This is a traditional article dedicated to results of the earnings season for offshore drillers. Here, we will discuss the situation in the oil market, key trends in the offshore drilling industry and individual offshore drillers whose stocks trade at major U.S. stock exchanges.
Oil
Back on February 22, I wrote that OPEC had little time to push Brent oil (NYSEARCA:BNO) over $57.50 before the inevitable downside correction. The rationale for this was simple - there were too many long speculative bets in oil without a corresponding increase in oil prices. Recent inventory data was the last straw that broke the camel's back, and both Brent and WTI (NYSEARCA:USO) experienced big sell-offs.
This move cemented $57.50 for Brent and $55 for WTI as key resistance levels. Should prices come back to these levels, you can expect increased selling due to profit taking, hedging of outright shorting. Oil will need a significant fundamental catalyst to break through this resistance. Long bets by speculators proved insufficient to push oil above the major resistance line.
This is very bad news for all offshore drilling companies. Previous oil price levels were not good enough to increase contracting activity as highlighted by earnings and fleet status reports. The new downside move means that oil will spend at least some more time under $57.50. Also, such fast moves are negative for oil producers' confidence in price stability. Unless oil majors become confident that prices will stay at $55 - $60 (at minimum!) per barrel, all incremental money will go to short-cycle projects like shale.
The move is also bad for the OPEC deal. Compliance to the deal heavily depends on the cartel's ability to sustain prices. Should prices go lower, participants will realize that they have done everything wrong - provided a lifeline for struggling U.S. shale producers, lost market share and did not get better prices.
Some observers expect that OPEC will be able to negotiate an even bigger cut if they fail to improve the pricing environment, but I expect the exact opposite. If OPEC deal fails to improve prices and the cartel finds itself selling less oil at the very same prices that were before the deal, the deal will fall apart. There will be no reason to subsidize U.S. shale and other producers at the expense of OPEC countries.
Oil is oil, so there's a lot of volatility ahead. The key takeaway for offshore drilling industry is that OPEC deal was no silver bullet and the industry will have to wait even more for recovery.
Key highlights from the earnings season
Long-term contracts at rock-bottom rates started to emerge. Examples include Noble Corp.'s (NYSE:NE) and Ensco's (NYSE:ESV) contracts with Saudi Aramco. Judging by drillers' comments during conference calls, the industry expects there's more to come. While contracts are important to provide financial visibility in the future, they tie up the fleet at rates that contribute nothing or next-to-nothing to the bottom line.
There is no mass scrapping. The chart from recent Atwood Oceanics (NYSE:ATW) presentation highlights that pace of scrapping increased, but not dramatically:
Most companies continue to clutch at straws and hang on to their rigs as long as they can. Another problem with scrapping rigs is the accompanying impairment on the balance sheet - drillers don't want to scare investors (and potentially violate covenants!) with real numbers. Ocean Rig (NASDAQ:ORIG), which is preparing for restructuring, showed how hard can it get by writing off 60% of value of its modern (!) fleet.
Most management teams portrayed a better future, but they had no facts to back up their optimism. More calls, more talks, more everything with clients - that's how most drillers described the situation after the OPEC/non-OPEC deal. We have heard this before. You can check my article on the results of the Q3 2016 earnings season, where I highlighted that drillers mentioned increased customer inquiries. In my view, words mean nothing until we see tangible evidence.
Restructuring talks proved to be extremely complicated. Suddenly, Seadrill Partners (NYSE:SDLP) turned out to be not immune to Seadrill (NYSE:SDRL) restructuring, presenting a wonderful short opportunity. Seadrill itself spent a whole year to come up with a poor proposal which was based on unrealistic expectations. There's little surprise that the company still has to work on a viable deal and Chapter 11 is already in sight. Pacific Drilling and Ocean Rig restructuring talks also continue. Faced with unprecedented downturn, creditors try to find a scheme that will save their money, but it's not easy (or even possible) given the current market situation.
Floaters remain dead money. Oil price is not high enough to improve demand for floaters, period. It's safe to say that you can forget about any material improvements in the segment with a sub-$55 oil.
Jack-ups are better, but rates are low. Jack-ups are getting some work, but the jack-up overcapacity is so huge that dayrates are glued to the very bottom. I see no catalysts that can push rates from the bottom in the near term.
