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Offshore drillers hit by wave of downgrades as dim short-term outlook lingers

Credit analysts are concerned about the health of the offshore drilling sector despite a modest uptick in activity, saying a decline in oil prices could lead to further deterioration in the already struggling sector. But if activity continues to pick up, brighter days could be on the long-term horizon.

"In our view, industrywide market conditions for most offshore contract drilling services will continue to be difficult until the latter half of 2020, with a more meaningful recovery in 2021," S&P Global Ratings wrote in a Sept. 25 ratings action. "Despite improving utilization for drillships and floating rigs since 2017, dayrates have not meaningfully increased, while mobilization and reactivation costs — along with stacking costs for the uncontracted fleet — have offset much of the near-term benefits."

The ratings agency on Sept. 25 lowered its issuer credit rating on Transocean to CCC+ from B- and lowered its issuer credit rating on Diamond Offshore Drilling Inc. to CCC+ from B. A day earlier, it lowered its issuer credit rating on Valaris PLC to CCC+ from B-.

Moody's also sees the segment balancing a risky short-term outlook with longer-term potential.

"The offshore segment of the oilfield services and drilling sector has struggled the most since oil prices retreated in 2014 and then only partially recovered, as producers have preferred to focus on less-costly opportunities onshore," Moody's analyst Sreedhar Kona said Sept. 17.

Most offshore drillers continue to face substantial financial stress as any significant debt reduction will depend on sustained higher day rates and improved cash flow, Moody's said. The strong liquidity of offshore drillers supports credit quality even as high debt levels and weak or negative free cash flow generation pose significant downside risk, the Moody's report said.

Kona said drillers are seeing modest increases in both short-term and long-term contract awards. The Moody's analyst said Transocean and Diamond Offshore Drilling each announced new long-term contracts while most of the major drillers are seeing increased fleet utilization through short-term contracts.

But drillers' capital structures remain overleveraged in the context of relatively small increases in day rates that have lagged the more visible recovery in global rig utilization, Kona said. The long-term contract awards to Transocean and Diamond Offshore implied day rates in the $250,000 per day to $300,000 per day range — better than spot rates of well under $200,000/day in recent years but well below the prior peaks of more than $550,000/day.

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The high short-term utilization rate provides some indication of supply and demand for equipment that portends higher day rates through mid to late 2020, Kona said. "If the improving utilization trend persists and day rates improve materially, we would consider changing the offshore drillers' rating outlooks to stable from negative," Kona said.

S&P Ratings analysts echoed that sentiment in their recent note. "A sustained improvement in market conditions and contract drillers' financial performance will depend on supportive crude oil prices, rig attrition, and the industry's ability to continue to lower costs and improve efficiency such that offshore returns become competitive with onshore," the analysts wrote Sept. 25.

Rig data shows the bottom of the sector seems to be in the rearview. Baker Hughes' rig count data shows U.S. offshore rig activity has improved from 2018 levels, contributing to an overall increase in global offshore activity. Globally, as of Sept. 25, a count by IHS Markit showed the worldwide supply of jack-ups, semi-submersibles and drillships at 760, down one from Sept. 20 and down seven on the year.

IHS Markit offshore rig analyst Justin Smith said in an email that the marketed supply is 657 units, which excludes unavailable rigs like those that are cold stacked or owner-operated. Of the marketed supply, 541 are contracted bringing the total utilization rate to 71.1% and the marketed utilization to 82.2%. A year earlier, the marketed supply was 641, the contracted count was 484, and the utilization rate total was 63.1% and marketed was 75.5%.

The tentative recovery in the global offshore market is expected to continue, Smith said in a Sept. 18 note. Rig demand is expected to increase by approximately 16.3% between 2019 and 2021 with an average demand of 473 units in 2019 climbing to 550 units in 2021.

Smith said the demand for rigs is front loaded with more drilling programs visible in the short term. He warned that many drilling campaigns could be delayed, lowering demand in 2020 and pushing it out into 2021 and beyond. "This is particularly true the longer the price of oil remains low and relatively unstable, especially in the face of cheap onshore alternatives and general disruptions in the form of trade and geopolitical disputes," he said.

While the short-term is uncertain, there are some stable spots in the sector. Moody's flagged Shelf Drilling Ltd.'s B2 stable rating and Noble Holding International Ltd.'s Caa1 stable rating as outliers from the list of sector companies with negative rating outlooks.

Stock analysts at Tudor Pickering Holt & Co. said they favor Oceaneering International Inc. for its subsea business orders and offshore rig activity. The analysts also like Transocean Ltd., which recently decided to relinquish its interests in two uncontracted new-build drillships. The move will save Transocean about $1.1 billion in costs and payments associated with the delivery and placing of the ships into service, the company said Sept. 23.

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