Transocean’s Key Risks: Lower Dayrates On New Contracts, Utilization Rates

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Transocean (NYSE:RIG), the world’s largest offshore drilling contractor, posted a strong set of Q1 2014 earnings last month, recording improved revenue efficiencies and dayrates (related: Transocean Has A Good Q1 As Dayrates And Revenue Efficiencies Rise). However, despite the strong performance, the stock has been trading just off its 52-week lows. We believe that the pessimism in the market could be stemming from threats to the company’s utilization rates and dayrates, considering the looming oversupply of rigs in the usually lucrative ultra-deepwater market.

Trefis has a $46 price estimate for Transocean, which is nearly 10% ahead of the current market price.

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Oversupply Of Rigs: Deepwater drilling activity was strong over the last few years, driven by stable to increasing commodity prices and several exploration successes. Offshore drilling contractors responded quickly to the growing activity, investing record sums in constructing new deepwater and ultra-deepwater rigs. However, it looks like the industry may have gotten ahead of itself. Of late, big oil companies have been slowing down on their exploratory drilling, instead focusing on improving production from existing wells in order to increase cash flows and shareholder returns. This is leading to an oversupply in the ultra-deepwater drilling rig market. While the number of ultra-deepwater rigs globally is expected to grow to around 160 units by the end of 2014, demand (including existing contracts, options as well as possible contracts) is expected to stand at just about 140 rigs by the end of 2014. [1]  Under these circumstances, Transocean’s rig utilization rates could be impacted significantly, given that its fleet is older (on average) compared to many of its peers. Transocean’s Q1 results partially reflected this trend, with utilization rates declining by around 4% year-over-year to around 90%.

Dayrates Remained Strong In Q1, But New Contracts Are Key: During Q1, Transocean’s average dayrates rose by around 14% year-over-year to about $413,100. [2] This increase was largely attributable to the company’s fleet of deepwater and ultra deepwater rigs, which saw their rates rise by over 20% year-over-year. However, it’s possible that the rates that the firm is currently witnessing are due to contracts that were signed previously, when contracting activity remained strong in the deepwater market. However, it will be important to see the rates that the company garners on new contracts that it signs. Recent indicators from the company’s fleet status reports don’t seem particularly encouraging. For instance, the Dhirubhai Deepwater KG1 drillship was recently awarded a three-year contract for work in Brazil at a rate of around $440,000, which is almost 14% below the previous contract rate. [3] The lower rates could prove a threat to Transocean’s revenues, since about 10 of  the company’s 27 ultra-deepwater rigs (per the April fleet report)  have contracts that will expire this year. A bulk of these rigs do not have new contracts lined up.

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Notes:
  1. Howard Weil Energy Conference Presentation, Transocean, March 2014 []
  2. Transocean Q1 2014 Earnings Press Release []
  3. Transocean Fleet Status Report May 2014 []