Off-shore drilling business. How much is it likely that it will recover?

Hi all,

at the moment off-shore companies such as Transocean (NYSE:RIG), National Oilwell Varco (NYSE:NOV), and Helmerich & Payne (NYSE:HP) seem to be very beaten up. Transocean in particular is trading at 0.2 its book value.

Can this be the bottom of another cycle? Will offshore still be competitive again, considering that onshore drilling is much cheaper and new technologies for onshore allow to extract oil from more difficult reservoirs? How do you see the oil price going?


  • Hi Mora,

    Yes, it will recover, because at some point oil prices will rise and it will be become profitable to expend capital on off-shore drilling. The presence of cycles is apparent in all things, including the economic realm and the price of oil is a component of this system. The real question is when will it recover?, as Preston and Stig have discussed in the recent forecasting podcast, the further out into the future you look, the harder it is to predict.

    I would begin by asking 'what are the reasons why the oil price is low?'

    1. Slowing demand from China as expansion in credit inevitably occurs.
    2. A strong USD, more often than not, correlates to a weak oil price.
    3. The Shale oil boom has increased supply into the market
    4. The OPEC countries have kept supply output at fairly high levels to try and make it unprofitable for shale producers

    Now we ask what could change this?

    1. A weakening USD would most likely result in a rise in commodities prices
    2. The outbreak of war/terrorism in some of the major oil producing countries would impact the supply side
    3. Supply side should, at some point, contract as a result of cutbacks in exploration and extraction by the industry
    4. Demand could rise if the US, or some other major economy such as India experiences significant economic growth (Unlikely in my opinion)
    5. The lower oil price results in bankruptcies for the less efficient producers resulting in decreased supply.

    Obviously there are a myriad of other factors to consider such as the increased development and implementation of green technology, unforeseen natural events either increasing or decreasing demand for Oil & Gas, new technologies for extraction and the emergence of new markets/fields which require increased energy.

    In summary, yes, oil prices will recover but it is difficult to predict exactly when they will. Will prices be higher 10 years from now?, in my opinion this is likely to be the case but when they will begin to turn is much harder to predict. Commodities traders tend to monitor the prices of futures contracts and watch the trend, when the price for present demand rises above the longer-term futures price it is considered to be a sign that the cycle has entered an upward arc.

    I'd be interested to hear the thoughts of other board members on this subject,


  • Hi Anaximander,

    thanks for answering.

    Reading some articles here and there, it actually looks like OPEC has started cutting the production with the hope to increase the price. Here the article

    Their attempt so far has been counteract by an increase in production from shale oil from US. Therefore the price keeps decreasing.

    I would be also interested to hear what are the other members' thoughts on this.
  • Hi Mora and Anaximander,

    I think that this is a really hard question. First of all a comment reg. the link with the OPEC price cut:
    This is about the 10th time in the last two years that OPEC has proposed a similar cut. And it has never worked.
    First of all, the OPEC members do not find common ground. And even if they do, there is just so much easiliy available spare capacity from the shale producers, filling the output gap immediately. OPEC is simply not in the position to influence prices any more.

    Secondly, I am not sure, if prices really recover. The shale boom really changes the game for me. These producers can switch on and off the wells quite fast, thereby immediately adapting to supply and demand. Right now I simply do not see, how prices should go higher. An external shock might be a possibility. And then the future is always unpredictable. I just find it hard to see.

    If you invest in such companies, the most important thing I would look for is the balance sheet. This downturn can last a long time - so you only want the most resiliant companies. P/B of 0.2 sounds good, but it really says nothing. If the company has high debt, all of their assets are Goodwill and long-term investments, then the P/B ratio can easily go to zero - because the company goes bancrupt and therefore P goes to zero.

    I like NOV (and also the split-off DNOW) quite much and have owned it in the past. In the end I sold - but this was more due to the fact that I expect a major crash soon and so want to have much cash on hand. Was no specific decision against the company.

    All in all, you need to do quite some work on such companies, before you invest. Like I said, my advice is: Only invest in companies that can survive a year-long slump of oil prices. Look at the balance sheet.


