I've been following Teekay Offshore Partners (NYSE:TOO) for some time due to my interest in everything offshore drilling - related. Finally, a Morgan Stanley downgrade led to a decisive downside gap in Teekay Offshore units and I decided to take a closer look at the situation to determine whether the move presented a speculative opportunity.

On the surface, there were two catalysts behind the major downside moves in May and June. In May, Teekay Offshore reported its quarterly results where it stated that it received a notice of termination for the Arendal Spirit UMS (unit for maintenance and safety). In June, Morgan Stanley report assigned a $1.50 target to Teekay Offshore units.

At first glance, the market reaction is strange. Arendal Spirit has not been paid since November 2016, so the termination is hardly a surprise. As for the Morgan Stanley downgrade, the report did not include any new and surprising information that has not been available before. However, I'd argue that nothing strange happened - in fact, the stock market often operates in this way.

Arendal Spirit termination is minor news - the absolute majority of Teekay Offshore's revenue comes from FPSOs and shuttle tankers. At the same time, such negative news put the company in the spotlight and the market reacts to what it should have reacted previously - the refinancing concerns regarding Teekay Offshore.

Businesses like Teekay Offshore depend on open credit and equity markets for their operations. As of March 31 the company had $193 million of cash on the balance sheet while the current portion of long-term debt stood at $621 million. During the conference call, the company stated that it was working with lenders under the facility secured by the Arendal Spirit to grant an extension of the facility while the company was searching for the new job for the unit. Also, Teekay Offshore stated that it was considering partial asset sales and joint ventures to improve its liquidity.

In current circumstances, it looks increasingly unlikely that Teekay Offshore will be able to tap equity markets for short-term financial help. In this sense, Morgan Stanley's downgrade acts as a self-fulfilling prophecy, pushing Teekay Offshore's units down and almost eliminating the possibility of an equity raise. Another problem is the state of the offshore drilling market, which is yet to see the light at the end of the tunnel.

There was much talk about offshore drilling adaptation to lower oil prices during the recent earnings season but I have not seen factual confirmation for this. Oil price action itself is alarming, with both Brent (NYSEARCA:BNO) and WTI (NYSEARCA:USO) below $50 per barrel despite OPEC/non-OPEC deal. The outlook for the offshore drilling market will certainly influence the lender's decision regarding Teekay Offshore's indebtedness.

The main problem as I see it may be that lenders demand significant concessions from Teekay Offshore including the elimination of distribution. The elimination of distribution typically puts big pressure on the units as distribution is the main reason to invest in such companies.

In my view, the risk/reward balance is not great neither for the long nor for the short side here. Any real positive news on negotiations and the shorts could be killed as Teekay Offshore units are already at low levels. At the same time, the fundamentals of the offshore drilling business are bad in the short-term and will influence the company's negotiations with lenders. In these games, common unitholders carry a disproportionate amount of risk. I think that not all this risk has already been baked in Teekay Offshore's unit price so if additional negative information comes out there'll be more room to fall.

My verdict is that Teekay Offshore units are currently an avoid for everyone except short-term traders who rely on technical analysis for their entries and exists. I believe that it will be hard to control risk in both a long or a short position if it held for more than a couple of days.

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.

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Teekay Offshore: Speculative Opportunity? - Seeking Alpha