in between these two numbers, but the difference between estimates is so huge that this difference itself creates uncertainty, and uncertainty is no friend of upside.

Now, let's get to driller's exposure to U.S. Gulf of Mexico.

Atwood Oceanics (NYSE: ATW) currently has two UDW drillships working in the U.S. GoM - Atwood Advantage and Atwood Condor. The number does not sound big, put it's a significant part of Atwood's working fleet so changes in U.S. GoM regulatory environment should be monitored closely by Atwood's shareholders.

Diamond Offshore (NYSE: DO) has 4 working rigs in the U.S. GoM. These rigs are recent newbuilds with long-term contracts on attractive dayrates. Also, Diamond Offshore has 8 rigs stacked in the region. I think most of them will ultimately go to scrap. Diamond Offshore's exposure to GoM is big, and new rules might have a notable negative impact on the company.

Ensco (NYSE: ESV) has 23 rigs in the U.S. GoM, seven of them are currently working (including those under drilling management). If the real damage is closer to Exxon Mobil's estimate than to the administration estimate, Ensco will have a U.S. GoM exposure problem in addition to Petrobras (NYSE: PBR) exposure.

Noble Corp. (NYSE: NE) has 10 rigs in the U.S. GoM - one third of its fleet. In my view, the potential damage of new regulations could be significant for the company.

Ocean Rig (NYSE: ORIG) has no rigs in the U.S. GoM and is currently insulated from the problem.

Pacific Drilling (NYSE: PACD) has two rigs working for Chevron (NYSE: CVX) in the GoM. While being obviously bad news, the new regulations do not change the outlook for Pacific Drilling as, in my view, the company is doomed anyway unless we see a real miracle on the oil price front.

Rowan (NYSE: RDC) has 4 rigs working in the U.S. GoM and 2 rigs stacked. The 4 rigs working are the only drillships that Rowan has, so the company might see all its UDW fleet under pressure of new regulations.

Seadrill's (NYSE: SDRL) exposure to U.S. GoM is limited compared to the size of its fleet - the company has 6 rigs in the U.S GoM. Four of these rigs are operated by its subsidiary Seadrill Partners (NYSE: SDLP), for which it is a much more significant part of the fleet. However, the most important driver for both Seadrill and Seadrill Partners is the upcoming restructuring of Seadrill.

Transocean (NYSE: RIG) currently has 7 rigs in the U.S. GoM. Three of those rigs are operated by the company's subsidiary Transocean Partners (NYSE: RIGP), which is the whole Transocean Partners' fleet.

So, is the situation similar to the one we've seen in coal? No, it is not. Drillers are mostly diversified among geographies while coal companies were glued to domestic utilities while the seaborne market got totally crushed.

However, I would like to point out one thought. In my view, the rigs will become glued to the place where they work during this downturn. With so many rigs competing for a few jobs, there is no economic sense to move rigs around the globe. That's why I believe that the companies' exposure to U.S. GoM could become a factor in the longer run if the new regulations are fiercely imposed on the industry.

Things might change, though, due to the outcome of the upcoming presidential elections and continuing efforts from major oil companies, who certainly don't need another blow after the collapse of oil prices. I don't think there is a significant risk of regulatory "contagion" as other offshore hot spots like Brazil or West Africa are now battling for survival and won't impose similar measures in the foreseeable future.

Despite mitigating factors, the story should be closely watched as it creates additional risks for the industry pressured by lack of new contracts and rig oversupply.

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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