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Can Offshore Drilling Industry Weather the Coronavirus Storm?

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The whole world waits with bated breath to see the curve being flattened. An all-out effort is being made in every sphere to wipe out the novel coronavirus from the face of the earth. However, the road to recovery seems a long, arduous process. In fact, no sector is immune to this fast-evolving deadly virus, especially the energy space wherein the offshore drilling industry — responsible for 30% of the global oil production — is facing an impossible set of challenges.

Industry Performance

Let’s take a look at the price performance of the Oil and Gas - Drilling industry. In the year-to-date period, the S&P 500 Index has dipped 3.2% compared with the oil and gas energy sector’s 37.8% slump. During this period, the Zacks Oil and Gas - Drilling industry has also plunged a whopping 67.9%. Moreover, the industry currently ranks at the bottom 21% of the Zacks Industry Rank.

With the world awash in excess oil, crude prices at multi-decade lows and demand likely to be tepid for the long haul, offshore drillers are in the soup. 

Crude Crush Intensifies Offshore Industry Struggles

When oil was trending in the triple-digit territory in 2014, energy companies had billions reserved for exploration budgets. This aggressive approach was essentially in response to fluctuating commodity prices and severely-dented balance sheets when prices fell to a 13-year low of around $26 per barrel in 2016. With operating profitability being compromised, the worst oil price rout in more than half a century triggered a major restructuring in the companies’ long-term focus. Most producers grew cautious by shunning large, capital intensive projects.

Particularly, the dwindling price forced top energy players to cut spending due to costly offshore drilling projects on account of squeezed profit margins. This, in turn, meant less work for the beleaguered drillers. With old contracts rolling off, the companies either got rigs stacked or bore high reactivation expenses and accepted much-reduced dayrates. As a result, overall revenues took a hit. Most offshore drilling stocks lost billions in market value during this period.

Barely had they overcome from the oil price plummet when the coronavirus outbreak struck them hard, further aggravating their woes. The pandemic triggered an unprecedented sell-off of the commodity of oil. On a worrying note, with major cities on lockdown and travel restrictions in place, the consumption for crude is set to take a substantial beating. Global efforts to combat the adverse COVID-19 impact and rev up the economic activity have been partly effective. The virus-inflicted demand slowdown induced a significant oil sell-off, forcing E&P players to take a relatively conservative approach to capex programs, thereby scrapping contracts with many offshore drillers. Many oil producers are withdrawing from endeavors that require oil to be pegged $60 per barrel to make a profit and this could consume enough time before they can actually achieve that price again. Big Oil companies like Chevron (CVX - Free Report) , ExxonMobil (XOM - Free Report) and Royal Dutch Shell (RDS.A - Free Report) abandoned drilling deals earlier this year to preserve liquidity and shareholder value.

The highly cyclical nature of the industry makes its participants — who generally build big and expensive drilling rigs — heavily dependent on the prevalent unpredictable business environment. In other words, it’s extremely difficult for any driller to perform well during a commodity downturn. 

The coronavirus chaos sent most offshore drilling companies into a tizzy. As the drop in oil prices and the ramp-down in business activity due to the pandemic mess weakened demand for offshore drilling services, the relevant companies encountered a second wave of bankruptcy.

Of the seven largest offshore drillers,  the currently Zacks Rank #4 (Sell) Diamond Offshore Drilling Inc as well as three other companies, namely Noble Corporation (NE - Free Report) , Seadrill Limited and ValarisPlc (VAL - Free Report) either sought protection from creditors under chapter 11 or already began debt-restructuring discussions to avoid insolvency. These companies tend to utilize the proceedings of reformation to streamline and boost its balance sheet, thereby attaining a more secure debt profile while continuing to concentrate on safe, reliable and efficient contract drilling services for its global clients. You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

Conclusion

The near-term market softness on account of the latest oil price collapse is a significant threat to the offshore drilling contractors. That said, a few players are well-equipped to deal with the current market headwinds. 

Sector consolidation, adoption of superior technologies, new operational systems’ optimization of the fleet through strategic sell-offs, acquisition and profitable collaborations among other tactical strides certainly bode well for the drilling companies.

For offshore players, curtailed costs amid strong operating efficiencies are likely to generate decent returns for most projects even at today's oil prices. As a matter of fact, the lower breakeven and attractive project economics are sealing more offshore deals.

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