How Transocean’s Key Metrics Are Being Impacted By The Offshore Downturn

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Transocean (NYSE:RIG), the world’s largest offshore driller, has seen its stock price fall by over 50% in the last 6 months on the back of a glut in the deepwater drilling markets and tumbling crude oil prices. The company’s two key operating metrics – day rates and utilization rates – have come under significant stress, as demand appears tepid with oil and gas companies scaling back on their capital spending plans. While the company has been relatively proactive in right-sizing its fleet and pruning down its cost base, its older fleet and near-term contract status indicate that it is poised for a challenging year ahead. In this note, we take a look at some of the recent trends from Transocean’s fleet status report and the near term outlook for the company.

Trefis has a $26 price estimate for Transocean, which is significantly ahead of the current market price.

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Lower Upstream CapEx Spending

Benchmark Brent crude prices have fallen by over 45% since mid-June 2014 to levels of around $55 per barrel owing to strong production from U.S. shale fields, higher output from Libya and sluggish forecasts for oil consumption growth. This has significantly stressed the cash flows of upstream players, who have been curtailing their capital budgets for 2015. For instance, Petrobras (NYSE:PBR) has said that it would curtail spending to between $31 billion and $33 billion this year, down from a budgeted $42 billion in 2014, while BP Plc. (NYSE:BP) intends to slash its capital expenditures by 20% to $20 billion for 2015. The current oil pricing environment is not conducive to growth in the offshore drilling markets, given that exploring and producing from offshore deepwater and ultra-deepwater wells involves significant capital expenditures and needs to be supported by high oil prices that can yield attractive returns on investments and justify risks. For example, a single ultra-deepwater well can cost as much as $300 million, while onshore shale wells can be completed for less than $10 million each. Offshore projects also have much longer capex planning cycles compared to onshore projects and customers could be more circumspect about committing to new offshore wells and leasing new rigs.

Lower Dayrates, Weaker Contracting

In the current environment, customers have significantly better leverage in negotiating new contracts and extensions, leading to less favorable contract terms and dayrates. For instance, Transocean’s Searcher rig was awarded a one well contract in the Norwegian sector of the North Sea at a dayrate of $340,000 compared to a prior dayrate of $368,000. The company’s Dhirubhai Deepwater KG1 drillship was awarded a three-year contract for work in Brazil in 2015 at a rate of around $440,000, which is about 14% lower than the previous contract rate. Besides dayrates, overall contracting activity has diminished. Transocean’s January fleet status report indicated that it had added just $24 million in new contracts since the December fleet summary, which is about half as much as it added during the same period a year ago. [1]  As of Q3 2014, the most recent data available, Transocean saw its fleet-wide utilization rates decline to about 75%, from around 83% in Q3 2013 and 78% during Q2 2014, impacted by weaker usage of the company’s high-specification floaters. We believe that utilization rates could decline further, since we estimate that the company has over 10 rigs that come off contract during the first half of this year. The company’s fleet remains poorly contracted over the long term as well. As of December 2014, 46% of the company’s fleet remained uncontracted for 2015 with 73% and 81% of rigs uncontracted for 2016 and 2017. This is significant worse compared to the market average of 35%, 45% and 57% respectively, for the 3 years. [2]

Transocean has been aggressively right-sizing its fleet, recently outlining plans to scrap a total of 12 low-specification midwater and deepwater floaters including the Sedco 710, Sovereign Explorer, Sedco 700, Sedco 601, J.W. McLean, GSF Arctic I, Falcon 100 and the Discovered Seven Seas. The company intends to take a non-cash charge of $100 million to $140 million, net of taxes, with its Q4 2014 results to account for this. The company has also noted in its January fleet status report that it intends to sell the previously stacked Transocean Rather rig. These moves should help bring down operating and maintenance costs while also freeing up some liquidity. However, we still believe that the broader market conditions and the company’s weak contracting position are likely to put pressure on earnings in the near term.

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Notes:
  1. Transocean Fleet Status Report []
  2. Deepwater drilling markets – Darkness before dawn, OE Digital, February 2014 []