SeaDrill: A Recovery Might Be Around The Corner

| About: Seadrill Limited (SDRL)

Summary

SDRL has been beaten down badly due to the oil downturn, but a recovery in rig counts bodes well for the company as it signals the return of drilling.

Oil production in the Gulf of Mexico will increase from 1.63 million bpd this year to 1.91 million bpd by December 2017, accounting for a fifth of U.S. oil production.

SDRL will also benefit from robust offshore oil investments in Africa and Latin America, which will account for the majority of investment in this segment going forward.

Capital spending on deepwater projects will increase to $210 billion by 2019, a jump of 69%, with $173 billion accounted for by Africa, Latin America, and North America.

SDRL has already witnessed positive commercial developments in Africa and Latin America with new contracts that have impacted its backlog positively.

In an article on SeaDrill (NYSE:SDRL) last week, I had advised investors to be bullish about the stock as the company's moves to keep its efficiency at high levels has allowed it to keep its gross margin in good shape despite the downturn. Additionally, I had also pointed out that the offshore drilling environment will recover in the future due to an increase in demand for oil and also the fact that there are a number of offshore oil discoveries ready to be developed.

Now, in my opinion, the latest development in the rig count in the U.S. and abroad indicates that the end-market conditions for SeaDrill can now improve. As such, in this article, we will take a closer look at the recent indicators and see why SeaDrill could see a rebound in its business going forward.

Are market conditions improving?

The continued weakness in oil and gas prices led to a dramatic decrease in the rig count in the United States and abroad. This is because exploration and energy companies have been reducing their capital outlays to preserve the balance sheet. However, of late, the situation for companies such as SeaDrill has started improving on the back of a recovery in the rig count.

According to the latest data by Baker Hughes, the U.S. rig count increased by 6 units for the week of June 10, 2016. Additionally, Canada's rig count also increased by 24, while the international rig count increased by 9, as compared to the preceding week. In fact, the U.S. rig count has increased for two weeks on the trot now, signaling a turnaround in drilling activity.

Moreover, the EIA also anticipates that oil production from the Gulf of Mexico will continue to pick up pace until next year. The EIA forecasts that oil production in the Gulf will increase from an average of 1.63 million bpd this year to 1.91 million bpd by December next year, accounting for 18% and 21% of oil production in the U.S. in 2016 and 2017, respectively.

The increase in production in the Gulf of Mexico will be driven by the start-up of new projects. The following table gives a snapshot of projects that are expected to go online in this area in 2016 and 2017:

Source: EIA

Apart from the Gulf of Mexico, offshore oil activity will continue to remain at robust levels in Africa, where SeaDrill has recently won a new contract. In fact, according to a research by Douglas-Westwood, Latin America and Africa will drive the growth of the offshore oil industry going forward.

Douglas-Westwood forecasts that capital spending on deepwater projects will increase to $210 billion by 2019, a jump of 69%. The majority of this growth will be driven by combined spending in Latin America, Africa, and North America, which will account for $173 billion of the spending over the coming five years, with Africa spending the highest amount. Thus, it won't be surprising to see a recovery in offshore drilling in the coming years and this will allow SeaDrill to get its financial performance back on track.

More important, SeaDrill's recent contract gains indicate that it is benefiting from anticipated growth in the areas mentioned above.

New commercial developments are positives

Considering the strength in offshore drilling in certain areas of the globe, it is not surprising to see that SeaDrill has landed new contracts with some of its customers. For instance, the company was awarded a contract in Angola last quarter. This contract is for a fixed period of two years and adds approximately $285 million to its backlog. Likewise, its West Tellus drillship was awarded an 18-month contract extension by Petrobras, which will commence in April 2018.

Additionally, SeaDrill's Sevan Driller has been awarded a well-intervention contract by Shell (NYSE:RDS.A) (NYSE:RDS.B) in Brazil for 60 days, and this will add around $11 million to the company's backlog. Thus, it is evident that the positives in offshore drilling in Latin America and Africa have helped SeaDrill land more contracts, and therefore keep its utilization rate at elevated levels.

Conclusion

Given the points discussed above, I think that investors should continue to expect a recovery at SeaDrill. There are certain areas where offshore drilling will continue to remain strong and help the company make a comeback in the long run. Investors, therefore, should continue to remain positive about SeaDrill as a recovery is still in the cards.

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.