Offshore Drilling: Drillships Fundamentals May 2019 Edition

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Includes: CVX, DO, ESV, NE, PACD, PBR, RIG, SDLP, SDRL
by: Vladimir Zernov
Summary

In this article, I discuss the current fundamental situation in the drillship segment of the offshore drilling market.

The upside trend continues.

The stock market ignores this completely, with some stocks storming new lows.

The recent downside in offshore drilling stocks prompted me to take another look at the industry's fundamentals. Here, on Seeking Alpha, the topic which can be loosely called "market sentiment vs. reality" has been debated for several weeks now. Even Bassoe Offshore recently came up with an article, which basically says that investors' expectations are their own problems, and that the industry is on its way up fundamentally.

Numbers don't lie, so we'll look at the numbers. As usual for this type of work, I'll use Bassoe Offshore database to get current drillship data. Fundamentals of the drillship market segment are relevant for investors and traders in companies that have drillships in their fleet: Transocean (RIG), Ensco Rowan (ESV), Diamond Offshore (DO), Noble Corp. (NE), Seadrill (SDRL), Seadrill Partners (SDLP), and Pacific Drilling (PACD).

Let's first compare the data from December 2018 and March 2019 to current numbers.

December 2018

March 2019

May 2019

Drilling

57

63

66

Warm Stacked

34

29

24

Cold Stacked

18

16

18

Under Construction

20

20

18

Total

129

128

126

Source: Bassoe Offshore, author's work

The upside trend is clear: the number of working drillships increased from 57 in December 2018 to 66 in May 2019. Meanwhile, the number of warm-stacked rigs decreased from 34 to 24. Note that some rigs classified as warm-stacked may have contracts in the future. A great example of this phenomenon are Deepwater Corcovado and Deepwater Mykonos, which are currently warm stacked but have long-term contracts with Petrobras (PBR), which are set to begin in November 2019.

We should also note that three rigs have left the fleet since December 2018. I think that none of the industry observers expects mass scrapping in the drillship segment any time soon. The key problem here is that drillers simply cannot afford this from a balance sheet perspective. While scrapping a rig does not deal monetary damage, it causes a material write-down and may lead to problems with covenants. A good example of rigs which should have been scrapped but are staying in the fleet for the time being are Transocean's Discoverer Deep Seas (2001), Discoverer Enterprise (1999), and Discoverer Spirit (2000), which are cold-stacked in Trinidad. Also, Transocean has recently stated that it increased its reactivation estimates for former Ocean Rig drillships to $45 million - $50 million, which, given the company's financial situation and projected capex spending in 2019-2021, means that these rigs will likely stay out of the game for quite some time.

Many contracts that were made during this downturn were short term in nature, so a number of rigs which are currently working will have to find new contracts this year. However, this was always the case in the last few years, but utilization is increasing. Oil companies still have plenty of rigs to choose from - they can search in the current active fleet which rolls off contracts soon, or among the warm-stacked rigs, or among newbuilds. That's why dayrates are still estimated at just $175,000 - there is too much supply. However, top rigs have started to get better rates for long-term work, with examples being Transocean's contract with Chevron (CVX) and Diamond Offshore's contracts in Senegal. We'll likely see more such contracts as we move into the next decade.

In my opinion, we continue to witness a gradual recovery in the ultra-deepwater space. There is no fast solution to the problems, but the industry is moving in the right direction, and real-life numbers support this conclusion. Investors have likely been too optimistic on the speed of the recovery and now are driving offshore drilling shares to really low levels out of frustration.

I believe that such moves create an opportunity for a rebound trade in offshore drilling shares, but the timing of such a trade is uncertain at this point - there's no reason to fight the tape. My current favorites for such a trade will be Diamond Offshore, which I favor from a fundamental point of view, and Ensco Rowan (NYSE:ESV), which has been pushed to ridiculous levels after merger with Rowan, although a simple basket of leading offshore drilling stocks will also serve well for such a trade. From a longer-term point of view, I maintain my view of offshore drilling as a speculative industry, which is not perfectly suitable for buy and hold investing.

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Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in DO, ESV over 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 above-mentioned stocks.