Offshore drilling has certainly been the hardest hit of any of the horrendous energy sub-sectors. Stocks such as previously well-loved Transocean (RIG), Ensco (ESV), Diamond Offshore (DO) and personal holding SeaDrill (SDRL) have all collapsed. Now, viewing in retrospect the third-quarter results from the oil companies that are the clients of these offshore companies, I see even worse news. Offshore's down cycle looks like it will last even longer than we feared.
In today's depressed oil environment, production sources get even more competitive than normal. In good times, when supply only meets demand, the most expensive source of oil is as welcome as the least -- every barrel of oil is needed in order to satisfy the market. But in the surplus market we've had over the past 14 months, oil companies will be even more incentivized to find the lowest cost and most flexible oil supplies. Combine that with capex budgets that are in massive retreat, and you're left with oil companies that choose even more carefully where to invest their limited dollars.
Two years ago, offshore drilling was fairly competitive in "earning" those investment dollars. Oil from the Arctic, oil sands projects and a large proportion of shale fracking weren't any more cost effective than even the most complex deep-water projects -- and deep-water drillers fared just fine.
But the latest results from large-cap oil companies such as Anadarko (APC), Murphy Oil (MUR), Action Alerts PLUS holding Occidental Petroleum (OXY), Chevron (CVX), Whiting (WLL) and others continue to show exponential improvements in shale oil results through spacing and fracking techniques, shifting the competitive edge more strongly toward the onshore world -- and setting back the offshore specialists even further.
Further digging into the reports reveals deeper cuts than expected to offshore production commitments. Anadarko is cutting back on 13% of its offshore wells, and ConocoPhilips (COP) has chosen to abandon the space entirely, at least temporarily. This despite the fact that fabulous preliminary results have been seen in some of the strongest new offshore prospects, including Hess's (HES) Tubular Bells, Anadarko's Shenandoah, Noble Energy's (NBL) Big Bend and Chevron's Anchor projects. All of these projects are sure to slow through 2016 and 2017 as capex allowances get squeezed.
The bottom line is an extended down cycle to even the worst-case scenario I pictured for offshore players. Even if I maintain my timeline prediction of a constructive move for oil prices in late 2016 (I do), it still doesn't translate into constructive moves for the offshore players as quickly, considering their very long-term timelines for rig contracts.
Neither Transocean at $16, Ensco at $17 or SeaDrill at $6.50 scare me, as none of these are in serious risk of bankruptcy, but neither are they in serious risk of major up-cycle moves any time soon. Ensco, for example, has done a fantastic job of shelving non-productive rigs and cutting costs and rates to ride out the offshore storm. And I continue to hold SeaDrill, which I still see as a long-term speculative play with huge upside possibilities and small further downside risks, despite the new bad news from the reporting majors.
But the game for these names did just get noticably worse.