Analyzing Current Utilization And Day Rate Trends In The Offshore Drilling Industry – March 2020 Edition – Seeking Alpha

About once a month, energy consulting firm IHS Markit releases a report on the offshore drilling industry that it calls the Offshore Rig Day Rate Trends report. In this report, the firm discusses both the utilization rate and leading market new contract dayrate trends for four types of offshore drilling rigs that it believes serve as effective proxies for the broader industry. For the most part, it has chosen quite well as will be explained over the course of this article. These trends are important for investors to follow, as this data is important for understanding the trajectory of the industry and the way that the financial performance of these companies is likely to progress going forward. We will look at each of the different types of rigs discussed in the report and their dayrate and utilization trends in turn.

The first type of rig that has its dayrate and utilization trends tracked by the IHS Markit report is ultra-deepwater semisubmersibles. These are defined as semisubmersible drilling rigs that are capable of operating in at least 7,500 feet of water. A semisubmersible rig is essentially a floating platform that is supported by two pontoons that sit below the water surface. These are the rigs that most people think of when they picture an offshore drilling rig.

Source: RigZone

As the IHS Markit report only includes the data for those semisubmersibles that are capable of operating in an ultra-deepwater environment, these are the newest semisubmersibles. This is important because exploration and production companies have shown a marked preference for hiring modern units, so the ones analyzed in the report would have higher demand than the semisubmersible fleet as a whole. With that said though, these rigs have seen a marked decrease in popularity since the last recession and most ultra-deepwater rigs that have been constructed over the past decade are drilling ships, which will be discussed later. Thus, while these may be the most modern semisubmersibles, most of them are still not going to be particularly new rigs.

Here are the utilization and new contract dayrate trends for the world's ultra-deepwater semisubmersible fleet:

Source: IHS Markit

As we can see, the utilization rate for these rigs has generally been increasing over the second half of 2019, although it still remains quite low. While it has been decreasing a bit this year, it still remains higher in the most recent month than it did over the entirety of the last two years. This is something that may be surprising to some readers given the severe impact that the coronavirus pandemic has had on the energy markets, but it does typically take a long time for price fluctuations to reverberate through the market and cause the companies in it to change their plans. We have already begun seeing some projects get postponed, but as I mentioned in a recent article, this has had more of an impact on long-term projects than near-term ones. Semisubmersibles are mostly used in development work due to their stability and lack of mobility so if we start seeing offshore projects delayed en masse due to low oil prices, this will eventually begin to have an impact on this segment of the market.

The economic law of supply and demand allows us to assume that dayrates will go up when utilization does because of the reduced supply of available rigs in the market. We do certainly see this as the leading new contract dayrate is well above 2017 and 2018 levels. With that said though, we can still see that half of the global fleet is still unemployed, so there is still insufficient pressure on dayrates to push the new contract dayrate up significantly. This will likely continue to be the case for several more months, if not longer given the current low oil price environment.

The second type of rig that has its dayrate and utilization trends tracked by the IHS Markit report is ultra-deepwater drillships. As was the case with their cousins, these are defined as drillships that are capable of operating in at least 7,500 feet of water. These are therefore the most modern and technically-capable drillships in the global fleet today, which does grant them the preference that modern rigs enjoy when it comes to securing those contracts that are available from exploration and production companies. As the name implies, a drillship is a ship (frequently a modified oil tanker) that has been specially equipped to perform drilling operations. This design grants these rigs superior mobility to a semisubmersible rig, but they are much less stable in harsh or choppy water conditions than their cousins. As a result, drillships are commonly used in exploratory operations where their mobility proves to be an asset in moving from site to site.

Here are the utilization and new contract dayrate trends for the world's ultra-deepwater drillship fleet:

Source: IHS Markit

We can see some similarities here between the ultra-deepwater drillships and their semisubmersible cousins. In particular, we can see that the utilization rate for this type of rig is currently higher than at any other time over the past two years. This shows very real evidence that the industry has been recovering, which is in line with what the managements at various offshore drilling companies have been telling us. We can still see though that the utilization rate does still remain below 80%, which is the level that is generally considered to represent a sustained recovery. As I explained in a recent article too, we have begun to see energy companies cut spending on their exploration programs in response to low oil prices, so it will be interesting to see if the utilization rate can sustain this level going forward in the face of lower demand. This is somewhat doubtful.

