Offshore Exclusive: Creating a road to recovery for the offshore drilling sector

The narrative that has been unfolding in the offshore drilling industry since the price crash of oil in 2014 is rapidly approaching a climax.

To an already toxic mix – composed of stubbornly low crude prices, a chronic oversupply of drilling rigs, unsustainable capital structures, and furious operational cash burn – has been added the global COVID-19 pandemic, which has further weakened demand and day-rates while imposing tight constraints on offshore drilling operations.

The harsh market environment has driven drilling rig contractors and their creditors to finally bite the bullet and undertake major restructurings, including, in some cases, Chapter 11 bankruptcy protection. More contractors could follow suit.

After contractors and investors perform the necessary financial surgery, the offshore drilling sector could look very different than it does today, but it will likely still labour under the burdens that have weighed on it since 2014.

Although most if not all of the sector’s more than US$45 billion in cumulative debt could be converted to equity, contractors will still have to retire a significant portion of their drilling assets – and the sector will have to consolidate. Absent such drastic measures, contractors may never regain pricing power or generate returns that exceed their (very high) cost of capital. As potential new shareholders, current creditors – especially bondholders – could be key facilitators of a consolidation wave.

Paradoxically, the contractors that currently enjoy the largest contract backlogs and soundest balance sheets could soon find themselves at a competitive disadvantage to their more-troubled peers. If the stronger players do not restructure, retire assets, and aggressively lower their cash breakeven points, they could wind up losing business to rivals that have already slimmed down and could be left on the side-lines of any consolidation wave.

But no matter how the competitive reshuffle shakes out, the offshore drilling sector as we have long known it could be approaching its end. The sector that emerges to replace it will likely be shaped by the critical moves that contractors, creditors, and investors make – or don’t make – today.

The sector that emerges at the end of any consolidation phase might operate by models very different from those followed by today’s drillers. A restructuring proposal offered by Valaris suggests that today’s diversified model could give way to two predominant models: floater companies, focused on deep-water drilling and characterised by high risk and returns, and jack-up specialists, which would engage in shallow-water projects with relatively lower risk/return profiles.

Variants of Seadrill’s fleet management model, in which a contractor performs commercial and operational activities on behalf of rig owners, could emerge as well.

As noted, some offshore drillers and their creditors are continuing their long-standing practice of negotiating amend-and-extend deals to relieve their debt pressures. But such temporising measures do little to address the sector’s persistent overcapacity of drilling assets, and they ignore the pressing need for drilling companies to improve their competitive positions by radically overhauling their cost and capital structures.

Consolidation and aggressive asset retirement could enable drilling companies to regain some measure of pricing power and earn rates of return in excess of their costs of capital.

The sector’s bondholders, which would likely become shareholders in the aftermath of any restructuring, could facilitate consolidation through mergers, acquisitions, and asset sales.

The process may be painful at times for all of those involved, but the alternative – a permanently ailing industry always on the verge of crisis – would be far more painful indeed.

Editor’s note: This is an excerpt of a longer report, “Restructure, Retire, Consolidate: The offshore drilling sector’s path to recovery,” published by Alix Partners in November 2020.

Source: Offshore Magazine