Seadrill Partners: Why Are You Shocked?

| About: Seadrill Partners, (SDLP)


Seadrill Partners cuts quarterly distribution from $0.25 to $0.10 per unit.

The company's units tank on the news.

Will the downside continue?

Seadrill Partners (NYSE: SDLP) has recently shocked investors by cutting the quarterly distribution from $0.25 per unit to $0.10 per unit.

I used the word "shocked" solely judging by the trading action - Seadrill Partners' units went from $5.85 to $4.09 in one day on big trading volume.

However, the decision itself is hardly a big surprise to anyone who closely follows the industry. The decision came earlier than most expected, which, perhaps, caused the massive reaction to the news.

Back in February, I wrote the following: "However, I see huge risks that are not mitigated by Seadrill Partners' cash distribution, which could be cut at any time. I remain bearish on Seadrill (NYSE: SDRL), so I am automatically bearish on Seadrill Partners, but I admit that the latter is a better way to bet on a fast rebound in the offshore drilling market".

Such a forecast looked a bit silly when Seadrill and Seadrill Partners were enjoying upside together with a rebound in the oil price.

However, the fates of both companies quickly diverged, as upcoming restructuring put significant pressure on Seadrill shares while Seadrill Partners units enjoyed better performance fueled by purchases from yield-hunting investors.

I suspect that a great part of Seadrill Partners rally was due to yield-hunting, hence the strength of the reaction to the news.

On the fundamental side, nothing has changed. The outlook for offshore drilling market recovery has previously been bleak and still remains bleak.

The oil's rise above $50 did not lead to a flurry of new contracts. More, as problems in Canada and Nigeria left the headlines, oil quickly found itself under pressure and is already trading below $45 per barrel.

Explaining the decision to investors, Seadrill Partners stated that the extended standby rate period for West Capricorn as well as the termination of the drilling contract for West Capella were key factors. However, I suspect that the offshore drilling market outlook itself forced the company to make this move.

Take the West Capricorn agreement, for example. BP (NYSE: BP) agreed to pay $316,000 per day to have the rig not working until late 2017, when the rig should return to the day rate of $526,000.

This effectively means that if BP did not have a contract in place, it supposed that the earliest date where it will need the rig may been somewhere in the last months of the next year.

In my view, this is a perfect example of what oil producers themselves think about the demand for offshore drilling services.

Not surprisingly, Seadrill Partners had to play it safe in such environment.

The company stated that available units were bid on a number of opportunities and that extension conversations continued, but that's the narrative you'll hear from any offshore driller nowadays and it does not signal anything.

So, what will be the outcome for Seadrill Partners' units? The current negative momentum can continue as income-oriented investors unload their shares and short sellers join the party.

However, the current yield is still big enough to attract newcomers who are not familiar with the industry. Anyway, the offshore drilling is surely not an industry for those seeking income.

The price of Seadrill Partners' units depends on multiple factors, including the price of oil and the outcome of Seadrill restructuring.

Speaking about the price of oil, Seadrill Partners' units did not react to the recent oil price downside, and I suspect that they may catch-up with the news as now investors and traders will be willing to search for negative sides of investment in Seadrill Partners.

I don't think that the news will have a major impact on the shares of the parent company, Seadrill.

Seadrill has much bigger problems to deal with, and the fate of its shares mostly depends on the outcome of its negotiations with banks.

It's interesting that Seadrill found a stone-wall support around $3 per share and that the recent downside in oil did not put more pressure on the company's stock. However, when (and if) this support is broken, I expect that Seadrill shares will quickly find themselves at $2.25 or lower.

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.