Is it over yet? The year 2015 certainly will go down as the worst year for energy stocks since 2008 -- that is, unless 2016 beats it for misery. Looking at certain sub-sectors, such as offshore drilling, 2016 unbelievably could make 2015 look tame.
We always knew that the bust cycle in oil prices was going to bring a lot of bad times for energy stocks, but no one imagined such carnage, even among the strongest names. I have been focusing on what I have called "the survivors" and am trying to find value in the shares of names such as EOG Resources (EOG), Cimarex (XEC) and Hess (HES). With offshore drillers, I've imagined even more awful times ahead, but took a speculative shot with Seadrill (SDRL) as I look down the road two years at the inevitable rebound in deepwater drilling.
However, the resilience of many of the unconventional drillers unexpectedly has extended the timeline in this oil bust cycle, catching me by surprise. We're operating inside this insane Catch-22: Oil prices can't get constructive until U.S. and other non-OPEC producers start to trim their outputs, yet oil companies continue to use efficiency gains and top-line spending cuts to stay in the game and maintain production. Oil prices stay low and drift lower. Consequently, 2016 will not be happy, at least for the first few quarters.
It gets worse: Oil companies have pushed their debt deftly down the curve, with only a tiny number of high-yielding issues coming due and requiring refinancing this coming year, thus promising an even more extended period of financial life support. We've seen the wild outcome of a few of the early bankruptcies in U.S. independents: Both Quicksilver Resources and Magnum Hunter have seen their common shares go to zero and have been forced to declare Chapter 11, but also have been ordered to continue operations pending break-up or other restructuring.
Even bankruptcy, it seems, can't slow U.S. production much.
With spending cut to the bone, core wells being run dry and few wells being drilled to take their place, the "Red Queen" of shale production (running as fast as you can to stay in the same place) most certainly will hit a very firm wall, and it will hit it sometime in 2016, of that I'm sure.
But that initial, massive drop in production from unconventional shale may not come in time to save offshore players, including possibly Seadrill. We've seen this week, for example, the cancellation by Shell (RDS.A) of the remaining time of Transocean's (RIG) Polar Pioneer contract. There was little surprise in this move, as the first exploratory Arctic well came up disappointedly empty and Shell already had withstood massive environmental pushback in the Arctic. With several other timing missteps from Shell in regards to the oil and gas market (think BG Group merger), it's no surprise that Polar Pioneer was given back.
And while Transocean will be made whole for the contract time, it does go to a point about offshore in general: Almost all of the time options on current deepwater rig contracts are being refused by the exploration-and-production companies. More and more rigs are going idle and remain uncontracted further into the future.
As the timeline of destruction gets longer, so do the chances of full-scale default in the deepwater sector. While I had been hoping for a resurgence of offshore contracts in late 2017, it now is possible that the cycle won't find a turnaround until perhaps 2019 or 2020.
Wow! That makes the risk of holding Transocean, Noble (NE) or my beloved Seadrill positively depressing.
At current prices, I cannot recommend a sale of Seadrill -- it was always a speculative play that I budgeted for possibly going to zero, and I'm willing to let that play out. And I'm definitely not looking for any double-up or averaging of basis prices, either. Indeed, it seems certain that both RIG and Noble will see single-digit prices in 2016 and Seadrill will sink below $3, if not flirt with the same Chapter 11 fate of Quicksilver and Magnum Hunter.
And in that, if it's any consolation, they certainly won't be alone in the coming year.
