Image: SemiSubmersible Sevan Driller

Investment Thesis

The offshore drilling industry is suffering through the worst bear cycle in history. The oil crash that began late in 2014 had a terrible effect on the offshore drilling players such as Transocean (NYSE:RIG), Seadrill (NYSE:SDRL) or Noble Corporation (NYSE:NE) and another dozen or more companies struggling to avoid a financial meltdown, due to a basic lack of work, dismal day rates and rig oversupply, which is the unavoidable trichotomy of an offshore drilling bear market that continues unabated as I speak today.

Oil majors have reduced exploration CapEx to a bare minimum just barely higher in 2017 but still painfully insufficient.

I have followed this sector closely for years and tried to report the slow degradation of the business environment until now and I am still waiting to see some meaningful signs of a potential recovery. However, of late, we may have experienced an important change in the oil market that may lead to a bottom for offshore drilling and a possible recovery late in 2018 or early 2019?

OPEC and non-OPEC producers have agreed to cut production by a little less than 1.8 MBOPD, and quickly in December 2016 the price of oil began to trend up, at least until January 2017. Unfortunately, oil prices have stalled abruptly after reaching a range of $53-$56 per barrel, due to a booming US shale new activity -- especially in the Permian sector and doubt about the effectiveness of this supply reduction long-term.

Yet, some analysts are still forecasting slightly over $60 a barrel in 2018, which is enough to change the dynamic in the offshore exploration, notably in the deepwater segment which needs about $63 per barrel to be economical. Nonetheless, the situation is not an easy one and a potential to return to the $40's a barrel is also a present and real danger.

While waiting for concrete signs of tendering activity, it is important to know what exploration sectors will provide for the deepwater and ultra-deepwater business in the near future?

One important area that could help the offshore industry to survive this downturn is India offshore, which is the main topic of my article today. ONGC is active and is about to award three rigs on a three-year contract for its KG-DWN-98/2 block.

Description of the Krishna Godavari basin:

Total oil initially in place in the KG-DWN-98/2 block is estimated at 106 million cubic meters, production of only 26.71 million cubic meters is envisaged during 2019-2031.

Similarly, the gas initially in place is estimated at 69.57 billion cubic meters "BCM," of which only 51.33 BCM can be produced during 2018-34.

On December 23, 2016, we learned from Upstream that ONGC submitted offers for two units able to drill in 1500 meters of water, and one rig to drill in 600 meters.

[Translated from Norwegian] Seadrill is one of several bidders in a tender for three deepwater rigs from India's state oil company ONGC, reports Upstream, according to TDN Finans. The rigs will be used on flagship block KG-DWN-98/2 outside India's east coast. The first part of the tender process consists according to news agency two dynamically positioned drillship or semi rigs to drill in 1,500 meters. It is in this category Upstream sources mention Seadrill that one of the bidders, with the drillship "Sevan Driller". In addition participates among others Transocean , Vantage Drilling (OTCPK:VTGDF), Universal Energy Resources, Noble Drilling ((NYSE:NE)) and Ocean Rig (NASDAQ:ORIG).

On March 3, 2017, We learn again from Upstream that ONGC is now close to award the three 3-year contracts.

Three leading international drilling contractors are poised to win three-year, deep-water rig contracts from India's Oil & Natural Gas Corporation (ONGC) for its flagship Block KG-DWN-98/2 development off the country's east coast.

ONGC requires two 1500-metre, dynamically positioned drillships or semi-submersibles in one category and a single anchor-moored rig capable of drilling in 600 meters of water in the second.

London-headquartered giant Seadrill and Singapore's Vantage Drilling are expected to win three-year rig charter contracts in the 1500-metre category, while Brazil's Queiroz Galvao Oil & Gas (QGOG) is likely to win a three-year rig contract in the 600-metre category, sources said.

On February 27, 2017, commercial bids were opened by ONGC and the results are indicated in a small table below:

Seadrill with its Subsidiarie Sevan Drilling.

Sevan Drilling ASA (SEVDR.OL) (OTCPK:SDRNF), listed on the Oslo stock exchange: SDRL owns 50.11% (14.897 million shares) of the company.

Semisubmersible Sevan Driller (2009)

Actually Ready stacked in Singapore

Drillship Platinum Explorer

(2010)

Actually Ready stacked in India

Midwater Semisub Olinda Star

(1983)

Actually Ready stacked in Brazil

Transocean (RIG) is said to be the biggest loser in this fight for survival. The company offered no less than three drillships in the first category and one semisubmersible in the second category:

More than a dozen rigs were offered by nine contractors in the 1500-metre category.

Transocean is believed to have offered the highest bid with $166,750/d for the three drillships offered. For the second category, Transocean was the second bidder with $146,050/day (only three bidders in this category with the Semisubmersible Hakuryu-5 from Japan drilling but seems to have been disqualified?

Conclusion:

Let's all be honest here. Who in its right business mind and most importantly, why, a company is willing to commit to a 3-year drilling contract at a certain operating loss? The basic reasoning is evading my understanding. It doesn't make any sense. To paraphrase Galileo Galilei "and yet it moves", I would say, and yet offshore drillers do it.

First topic: What is the actual average day rates for Semisubmersibles and Drillships. According to IHS Markit.

Day rates are quite constant since October 2016 which is a sign that we are now at breakeven level.

As an example, let's calculate a breakeven cost using Transocean, which is the leader in this sector. I took this table from my article about Transocean 4Q'16 results. If you want to read it please click here.

Day rate for RIG fleet.

Dayrate

2016 Estimated

$K/d

4Q'16

$k/d

3Q'16

$k/d

2Q'16

$k/d

1Q'16

$k/d

4Q'15

$k/d

3Q'15

$K/d

2Q'15

$K/d

4Q'14

$k/d

Operating and Maintenance expenses were $314 million in 4Q'16 and total revenues were $974 million for the same period. Operating and maintenance expenses are 32.2% of the total revenues. I do not even talk about the debt here...

I we apply to the average day rate 4Q'16 for UDW we have a breakeven price per day of, $490,600/d x 32.2% = $158,000/d

Thus, I consider that $158k/d is a good estimate of what could be considered as "breakeven operating price" for a drillship in 2017, in general. This simple calculation justifies the day rate offered by Transocean for the three drillships at $167k/d including tax.

Transocean offers its service at breakeven operating costs for 3-years. Now, how can Vantage drilling Inc., or Sevan Drilling can justify such day rate?

I am sure, many will find a way to justify this move, but, the fact of the matter is that the companies working for ONGC will consistently lose money, and for the next three years, period.

The Industry is not thinking straight, in my judgment. The price war has gone too far, and should not be even tolerated.

Risks of labor abuse and all kinds of neglect of basic maintenance costs may result to catastrophic hiccup down the road. The Industry should meet and create a minimum guideline with a minimum viable day rate under which it is not allowed to go.

Important note: Do not forget to follow me on SDRL and other offshore drillers. Thank you.

Disclosure: I am/we are long RIG AND OTHERS.

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.

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.

Excerpt from:

Seadrill - 3 Offshore Drillers Poised To Win The 3 ONGC 3-Year Tenders - Is It Really Worth It? - Seeking Alpha