  • Hi Christoph,

    thanks for sharing your thoughts. I think I will put this company in the "too hard" shelf for the moment. I will keep and eye on them and see how the situation evolves in the future.


  • Guys,

    Ticker SDRL, Seadrill...I know oil has dropped and there is an over supply of it. Do you think SDRL is extremely over sold? I think its worth a small buy. I will buy 500 shares which i know it is possible to lose it all but its a small sum to lose so not worried about the loss. I just think the risk is worth it. The book value is way above the trading price which is .45 a share right now.
    There debt is high but i think they can cover it, they also have a good amount of cash on hand.
    What do you guys think???
  • Hi joseee2,

    I would advise extreme caution here. The current short position on SDRL is around 25%, those shorting a stock tend to do their homework on a company because they are engaging in a naked trade and thus their risk is higher. This high short position is the first red flag. This prompted me to look at the company's liquidity position which is very weak indeed, it turns out that the company does not have enough assets to meet it current liabilities and is in talks to attempt to restructure it's debt position. This is not good, if the company cannot restructure it's debt it is highly likely to be forced into liquidation, in which case assets will be sold(at a discount!) in order to settle with the creditors, i.e. bank debt and bond holders, common stock holders are last in line for settlement. If this does occur there will be no discount to BV as it will evaporate as creditors are repaid. Even if the debt can be restructured the debt position still looks very high to me and if present low oil prices persist the company could still go bankrupt.

    Looking at the company's latest 10-K I noticed this;

    "We are in ongoing comprehensive restructuring negotiations, which creates significant uncertainty, which may result in
    impairment, losses or substantial dilution for stakeholders and which will likely involve schemes of arrangement in the
    United Kingdom or Bermuda or proceedings under Chapter 11 of Title 11 of the United States Code."

    This is basically warning investors that in order to restructure the debt the company may have to hand over a large piece of equity to creditors and this will likely involve massive share dilution for shareholders meaning the discount to BV will evaporate and thus any potential for ROI.

    Later in the 10-K this ominous line appears;

    "As a result, we currently expect that shareholders are likely to receive minimal recovery for their existing shares."

    This is enough for me to stop looking any further, straight on the 'No' pile!


  • There was a very interesting podcast on the Adventures in Finance podcast which suggests that the price of oil will be low for quite a while yet. It reveals that the oil market is actually largely misunderstood. Worth a listen.
  • Thanks Anaximander,

    I have been speculating since i was 17, I am 34 now. I have been really lucky, i mean really lucky... its more of a hobby and something i really enjoy...... I have traded everthing you can think of. ES emini, Gold, softs futures, oil, forex on cme exchange and the list goes on. I started to think about Warren Buffet and how he has made so much with stocks. I am reading some of the books you guys recommend and I wish I started to read earlier in life. I have a lot to learn about investing. This site has been the go to for me and the videos which I listen to on youtube. I saw I found this site 3 months ago and I have been value investing. Just bought some costco stocks after the amazon buying wholefoods deal coming out... its trading about 150 per share. I also have v been selling put options on Costco... bank of America, walamrt, goldman Sachs. I do trade deltas and high spikes in IV. Anaximander, i bought SDRL already before the post... i got it at .43 cents 500 whichbis only 215 dollars which I collected from premium. It is the houses money. I promise that is my last gamble play. I will keep reinvesting my earnings smartly. I can read about the markets all day everyday which gives me an advantage, i just didnt realie that before. I appreciate all the input.
  • To echo what others have said, Seadrill currently cannot service its short term debt. Further, their debt structure is very complicated and involves over 40 banks/institutions. The likely outcome will be a chapter 11 reorganization, or an out of court settlement involving issuing of convertibles; this will very likely dilute existing shareholders significantly. The best thing to do is look at other incumbents in the space who have already undergone restructuring such as Ocean Rig UDW (ORIG).

    if you really want to play in this space, it would be a speculative purchase, but I would wait until after the debt situation is figured out. Don't bank on events like Big john to bail the company out and squeeze the shorts - fun to think about, poor to invest on.

    I know i'll be investing in this space in due time. I have some money in Transocean, but the overcapacity in the space is hard to ignore.
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