While demand for offshore contract drilling rigs and services has reached the bottom, a sustained sector recovery depends on supportive crude oil prices, higher rig attrition and the industry's ability to continue lowering costs and improving efficiency, S&P Global Ratings said.
An offshore recovery could be on the horizon, but demand for offshore drilling rigs and services will remain weak in the next 18 to 24 months, especially for deepwater rigs, Ratings said Oct. 4. Deepwater projects compete with onshore shale projects for investment dollars, which continue to flow toward shale projects, the analysts said.
Shale projects have a quick payback, particularly under the long-term price outlook for West Texas Intermediate and Brent crude oil of $55 per barrel, Ratings said. Oil and gas producers' capital allocation has shifted away from long-cycle offshore projects in favor of the shorter-cycle projects that offer lower operational risks and costs.
"The long lead-time and high capital spending prior to first production for offshore projects [do] not conform to [exploration and production] companies' newfound capital discipline to live within cash flows and return excess cash to investors," the agency said.
Despite the stronger pull toward onshore projects, S&P Global Ratings noted that there are signs of a possible recovery in the offshore drilling market.
Utilization rates have improved for jack-up rigs, especially the high-specification and harsh-environment segment, and day rates have strengthened, Ratings said. These rigs typically support shorter-horizon and lower-risk projects, making returns more competitive with onshore projects, the rating agency said.
"However, jack-ups continue to generate lower margins than deep-water rigs, and we believe day rates have not yet recovered to their full potential," Ratings said.
In the drillship and floating rig segments, utilization rates have improved since 2017, but day rates have not meaningfully increased beyond the break-even cash flow level. For day rates to improve, utilization has to move closer to 75% to 80%, a level not expected until 2021, Ratings said.
Amid the slow recovery, Ratings pushed back its assumptions for the improvement in day rates on ultra-deepwater rigs. The rating agency now assumes contracting rates will be in the $200,000 to $225,000 per day range in 2020. An increase to about $250,000 per day is expected in 2021, "with some variation depending on the rig quality and location," the rating agency said.
In the near term, to improve margins, drillers could scrap less-desirable deepwater rigs or cold stack them. Cold stacking at the cost of less than $5 million per year compares with warm stacking costing of at least $15 million per year, Ratings said.
Additionally, fleet consolidation through mergers, including those that created industry leaders Valaris PLC and Transocean Ltd., could accelerate the rate of rig attrition, Ratings said.
Market conditions, however, will remain challenging for the beleaguered offshore drilling sector until the latter half of 2020, with more meaningful recovery in 2021, Ratings said.
Driven by the outlook, S&P Global Ratings lowered its revenue and cash flow estimates for offshore drilling contractors. In late September, the agency lowered its ratings on Valaris, Transocean, Noble Corp. and Diamond Offshore Drilling Inc. to CCC+.
Ratings said the revisions reflect the view that leverage has become unsustainable and that the companies are dependent on favorable business conditions to meet their long-term financial obligations.
Valaris and Transocean have a negative outlook attached to the ratings, while Noble and Diamond Offshore have a stable outlook due to relatively strong liquidity positions.
"Despite unsustainable debt leverage in excess of 10x over the next 12 to 24 months for all offshore drillers, solid liquidity should keep companies afloat over the next 12 months," Ratings said.
Most industry players have large cash balances, limited debt maturities coming due in the next 24 months, and access to large, undrawn (or little drawn) revolving credit facilities, the rating agency said.
This S&P Global Market Intelligence news article may contain information about credit ratings issued by S&P Global Ratings. Descriptions in this news article were not prepared by S&P Global Ratings.
