Fitch Ratings

International rating agency Fitch Ratings is very pessimistic about exploration-focused oilfield service (OFS) companies. The rating agency stated that the sector will face the largest demand decline as a result of oil and gas producers cutting their capex and operating expenditure. These developments will be the same for drillers. Both sectors are going to feel the negative impact of cuts in oil and gas producers capital programs, where exploration investment cuts are expected to be a reduction of 20%-30% in 2020 yoy.

Fitch reported also OFS companies serving projects with high full-cycle costs, such as deep-water offshore assets or shale basins, will also be affected. North America-focused Nabors (B-/Rating Watch Negative) and Precision Drilling (B+/Negative) are exposed to the volatile spending patterns of US shale producers.

OFS diversified companies, exposed to the entire life-cycle of a well, are more resilient. Fitch is reasonably positive about ADES International (B+/Stable), currently servicing customers in Saudi Arabia and Kuwait, while Eurasia Drilling (BB+/Stable) is focused on Russia. Even that they both will be effected by OPEC+ production cuts, their overall performance will continue as their producing areas are lower-cost geographies.

The current overall global downturn will be for an extended period of time, as the OFS market will experience a recovery lag of four to six quarters. Even if oil and gas prices will recover slowly, oil and gas producers, the main clients, will be very cautious about increasing exploration and drilling activity. Even if utilization rates for rigs and vessels will improve to 2019 levels in 2021, day rates and need for new builds will be lagging behind 1-1.5 years at the least.

At the same time, most offshore drillers will be faced very soon by a combination of threats. Most OFS and drilling companies have been stacking an increased amount of assets. The latter is seen as cost saving measure. Still they are facing lower revenues and cash flows the next coming years. This combination is maybe for some even very toxic.

Fitch warns that OFS companies with significant debt maturities up to 2022 will face refinancing challenges. A combination of low operation cash flow generation and lacking access to capital markets could lead to a potential shake out. Ongoing crisis measures in the sector is also not promising, as shedding workforce or closing production facilities by shipyards worldwide decreases flexibility to react to changing markets, and puts several blockades already in place in time of recovery. Sembcorp Marine or Noble Drilling are prime examples of the current crisis situation.

The offshore drilling market could even be facing another major threat, if the news coming out of India is right. In light of the India-China military and geopolitical rivalry, offshore drilling companies and shipyards are now in the crosshairs of the Indian officials.

Potential direct links between international drillers and the Chinese government could be a future threat to the sector. At least in India after that the Indian government has started an assessment of the position of Chinese government-linked investors in Dubai-based Shelf Drilling. The latter offshore driller holds almost 30 per cent market share in Indias shallow water oil drilling market, in terms of drilling rigs on charter.

The issue has come on the table due to the fact that the Indian government and its agencies have restricted, or even banned, the use of Chinese products and services in the country, following the recent flare-up along the border. Shell Drilling, listed on the Oslo Stock Exchange, and a major largest pure-play jack-up oil drilling rig contractor, works in India mostly for state-owned ONGC Ltd, Indias biggest explorer of oil and gas.

News that China Merchants and Great Wall Ocean Strategy & Technology Fund (China Merchants), a $1-billion marine industry-focused fund sponsored by China Merchants Group (CMG), is the largest shareholder of Shelf Drilling with a 19.7 per cent stake, is a possible major security issue.

China Merchants is a $1 trillion diversified group fully owned by the Chinese state. The jack-up rigs were constructed at China Merchants Heavy Industries (CMHI), the worlds largest CJ jack-up drilling rig manufacturer. Shelf Drilling operates eight rigs in India of which seven are currently on contract with ONGC out of the 25 jack-up rigs chartered by ONGC. All seven are deployed in the hyper-sensitive Arabian Sea region. Several of these are located near Mumbai, the financial capital of India.

According to Indian government officials, the presence of the Chinese government in the strategic and sensitive offshore oil drilling sector has become a matter of concern. Since years, Chinese companies linked to the Beijing government are barred from bidding for Indian port construction and operation contracts mainly due to the sour political relations between the two sides. India is also discussing to classify exploration and drilling of oil and gas as a strategically sensitive sector (both economically and for national security), and accordingly provide protection and oversight by restricting participation in the sector to entities.

Taking the Indian developments to a more global power play, the Indian views could be taken over soon by others too. An emerging anti-China position in the EU and USA could result the coming months in a focus on Chinese maritime sector investments and the stranglehold some of these Chinese parties have. Offshore oil and gas projects are until now not regarded very sensitive, but looking at the current production regions and maritime position, an opposite position could be supported very soon.

If these issues are going to play a role, the OFS, and especially offshore rig markets, will be heading for a major restructuring. Blocking or restraining Chinese government interference and power play in oil and gas developments are likely to see some support in Washington, Brussels and India. Domestic support for the struggling maritime sectors in these regions is already available. For offshore vessel or jackup companies it looks to be time of reassessing their options. Better to be prepared than to be confronted by political and security facts without a warning.

For all non-Chinese parties in offshore drilling it will be a necessity to keep an eye on the Indian developments, while addressing other options. COVID already is a Black Swan of unknown importance. Threats from Chinese interference could be having major impact on the valuations of them all.

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Betting on Offshore Oil and Gas could be Challenging, as Sector Hit by COVID and China Risks - FX Empire