Transocean Ltd (RIG) is the world’s largest offshore oil driller, with 139 drilling rigs in all four categories: ultradeep water, deepwater, midwater, and jackup. Its fleet includes 47 high-specification floating rigs (ultradeep, deepwater, and harsh environment), 26 midwater floaters, and 65 jackups and is about twice the size of its nearest competitor’s, Noble Corp. (NE). Other offshore drillers include Ensco (ESV), Diamond Offshore (DO), SeaDrill (SDRL), and Pride International (PDE). Transocean has rigs at work in all the major offshore oil basins in the world, including the Gulf of Mexico (GOM), West Africa, the Far East, the North Sea, Brazil, and India. Its revenues come about 37% from integrated oil companies, 36% from nationally owned companies, such as Aramco, and 27% from independent oil exploration and production firms.
The offshore drilling industry is in something of a quiet period now, and Transocean’s rig status reflects that. The company has only one ultradeep rig available now, but it has unused capacity in the other floating categories, and around half of its jackup rigs are idle. Looking ahead a bit, we expect the picture to improve as 2011 progresses. There is ample idle jackup capacity for standard rigs, though demand is picking up for the larger jackups. There are no new midwater rigs under construction, but bigger rigs are competing at midwater depths, and excess capacity for deepwater rigs could hurt a bit in that category. The U.S. has lifted its drilling ban in the Gulf of Mexico, though the newly constituted Bureau of Ocean Energy, Management, Regulation, and Enforcement (BOEM or BOEMRe) has yet to issue new permits to drill. We expect the industry to comply with new blowout preventer and other requirements so that permits will begin to flow soon.
The outlook is good for ultra deepwater equipment, not only because the price of oil has risen recently to a more-than two-year high, but because Petroleo Brasileiro (PBR) is planning to put over 25 new rigs to work over the next few years. That should help Transocean, even though Brazil is expanding its domestic rig construction industry to build the needed equipment. While RIG may not own any of the new rigs, it could benefit as a contract operator since Brazil’s local offshore drilling industry does not have the manpower to run the new rigs. Farther out, all industry players agree that most new oil will come from deep water or harsh environments, where Transocean has a distinct advantage.
Transocean estimates that its current firm backlog is around $26 billion, through 2022, and that these contracts will generate around $12 billion in free cash flow through 2019, after capital expenditures. With debt maturities of about $8 billion over the same time frame, RIG should have several billion dollars for dividends and acquisitions. Last year, the company received stockholder approval of a plan to pay around $3 billion in dividends over the following 12 months. The payment, however, has been rejected by the Swiss Cantonal authorities, which cited possible liabilities for the five million barrel oil spill from BP’s (BP) broken Macondo well. If, as we think likely, Transocean is not deemed liable for any substantial part of the oil cleanup or any severe penalties, the Swiss authorities will probably give their approval to the dividend.
This brings us to—as famed-commentator Paul Harvey used to say, the rest of the story. In April 2010, the Macondo oil well off the Louisiana coast ruptured, sending oil and gas up to the rig, which exploded, killing 11 crew members and starting a five million barrel oil spill, the biggest in U.S. history. While Transocean owned the rig Deepwater Horizon, its client BP was responsible for most well design and other major decisions, and the contract indemnifies Transocean for operational errors as long as they do not constitute gross negligence. That there had been a good many things wrong on Deepwater Horizon was made clear by a review BP and Transocean completed in September 2009. Transocean says that most of those shortcomings were corrected by April 2010. But when the well ruptured, some of the rig’s systems did not work properly, such as emergency power. The National Commission on the BP Deepwater Horizon Oil Spill and Offshore Drilling recently released its report on the disaster. Chapter 4 includes a summary of nine decisions that probably saved time but entailed higher risk. Transocean is named as the decision maker in just one of these operating decisions. That suggests to us that Transocean may not be found grossly negligent and thus partially liable. The company will probably pay a few hundred million dollars in any settlement of all the suits, but it can easily afford that much.
RIG stock perked up with the release of the Commission report but still represents good value, assuming minimal liabilities for the Macondo well disaster. Now that the world’s economy is on the mend, and economists are raising their modest growth forecasts for the U.S., rig day rental rates will probably respond in a few quarters.
At the time of this article’s writing, the author did not have positions in any of the companies mentioned.