As was the case with the semisubmersible rigs, the improvement in the utilization rate has had the beneficial effect of pressuring dayrates up. However, there is still around 30% of the global fleet unemployed, so there is still a significant amount of slack in the market. The utilization rate historically needs to get above 80% before it starts to exert significant and sustained upward pressure on dayrates. As we just discussed, it may not be able to reach that because of cost cuts on the part of energy companies. In addition to this, the leading new contract dayrate is still relatively low, but it is high enough for drilling companies to generate a positive cash flow off of the contracts that they are able to get. We could soon see a reversal here though if the utilization rate does indeed begin to decline, which seems likely.

The third type of rig that has its utilization and new contract day rate trends tracked by the IHS Markit report is harsh-environment jack-ups. As the name implies, these are shallow-water drilling rigs that have been specially equipped to operate in some of the harshest weather conditions in the world such as those found in the Arctic or the North Sea. Unlike with the other types of rig, IHS Markit did not choose to use the newest rigs in this classification when compiling its report. The company instead opted to use standard units, which are defined as those rigs that have a maximum operational water depth of 350 feet. While these are not the most modern units around, they are by far the most numerous so this does work reasonably well as a proxy for the fleet as a whole. The consulting firm has also opted to use the data only for those rigs operating in Northwest Europe. This is the location where most of these rigs operate so the data from these rigs should give a reasonably approximation of the global trends.

Here are the utilization and leading new contract dayrate trends for the harsh-environment fleet:

Source: IHS Markit

The harsh-environment market was one of the few bastions of strength in the offshore drilling market over the past few years. Unfortunately, we can see that this strength appears to be waning as the utilization rate has now dropped back to the lowest level that it has had since mid-2018. The rate has been flat at 50% for many months now, though. This is not a particularly attractive rate however as we can see that fully half of the fleet is unemployed. These rigs tend to have reasonably long contract terms, so this type of rig might see its utilization rate hold up a bit better going forward than some other rigs in the current environment, depending of course on how long the current low price environment persists.

We can also see here that the leading market dayrate has been relatively consistent over the past several months and currently sits just below $75,000, which is the highest that it has stood over the past two years with the exception of one month. It is unfortunately questionable whether or not the current dayrate is high enough to allow the companies that own the rigs to generate a positive cash flow off of the rig contracts. As was the case with many of the other rig types, the utilization rate is likely too low to pressure dayrates up much more. Thus, we will probably not see any real improvements here for a while.

The final type of rig that has its dayrate and utilization trends tracked by the IHS Markit report is high-specification jack-ups. For the purposes of this report, a high-specification jack-up is defined as an independent leg cantilever jack-up rig capable of operating in a maximum water depth of 361 to 400 feet. Curious, this definition would exclude even more capable rigs like the Gorilla-series operated by Valaris (VAL). For the most part though, this definition would encompass most of the modern jack-up fleet. Thus, these are going to be the rigs that are most in demand by exploration and production companies, so should give us a good idea of the broader trends affecting this segment of the industry.

Here are the utilization and new contract dayrate trends for the benign-environment, shallow-water fleet:

Source: IHS Markit

We can clearly see here some real signs of strength in the utilization rate. As we can see, it has generally been steadily climbing over the past two years. It does unfortunately remain well below the 80% level that we need to show a sustained recovery in the industry. This part of the global fleet may also be more vulnerable to a slowdown in exploration activity than other fleet segments. This is because the contracts for shallow-water rigs tend to be exceptionally short and are frequently only for one or two wells. This allows the customers to get out of a contract quickly since they can always deny a renewal. As a result, the high-specification jack-up segment is typically a leading indicator for the rest of the offshore drilling industry. We will want to keep an eye on this metric over the next few months to see if the industry ends up being devastated by the cutbacks in upstream exploration spending.

Thus far, we can see that the leading new contract dayrate has held up okay, although it has been falling over the last two months. It still remains at a higher level than what we have seen over most of the past two years. At $75,000 per day too, it is high enough to allow these rigs to produce a positive cash flow to their owners, although it will not be a particularly high cash flow and may not be enough to cover things like onshore general and administrative costs that are not allocated to any individual rig. It is also possible the new contract dayrate will decline should the utilization drop in response to low oil prices, which would stress the finances of the companies in the industry further.

In conclusion, we are seeing some very real signs of a recovery in the offshore drilling industry here, although it is weaker than we really want to see. The problem could be that upstream companies have begun to cut back on exploration spending and this will reduce the demand for drilling rigs, killing the nascent recovery. We will want to keep an eye on the relevant metrics here over the next few months to see if this scenario plays out in order to make a more informed investment decision.

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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.