Offshore Drilling - Deconstructing The Excess

by: Sushyant Krishnan

Summary

The Offshore drilling market is highly fragmented - there are a number of small sized operators with insignificant fleet sizes; e.g. 67% of operators have <=5 rigs.

Operator size is a clear differentiator of rig performance; a significant portion of the uncontracted offshore fleet is concentrated among these small sized operators.

I believe this would lead to consolidation and hence a fast recovery; since small sized operators are unlikely to have the financial backing to stay afloat for a long time.

Oil prices have significantly declined over the last 1 year with WTI falling 45-50% during the time period. A closer look at the worldwide active rig count shows a correlation between oil prices and active rigs - which intuitively makes sense and is potentially a relationship that holds for any commodity business. Higher commodity prices means higher operating margins which in turn drives higher investments to explore and produce the commodity. The oil industry witnessed this trend, with a flurry of investors jumping in over the 2010-2014 period to capitalize on the oil price increase and get a share of the pie. This investor enthusiasm eventually pushed this to a point where supply exceeded demand, causing a decline in oil prices. As you can see in the chart below, this oil price decline is being followed by a drop in the active rig count.

For the industry to recover, this supply - demand imbalance needs to be restored; which requires this excess rig supply and subsequently excess oil production to be eliminated from the system. However, it is to be seen how the rig count decrease impacts oil production and oil prices in the coming months. Note that the chart represents the total rig count and has only been used to illustrate the cyclical trend in the overall oil industry. However, the article primarily focuses on the offshore drilling industry and attempts to specifically understand the glut in offshore rigs. The analysis that follows primarily leverages publicly available data (May 2015) from rigzone.com and any conclusions drawn are constrained based on data limitations.

Offshore rig operator distribution:

As a first step, let's look at some basic statistics related to the offshore drilling industry. Here are some high level rig statistics -

  1. Total operators doing business - 193
  2. Average Fleet Utilization - 56%
  3. Average number of rigs per operator - 7.6
  4. Range of rigs owned per operator (Min - Max) - (1 - 77)

At first glance it's clear that the industry is highly fragmented. The range of fleet size is significantly wide with some operators operating as low as 1 rig!

As a next step let's look at the cumulative frequency distribution of operator size. The data in the charts below group operators into buckets based on their fleet size. Ex. 5-10 category represents operators with >5 and <=10 rigs and so on. The top chart (Cumulative Distribution - Rigs) is a distribution of rig volume, while the chart below (Cumulative distribution - operators) is a distribution by operator count.

Source: Rig fleet by operator from www.Rigzone.com

Source: Rig fleet by operator from www.Rigzone.com

Let's read these charts together. I am going to take the solid and dotted line as examples -

  1. Solid line - 67% of operators have <=5 rigs, contributing to only 19% of total rigs
  2. Dotted line - 82% of operators have <=10 rigs contributing to only 35% of total rigs

It's clear how fragmented the offshore drilling market is - there are several small operators with very insignificant fleet sizes. At the same time, the industry is very concentrated on the other end - 18% of the operator's control 65% of the total fleet in the industry!

As a next step, let's see how these small operators are performing in terms of fleet utilization. The chart below shows average fleet utilization (contracted fleet/total fleet) by operator size (the buckets are similar to what is shown in the previous charts) -

Source: Rig fleet by operator from www.Rigzone.com

It is clear how utilization shows a positive correlation with operator size. Smaller operators clearly have a much smaller portion of their fleet contracted. Let's dive into this further to understand how fleet utilization is distributed. The charts below tell a very compelling story.

Source: Rig fleet by operator from www.Rigzone.com

Source: Rig fleet by operator from www.Rigzone.com

The x-Axis is utilization buckets, ex. 0-45% represents rig volume (top chart) and operator count (bottom chart) distributions that have fleet utilization between 0 to 45%. So what do we see here?

  1. 41% of the operators, who only contribute 13% of the total rigs, have ZERO contracts on their rigs!
  2. 49% of the operators, with 26% of total rigs have <45% utilization!

Clearly, a significant portion of the uncontracted offshore fleet is concentrated among these small operators.

Rig Utilization by region:

The above charts show a clear relationship between operator size and performance. Let's look at fleet utilization by region to see if there are any region specific utilization trends. Instead of looking at current snapshot of data, I have looked at the change in utilization over the last one year for important category of regions. The chart below shows the current utilization in every region indexed to (divided by) utilization 1 year ago. Ex. 100% would mean no change over the last one year, <100% would mean a drop in fleet utilization and so on, which means that a number significantly below 1 shows worsening. Based on how this has been set up, the regions highlighted in red - Asia and N. America show ~30% lower utilization than a year ago. Other regions have more or less remained flat.

Source: Rig Fleet by Region from www.Rigzone.com

Let's dive into these regions further to see where this is coming from. The chart below breaks out Asia and N. America into smaller regions. It's pretty clear that US Gulf of Mexico, South/South East Asia are amongst the worst affected.

Source: Rig Fleet by Region from www.Rigzone.com

Conclusion:

As I mentioned earlier that the analysis is based on publicly available data on www.Rigzone.com, which limits the quality of conclusions that can be drawn. Based on observed data, here is a summary of my conclusions -

  1. Concentration of glut with small operators: The excess and inefficient supply seems to be concentrated with the small sized operators. On average, the large sized operators are doing much better with a much higher portion of their fleet contracted. Additionally, worsening is concentrated to certain regions - ex. Parts of Asia and US Gulf of Mexico. Operators with large exposure to these areas are likely to be more impacted and will find it tougher to recover.
  2. Downturn is unlikely to be prolonged: These small sized operators are unlikely to have the financial backing to stay afloat for a long period of time. The industry is likely to see a lot of consolidation through bankruptcies and M&A activity.
  3. Strong recovery for survivors: Large sized operators with strong fleet utilization, revenue backlogs and solid balance sheets will survive this downturn. Survivors will come out into a strong industry with higher oil prices and much lesser competition due to industry consolidation.

While I am not recommending any specific stocks as part of this article, I believe that the offshore industry will see a recovery relatively soon. I would recommend picking up good quality offshore drilling companies and holding on to them for the next few years.

Risks and Uncertainties:

I would like to call out the key risks with my assumptions:

  1. My assessment of the offshore drilling industry takes a narrow lens (focused only on offshore industry data) and does not account for all drivers of supply/demand and associated issues - ex. Other types of Drilling and its issues, political impacts on supply etc.
  2. There is an inherent assumption that operators with lesser number of rigs are smaller in size, this may not be true in all cases ex. there might be large drilling companies with small offshore fleets.

Disclosure: This article is a reflection of the author's own opinions, and is not meant to offer investment recommendations. It is important you conduct your own research and/or consult a professional investment advisor before making any investment decisions.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.