The offshore oil drilling companies had a rough few years as oil prices dropped and the demand for crude oil seemed to wane drastically. Nevertheless, the stocks of these companies are currently gaining the attention of investors. It’s no secret that the energy industry has been transitioning towards more sustainable alternatives, but the fact remains that we still need oil to keep the world running for decades to come.
Despite the historic downturn for offshore rigs during the pandemic lockdowns, these companies, such as Noble, Valaris, and Seadrill, have arisen in a better financial position than when they filed for bankruptcy in 2021 and 2022. They are now poised to rise above the rest as major energy companies increase their offshore spending.
It’s true that oil prices have fallen from the low $80s to under $70 a barrel, but investors remain optimistic about these companies. In fact, drillers are now getting higher leasing rates for their rigs, translating to better earnings in the future.
As most of the offshore drilling companies have little to no net debt– thanks to restructuring during their bankruptcy period– some are initiating or expanding buyback programs, and payouts might be reinstated as free cash flow would grow sharply over time.
In conclusion, despite past risks, these stocks are worth investing in as the offshore drilling companies are expected to be lucrative in the coming years with reduced investor risks.
The Offshore Industry: A Lucrative Investment Opportunity
According to David Anderson, a Barclays analyst, the offshore drillers in the energy service sector present an excellent investment opportunity as they are in the second year of a minimum of a five-year investment growth cycle. Noble, Transocean (RIG), Valaris, Seadrill, and Diamond Offshore Drilling (DO) lead the concentrated niche of the offshore industry, and their rigs are increasingly in demand.
Offshore fields play a vital role globally as oil production now runs at about 100 million barrels a day, and it isn’t expected to change much over the coming decade. While onshore wells using fracking may produce only 1,000 barrels of oil per day, offshore fields off the coast of Guyana in South America can hold billions of barrels of crude oil, and individual wells can produce up to 20,000 barrels of oil per day, according to Evercore ISI analyst James West. Moreover, annual rate production declines for offshore wells rest typically in the single digits as compared to 50% or more for first-year fracked wells in the US.
Despite facing opposition from climate activists, European majors such as BP and Shell have decided to take a step back from renewable energy investments to invest more heavily in oil. As James West points out, “There’s a realization that the oil age will last longer than many prognosticators have suggested. The major energy companies recognize they need baseload oil production, and they need offshore for that.”
It’s all about the money. The oil-service industry leader SLB (previously known as Schlumberger) highlighted the lucrative offshore opportunity this past week, projecting that major oil companies would commit up to $500 billion in new projects from 2022 through 2025. SLB knows what it’s talking about since 85% of offshore fields are still profitable even if oil prices fall to $50 a barrel.
With the necessity of oil production and the demand for offshore drilling on the rise, it’s an excellent opportunity to invest in offshore drillers.
Exploring the World of Offshore Drilling Rigs
Offshore drilling rigs are essential for extracting oil and gas from deep-sea reservoirs. They are massive platforms that can operate in water depths ranging from 500 feet to 10,000 feet. These rigs come in two types: jackups and deepwater rigs.
Jackups are used in shallow waters of 500 feet or less. In contrast, deepwater rigs are either ships or floating platforms that can reach reservoirs several miles below the seafloor. These rigs command the highest rates and are owned and operated by public offshore drillers.
Currently, there are around 100 to 150 deepwater rigs operating in places like the Gulf of Mexico, the North Sea, and Guyana. The day rates for these rigs hit rock bottom at around $125,000 a day during the pandemic crisis in May 2020 but are now approaching $500,000 a day. With operating costs generally below $150,000 a day, they remain highly profitable.
However, not all of the profits are flowing through to the drillers just yet since the current earnings are depressed by older contracts carrying lower leasing rates. Nevertheless, profits are expected to ramp up sharply from 2024 to 2026 due to newer contracts with higher rates.
The bankruptcies, consolidation, and tight supply in the industry have also resulted in more pricing discipline, limiting overspending by offshore drillers. Moreover, as there is virtually no new construction of rigs, which can cost nearly $1 billion each, the most desirable rigs are expected to remain in short supply.
Noble, for instance, is expected to witness earnings more than double, nearly reaching $6 a share in 2024 from $2.45 this year, with further increases in 2025. As offshore drilling becomes an essential component of the global energy market, the demand for these platforms will only continue to grow.
Offshore Drillers to Watch
Barclays’ Anderson has identified Noble as a top pick, citing the company’s “enormous recontracting opportunity” over the next two years. Noble has a clean balance sheet and a buyback program in place. In May, the company secured a 2.5-year contract with Petrobras for a floating rig at $490,000 per day, a new high for the industry. Anderson has set a $56 price target for Noble, which would be a more than 50% increase from the recent closing price of $35.62. While slightly more expensive than other drillers, Anderson believes the company is of higher quality.
Valaris has underperformed its peers primarily due to leasing rigs at rates below market value, which will delay their re-contracting opportunity. The company does have an attractive rig joint venture with Saudi Aramco that could go public in the future. West believes that Valaris is well positioned due to its high-quality deepwater fleet and the potential for rigs to be reactivated. He has set an Outperform rating and $86 price target on the stock, which closed Friday at $56.56.
Diamond Offshore has the smallest market value of the major offshore drillers, but it includes four “seventh-generation drillships”. This has attracted Anderson’s attention as he thinks the company’s small size makes it a potential acquisition target. The stock is trading at nine times projected 2024 earnings and Anderson believes it has potential for growth. He has set a $20 price target, which would be a more than 60% increase from the current price of $12.37.
Consolidation in the Oil Drilling Industry
Seadrill has made a name for itself by acquiring smaller firms, and its merger with Aquadrill earlier this year has created a “best in class” fleet of seven seventh-generation drillships. As low-priced legacy contracts expire, Seadrill’s earnings should increase in the years to come. At $38, the company trades at eight times its projected 2024 earnings.
Transocean, however, is a riskier investment option but also offers substantial rewards. It dominates the industry with the highest number of operational deepwater rigs and has a large fleet that can be returned to market. Although it has a debt of $7 billion, higher than its market value of $4 billion, it is the only major rig operator that has not gone bankrupt. Despite its high debt, paying it down could increase equity prices since ownership would pass from bondholders to shareholders.
According to Anderson, Transocean could be “one of the greatest deleveraging stories” in energy in the coming years, with an estimated annual free cash flow of $1 billion between 2024 and 2026. Investing in Transocean’s equity is a powerful play on the industry’s revival, and investors can also consider purchasing its debt, such as the 6.8% bonds due in 2038, currently yielding approximately 11%.
Although rig lifespans are limited and subject to energy transitions, oil is expected to remain a key source of energy for decades to come. The consolidated and financially disciplined rig industry could be the best way for investors to take advantage of this longevity without being exposed to high-risk exploration activities.
Conclusion
Seadrill is well-positioned for long-term growth. Meanwhile, despite considerable debt and significant risks, Transocean may be the best way for investors to benefit from an industry revival thanks to their potential annual free cash flow of $1 billion in 2024 through 2026. As with any investment opportunity, there are risks that investors should be aware of.