Oil majors have already chosen their strategy for 2017. They will preserve their balance sheets and allocate money to shale. The wild card was that oil breaks through $57.50 with a vengeance, continuing the post-OPEC deal upside, but this did not happen. While this is early in the year, I already expect that any improvements are postponed to 2018. The reason for this is that oil producers need stable prices at higher levels to increase their offshore exposure. "Stable" means that prices spend months above $57.50 or even $60, and we are not even there yet.
Let's now turn to individual names.
Atwood Oceanics
While Atwood Oceanics does not have immediate cash problems, especially after equity issue at the beginning of the year, the company's backlog remains a big problem. Atwood's shares have already corrected significantly from the $14 level, but more downside may follow if oil prices fail to rebound swiftly. I continue to believe that the situation remains dangerous for the company.
Diamond Offshore Drilling (NYSE:DO)
Shares of Diamond Offshore Drilling are close to the key support level. As I wrote in the comments section of my previous article on the company, I believe that its shares may be an interesting bet here if the stock breaches the support to the downside and then immediately returns above $15. If you are more optimistic than me on oil prices, Diamond Offshore Drilling's current level may be suitable for you.
Ensco
The $12 level proved to be a wall for Ensco's shares, and now they are correcting together with oil prices. Ensco is definitely part of the survivor group, but current momentum looks strong and the stock needs to stabilize first before any upside is possible.
Noble Corp.
Troubled by the usual problem - lack of specific catalysts - Noble Corp. shares are slowly gravitating towards November lows. I expect a wide range trading for Noble Corp. stock and I believe that it may be attractive for a range play when the low end of the range is established. Judging by what we see on the fundamental (no improvement in the market situation) and the technical (sell-off across all offshore drillers, current support does not look strong) fronts, entering at $6 may be premature.
North Atlantic Drilling (NYSE:NADL)
Avoid North Atlantic Drilling. The probability of Seadrill restructuring being beneficial for North Atlantic Drilling is close to zero.
Ocean Rig
Avoid Ocean Rig. After the recent write-off, shareholder equity became negative which highlights that there is no value left in common shares and the company knows it.
Pacific Drilling (NYSE:PACD)
Avoid Pacific Drilling. Market for floaters is awful and the debt is huge. Creditors will need to take significant haircuts to make the company a viable enterprise again, which means that common shareholders stand to receive nothing in the upcoming restructuring.
Rowan (NYSE:RDC)
Rowan continues correction along with other offshore drilling names. This is one of the best companies in the industry that receives little interest from retail investors compared to battleground stocks like Seadrill. The next support level for Rowan is at $15, it will be interesting to see whether the stock will be able to hold at this level. While the company right now is hardly a momentum play, it should be closely watched for buying opportunities.
Transocean (NYSE:RIG)
I believe that Transocean was a bit overhyped following the OPEC/non-OPEC deal, so correction was almost inevitable. The company has a whole fleet of stacked rigs, and I believe that many of them won't work again. I see Transocean as a survivor and I believe that it may present a buying opportunity after the current sell-off.
Seadrill
Seadrill is only good for daytrading now. The Chapter 11 possibility is real. Should the company file for bankruptcy, shareholders will be lucky to get anything at all. Unless you are a real gambler, you'd be better off watching Seadrill from the sidelines.
Seadrill Partners
The easy short is over. At the same time, uncertainty will lead to increased volatility in the coming days and weeks. Those willing to grab Seadrill Partners units after the big sell-off should keep in mind that the company may end up being part of Seadrill restructuring, which would be a real catastrophe for Seadrill Partners unitholders. Risks are very significant.
Bottom line
I see no evidence of recovery. I believe that offshore drilling stocks remain a vehicle for momentum plays - both long and short. Those willing to commit to offshore drilling for the long-term (for whatever reason) will be better off sticking to best players and avoiding gambling with battleground stocks like Seadrill and Ocean Rig. The industry is in bad shape and mistakes will cost dearly for investors.
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.
Editor's Note: This article covers one or more stocks trading at less than $1 per share and/or with less than a $100 million market cap. Please be aware of the risks associated with these stocks.
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Offshore Drilling In Deep Trouble As Oil Dives Lower - Seeking Alpha