Transocean Secures Important CAT-D Rig Contracts With Equinor - Buy On Weakness

Summary

• Company secures eagerly-awaited follow-on work with Equinor for two of its so-called Category D ("CAT-D") rigs at respectable terms.
• Total firm backlog addition amounts to $382 million. Both rigs will be upgraded at the expense of Equinor.
• While Transocean will take a slight cash flow hit under the new contract terms, rates are actually among the highest awarded offshore Norway in recent years.
• While the company still needs to secure near-term work for the harsh environment rigs Transocean Equinox, Transocean Endurance, and Transocean Barents, Tuesday's announcement represents a major step forward in navigating ongoing weak market conditions in the North Sea.
• While I wouldn't chase the shares after the most recent recovery rally, investors should consider adding on any major weakness.

arild lilleboe/iStock via Getty Images

Note: I have covered Transocean (NYSE:RIG) previously, so investors should view this as an update to my earlier articles on the company.

After the close of Tuesday's regular session, leading offshore driller Transocean announced eagerly awaited follow-on work for two of its so-called CAT-D rigs, the Transocean Encourage and Transocean Enabler:

Transocean Ltd. today announced contract awards for two of its harsh environment semisubmersibles. Together, the fixtures represent approximately $382 million in firm contract backlog.

Transocean Enabler will provide drilling services for 19 firm wells and up to eight optional wells for Equinor on the Johan Castberg field in the Barents Sea. The estimated 570-day contract is expected to commence in April 2024 and contribute approximately $217 million in backlog, excluding additional services and potential performance bonuses.

Transocean Encourage will provide drilling services for nine firm wells for Equinor in the Norwegian North Sea. The contract is expected to commence in December 2023 in direct continuation of the rig’s current program. The estimated 460-day contract is expected to contribute approximately $165 million in backlog, excluding additional services and potential performance bonuses.

As part of the Enabler and Encourage contracts, each rig will receive customer-paid upgrades to digital management systems, robotics, and operational automation. These upgrades are expected to further reduce emissions from the rig and enhance personnel safety. Transocean and Equinor have also entered into a strategic collaboration agreement to explore future opportunities in areas such as technology development, operational efficiency, and environmental sustainability. (...)

CAT-D rig background:

The Category D ("CAT-D") rigs have been purpose-built for Equinor (EQNR) between 2012 and 2016 and are designed as workhorses for mature North Sea fields with their primary use being the drilling of production wells and well completion.

Equinor originally partnered with Songa Offshore ("Songa") for four of these units but construction at DSME shipyard in Korea experienced massive delays and cost overruns which resulted in Equinor reducing contract durations by an aggregate 663 days after originally awarding 8-year contracts with four three-year options for each rig.

In August 2017, Transocean announced an agreement to purchase Songa Offshore for an eye-watering enterprise value of approximately $3.4 billion at that time. The deal was expensive and highly dilutive for Transocean's existing equity holders but nevertheless required to buy more time for the ailing company to make it through the downturn.

While the acquisition of Songa added approximately $4 billion in much-needed high-margin backlog at that time, Transocean recently failed to secure follow-on work with Equinor for the first two units, Transocean Equinox and Transocean Endurance.

While Transocean Endurance remains contracted until June, Transocean Equinox has already been sitting idle for almost six months after Equinor surprisingly decided to terminate the initial contract slightly ahead of its original expiration date last year.

With the market offshore Norway widely expected to remain weak for the next couple of quarters, the fate of the last two units Transocean Encourage and Transocean Enabler remained unclear until Tuesday.

That said, on Transocean's recent Q4 conference call, CEO Jeremy Thigpen was highly confident in the company's ability to successfully navigate extended weakness in the harsh environment markets (emphasis added by author):

(...) With that said, we have line of sight jobs on pretty much all of our harsh environment including the stacked CAT-D and I can’t really disclose the details about that, but essentially it’s safe to say that for all of our harsh environment fleet, including the stacked CAT-D we’re in active negotiations for placing in all of those.

I think and over the period of this year, you’re going to see pretty much all those rigs get fixtures on them. And you’ll see that the day rates associated with those and the locations should raise a few eyebrows in terms of the trajectory of rates for harsh environment rigs.

While Transocean still needs to secure work for the Transocean Equinox and Transocean Endurance as well as for the Transocean Barents, extending the Transocean Encourage and Transocean Enabler at respectable terms in times of protracted harsh environment market weakness should be viewed as a major success for the company.

1. Transocean Encourage will provide drilling services for nine firm wells for Equinor in the Norwegian North Sea. The contract is expected to commence in December 2023 in direct continuation of the rig’s current program. The rig is expected to work approximately 460 days at a calculated dayrate of $358,700, 12.5% below its current dayrate of $410,000. Total backlog addition amounts to $165 million.
2. Transocean Enabler will provide drilling services for 19 firm wells and up to eight optional wells for Equinor on the Johan Castberg field in the Barents Sea. The contract is expected to commence in April 2024 with the rig expected to work approximately 570 days at a calculated dayrate of $380,700, 12.1% below its current rate of $433,000. Total firm backlog addition amounts to $217 million.

In addition, both rigs will be upgraded at the expense of Equinor.

While Transocean will apparently take a slight cash flow hit under the above-discussed terms, contracted rates are actually among the highest awarded offshore Norway in recent years, particularly when considering the fact that the customer is paying for required upgrades.

Moreover, there won't be no (Transocean Encourage) or only little (Transocean Enabler) idle time for the rigs following the conclusion of their current contracts.

Bottom Line

Transocean secured very important follow-on contract awards with Equinor offshore Norway for its remaining two CAT-D rigs at respectable terms.

While the company still needs to secure near-term work for the harsh environment rigs Transocean Equinox, Transocean Endurance and Transocean Barents, Tuesday's announcement represents a major step forward in navigating ongoing weak market conditions in the North Sea.

Since the beginning of the year, Transocean has made great progress as the company replenished liquidity and extended near-term debt maturities at reasonable terms while bagging a number of high-margin drillship contracts offshore Brazil.

In addition, with profitable backlog increasing and expectations for industry conditions to improve even further over the course of this year, additional upside appears likely even with the company looking expensive from a fundamental perspective relative to peers.

While I wouldn't chase the shares after the most recent recovery rally, investors should consider adding on any major weakness.

Despite recent volatility in oil prices and related stocks, I remain positive on the entire industry, including leading U.S. exchange-listed players Seadrill (SDRL), Valaris (VAL), Noble Corp. (NE), Diamond Offshore Drilling (DO), Borr Drilling (BORR), Helix Energy Solutions (HLX) and offshore drilling support providers like Tidewater (TDW) and SEACOR Marine Holdings (SMHI).

Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such 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.