The sixth month of this year ends in a few days and I feel its high time to look at the results of the offshore drilling sector and where it is headed. Heres what I believe are major highlights of the first half together with my thoughts on the future.

Oil prices drop and postpone recovery

It is now a fact OPEC failed to lift oil prices, at least in the short term. Both Brent (BNO) and WTI (USO) trade at about the same levels where they traded before the first announcement of the OPEC decision to cut production. The prolongation of the deal did not inspire the market and led to a downtrend in oil prices.

In my view, oil prices continue to trend in a wide range, which is roughly $44-58 for Brent and $42-55 for WTI. To get out of this range, oil prices will need strong upside catalysts. So far, the effect of the OPEC/non-OPEC deal was not sufficient enough to push oil prices to the desired $60+ range, which will create a meaningful uptick in the contract activity in the offshore drilling space.

The effect of the recent drop is really negative for the potential recovery. There is little reason to rush into offshore drilling spending for most oil companies. In all likelihood, they will continue to prioritize short-cycle investments like shale over offshore drilling in the second half of this year.

Day rates reach bottom and wont recover in H2 2017

As those who follow the industry regularly know well, many contracts now come at undisclosed day rates. Its not hard to decipher what undisclosed means the rate is so low that a company does not want to show it to both investors and competitors.

For day rates to increase, utilization should increase significantly. I do not see it happening in the near term. New contracts are scarce while many rigs roll off their previous contracts. Scrapping could have helped, but accounting consequences of scrapping (the necessity to take impairments which could lead to problems with credit covenants) prevent many drillers from retiring their rigs.

Offshore drilling is getting more competitive? Too early to celebrate

Here and there we can read that offshore drilling is getting more competitive and that the sole obstacle in its competition with shale is the necessity to make big upfront investments. There is no surprise that offshore drilling becomes more attractive as offshore drillers agree to contracts at cash breakeven rates! This is not sustainable and everyone understands it. Offshore drilling will be competitive with shale when it will be able to operate with same costs while all companies involved get rational rates, allowing them to profit and invest for the future.

M&A begins

Two major deals were announced (and one already executed) in the first half of this year. Transocean (RIG) sold its entire jack-up fleet to Borr Drilling. Ensco (ESV) announced a merger with Atwood Oceanics (ATW). It is not yet clear whether Ensco shareholders will vote for the merger with Atwood.

The necessity for consolidation in the industry has been discussed many times. Currently, it looks like smaller companies dont have a good place in the future of the industry as clients prefer stable companies with solid finances. However, potential acquirers themselves are not in their best shape. First, companies like Ocean Rig (ORIG) and Pacific Drilling (PACD) have to go through restructurings and get rid of debt, and only then deals similar to Ensco Atwood could be considered.

Among U.S.listed stocks, its difficult to find a company which looks ready to grab another driller right now. Frankly, Enscos move was a surprise to me. Nevertheless, I do not anticipate that other companies will immediately follow Ensco's steps. Neither Rowan (RDC), Diamond Offshore Drilling (DO), Noble Corp. (NE) nor Transocean looks ready for a deal, especially now, when the more obvious target has been approached by Ensco.

In my view, the EnscoAtwood deal will be positive for the industry if it goes through shareholder votes as it will likely lead to rationalization of Ensco's fleet. At the same time, the recent Transocean sale led to an increase in competition. The net result of these two deals is hardly positive as Borr Drilling emerged as a new competitor with a significant fleet.

Offshore drilling stocks trade near yearly lows

The direct consequence of the recent drop in oil prices is the price action in nearly all offshore drilling stocks. In case oil is really in a range and it will rebound from current levels, offshore drilling stocks will also experience a rebound. However, I do not think they can reach highs of the beginning of this year unless oil breaks out of this range and trades above $60. Current range has already proved insufficient for meaningful recovery, so each month oil stays in $50 whereabouts the fundamental situation gets a bit worse for the industry. Thus, its hard to expect that drilling stocks will react to oil upside with the same enthusiasm as at the beginning of this year, when the market implied that OPEC/non-OPEC deal will provide big support for oil prices.

In my view, the safest play from the long-term perspective is Rowan. However, it does not mean that this stock will be the best from the trading perspective in the shorter term should oil prices rebound from current levels.

H2 2017 will be very interesting and volatile

Im expecting that more contracts will surface in the second half of this year as oil companies will prepare for their drilling programs in 2018. Despite all the current attractiveness of shale and all the fuss about the end of the oil age, offshore drilling is a huge part of the world oil supply and oil companies will start locking cheap day rates after a few years of hiatus.

However, until the real, tangible signs of offshore drilling recovery materialize, offshore drilling stocks will remain more suited for trading than to be longer-term holdings. Timing of the recovery is uncertain and drilling stocks may experience many local up and down cycles before establishing an upside trend in case of oil price recovery.

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.

Additional disclosure: I may trade any of the abovementioned stocks.

Editor's Note: This article covers one or more stocks trading at less than $1 per share and/or with less than a $100 million market cap. Please be aware of the risks associated with these stocks.

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Offshore Drilling: Discussing First-Half Results - Seeking Alpha